Sean Griffith - Jessica Erickson - David H Webber - Verity Winship - Research Handbook On Representative Shareholder Litigation-Edward Elgar Publishing (2018)

RESEARCH HANDBOOK ON REPRESENTATIVE
SHAREHOLDER LITIGATION
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RESEARCH HANDBOOKS IN CORPORATE LAW AND GOVERNANCE
Series Editor: Randall S. Thomas, John S. Beasley II Professor of Law and Business, Vanderbilt
University Law School, USA
Elgar Research Handbooks are original reference works designed to provide a broad overview
of research in a given field while at the same time creating a forum for more challenging,
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Making a major scholarly contribution to the field of corporate law and governance, the
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Titles in this series include:
Research Handbook on Shareholder Power

Edited by Jennifer G. Hill and Randall S. Thomas
Research Handbook on Partnerships, LLCs and Alternative Forms of Business Organizations
Edited by Robert W. Hillman and Mark J. Loewenstein
Research Handbook on Mergers and Acquisitions
Edited by Claire A. Hill and Steven Davidoff Solomon
Research Handbook on the History of Corporate and Company Law
Edited by Harwell Wells
Research Handbook on Corporate Crime and Financial Misdealing
Edited by Jennifer Arlen
Research Handbook on Fiduciary Law
Edited by Gordon Smith and Andrew Gold
Research Handbook on the Regulation of Mutual Funds
Edited by William A. Birdthistle and John Morley
Research Handbook on Representative Shareholder Litigation
Edited by Sean Griffith, Jessica Erickson, David H. Webber and Verity Winship
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Research Handbook on
Representative Shareholder
Litigation
Edited by
Sean Griffith
T.J. Maloney Chair and Professor of Law, Fordham University School of
Law, USA
Jessica Erickson
Professor of Law and Associate Dean for Faculty Development, University
of Richmond School of Law, USA
David H. Webber
Professor of Law, Boston University School of Law, USA
Verity Winship
Professor of Law, University of Illinois College of Law, USA
RESEARCH HANDBOOKS IN CORPORATE LAW AND GOVERNANCE
Cheltenham, UK • Northampton, MA, USA
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© The Editors and Contributing Authors Severally 2018
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or
transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or
otherwise without the prior permission of the publisher.
Published by
Edward Elgar Publishing Limited
The Lypiatts
15 Lansdown Road
Cheltenham
Glos GL50 2JA
UK
Edward Elgar Publishing, Inc.

William Pratt House
9 Dewey Court
Northampton
Massachusetts 01060
USA
A catalogue record for this book

is available from the British Library
Library of Congress Control Number: 2018945844
This book is available electronically in the

Law subject collection
DOI 10.4337/9781786435347
ISBN 978 1 78643 533 0 (cased)

ISBN 978 1 78643 534 7 (eBook)
Typeset by Servis Filmsetting Ltd, Stockport, Cheshire

02
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Contents
List of contributorsviii
Introduction1
PART I SECURITIES CLASS ACTIONS
1 The development of securities litigation as a lawmaking partnership 12

Jill E. Fisch
2 Securities class actions and severe frauds 29
James J. Park
3 The shifting raison d’être of the Rule 10b-5 private right of action 39
Amanda Marie Rose
PART II SHAREHOLDER DERIVATIVE SUITS
4 The (un)changing derivative suit 58

Jessica Erickson
5 Claim character and class conflict in securities litigation 80
Richard A. Booth
6 Illegality and the business judgment rule 98
Charles R. Korsmo
PART III MERGER LITIGATION
Section A Managing Multijurisdictional Litigation
7 Fighting frivolous litigation in a multijurisdictional world 110

Adam Badawi
8 Addressing the “baseless” shareholder suit: mechanisms and consequences 121
James D. Cox
9 Who collects the deal tax, where, and what Delaware can do about it 140
Sean J. Griffith and Anthony Rickey
10 Forum shopping in the bargain aisle: Wal-Mart and the role of adequacy of
representation in shareholder litigation 156
Lawrence A. Hamermesh and Jacob J. Fedechko
11 Limiting litigation through corporate governance documents 176
Ann M. Lipton
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vi Research handbook on representative shareholder litigation
Section B Judicial Perspectives on Shareholder Litigation
12 Disclosure settlements in the state courts post-Trulia: practical

considerations191
James L. Gale
13 Changing attitudes: the stark results of thirty years of evolution in Delaware
M&A litigation 202
J. Travis Laster
14 Appraisal rights in complete tender offers in Israel: a look into Israeli case
law229
Ruth Ronnen
Section C Appraisal Actions
15 Recent developments in stockholder appraisal 243

Charles R. Korsmo and Minor Myers
16 Appraisal as representative litigation 254
Minor Myers
PART IV LITIGANTS AND LAW FIRMS
Section A Plaintiffs and Law Firms
17 Lead plaintiffs and their lawyers: mission accomplished, or more to be done? 271
Stephen J. Choi and A.C. Pritchard
18 The mimic-the-market method of regulating common fund fee awards: a
status report on securities fraud class actions 287
Charles Silver
19 What do we know about law firm quality in M&A litigation? 304
Steven Davidoff Solomon and Randall S. Thomas
Section B Officers and Directors
20 Jurisdiction over directors and officers in Delaware 316

Eric A. Chiappinelli
21 Stockholder litigation, fiduciary duties, and the officer dilemma 330
Megan Wischmeier Shaner
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Contents vii
PART V COMPARATIVE AND INTERNATIONAL SHAREHOLDER

LITIGATION
Section A The Globalization of Shareholder Litigation
22 The globalization of entrepreneurial litigation: law, culture, and incentives 351

John C. Coffee, Jr.
23 The Teva case: a tale of a race to the bottom in global securities regulation 372
Sharon Hannes and Ehud Kamar
Section B Comparative Shareholder Litigation
24 A transatlantic perspective on shareholder litigation in public takeovers 415

Dan Awrey and Blanaid Clarke
25 Private ordering of shareholder litigation in the EU and the US 439
Matteo Gargantini and Verity Winship
26 Mapping types of shareholder lawsuits across jurisdictions 459
Martin Gelter
27 Securities class actions in Canada: ten years later 482
Poonam Puri
Section C Other Modes of Enforcement
28 CSRC enforcement of securities laws: preliminary empirical findings 513

Chao Xi
Index529
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Contributors
Dan Awrey is Professor of Financial Regulation and Fellow of Linacre College, University
of Oxford.
Adam Badawi is Professor of Law at UC Berkeley School of Law.
Richard A. Booth is Professor of Law and Martin G. McGuinn Chair in Business Law at
Villanova University Charles Widger School of Law.
Eric A. Chiappinelli is Frank McDonald Endowed Professor of Law at Texas Tech
University School of Law.
Stephen J. Choi is Murray and Kathleen Bring Professor of Law and the Co-Director of
the Pollack Center for Law & Business at New York University School of Law.
Blanaid Clarke holds the McCann FitzGerald Chair in Corporate Law at Trinity College
Dublin.
John C. Coffee, Jr. is Adolf A. Berle Professor of Law and Director of the Center on
Corporate Governance at Columbia Law School.
James D. Cox is Brainerd Currie Professor of Law at Duke Law School.
Jessica Erickson is Professor of Law and Associate Dean for Faculty Development at the
University of Richmond School of Law.
Jacob J. Fedechko is a former law clerk in the Delaware Court of Chancery and is now a
litigation associate in Wilmington, Delaware.
Jill E. Fisch is Perry Golkin Professor of Law and Co-Director of the Institute for Law
and Economics at the University of Pennsylvania Law School.
James L. Gale is Senior Business Court Judge for Complex Business Cases assigned to
the North Carolina Business Court.
Matteo Gargantini is Assistant to the Commissioner at the Commissione Nazionale per
le Società e la Borsa (“CONSOB”).
Martin Gelter is Professor of Law at Fordham University School of Law.
Sean J. Griffith holds the T.J. Maloney Chair in Business Law and directs the Fordham
Corporate Law Center at Fordham University School of Law.
Lawrence A. Hamermesh is Executive Director, Institute for Law & Economics at the
University of Pennsylvania Law School, as well as Professor Emeritus and the former
Ruby R. Vale Professor of Corporate and Business Law at Widener University Delaware
Law School.
viii
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Contributors ix
Sharon Hannes is Professor of Law and Dean of the Buchmann Faculty of Law at Tel
Aviv University.
Ehud Kamar is Professor of Law at the Buchmann Faculty of Law at Tel Aviv University.
He serves as the Director of the Tel Aviv University Batya and Isachar Fischer Center for
Corporate Governance and Capital Markets Regulation.
Charles R. Korsmo is Professor of Law at Case Western Reserve University School of Law.
J. Travis Laster is Vice Chancellor on the Delaware Court of Chancery.
Ann M. Lipton is Michael Fleishman Associate Professor in Corporate Law &
Entrepreneurship at Tulane University Law School.
Minor Myers is Professor of Law at Brooklyn Law School.
James J. Park is Professor of Law at UCLA School of Law.
A.C. Pritchard is Frances and George Skestos Professor of Law at the University of
Michigan Law School.
Poonam Puri is Professor of Law at Osgoode Hall Law School, York University.
Anthony Rickey is the founder of Margrave Law LLC.
Judge Ruth Ronnen is in the Economic Division of the Tel Aviv District Court.
Amanda Marie Rose is Professor of Law at Vanderbilt Law School and Professor of
Management at the Owen Graduate School of Business, Vanderbilt University.
Megan Wischmeier Shaner is Professor of Law at the University of Oklahoma College
of Law.
Charles Silver holds the Roy W. and Eugenia C. McDonald Endowed Chair in Civil
Procedure at the School of Law at the University of Texas at Austin. He is also Professor
of Government and Co-Director of the Center on Lawyers, Civil Justice, and the Media.
Steven Davidoff Solomon is Professor of Law at UC Berkeley School of Law and Faculty
Director of the Berkeley Center for Law and Business.
Randall S. Thomas holds the John S. Beasley II Chair in Law and Business, and directs
the Law & Business Program at Vanderbilt Law School. He also serves as a Professor of
Management at the Owen Graduate School of Management, Vanderbilt University.
David H. Webber is Professor of Law at Boston University School of Law.
Verity Winship is Professor of Law at the University of Illinois College of Law.
Chao Xi is Professor and Vice Chancellor’s Outstanding Fellow of the Faculty of Law at
the Chinese University of Hong Kong.
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Introduction
Shareholder litigation—primarily representative litigation on behalf of all stockholders

of a corporation—has proliferated globally. Shareholder litigation has long been part of
the corporate landscape in the United States, where shareholders can challenge nearly
any corporate decision. The scope of shareholder suits, however, has been kept largely
in check by a set of substantive and procedural rules. But in recent years these suits have
proliferated as shareholders have taken advantage of innovative tactics and new doctrines.
Moreover, shareholder litigation has begun to spread to jurisdictions other than the US,
where it has taken on new forms.
This research handbook provides a modernday survey of the state of shareholder litiga-
tion and offers empirical evidence of how these suits have developed. Its chapters provide
indepth analyses of the forms of shareholder litigation, including securities class actions,
merger litigation, derivative suits, and appraisal litigation. Through its examination of
these different types of litigation, the book details some of the advantages and disad-
vantages of shareholder litigation. It explores such issues as the agency costs inherent in
representative litigation, the challenges of multijurisdictional litigation and disclosure-
only settlements, and the rise of institutional investors. It also surveys how related issues
are addressed across the globe, with examinations of shareholder litigation in the United
States, Canada, the United Kingdom, the European Union, Israel, and China.
1. SECURITIES CLASS ACTIONS
The book begins, in Part I, by examining securities class actions. In “The Development
of Securities Litigation as a Lawmaking Partnership,” Jill E. Fisch discusses the unusual
pedigree of federal securities fraud litigation. Unlike most private federal litigation,
which is based on an explicit statutory private right of action, the securities fraud cause
of action was created by the federal courts. The absence of a statute defining the scope
of the claim required the courts to play a significant lawmaking role. Although Congress
has in turn responded, its interventions have been limited in scope and largely deferential
to the resulting body of judgemade law. As discussed in this chapter, the collaborative
process by which Congress, the courts, and the SEC have developed private securities
fraud litigation reflects a lawmaking partnership. The chapter defends this partnership as
a normatively desirable approach and identifies distinctive advantages over alternatives
such as a more detailed statute or a broad delegation by Congress to the courts or an
administrative agency. The chapter concludes that, as a result, the Court should use the
existence of a lawmaking partnership as a canon of construction in construing the scope
of its own lawmaking authority. Where the Court finds evidence of this type of collabora-
tive process, the Court should be empowered to use policy analysis to determine how best
to further Congress’s lawmaking objectives rather than limiting its inquiry to the contours
of the statutory text.
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2 Research handbook on representative shareholder litigation
The next chapter, “Securities Class Actions and Severe Frauds” by James J. Park,
examines the impact of the Private Securities Litigation Reform Act of 1995 (PSLRA) on
securities class actions in light of the severe frauds that occurred in the years after its pas-
sage. In what was a fortuitous turn of events for the securities class action, the years after
the PSLRA coincided with a period of significant accounting restatements. Securities
class actions after the PSLRA thus often addressed what were believed to be severe frauds
at large public companies. In light of these lawsuits, the PSLRA’s assumption that securi-
ties class actions do no more than harass companies with volatile stock prices is no longer
valid. This narrative may have been true before the PSLRA, but it has been displaced in
part by examples of securities class actions that have provided investors with a remedy for
the worst frauds. This success will likely secure the survival of the securities class action for
another generation, but also raises new questions about how to ensure that such actions
are effective in addressing severe frauds.
In “The Shifting Raison d’Etre of the Rule 10b-5 Private Right of Action,” Amanda
Rose recounts the historical evolution of the private right of action under Rule 10b-5,
explaining how it began as a cause of action not unlike traditional common law fraud and
later morphed into the modern fraud-on-the-market class action. While the early version
of the Rule 10b-5 private right was arguably consistent with standard corrective justice
and deterrence rationales for private litigation, Rose argues that the modern fraud-on-the-
market class action is difficult to defend on these grounds. The historical and theoretical
context the chapter provides offers a lens for understanding contemporary scholarly
debates over the social desirability of private Rule 10b-5 enforcement.
2. SHAREHOLDER DERIVATIVE SUITS
Part II analyzes shareholder derivative suits and the characterization of representative

stockholder litigation. It begins with “The (Un)Changing Derivative Suit,” by Jessica
Erickson. Her chapter sets the stage by providing an overview of the available empirical
data about derivative suits. It contrasts the reform efforts in securities class actions and
merger cases with legislative and judicial inaction in derivative suits. Building on the
data and history of problems and reform, the chapter proposes additional scrutiny for
derivative suits. It identifies mechanisms such as close judicial review of settlements, use
of litigation-limiting charter and bylaw provisions, and the imposition of heightened
procedural requirements.
Direct and derivative shareholder suits are the subject of Richard Booth’s chapter,
“Claim Character and Class Conflict in Securities Litigation.” His detailed analysis of
the distinct sources of losses suffered by buyers in a typical securities fraud class action
leads him to conclude that courts have mischaracterized many shareholder claims. These
claims are properly seen as belonging to the corporation—as derivative claims—rather
than direct claims belonging to individual buyers. The chapter identifies legal support for
recharacterizing the claims and considers consequences for shareholder litigation.
The next chapter, “Illegality and the Business Judgment Rule,” addresses derivative
claims that seek to hold corporate officers and directors liable for causing the company to
commit illegal acts. Charles Korsmo argues that corporate law should not subject defend-
ants to greater judicial scrutiny in stockholder suits simply because they have caused the
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Introduction 3
company to violate the criminal or civil law. Corporations that violate the law may well
face financial penalties and other legal repercussions under the relevant substantive law,
and individuals personally involved may also face sanctions of their own. It is less clear,
however, whether directors violate their fiduciary duties by approving illegal acts, espe-
cially where those acts do not harm the corporation. Many corporations today have made
violating, and ultimately changing, the law part of their business model, from Airbnb to
Uber and driverless cars. This chapter argues that corporate lawbreaking under this model
may be both profitable and socially beneficial. As a result, stockholder litigation seeking
director liability for illegal actions threatens to be a formidable obstacle to progress, with
few if any countervailing benefits.
3. MERGER LITIGATION
Representative stockholder litigation challenging corporate mergers and acquisitions is

the subject of Part III. Much of this merger litigation has been multijurisdictional, and
the part begins by addressing how courts, litigants, and companies manage such litigation.
Several of the chapters address concerns about the merits of shareholder litigation, par-
ticularly in the context of “disclosure-only” settlements in which shareholders’ recovery is
limited to additional disclosures. The part then offers judicial perspectives on M&A litiga-
tion from prominent judges. It concludes with several chapters on appraisal proceedings.
A. Managing Multijurisdictional Litigation
In “Fighting Frivolous Litigation in a Multijurisdictional World”, Adam Badawi inter-

rogates recent efforts by the Delaware Chancery Court to rein in disclosure-only settle-
ments. Under Badawi’s analysis, such suits might constitute a “necessary evil” in service of
another goal: “Delaware’s ability to stay at the forefront of corporate law.” Much depends
on whether plaintiff law firms know the strength of their cases at filing, or whether they
only develop that understanding over time. If the latter, rational firms might bring cases
outside of Delaware—even strong cases—for fear that the lack of ability to obtain a
disclosure-only settlement would leave them unable to recover costs in Delaware if the
case turned out to be weak. Badawi raises the possibility that Delaware’s crackdown on
such settlements may be incompatible with its commitment to remain the leading forum
for corporate litigation.
The next chapter is “Addressing the ‘Baseless’ Shareholder Suit: Mechanisms and
Consequences” by James D. Cox. This chapter examines several mechanisms—pretrial
hearings, the derivative suit’s demand requirement, and settlements—that exist for
screening shareholder suits. Screening serves a dual purpose: discarding meritless suits
and enabling, indeed strengthening, meritorious suits so that injuries can be prevented or
compensated. Yet not all of these screening mechanisms are created equal. As this chapter
details, pretrial hearings and the demand requirement often work fairly effectively,
providing courts with an early opportunity to assess a suit’s quality. In contrast, approval
of settlements is a far less effective approach to screen shareholder suits. Even outside
the specific context of disclosure-only settlements, judges are in a poor position to assess
the quality of a settlement at a settlement hearing, given the nonadversarial nature of
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the process and the frequent disconnect between the allegations in the complaint and the
terms of the settlement. As a result of these concerns, the author argues that judges should
withhold approval of the settlement and deny attorneys’ fees if they have reason to believe
that the settlement does not provide tangible benefits to the corporation or the class.
In “Who Collects the Deal Tax, Where, and What Delaware Can Do About It,” Sean
J. Griffith and Anthony Rickey similarly focus on Delaware’s efforts to crack down on
disclosure-only settlements. Griffith and Rickey test one theory of plaintiff law firms:
that there are “white hat” and “black hat” firms, that is, firms that bring meritorious
cases and firms that bring weak ones. They find evidence consistent with the existence of
“black hat” firms, but also evidence that “white hat” firms may in fact be “gray”, filing
strong cases in Delaware and weaker cases outside it. To deal with the problem of “gray
hat” behavior, the authors suggest that Delaware probe lead counsel applicants’ conduct
outside of Delaware in making lead counsel appointments. Delaware can use its unique
position as the center of corporate law to assure that meritorious cases continue to be
brought there.
Lawrence A. Hamermesh and Jacob J. Fedechko address the interaction among
representative stockholder suits brought in multiple, competing jurisdictions in their
chapter, “Forum Shopping in the Bargain Aisle: Wal-Mart and the Role of Adequacy of
Representation in Shareholder Litigation.” Focusing on the US and Delaware context,
they articulate an approach to limiting litigants’ incentives to file quickly and settle
quickly. The chapter proposes a framework for courts to assess adequacy of representa-
tion when considering the preclusive effects of a prior judgment.
In response to a perceived increase in the amount of frivolous stockholder litigation,
corporations have begun to insert provisions in their corporate governance documents
that restrict shareholders’ ability to pursue private litigation. In “Limiting Litigation
Through Corporate Governance Documents,” Ann M. Lipton sheds light on how these
limitations, such as forum selection clauses, arbitration clauses, feeshifting agreements,
and minimum stake requirements, could be abused. The chapter begins with the historical
evolution of these provisions and the shifting legal justifications for them. It then explores
some policy concerns regarding these limitations, including the scope of the limitations,
the enforceability of such limitations, and, more broadly, the theoretical inquiry as to
whether such limitations are appropriate for inclusion in corporate governance documents
in the first instance. The author concludes that the answer can shift one way or another
depending on whether one views the function of shareholder litigation as providing for
compensation or deterrence.
B. Judicial Perspectives on Shareholder Litigation
In “Disclosure Settlements in the State Courts Post-Trulia: Practical Considerations,”

Judge James L. Gale of the North Carolina Business Court takes a close look at share-
holder class actions following the Delaware Court of Chancery’s 2016 opinion in In re
Trulia, Inc. subjecting disclosure settlements to heightened judicial scrutiny. Although
Trulia reduced the number of disclosure settlements in Delaware, plaintiffs have shown
continued willingness to present such settlements in courts outside of Delaware, where
judges may face substantive and procedural obstacles to applying the same standards. In
this chapter, Judge Gale reports on the considerations facing judges outside of Delaware
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Introduction 5
in evaluating disclosure settlements under Trulia. First, the chapter draws a distinction
between the corporate benefit doctrine and the common fund doctrine to shed light
on how Trulia may be applied differently in different states. It goes on to discuss the
considerations involved when a court is to apply Delaware law or another state’s laws,
including class action procedures, professional responsibility regarding attorney’s fees,
and evidentiary rules in assessing the materiality of disclosures.
In the next chapter, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery
compares how the Delaware Supreme Court applied enhanced scrutiny in M&A settings
during the decade that followed the creation of the intermediate standard of review
with the Delaware Supreme Court’s current approach to similar issues. The chapter—
“Changing Attitudes: The Stark Results of Thirty Years of Evolution in Delaware M&A
Litigation”—cautions that the attitudes displayed in the early landmark decisions, and
the results they reached, no longer hold. The Delaware Supreme Court’s opinions from
Revlon through QVC displayed skepticism towards single bidder sale processes, prioritized
the interests of sell-side stockholders over the contract rights of acquirers, and resulted in
the issuance of targeted preliminary injunctions to block the effectiveness of problematic
provisions. By contrast, current Delaware law supports the use of a single bidder sale
process, prioritizes the contract rights of acquirers over the rights of sellside stockholders,
and rules out targeted preliminary injunctions. In place of vigorous judicial enforcement,
current Delaware law defers to the stockholders to protect themselves by voting down
deals that adversely affect their interests. The chapter posits that while multiple factors
contributed to this shift, the two most salient are the rise of institutional investors and the
generalized failure of stockholder-led M&A litigation.
Finally, in “Appraisal Rights in Complete Tender Offers in Israel: A Look into Israeli
Case Law”, Judge Ruth Ronnen of the Tel Aviv District Court’s Economic Division
examines two ways that courts appraise share value: via expert testimony on a company’s
“objective” value, and by reference to market prices. Surveying Israeli case law, and with
frequent reference to Delaware Chancery court rulings, Judge Ronnen offers insights
into how judges make appraisal decisions. In so doing she discusses numerous relevant
concepts, some of which are grappled with by commercial courts worldwide, others of
which are more prominent in Israel (where controlling shareholders predominate). These
concepts range from discounted cash flow analysis to market checks, consent of the
majority of the minority shareholders, consent of sophisticated shareholders, and the
presence of actual price negotiations.
C. Appraisal Actions
The discussion of appraisal actions continues with “Recent Developments in Stockholder

Appraisal.” Charles R. Korsmo and Minor Myers provide an overview of stockholder
appraisal activity—including recent data—together with an evaluation of recent legal
developments, both judicial and legislative. The year 2015 was a record one for
stockholder appraisal in terms of the number of mergers challenged and the dollar
amounts involved. The evidence shows, however, that appraisal remains relatively rare
and continues to be focused on deals with abnormally low merger premia and sales
processes marked by conflicts of interest. As this chapter explains, developments in
Delaware suggest a growing acceptance of the recent blossoming of appraisal arbitrage
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as an investment strategy, coupled with sensible prophylactic measures against potential

abuses of the appraisal remedy.
“Appraisal as Representative Litigation” connects appraisal actions to the broad
themes of this book by examining the ways in which appraisal is a form of representative
litigation. Minor Myers explains that, although appraisal claims cannot be brought
as class actions, they are nonetheless a form of collective action. The outcome of an
appraisal proceeding binds all dissenting stockholders, not just those who have filed a
petition in court, and petitioning stockholders can recover their expenses pro rata from
other members of the dissenting group. The representative nature of these suits gives rise
to legal questions about control of claims, sharing of expenses, settlement rights, and
notice obligations to other dissenters that are familiar but distinct from the class action
context. This chapter explores these questions by analyzing the dynamics of an appraisal
claim through its life cycle, from the initial decision to dissent to the sharing of expenses
following a trial judgment.
4. LITIGANTS AND LAW FIRMS
Part IV examines the dynamics of representative shareholder litigation. It takes a close

look at the players involved in these disputes, examining litigants on both sides and
interactions within and among the law firms that represent these parties.
A. Plaintiffs and Law Firms
Stephen J. Choi and A.C. Pritchard evaluate the effectiveness of the lead plaintiff
provisions in the Private Securities Litigation Reform Act in “Lead Plaintiffs and Their
Lawyers: Mission Accomplished, or More to Be Done?” The PSLRA created a presump-
tion that courts should appoint as lead plaintiff the class member seeking appointment
with the largest financial interest in the relief sought. It also vested the lead plaintiff
with authority to select and retain class counsel. More than 20 years has passed since
the PSLRA was adopted, and the empirical record shows that, in substantial measure,
the PSLRA’s lead plaintiff provision has succeeded. Institutional investors have stepped
forward to serve as lead plaintiffs in a substantial number of cases, and they may play
a role in ensuring greater recovery for investors in those cases. In addition, institutional
investors seem to have reduced the share of recovery that goes to pay lawyers post-
PSLRA. There is also evidence, however, that the competition among lawyers to serve as
lead counsel has not been driven exclusively by price and quality of representation. The
larger institutional investors that have most frequently agreed to serve as lead plaintiffs
in securities class actions have been government-sponsored pension funds. The political
influence over these funds raises suspicion that at least some class action law firms are
buying lead counsel status with campaign contributions, that is, lawyers are paying to play.
This chapter reviews the empirical record and then suggests specific reforms that might
promote additional transparency and competition on price, as well as additional require-
ments for lead plaintiffs to further enhance the screening role played by the PSLRA.
In “The Mimic-the-Market Method of Regulating Common Fund Fee Awards: A
Status Report on Securities Fraud Class Actions,” Charles Silver tracks the growth and
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Introduction 7
development of the mimic-the-market approach in setting attorneys’ fees in securities

class actions. This approach calls for judges to assess what the market would have paid
for the lawyer’s services, rather than the more traditional lodestar calculation. An idea
that Silver himself advocated early on, the mimic-the-market approach to setting fees
has gained traction in many jurisdictions across the United States, notably in the Second,
Third, and Seventh Circuit Courts of Appeal, and in several district courts. Silver points
out that following the mimic-the-market approach requires a measure of judicial courage,
because it sometimes results in the award of very large fees. Silver also revisits his own
prediction that judges would begin to set fees at the outset of cases, and considers why he
believes that prediction has not been realized.
Steven D. Solomon and Randall S. Thomas inquire into law firm quality as measured
by outcomes in class action shareholder litigation. “What Do We Know About Law Firm
Quality in M&A Litigation?” reviews the state of the literature on law firm quality and
asks what can be known about plaintiff and defense-side firms in class action shareholder
litigation. Several dimensions of the question are explored, such as: How do clients select
law firms? What substantive and reputational factors influence law firms’ decisions to
represent a client? To what extent does the client influence the outcome? How should
a law firm’s performance be measured when its client or potential client, particularly a
repeat player defendant in M&A litigation, dictates the law firm’s strategy in handling the
litigation? The chapter closes by emphasizing the relatively underdeveloped state of the
empirical evidence, offering several directions for future research.
B. Officers and Directors
Defendant officers and directors are the subject of the final two chapters in this part.
Each examines limits on the ability of representative shareholder litigation to reach these
actors. In “Jurisdiction over Directors and Officers in Delaware,” Eric Chiappinelli pro-
vides an overview of the necessary jurisdictional underpinnings for shareholder litigation,
with a focus on Delaware. Over time, the courts and the state legislature have developed a
set of statutes and standards that allow Delaware courts to hear cases against nonresident
directors and officers of corporations organized in the state. The chapter outlines the
multiple sources of adjudicatory power: implied consent statutes, long-arm statutes, and
conspiracy jurisdiction. With a critical eye, it analyzes the expansive geographic reach
claimed by Delaware courts.
Shareholder litigation against corporate officers is the focus of Megan Wischmeier
Shaner’s chapter, “Stockholder Litigation, Fiduciary Duties, and the Officer Dilemma.”
Tracing the divergence between the development of director and officer fiduciary duties,
she points out that stockholder litigation is rarely used to hold officers accountable. The
chapter explores the causes and consequences of this gap in corporate law, and suggests
remedial approaches targeted at officers’ managerial role.
M4633-GRIFFITH_t.indd 7 30/10/2018 08:16

5. COMPARATIVE AND INTERNATIONAL SHAREHOLDER

LITIGATION
A. The Globalization of Shareholder Litigation
“The Globalization of Entrepreneurial Litigation: Law, Culture, and Incentives” intro-

duces the broad themes of this part of the book. John C. Coffee, Jr, examines the expan-
sion of class action litigation in Europe and Asia, comparing the role of law, culture, and
incentives in fostering entrepreneurial litigation similar to or different from the forms
developed in the United States. This comparative analysis is especially important because
the United States Supreme Court’s ruling in Morrison v. National Australia Bank Ltd.
effectively limits the ability of shareholders to pursue certain claims within the United
States, potentially prompting a renewed emphasis on the availability of representative
litigation in other jurisdictions. The chapter begins with a presentation of the representa-
tive litigation models utilized in different jurisdictions. In the Netherlands, for example,
a device called the “stichting” has been combined with the country’s Act of Collective
Settlement to create a form of litigation substantially similar to opt-out securities class
actions. Asia, on the other hand, with its relatively modest exposure to class action
litigation, currently employs a model that lies somewhere between the United States’
and the European Union’s models. The chapter highlights some of the advantages and
disadvantages of each model of collective litigation, ultimately finding strong evidence
that “entrepreneurial” litigation has indeed begun to spread to other jurisdictions.
In “The Teva Case: A Tale of a Race to the Bottom in Global Securities Regulation,”
Sharon Hannes and Ehud Kamar offer a unique perspective on shareholder litigation,
describing their experience as plaintiffs in a transformative securities class action lawsuit
in Israel. Israel-based Teva is the world’s largest manufacturer of generic drugs and is
crosslisted in both the United States and Israel. The company reported its executive
compensation in the aggregate, rather than individually, using its crosslisted status to
avoid what Hannes and Kamar viewed as a straightforward requirement of both US and
Israeli law. In contrast, companies listed only in Israel disclosed individual executive pay,
and were therefore the only companies subject to media scrutiny of their compensation
practices. Hannes and Kamar’s class action—opposed not just by the company, but by
the Israel Securities Authority—eventually led to the requirement that all publicly traded
Israeli companies disclose the compensation of each executive individually, regardless
of whether the company is crosslisted. A copy of Hannes and Kamar’s groundbreaking
complaint is included.
B. Comparative Shareholder Litigation
The chapters in this section take an explicitly comparative approach to the broad themes
of this book and to some of the specific issues addressed in earlier chapters. The section
begins with “A Transatlantic Perspective on Shareholder Litigation in Public Takeovers,”
in which Dan Awrey and Blanaid Clarke compare the regulatory environment facing
takeovers in the United States, the United Kingdom, and the Republic of Ireland. After
recognizing some commonalities among the jurisdictions, including highly developed stock
markets and each jurisdiction’s “market-oriented” approach to corporate governance that
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Introduction 9
seeks to maximize shareholder value, this chapter focuses on the major substantive and
procedural differences between the regulatory regimes. The chapter offers a comprehensive
analysis of the City Code of the United Kingdom and the corresponding Takeover Rules
in Ireland that govern public takeovers and explains how these regimes may be preferable
to more litigation-based models of takeover. Specifically, Awrey and Clarke identify three
advantages of these regimes: the responsive and proactive rulemaking system of expert
panels, the speediness of review, and cost savings offered by the difference processes.
The next chapter is “Private Ordering of Shareholder Litigation in the EU and the
US” by Matteo Gargantini and Verity Winship, which takes a comparative approach to
private ordering of shareholder litigation. To what extent can the players in shareholder
litigation—companies, management, shareholders, and other investors—set the rules for
litigation through private agreement? The chapter begins with the US example, in which
dispute resolution provisions emerged in the constituent documents of US companies as
a response to pressures from litigation. The contours of permissible provisions have not
been exhaustively drawn, but dispute resolution bylaws have been tested in US state courts
and were the subject of subnational legislation. The chapter then examines how private
ordering of shareholder litigation—both intracorporate and securities suits—might
function (or not) in the context of the EU and some of its constituent countries. This
comparison highlights many of the similarities, as well as important differences, in how
the United States and the European Union approach private ordering in shareholder
litigation.
In “Mapping Types of Shareholder Lawsuits across Jurisdictions,” Martin Gelter
compares the various forms of shareholder lawsuits that are found in the United States,
the United Kingdom, and several European and Asian countries. This chapter notes that
conflict of interest claims are the most prevalent claims brought by shareholders against
directors, managers, and other shareholders. While shareholder litigation may, in some
jurisdictions, be primary under the purview of the supervisory board, other, more liberal
jurisdictions have procedural mechanisms that allow shareholders to bring a lawsuit on
their own with varying limitations of the types of claims or suits that may be brought.
This chapter discusses the various types of suits, such as direct, derivative, and rescission
suits, that are presented to shareholders in each jurisdiction as well as the mechanisms,
the difficulties therein, and the effectiveness of such lawsuits in deterring or remedying
unfavorable actions. The chapter concludes with an evaluation of the efficacy of each
jurisdiction’s models of shareholder litigation and highlights the difficulties in creating a
perfect system that could ensure the protection of shareholders’ rights while preventing
nonmeritorious or even abusive lawsuits.
The examination of comparative shareholder litigation concludes with “Securities
Class Actions in Canada: Ten Years Later.” In this chapter, Poonam Puri reports the
results of her comprehensive empirical study of secondary market securities class actions
in Canada. The chapter examines ten years of data, beginning with the introduction of
statutory secondary market liability in 2006 and ending in 2015. In addition to identifying
procedural barriers, she analyses the types of plaintiffs (especially institutional versus
retail investors) and defendants (large versus small, but also a concentration in the mining
industry), providing a rich account of the Canadian experience with representative
shareholder litigation for secondary market misrepresentations.
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C. Other Modes of Enforcement
The book concludes with “CSRC Enforcement of Securities Laws: Preliminary Empirical
Findings,” by Chao Xi, which considers public enforcement of the securities laws. This
chapter sheds empirical light on an important component of the public enforcement of
securities laws in China. The securities markets are a relatively recent market institution
in China. First appearing in the early 1990s, the Chinese securities markets have expanded
phenomenally and today are the second largest in the world. The burgeoning Chinese
securities markets have long been plagued by market misconduct and securities law viola-
tions. Private enforcement of securities laws, by way of aggrieved investors bringing civil
actions against wrongdoers, has been weak, with public enforcement thus significantly
greater in amount and intensity. This chapter examines this public enforcement, drawing
on a unique, handcollected dataset comprising all 447 sanction decisions taken by the
China Securities Regulatory Commission (CSRC), China’s primary securities regulator,
during the period from 2006 through 2012. This study reveals that the patterns of those
efforts have shifted over time, from an initial focus on violations of disclosure rules to
targeting a much wider spectrum of wrongdoing including, in particular, insider trading
and investment advisor violations. In enforcing China’s securities laws, the CSRC also
does not typically assume individual or corporate liability alone, but frequently holds
culpable both firms and the individuals responsible for the malfeasance in question.
M4633-GRIFFITH_t.indd 10 30/10/2018 08:16

PART I
SECURITIES CLASS ACTIONS
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1. T
he development of securities litigation as a
lawmaking partnership
Jill E. Fisch*
1. INTRODUCTION
Federal securities fraud litigation has an unusual pedigree. Unlike most private litigation,
which is based on an explicit statutory private right of action, the securities fraud cause
of action was created by the federal courts.1 The absence of a statute defining the scope
of the claim required the courts to play a significant lawmaking role. Although Congress
has, in turn, responded, its interventions have been limited in scope and largely deferential
to the resulting body of judge made law.
This chapter takes the position that the collaborative process by which Congress and the
courts have developed private securities fraud litigation reflects a normatively desirable
approach.2 The chapter terms this approach a lawmaking partnership,3 and argues that
the lawmaking partnership offers distinctive advantages over alternatives such as detailed
statutes coupled with a narrow judicial adherence to the statutory text, on the one hand,
or a broad delegation by Congress to the courts or an administrative agency, on the other.
The Supreme Court’s decision in Halliburton Co. v. Erica P. John Fund, Inc. (Halliburton
II)4 can be understood within this framework. In Halliburton II, the Court considered the
continued viability of a judicially created doctrine—fraud on the market (“FOTM”). The
Court had previously created FOTM in Basic Inc. v. Levinson as a tool to enable plaintiffs
in impersonal public capital markets transactions to address the reliance requirement in
federal securities fraud class actions.5
By enabling the class action, FOTM dramatically changed the nature of private
securities fraud litigation and generated large scale cases involving substantial poten-
tial damages (Fisch 2013). In turn, these developments led to complaints about the
resulting scope of litigation and the potential for litigation abuse (Fisch 1997). Some
commentators demanded that the Court reconsider its earlier decision (Brief for
* This chapter was drawn from Federal Securities Fraud Litigation as a Lawmaking Partnership,
93 Wash U. L. Rev. 453 (2016). It is excerpted and reprinted here with the permission of the
Washington University Law Review.
1
Judicial creation of a private right of action occurred during a period in which federal courts
implied private rights of action far more readily than they do today.
2
This chapter does not address broader questions about possible constitutional limits on
congressional authority to delegate lawmaking power. See Arthur (1986).
3
The partnership construct developed in this chapter is conceptually similar to but more
bounded than the manner in which Richard Fallon and Daniel Meltzer used the term. Fallon &
Meltzer (2007).
4
134 S. Ct. 2398, 2408 (2014).
5
485 U.S. 224 (1988).
12
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The development of securities litigation 13
Former SEC Commissioners 2014). Commentators also raised concerns in Congress

(Levitt 1995).
Although the Court did not revisit the validity of FOTM prior to Halliburton II, it
responded to claims of abusive litigation by imposing various limits on the private right
of action. Similarly, although Congress did not speak directly to the validity of FOTM, it
responded by enacting statutory reforms, first in the Private Securities Litigation Reform
Act of 1995 (“PSLRA”)6 and then in the Securities Litigation Uniform Standards Act
(“SLUSA”).7 Both the Court’s decisions and Congress’s refinements to the statutory
framework reflected a common goal of reducing the prospect of costly and frivolous
litigation while maintaining the viability of private litigation as a means of enforcing the
disclosure obligations of the federal securities laws.
The Court in Halliburton II did not discuss this cooperative enterprise in its opinion,
basing its decision instead on principles of stare decisis. Nonetheless, this chapter argues
that the Court’s adherence to Basic can alternatively be justified in terms of a lawmaking
partnership. More broadly, this chapter reasons that the Court should use the existence
of a lawmaking partnership as a canon of construction in construing the scope of its
own lawmaking authority. Where the Court finds evidence of this type of collaborative
process, it should be empowered to use policy analysis to determine how best to further
Congress’s lawmaking objectives rather than limiting its inquiry to the contours of the
statutory text. The virtues of this approach extend beyond the issue of FOTM and apply
generally to federal securities fraud litigation.
This chapter proceeds as follows. In section 2, the chapter positions Halliburton II
within the context of the development of private securities fraud litigation. Section 3 con-
ceptualizes the lawmaking partnership and identifies its structural advantages. Section 4
extends the analysis beyond FOTM and uses the example of insider trading regulation to
explain the potential value of the lawmaking partnership in enabling Congress, the courts,
and the Securities & Exchange Commission (“SEC”) to collaborate on the development
of federal securities law.
2. HALLIBURTON II AND PRIVATE SECURITIES FRAUD
2.1 Background—The Development of Private Securities Fraud
The general antifraud provision of the Securities Exchange Act of 1934, section 10(b),8
contains no express private right of action.9 Nonetheless, the federal courts recognized
a private right of action under the statute and the SEC’s Rule 10b-5, and subsequently
6
Private Securities Litigation Reform Act of 1995, Pub. L. 104-67, 109 Stat. 737 (codified as
amended in scattered sections of 15 U.S.C.).
7
Securities Litigation Uniform Standards Act of 1998, Pub. L. No 105-353, 112 Stat. 3227
(codified as amended in scattered sections of 15 U.S.C.).
8
Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (2015).
9
In contrast, the federal securities laws contain a number of provisions that create an express
private right of action, including sections 11 and 12 of the 1933 Act and sections 9(e) and 18 of the
1934 Act. 15 U.S.C. §§ 77k–l, 78i(e), 78r (2015).
M4633-GRIFFITH_t.indd 13 30/10/2018 08:16

delineated the scope of this judge made cause of action.10 As the Supreme Court
explained, “[w]hen we deal with private [securities fraud] actions under Rule 10b-5, we
deal with a judicial oak which has grown from little more than a legislative acorn.”11
The Supreme Court’s early decisions primarily involved articulating limitations on the
scope of a securities fraud claim (Kaufman 1990). Thus, in Ernst & Ernst v. Hochfelder,
the Court held that a claim could not be predicated upon a showing of mere negligence
but required proof of scienter.12 In Blue Chip Stamps v. Manor Drug Stores, the Court
limited standing in private litigation to plaintiffs who had purchased or sold securities in
connection with the fraud.13 In Santa Fe Industries, Inc. v. Green, the Court rejected an
attempt to address a breach of fiduciary duty through federal securities fraud.14
Even before the rise of the new textualism, which heightened the importance of
a statute’s language in its interpretation (Eskridge 1990), the Court grounded these
decisions primarily in the text of section 10(b). Policy considerations also played a role,
however, in the Court’s analysis. Throughout its development of private securities fraud
litigation, the Court sought to balance two competing policies—protecting investors
and limiting the potential for litigation abuse. In Blue Chip Stamps, for example, the
Court justified its restriction on the class of potential plaintiffs in terms of “considera-
tions of policy,” including a desire to limit the potential settlement value of lawsuits that
could not easily be dismissed prior to trial.15 Similarly, in Santa Fe, the Court identified
the concern that a more expansive interpretation of 10b-5 would create a “danger of
vexatious litigation.”16
The 1988 Basic Inc. v. Levinson decision took a somewhat different approach.17 First,
the Court relied more heavily on policy considerations than was the case in its earlier
decisions. Second, investor protection considerations led the Court to espouse a position
that expanded the scope of 10b-5 litigation. In Basic, the Court concluded that private
plaintiffs need not offer direct proof of reliance, but can use the FOTM theory to obtain
a presumption of reliance for securities that trade in an efficient market tainted by
public misrepresentations. Commentators have described the Basic decision as opening
the floodgates for private litigation, although, to be fair, this claim is overstated (Fisch
2013). Even in Basic, the Court’s role was one of reining in more expansive lower court
lawmaking (Fisch 2013).
The Basic Court explicitly justified its holding on the basis that it was necessary to adapt
the common law reliance requirement to the realities of the modern securities markets.
Moreover, the Court defended the FOTM presumption not by relying on the statutory
text or even congressional intent, but on “considerations of fairness, public policy, and
10
The starting point was a district court decision which recognized an implied private right of
action in 1946. See Kardon v. Nat’l Gypsum Co., 69 F. Supp. 512 (E.D. Pa. 1946).
11
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737 (1975).
12
425 U.S. 185, 193 (1976).
13
421 U.S. 723, 731 (1975).
14
430 U.S. 462, 474–76 (1977).
15
Blue Chip Stamps, 421 U.S. at 742–44.
16
Santa Fe Indus., 430 U.S. at 478–79 (quoting Blue Chip Stamps, 421 U.S. at 740) (internal
quotation mark omitted).
17
485 U.S. 224 (1988).
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probability, as well as judicial economy.”18 The Court reasoned that it was necessary to
“balanc[e] the substantive requirement of proof of reliance in securities cases against the
procedural requisites of [Federal Rule of Civil Procedure] 23.”19
By eliminating the need for plaintiffs to prove reliance directly, Basic made the modern
securities fraud class action possible. The Court did not act alone, however, in developing
the parameters of securities fraud class actions. Congress responded to Basic through
explicit statutory provisions that clarified and modified the scope of the class action. In
1995, Congress adopted the PSLRA,20 which reflected both congressional acceptance of
the judicially created private right of action and a reassertion of congressional authority
over the scope of that right of action. Congress included in the statute a heightened
pleading standard, a discovery stay, an explicit loss causation requirement, and refine-
ments to the calculation of damages (Fisch 1997). In addition, Congress adopted a lead
plaintiff provision in an effort to respond to the argument that securities fraud class
actions constituted “lawyer-driven litigation” by mobilizing institutional investors to act
as litigation gatekeepers (Fisch 2005).
Subsequently, in 1998, Congress enacted SLUSA, which preempted state court litiga-
tion for “covered class actions” in order to ensure that those cases were subject to the
provisions of the PSLRA.21 Later, as part of the Sarbanes–Oxley Act of 2002, Congress
extended the statute of limitations in private securities fraud litigation.22
In legislating with respect to private securities fraud, Congress reaffirmed the critical
policy considerations that had previously been identified by the Court. Congress explicitly
recognized the importance of private litigation as a supplement to public enforcement
efforts. Thus, the statement of managers accompanying the conference report for the
PSLRA described private securities litigation as “an indispensable tool,” both for protect-
ing investors and for “promot[ing] public and global confidence in our capital markets.”23
This policy judgment is consistent with the Court’s analysis. As the Court has repeatedly
explained, “private securities litigation [i]s an indispensable tool with which defrauded
investors can recover their losses—a matter crucial to the integrity of domestic capital
markets.”24
At the same time, Congress sought to structure private litigation so as to minimize the
potential for vexatious litigation (Fisch 1997). In the PSLRA, Congress chose to retain
the private securities fraud class action, but to refine its use by implementing substantive
and procedural safeguards against overuse and abuse. These safeguards serve similar
policy objectives as the limitations imposed by the Court in cases such as Ernst, Blue Chip
Stamps, and Central Bank.
18
Basic, 485 U.S. at 245.
19
Ibid at 242 (internal quotation omitted).
20
Private Securities Litigation Reform Act of 1995, Pub. L. 104-67, 109 Stat. 737 (codified as
amended in scattered sections of 15 U.S.C.).
21
Securities Litigation Uniform Standards Act of 1998, Pub. L. No 105-353, 112 Stat. 3227
(codified as amended in scattered sections of 15 U.S.C.).
22
Sarbanes–Oxley Act of 2002 § 804, 28 U.S.C. § 1658 (2014).
23
H.R. Rep. No 104-369, at 31 (1995).
24
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 320 n.4 (2007) (internal quotation
marks omitted) (citing Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 81 (2006)).
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2.2 The Halliburton Decision
Halliburton II presented the Court with the question of whether to overrule its prior
decision in Basic.25 The petitioner argued that academic consensus and new evidence
about market efficiency had undermined the economic theory upon which Basic was
based.26 Halliburton also argued that the class action litigation that Basic had spawned
was undesirable. Accordingly, it asked the Court to overrule Basic.
The Supreme Court disagreed. The Court explained that the petitioner had overstated
the degree to which the Basic decision relied on strong claims of market efficiency. Instead,
the Court stated that the presumption of reliance rested on the “modest premise” that
“public information generally affects stock prices.”27 The Court thereby reasoned that the
modern debate about the “degree” to which prices accurately reflect public information
is “largely beside the point.”28 Similarly, the Court reaffirmed Basic’s determination
that most investors rely on a security’s market price “as an unbiased assessment of the
security’s value in light of all public information.”29 Reasoning that Basic’s presumption
of reliance, as a substantive doctrine of federal securities law, was entitled to stare decisis
principles, the Court concluded that it was inappropriate to overrule Basic.
Because Halliburton II relied primarily on principles of stare decisis, the Court did not
revisit the policy considerations that had motivated the Basic decision. Under an alternative
approach, those policy considerations provide an independent justification for adhering to
FOTM. As noted above, a key feature of private securities fraud litigation, and the class
action in particular, is the fact that it is the product of a collaborative lawmaking partnership
between Congress and the Court. This collaboration is entitled to special weight in evaluat-
ing legal questions that bear on the continued viability of securities fraud class actions.
As explained above, the Court and Congress both contributed to the development of the
private right of action for federal securities fraud. The Supreme Court accepted FOTM
in Basic to enable securities fraud class actions to conform to the commonality require-
ment of Rule 23 of the Federal Rules of Civil Procedure. The Basic Court explained:
“Requiring proof of individualized reliance from each member of the proposed plaintiff
class effectively would have prevented respondents from proceeding with a class action,
since individual issues then would have overwhelmed the common ones.”30 The Court
went on to note with approval the District Court’s conclusion that FOTM offered “a
practical resolution to the problem of balancing the substantive requirement of proof
of reliance in securities cases against the procedural requisites of [Federal Rule of Civil
Procedure] 23.”31
25
Prior to Halliburton II, several cases had reached the Court that presented issues regarding
the requirements for class certification in securities fraud litigation and thereby raised questions
about the appropriate scope of class litigation (Fisch 2013).
26
Brief for Petitioners, Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (No
13-317).
27
Halliburton II at 2410.
28
Ibid.
29
Ibid at 2411, citing Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 133 S. Ct. 1184, 1192
(2013).
30
Basic Inc. v. Levinson, 485 U.S. 224, 242 (1988).
31
Ibid (quoting District Court) (internal quotation marks omitted).
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This focus was consistent with the intent of the Federal Civil Rules Advisory
Committee, which drafted Rule 23 with securities fraud as a model for class litigation.32 As
the Committee recognized, the class action device was also an important tool for ensuring
effective enforcement of the federal securities laws, explicitly recognizing this function
in developing the rule. By accepting FOTM, Basic empowered private securities fraud
litigation to serve as a tool for effective enforcement and created the opportunity for the
development of the modern securities fraud class action.
Similarly, Congress responded in the PSLRA to concerns about abusive litigation
with a range of procedural reforms expressly targeted to the class action (Fisch 1997).
Section 21D(a) of the PSLRA is entitled “Private Class Actions” and introduces a range
of reforms that apply exclusively to securities fraud class actions.33 These reforms placed
additional burdens on investors seeking to bring class actions, in an effort to reduce abu-
sive litigation. By tailoring the structure of the class action rather than eliminating it, the
PSLRA reflected an implicit congressional decision to retain the class action mechanism
and the FOTM theory that made it possible (Black 2009). Importantly, the adoption of
these reforms made little sense absent a desire to retain class actions (Langevoort 2015).
More broadly, the PSLRA can be understood as a legislative compromise in further-
ance of two competing goals: reducing burdensome and potentially frivolous litigation,
while preserving the ability of investors to pursue meritorious claims. Empirical evidence
suggests that Congress was successful in achieving both goals. Studies show that the adop-
tion of the PSLRA’s heightened pleading standard facilitated courts’ ability to dismiss
weak cases (Johnson et al. 2007). A further effect is that, according to some studies,
plaintiffs’ lawyers screen more diligently for case quality and do not even file weak cases
(Choi et al. 2009). Moreover, because of the PSLRA’s discovery stay, these cases do not
impose burdensome litigation costs upon defendants (Klausner et al. 2013).
At the same time, the lead plaintiff provision of the PSLRA has dramatically increased
the involvement of large institutional investors in securities fraud class actions (Perino
2012). In turn, this has had the effect of increasing settlement amounts in meritorious
cases and reducing the fees paid to class counsel (Choi 2005; Perino II 2012).
Congress’s adoption of SLUSA reflected similar objectives and enhanced the effective-
ness of the PSLRA reforms. SLUSA was adopted in response to efforts by plaintiffs
to avoid the procedural requirements of the PSLRA by litigating securities fraud class
actions in state court, and eliminated these efforts by preempting state court litigation.
Significantly, SLUSA, by its terms, applies to “covered class actions,” demonstrating both
an effort to retain the class action mechanism and to ensure that this litigation takes place
in federal court under the provisions of the PSLRA.34 In addition, Congress defined the
term “covered class action” explicitly to incorporate the FOTM presumption.35
32
Brief for Amici Curiae Civil Procedure and Securities Law Professors in Support of
Respondent, Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 133 S. Ct. 1184 (2013) (No 11-085).
33
15 U.S.C. § 78u-4(a) (2014).
34
A “covered class action” is defined as a class action where “damages are sought on behalf of
more than 50 persons or prospective class members, and questions of law or fact common to those
persons or members of the prospective class, without reference to issues of individualized reliance
on an alleged misstatement or omission, predominate.” Ibid § 78bb(f)(5)(B)(i)(I).
35
See ibid.
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The foregoing process can be understood as sequential collaboration between the Court
and Congress. First, the Court acted in Basic to identify the need for the fledgling class
action mechanism to enable the cost-effective litigation of private securities fraud claims
in order to ensure the litigation served as a viable means of enhancing enforcement. The
SEC evaluated the role of private litigation and defended the class action to the Court
and Congress as a necessary supplement to public enforcement. Congress, after observing
the development of the class action mechanism, adopted various procedures to refine its
operation in securities fraud cases. These adjustments offered the potential for securities
fraud class actions to offer more effective deterrence by increasing case quality and limit-
ing the potential for frivolous litigation.
The iterative adjustments to the securities fraud class action can be understood as a
type of lawmaking partnership in which both the Court and Congress have recognized
the objective of structuring a procedural device that facilitates effective enforcement of
the disclosure obligations of the federal securities laws and affirmatively acted to further
that objective. Because of Congress’s role in responding to Basic and revising the nature of
the securities fraud class action in important ways, Basic and its progeny are not properly
understood simply as judicial interpretations of section 10(b) of the 1934 Act. In the
PSLRA and SLUSA, Congress did more than acquiesce in judicial lawmaking; Congress
embraced and sought to improve upon the Court’s work.
This lawmaking partnership puts FOTM on a different legal footing than the standard
interpretation of a federal statute. Unlike cases of legislative silence, in which multiple
inferences can be drawn from Congress’s failure to act, Congress has taken affirmative
action by collaborating with the Court to refine the class action mechanism. Put dif-
ferently, Congress has expanded upon the “building block” of Basic. This expansion
reinforces the Basic decision as presumptively correct.
Importantly, this chapter reads congressional lawmaking with respect to the securities
fraud class action as an implicit endorsement of Basic. Concedly an implicit endorsement
is different from an explicit congressional statement codifying the judge made law. Indeed,
in the PSLRA, Congress expressly stated that it was neither codifying nor rejecting any
implied private right of action. As will be developed further later in the chapter, Congress
might have a variety of reasons for failing to codify such a right of action expressly,
including political constraints and a reluctance to constrain the scope of future judicial
interpretation. These considerations, as will be discussed, are fundamental reasons for the
use of a lawmaking partnership in preference to constraining judicial lawmaking through
a more restrictive statute.
The implications of the lawmaking partnership constitute more than a reason for the
Court not to overrule a prior interpretive decision, however. The collaboration reflected
in the partnership context suggests that the Court should understand congressional
interventions such as the PSLRA as refinements rather than rejections of its approach.
2.3 Conceptualizing the Lawmaking Partnership
Halliburton II’s decision to reaffirm Basic is supported by the collaboration between

Congress and the Court reflected in their lawmaking partnership. The use of such a
lawmaking partnership is not unique to securities fraud litigation, however. Other areas in
which Congress and the Court have engaged in collaborative lawmaking warrant a similar
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analysis. Simply put, judge made law in the form of a statutory interpretation that has
been developed or reinforced through a lawmaking partnership should be viewed by the
courts as presumptively correct absent clear congressional action overruling it.
A lawmaking partnership, as described in this chapter, has three distinctive features.
First, the original statute must be open-textured so as to contemplate judicial lawmaking
through the process of statutory interpretation. Second, Congress and the Court must
engage in sequential adjustments, in each case cognizant of and responding to concerns
that are raised in the other forum. Third, Congress and the Court must make these adjust-
ments to further a common objective.
Each of these features is a necessary component of a lawmaking partnership. The first,
an open-textured statute, has received considerable attention in the academic literature
(Manning 2014). Commentators argue that Congress uses this type of legislation pur-
posefully to enable a common law process (Sunstein 1989). Although this chapter does
not take a normative position on whether such congressional delegations are desirable, it
is reasonable to conclude that Congress chooses to use an open-textured statute in cases
in which it contemplates a more expansive interpretive role for the courts. Reasons for this
more expansive role might include limited congressional knowledge of the consequences
of specific regulatory choices and a desire to encourage the type of evolutionary approach
that characterizes common-law lawmaking (Eskridge 1989).
The second feature, sequential adjustments by both the Court and Congress, dis-
tinguishes the lawmaking partnership from mere congressional inaction. By taking
affirmative steps in response to judicial lawmaking, Congress demonstrates that its failure
to reject features of the judge made law is not the result of political gridlock or inatten-
tion. By definition, congressional responsiveness to the Court’s interpretation reflects
awareness of the Court’s actions. Similarly, the responsive legislation constitutes action
rather than inaction, thereby belying arguments that Congress was unable to react to an
erroneous interpretation because of gridlock, other policy priorities, or inertia.
Finally, a lawmaking partnership is characterized by a common set of policy objec-
tives. This distinguishes the lawmaking partnership as a common enterprise rather than
two actors that are competing or working at cross purposes. Specifically, congressional
responses to the Court’s interpretation should reflect a consistency rather than a replace-
ment of the policy objectives identified by the Court. Similarly, congressional action that
seeks to correct errors in the Court’s approach or to update policies that have become
obsolete would not qualify.
In the context of private securities fraud litigation, the partnership structure offers
distinctive lawmaking advantages. One advantage is that it enables Congress to achieve
a level of political insulation with respect to its enforcement policy. Private securities
fraud litigation is a political hot potato and, as a result, an area in which interest group
politics is a particular concern (Levitan 2014). Corporate issuers and their executives face
substantial liability risk in private litigation and incur considerable costs in both insurance
and litigation defense. These defendants pressure Congress to reduce the scope of their
liability risk by restricting private litigation. On the other hand, the plaintiffs’ bar is a
formidable political force as well. One study reports that the amount donated by lawyers,
primarily plaintiffs’ lawyers, to federal political candidates since 1990 is more than $1 bil-
lion (Copeland 2010). Putting aside the extent to which political donations and lobbying
influence congressional policymaking, it is easier for Congress to delegate determination
M4633-GRIFFITH_t.indd 19 30/10/2018 08:16

of the scope of private litigation to the federal judiciary, which enjoys life tenure. Judicial
lawmaking also provides a mechanism to overcome the gridlock that might result from
high levels of interest group engagement.
The lawmaking partnership also exploits the differential institutional competencies
of courts and Congress. The evaluation of the scope and quality of private litigation is
a subject that is peculiarly within the competence of the judiciary. The courts can read-
ily observe the quality of private lawsuits and the extent to which litigation filings are
correlated with serious misconduct. The courts can also determine the effect of various
reforms such as a heightened pleading standard on litigation volume and case quality.
At the same time, Congress has the capacity to consider evidence that the courts cannot
observe. This evidence might include the effect of litigation costs on issuers’ decisions to
go public or to list their securities in the United States, or the effect of private enforcement
on the capital markets. Thus, even with a common objective, the courts and Congress can
bring distinct issues of competence to the question of how best to achieve that objective.
By delegating the development of private enforcement to the courts, Congress creates
a potential check on the possibility of agency capture. The antifraud provision, like most
of the federal securities laws, can be enforced by the SEC as well as private litigants. Some
commentators have advocated for the elimination of private securities fraud litigation,
arguing for the superiority of public enforcement (Bratton & Wachter 2011). Yet the
effectiveness of public enforcement depends critically on the SEC’s exercise of its enforce-
ment authority (Langevoort 2006). An important constraint on public enforcement is the
availability of resources—the SEC depends on Congress for funding, and Congress can
limit enforcement activity just by pulling the purse-strings closed (Heminway 2005). In
addition, the broad scope of regulation and actors subject to federal securities regulation
requires the SEC to make policy choices. SEC officials and staff may make such choices
for a variety of reasons—such as a desire to appeal to the media, to further personal career
objectives, or to assuage congressional critics.
The courts are particularly well positioned to observe the areas in which SEC enforce-
ment operates effectively. Although the courts cannot address deficiencies in public
enforcement directly, they can identify those areas in which private enforcement is serving
as a useful supplement by targeting conduct or defendants that are not the focus of the
regulators (Cox 2005).
Finally, the lawmaking partnership offers a dynamic process. Common law adjudica-
tion has long been defended on the basis of its ability to operate incrementally and to
evolve in response to changing circumstances (Fisch 2000). These features prevent the
type of obsolescence that can occur in both congressional and agency lawmaking. In the
context of financial regulation, this flexibility and responsiveness are particularly valuable
because of the speed at which the market changes, creating new regulatory demands.
Again, the case of federal securities fraud offers an illustration. The public capital markets
have shifted, over the past 60 years, from retail to largely institutional markets in which
disclosure takes place primarily through the internet, and which feature new types of
traders and financial instruments. As the nature of the market changes, so do the nature
of securities fraud and the scope of litigation necessary to deter such fraud effectively, as
well as the costs and benefits of an enforcement regime.
A lawmaking partnership allows the different expertise and informational access of the
courts and Congress to identify and respond to these developments. For example, Basic
M4633-GRIFFITH_t.indd 20 30/10/2018 08:16

responded to the impersonal nature of the public capital markets by recognizing the dif-
ficulty for investors of proving reliance directly. The PSLRA responded to the emergence
of institutional investors by harnessing their larger stakes and greater sophistication in the
form of the lead plaintiff as a way of controlling litigation decisions. SLUSA responded
to an effort by the plaintiffs’ bar to shift litigation into state courts in order to avoid
provisions such as the discovery stay.
3. THE LAWMAKING PARTNERSHIP AND INSIDER

TRADING
3.1 Congressional and Judicial Development of Insider Trading Regulation
The analysis in this chapter is applicable beyond federal securities fraud. Although
consideration of the lawmaking partnership in the context of other statutory schemes is
beyond the scope of this chapter, securities regulation alone offers numerous instances in
which the collaborative interplay of congressional and judicial lawmaking suggests that
the Court should apply a more flexible and goal-oriented approach to interpreting the
applicable statute.36 Within federal securities fraud, evidence of a lawmaking partnership
might inform the Court’s analysis of a variety of issues.37
One such issue is insider trading. Federal insider trading liability is based on section
10(b), the same general antifraud provision that provides the basis for private securities
fraud litigation discussed earlier in this chapter. The statute itself contains no reference
to insider trading or nonpublic information (Brachman 2013). Instead, insider trading
liability has been developed through the joint actions of the Court and Congress.
In Chiarella v. United States, the Court first accepted the premise that trading on
material inside information could constitute securities fraud.38 The Court’s holding
was restrictive, however; it concluded that insider trading liability required a breach of
fiduciary duty. Importantly, the Court observed that its decision was not grounded in
the statutory text or a finding of congressional intent, noting that “neither the legislative
history nor the statute itself affords specific guidance” as to the circumstances in which
“silence may constitute a manipulative or deceptive device.”39
Chiarella did not address situations in which insiders, rather than trading themselves,
disclose inside information to others who subsequently trade. In 1983, the Court
addressed this so-called “tipping” in Dirks v. SEC.40 Importantly, Dirks reinforced the
Court’s holding in Chiarella that insider trading required a predicate breach of fiduciary
duty and concluded that tippees could only be liable if the tipper breached a fiduciary
duty in disclosing the inside information and if the tippee knew of the breach. Dirks
36
Similarly, the courts should consider the existence of a partnership in evaluating the legiti-
macy of agency rulemaking. Fisch (2013 II).
37
See Fisch (2016) (identifying other issues to which the lawmaking partnership may be
applicable and the implications of applying that approach).
38
445 U.S. 222 (1980).
39
Ibid at 226.
40
463 U.S. 646 (1983).
M4633-GRIFFITH_t.indd 21 30/10/2018 08:16

further explained that a tipper breached his or her duty by receiving a personal benefit in
exchange for the tip or if he or she intended to bestow a gift on the recipient.41
Many commentators were dissatisfied with the limitations on insider trading liability
imposed by the Chiarella and Dirks decisions (Phillips & Lavoie 1988). Commentators
also raised objections to the regulatory ambiguity (Painter et al. 1998). As Senator
Alfonse D’Amato observed: “the present state of uncertainty about the law is simply
not acceptable.”42 Between 1986 and 1988, Congress held four separate sets of hearings
devoted specifically to insider trading regulation (Joo 2007).
In 1984, Congress adopted its first response to the Chiarella and Dirks decisions. The
Insider Trading Sanctions Act of 1984 did not revise the judicial approach to insider trad-
ing liability or expand the scope of the prohibition but merely made minor modifications
to insider trading liability, including a prohibition on the trading of options and other
derivatives in circumstances in which it would be illegal to trade stock and a provision
providing for treble damages.43 The statute suggested that Congress was aware of the
scope of insider trading liability reflected in the Dirks and Chiarella decisions and chose
not to alter it. Despite the urging of several witnesses, Congress did not adopt a formal
definition of insider trading in the statute (Painter et al. 1998).
In 1987, in response to a request from the Senate Securities Subcommittee, the SEC drafted
proposed legislation that would have provided a definition of insider trading and modified
several aspects of the Supreme Court’s decisions (Macey 1988). A specific issue that had
divided lower courts was the extent to which insider trading liability could be premised on
an alternative theory: the misappropriation theory (Weiss 1998). The SEC’s draft legislation
sought to codify the misappropriation theory and to specify the circumstances and relation-
ships that might give rise to a predicate duty (Macey 1988). Instead, in the Insider Trading
and Securities Fraud Enforcement Act of 1988 (“ITSFEA”), Congress increased the
penalties for insider trading and also added a private remedy for contemporaneous traders.44
Notably, however, Congress did not codify the misappropriation theory, which was
enjoying general acceptance in the lower courts. Rather, the ITSFEA contained explicit
findings that the SEC’s rules regarding insider trading were “necessary and appropriate,”
and that it had “enforced such rules and regulations vigorously, effectively, and fairly.”45
As Steve Thel argues, these findings can be read as a congressional endorsement of the
misappropriation theory (Thel 1997).
The Supreme Court finally accepted the misappropriation theory in O’Hagan.46 The
O’Hagan decision departed from the narrow approach to insider trading liability reflected
in Chiarella and Dirks, relying instead on policy considerations to support its charac-
terization of misappropriation as informational fraud. As Justice Ginsberg explained,
41
Ibid at 663–64.
42
133 Cong. Rec. S16,393 (daily ed. June 17, 1987) (statement of Sen. Alfonse D’Amato).
43
Insider Trading Sanctions Act of 1984, 15 U.S.C. §§ 78c, 78o, 78t, 78u, 78ff (2014).
44
Insider Trading and Securities Fraud Enforcement Act of 1988, Pub. L. No 100-704, 102
Stat. 4677 (1988).
45
Ibid § 2.
46
United States v. O’Hagan, 521 U.S. 642 (1997). The misappropriation theory was based on
language in Chief Justice Burger’s dissent in Chiarella. See Chiarella v. United States, 445 U.S. 222,
243–45 (1980) (Burger, C.J., dissenting).
M4633-GRIFFITH_t.indd 22 30/10/2018 08:16

the misappropriation theory is “tuned to an animating purpose of the Exchange Act: to

insure honest securities markets and thereby promote investor confidence.”47 Although
O’Hagan did not eliminate all confusion over the scope of insider trading liability
exposure, the Court’s acceptance of the misappropriation theory reduced the pressure
on Congress to adopt insider trading legislation. This outcome was viewed as less than
optimal by some commentators who had argued that the scope of insider trading liability
should be definitively resolved through legislation (Nagy 1998).
Congress subsequently passed the Stop Trading on Congressional Knowledge Act
(“STOCK Act”) which prohibits members of Congress from trading on inside informa-
tion.48 Two aspects of the STOCK Act reinforce the characterization of the development
of insider trading regulation as a collaborative process. First, Congress again declined to
provide a statutory definition of insider trading. Second, in extending the prohibition,
Congress incorporated the fiduciary duty approach reflected in the Court’s decisions.
Specifically, the Act provides that members of Congress owe a duty of trust and confi-
dence to Congress, the federal government, and US citizens “solely for purposes of the
insider trading prohibitions.”49
3.2 A Third Partner—The SEC
The example of insider trading introduces an additional dynamic into the lawmaking
process—the SEC.50 The SEC’s initial role in developing insider trading law took the form
of bringing enforcement actions that were, in some cases, supplemented by Department
of Justice criminal prosecutions. It was the SEC—not Congress or the courts—that made
the initial decision to use the general antifraud provision as a basis for imposing insider
trading liability.51 Subsequently, the SEC’s enforcement actions have repeatedly tested the
boundaries of existing law and offered new theories of liability (Park 2012).
The SEC also responded to restrictive judicial decisions through formal rulemaking.
For example, the SEC responded to the narrow scope of the Chiarella decision by prom-
ulgating Rule 14e-3, which prohibits insider trading in connection with a tender offer and
does not require a fiduciary duty.52 The SEC responded to the information asymmetries
authorized by the Dirks decision by adopting Regulation FD.53 The SEC also codified its
expansive approach to Rule 10b-5 by promulgating Rules 10b5-1 and 10b5-2.54
Including the SEC in the lawmaking partnership adds an additional dimension to the
lawmaking process. In many cases, Congress and the Court have embraced the SEC’s
lawmaking initiatives, agreeing that the SEC’s approach furthered their common policy
47
Ibid at 658.
48
Stop Trading on Congressional Knowledge Act of 2012 (“STOCK Act”), Pub. L. No 112-
105, 126 Stat. 291 (2012).
49
Ibid § 4(g)(1).
50
Commentators have devoted considerable energy to debating the appropriate extent to which
Congress should delegate lawmaking authority to federal agencies. (Lemos 2010).
51
See In re Cady, Roberts & Co., 40 S.E.C. 907, 912 (1961).
52
17 C.F.R. § 240.14e-3 (2015).
53
17 C.F.R. § 243.100 (2015).
54
17 C.F.R. §§ 240.10b5-1 & 10b5-2 (2015).
M4633-GRIFFITH_t.indd 23 30/10/2018 08:16

objectives. Thus, for example, Congress explicitly found, in section 2 of the ITSFEA, that
the SEC’s rules and regulations governing insider trading were “necessary and appropri-
ate,” and that the Commission had “enforced such rules and regulations vigorously, effec-
tively, and fairly.”55 Similarly in O’Hagan, the Court both accepted the misappropriation
theory proffered by the government as encompassing the necessary deception required by
its earlier decisions and upheld the SEC’s adoption of Rule 14e-3.56
In other cases, however, the Court has restrained the SEC’s enforcement zeal. As noted
above, even as the Court accepted insider trading liability in Chiarella, and extended
that liability to tippees in Dirks, it held that the SEC’s desired scope of liability was too
broad. In particular, the Court rejected the SEC’s desired parity-of-information standard.
Similarly, in Dirks, the Court insisted that tippee liability be premised both upon a breach
of fiduciary duty and the tippee’s awareness of that breach, finding support for this
approach in the scienter requirement.
Recent enforcements by the SEC have raised similar concerns in the lower courts. Mark
Cuban fought a five-year battle with the SEC and won, along the way raising concerns
about the validity of Rule 10b5-2 that the court took seriously (Isidore & Wallace 2013).57
In United States v. Newman, the Second Circuit overturned the convictions of two hedge
fund managers, third- and fourth-degree “remote tippees,” suggesting the SEC’s prosecu-
tion theory stretched beyond the limits established by Dirks.58
4. IMPLICATIONS OF THE PARTNERSHIP APPROACH
As the foregoing analysis explains, insider trading law is the product of a lawmaking part-
nership. Insider trading liability is premised on section 10(b), an open-textured statute,
and the Court, Congress, and the SEC have made multiple adjustments and refinements
to insider trading regulation. In each case, these adjustments have been cognizant of and
responsive to the efforts of other lawmaking partners. Finally, as with private securities
fraud litigation, the lawmaking enterprise seeks to appear to share the common objectives
of addressing information disparities in the securities markets and maintaining public
confidence while providing sufficient limiting principles to allow the information flow
necessary to preserve healthy and efficient markets.
Insider trading also demonstrates the advantages of the lawmaking partnership in
developing financial regulation. Congress and the SEC, to some degree, have been
responsive to politically based concerns such as the public demand for greater enforce-
ment penalties in the wake of Wall Street scandals. The Court, with its greater degree of
political insulation, is able to provide a constraint on excess enforcement zeal, balancing
these demands with concerns over predictability, information flow, and market efficiency.
Judicial oversight can also check headline-driven lawmaking agendas, pushing the SEC in
particular to justify its regulatory choices. Thus, for example, the Court’s decision in Dirks
55
Insider Trading and Securities Fraud Enforcement Act of 1988, Pub. L. No 100-704, §2, 102
Stat. 4677, 4677 (1988).
56
United States v. O’Hagan, 521 U.S. 642, 655 (1997).
57
SEC v. Cuban, 634 F. Supp. 2d 713, 730–31 (N.D. Tex. 2009).
58
United States v. Newman, 773 F.3d 438, 443 (2d Cir. 2014).
M4633-GRIFFITH_t.indd 24 30/10/2018 08:16

led the SEC to focus its efforts on reducing information asymmetries on issuer disclosure
rather than recipient use of material nonpublic information through the adoption of
Regulation FD. The Second Circuit’s decision in Newman may similarly encourage the
SEC to direct greater attention to tippers/sources rather than remote tippees. Congress
also weighed in to readjust the SEC’s enforcement priorities with the adoption of the
STOCK Act. Notably, prior to the legislation, no member of Congress had been the
subject of an insider trading enforcement action, despite evidence suggesting widespread
use of material nonpublic information (Brick 2013).
Finally, the lawmaking partnership is well positioned to respond to the dynamic
structure of the securities markets and the evolution of information flow due to changes
in technology and market participants. Since the Chiarella decision, the markets have seen
the emergence of many new types of traders and trading strategies—hedge funds, high-
frequency traders, algorithmic trading, and index funds are all examples. Competition has
led to new demands for information, which are met by innovations such as web crawlers,
expert network firms, electronic road shows, and more.
These developments offer new challenges—both in defining material nonpublic
information and in identifying the manners of acquiring that information that should be
characterized as improper. While the financial incentives for acquiring an informational
advantage are higher than ever, the value of maintaining a rich information environment
offers reasons to be cautious about expansive liability provisions. A lawmaking partner-
ship is well suited to maintaining the necessary balance.
These insights are of particular value in the aftermath of the Newman decision.
Newman renewed the long dormant efforts to have Congress adopt a definition of insider
trading (Henning 2015). Properly understanding insider trading regulation as the product
of a lawmaking partnership, however, rebuts that claim and demonstrates that judicial
oversight has provided a valuable counterbalance to regulatory excess while retaining
flexibility to address market innovation. As former-SEC Chair Mary Jo White explained:
“I think it’s challenging to codify [insider trading law] clearly in a way that is both not too
broad and retains the strength of common law.”59
Moreover, the iterative process of adjudicative lawmaking itself offers the opportunity
to reconsider and refine the scope of Newman, as illustrated by the Supreme Court’s
subsequent decision in Salman v. United States.60 Salman reaffirmed the personal benefit
requirement of Dirks but rejected a narrow interpretation of that requirement, holding
that a tipper need not receive “something of a ‘pecuniary or similar nature’ in exchange
for a gift to family or friends.”61 Critically, this rationale highlighted the fact that tips
of inside information in the family context are distinctive, in that a tipper may receive
a personal benefit simply as the result of making a gift of inside information to a close
friend or family member (Fisch 2016 II).
As a result, the Salman decision reinforced the fact that gifting inside information to
family members is illegal, without undermining the concern reflected in Dirks that unduly
59
Ben Conarck, SEC’s White Says Agency Mulled Insider Trading Ban, Law360 (Mar. 24,
2015, 6:58 PM), www.law360.com/articles/635363/sec-s-white-says-agency-mulled-insider-trading-
ban (quoting then-SEC Chair Mary Jo White).
60
137 S. Ct. 420 (2016).
61
Id. at 428 (citing Newman).
M4633-GRIFFITH_t.indd 25 30/10/2018 08:16

expansive insider trading liability poses a threat to legitimate research and the market
efficiency that results from that research (Perino 2014; Fisch 2016 II). The flexibility
provided to the Court by the lawmaking partnership enabled it, in Salman, to structure
a decision faithful to both these concerns. In playing this role, the Court demonstrated
its continued fidelity to Congress’s objectives in developing the law of insider trading.
5. CONCLUSION
A variety of structural and political pressures constrain the effectiveness of the lawmaking
process with respect to financial regulation (Levitan 2014). The lawmaking partner-
ship offers one possible response. Through a judicial–congressional collaboration, the
lawmaking partnership enables the courts and Congress to temper their own institutional
shortcomings. This has led, in the context of private securities litigation, to a balance that
serves the dual objectives of investor protection and limiting the potential for litigation
abuse. The structural advantages of the lawmaking partnership support both deference to
this balance and a broader endorsement of the lawmaking partnership.
In the case of Halliburton II, the implications of this analysis suggest that the Court
reached the correct result in declining to overrule Basic, although perhaps for the wrong
reasons. More broadly, the analysis suggests that the Court should be empowered to strike
an appropriate balance with respect to the scope of private litigation under section 10(b).
Evidence of a similar collaborative process should inform the Court’s analysis of
insider trading liability. Because Congress has embraced the Court’s role in a lawmaking
partnership and approved of the Court’s choice of regulatory objectives, the Court should
view that participation as authorization to engage in its own policy analysis in further-
ance of those objectives. Judicial lawmaking in this context should be understood not
as unprincipled activism, but as consistent with a congressional choice of a lawmaking
approach that offers distinctive advantages.
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Trading Controls, Corporate Secrecy, and Full Disclosure,” Alabama Law Review 39: 439.
Sunstein, Cass R., 1989, “Interpreting Statutes in the Regulatory State,” Harvard Law Review 103: 405.
Thel, Steve, 1997, “Statutory Findings and Insider Trading Regulation,” Vanderbilt Law Review 50: 1091.
Weiss, Elliot J., 1998, “United States v. O’Hagan: Pragmatism Returns to the Law of Insider Trading,” Journal
of Corporation Law 23: 395.
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2. Securities class actions and severe frauds
James J. Park
1. INTRODUCTION
Congress passed the Private Securities Litigation Reform Act (“PSLRA”) in 1995 to
reduce the filing of securities class actions without merit. Much of the scholarship prior
to the passage of the PSLRA, as well as its legislative history, reflected a particular nar-
rative about such litigation. The typical case was understood to be a strike suit against
an emerging technology company with a volatile stock price. Class action attorneys filed
complaints without any evidence of fraud with the hope of extorting a settlement. This
portrayal of securities litigation was difficult for opponents of the PSLRA to rebut. At the
time, there were not many compelling examples of securities class actions with sufficient
merit that could concretely illustrate the benefits of providing investors with a private
action to address securities fraud.
The PSLRA arguably failed in that it did not reduce the costs of securities class actions.
As critics of securities class actions have noted, the size of payments to settle such cases
increased substantially in the decade or so after the PSLRA. One significant article began
its argument that securities class actions for secondary market fraud should be eliminated
by noting: “[m]ore than 3,200 private class action securities fraud lawsuits were filed
between 1997 and 2013. Settlements in these actions generated more than $73 billion and
comprise six of the ten largest settlements in class action history” (Grundfest 2014, 308).
The implication of this preamble was that the PSLRA had failed to manage the costs of
securities class actions and so the Supreme Court should do away with them entirely. This
argument failed to persuade the Court, which reaffirmed the validity of the fraud-on-the-
market presumption in its 2014 Halliburton v. Erica John Fund decision.
This chapter will contend that the PSLRA’s impact on securities class actions should be
understood in terms of the context of developments after its passage. In what was a for-
tuitous turn of events for the securities class action, the years after the PSLRA coincided
with a period of significant accounting restatements. Some of these restatements helped
trigger public company bankruptcies as well as Securities and Exchange Commission
(“SEC”) enforcement. Securities class actions after the PSLRA thus often addressed what
were believed to be severe frauds at large public companies.
Though scholars have analyzed evidence that the PSLRA itself changed the types of
cases brought by changing the definition of merit, less attention has been devoted to under-
standing how events after the PSLRA affected the types of securities class actions filed. The
PSLRA’s assumption that securities class actions do no more than harass companies with
volatile stock prices is no longer valid. The securities class action has evolved. In certain
circumstances, securities class actions address severe fraud at established public companies.
This chapter has five sections. Section 2 describes the early and unfavorable conception
of the securities class action that influenced passage of the PSLRA. Section 3 discusses
studies of the PSLRA’s effect on securities class actions. Section 4 considers how the
29
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prevalence of significant accounting restatements by public companies after the passage

of the PSLRA impacted securities class actions. Section 5 analyzes how perceptions
of securities class actions have changed in response to these developments. Section 6
concludes.
2. THE SECURITIES CLASS ACTION BEFORE THE PSLRA
The PSLRA was primarily directed at securities class actions targeting technology
companies with volatile stock prices. Scholars both before and after the passage of the
PSLRA understood securities class actions as affecting certain industries that were
vulnerable to strike suits. The PSLRA thus focused on reforms that would address such
meritless litigation.
In an influential article published in 1991, Professor Janet Cooper Alexander examined
a sample of lawsuits relating to 17 initial public offerings of “computer and computer-
related companies during the first half of 1983” (Alexander 1991, 507). This set of cases
involved an “especially risky segment of the stock market, initial public offerings, with a
group of unproven companies in a highly competitive and volatile industry” (Alexander
1991, 507). The advantage of focusing on this particular industry was that it allowed for
comparison of “virtually identical” lawsuits that should only vary based on the merits of
the case (Alexander 1991, 509). The main finding of the study was that this small sample
of securities class actions settled for similar amounts, indicating that the settlements were
unrelated to the strength of the case.
This story of a wave of strike suits that threatened to choke off innovative industries
with meritless suits was understandably compelling to Congress as it considered the
PSLRA.1 The Senate Committee on Banking, Housing, and Urban Affairs referred
to a “rising tide of frivolous securities litigation” that targeted “American business,
particularly younger companies in the high-tech area.”2 The House of Representatives
Committee on Commerce issued a report asserting that the “typical case involves a stock,
usually of a high-growth, high-tech company, that has performed well for many quar-
ters, but ultimately misses analysts’ expectations.”3 The Committee described these suits
as routinely filed after a stock price decline without any evidence of wrongdoing.4
The opponents of the PSLRA were unable to construct a compelling counternarrative
by pointing to particular cases that exemplified the virtue of the securities class action. A
prominent defense of the securities class action declared that “The Merits Do Matter,” but
1
It is important to note that the perception of the securities class action was far from uniform.
One article described securities class actions as being primarily directed at companies facing the
possibility of failure. It found that more than half of securities class actions might involve such a
situation (Arlen & Carney 1992, 725). The data it cited was limited, though, in that it had settle-
ment and judgment data for only about nine cases (Arlen & Carney 1992, 740).
2
S. Comm. on Banking, Hous., and Urb. Affairs, Private Securities Litigation Act of
1995, S. Rep. 104-98 at 38 (1995).
3
H. Comm. on Comm., Common Sense Legal Reforms Act of 1995, H. Rep. 104-50 at 15
(1995).
4
Ibid at 16.
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Securities class actions and severe frauds 31
spent most of its time criticizing studies by defenders of the PSLRA. The article did not
advance examples of cases with merit, perhaps because there were not many prominent
examples of such cases (Seligman 1994, 450). It rested its defense mainly on the standard
law and economics point that private litigation can deter fraud (Seligman 1994, 455).
Such a theoretical argument may not have been compelling to Congress in light of the
particular costs that were borne by issuers and other defendants.
The influence of the technology company narrative continued for some time after the
passage of the PSLRA. One of the most comprehensive empirical studies of securities
class actions focused on about 3,500 firms conducting an IPO from 1975 to 1986, in part
because “new-growth companies often have volatile stock prices and lack a disclosure
track record, making them particularly vulnerable to strike suits” (Bohn & Choi 1996,
908). The study concluded “that most securities-fraud class actions are, in fact, frivolous”
(Bohn & Choi 1996, 979). A number of event studies tested the impact of the PSLRA on
the value of firms and, tellingly, focused on technology firms. Spiess and Tkac looked at
firms in the biotechnology, computer, electronic, and retail industries. They found posi-
tive stock returns on the date that Congress voted to override President Clinton’s veto
of the PSLRA (Spiess & Tkac 1997). Johnson, Kasznik, and Johnson similarly looked
at firms in the pharmaceuticals, computer hardware, and computer software industries,
also finding positive returns associated with the veto override (Johnson, et al. 2000). A
study by Pritchard, Johnson, and Nelson tested the impact of a more restrictive scienter
standard set forth by the U.S. Court of Appeals for the Ninth Circuit. It looked at a
sample of 277 technology firms and found a positive stock market reaction to the deci-
sion (Pritchard, et al. 2000). The approach of these studies reflected the understanding
in the 1990s that securities class actions were primarily a burden on a particular type
of firm. Their findings implied that limiting securities class actions would increase the
economic value of technology firms that would no longer have to face the threat of a
strike suit.
3. THE IMPACT OF THE PSLRA ON SECURITIES CLASS

ACTIONS
The PSLRA undeniably influenced the sorts of securities class actions that plaintiffs filed
after its passage. By changing the definition of merit and encouraging investors with
substantial losses to participate in such litigation, the PSLRA created incentives to bring
certain types of lawsuits. Empirical studies have found that cases filed after the PSLRA
are more likely to include allegations that meet the PSLRA’s requirements. Thus, there is
an argument that the PSLRA resulted in the filing of more meritorious securities class
actions.
By requiring a description of facts in the complaint that would support a “strong
inference” of fraudulent intent, the PSLRA favors cases that describe “hard evidence”
of securities fraud. A case that simply alleges fraud in conclusory terms and points to a
stock price decline is unlikely to survive the motion to dismiss. Because plaintiffs do not
have access to the company’s internal files prior to filing the complaint, they must rely on
external information indicating the possibility of fraud. Writing soon after the passage of
the PSLRA, Professor John Coffee predicted that as a result of the higher standard for
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finding scienter, securities class actions might shift to targeting financial statement fraud
as opposed to the accuracy of projections (Coffee 1996).
Consistent with this prediction, plaintiffs began to base their complaints on publicly
available indicators of fraud. One common sign of an accounting fraud is a restatement
of the company’s financial statements. In such a restatement, the company concedes that
there is an error in its accounting. Though a mistake by itself is not fraudulent, a severe
mistake might be an indicator of recklessness that would support a theory of securities
fraud. Another event that could signal fraud is unusual insider trading by executives
connected with a misstatement. If directors and officers aggressively sell stock during the
period of the fraud, it might indicate that they deliberately inflated the stock price for
their own advantage.
Studies have compared securities class actions filed before the PSLRA with securities
class actions filed after the PSLRA and found that the cases filed after the PSLRA are
more likely to allege an accounting restatement and abnormal insider trading (Johnson,
et al 2006). Another study found that the PSLRA had a screening effect in that plaintiffs
were less likely to file lawsuits without hard evidence of securities fraud than prior to
the PSLRA (Choi, et al 2009). The PSLRA affected not only the filing of cases, but
also their outcomes. Securities class actions without hard evidence of fraud were more
likely to be dismissed or settle for nominal amounts after the PSLRA (Choi 2016), and
cases alleging a restatement were more likely to settle than end in dismissal (Johnson,
et al 2006).
In addition to increasing the burden of showing merit at an early stage of the case, the
PSLRA created a presumption that the lead plaintiff of the class should be the investor
who suffered the largest loss from the alleged fraud. In doing so, the PSLRA encouraged
the participation of sophisticated institutional investors in securities class actions. Such
investors, often public pension funds, are more qualified than most individuals to monitor
the attorneys representing the class, making it less likely that they will quickly settle good
cases for too little. Because such monitoring is somewhat costly, one would expect that
an institutional investor would be more likely to choose to apply for lead plaintiff status
in cases where it believed the merits are strong. Thus, the appointment of an institutional
lead plaintiff might signal that a particular case is meritorious.
Consistent with this analysis, studies have found that securities class actions with
institutional lead plaintiffs tend to be more meritorious on average than cases where
a retail investor is the lead plaintiff. Numerous studies have found that securities class
actions with a public pension fund lead plaintiff are more likely to result in a higher value
settlement (Choi, et al 2005; Cox, et al 2006; Cheng, et al 2010; Perino 2012). There is
also evidence that attorney fee awards are lower in cases with pension fund lead plaintiffs
(Perino 2012). The increase in settlement values after the PSLRA is thus not necessarily
evidence that the PSLRA failed to screen meritorious cases. Rather, part of the increase
can be attributed to increasing involvement by institutional investors who can identify
meritorious cases and push for larger settlements in such cases.
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4. SEVERE FRAUDS AND SECURITIES CLASS ACTIONS
The PSLRA was not the only factor that influenced securities class actions after 1995.
As noted earlier, the period after the passage of the PSLRA saw a rise in the number of
substantial settlements of securities class actions. Some of this increase can be explained
by changes in the incentives to bring cases with hard evidence of fraud as well as the
increasing involvement of pension fund lead plaintiffs. But much of the rise in large set-
tlements also reflects a period of increasingly large accounting restatements that started
soon after the PSLRA.
The rise and fall of the first internet stock bubble surely played a role in the rise of
notable securities class actions filed after the PSLRA. Just a few years after Congress
passed the PSLRA, the stock market rose steeply as investors became more willing to
believe that the internet offered companies unprecedented opportunities for profit. The
inflation of a bubble typically creates opportunities for speculative companies to thrive.
When investors are optimistic, they are willing to focus on the future prospects of a
company rather than whether there is a risk of fraud. When investor sentiment turns,
and the bubble deflates, the resulting decline in stock market prices can make it difficult
for a company to continue a fraud that started when times were good. Moreover, even
companies that did not commit fraud might find themselves vulnerable to allegations of
fraud when their stock prices decline and disgruntled investors try to recover their losses.
The political climate might be conducive to aggressive litigation by both private parties
and government enforcers.
The securities class actions against Enron and WorldCom are perhaps the most
prominent cases that can be linked to the fall of the internet bubble. Both companies
saw great success in an era when investors were willing to speculate on the future. Enron
was a company that promised to both revolutionize the energy market and create a wide
range of innovative ventures. WorldCom was a telecommunications company that sought
to capitalize on a growing market spurred by regulatory changes in that industry. Both
companies fell in the wake of the collapse of the internet bubble in the early 2000s, as
willingness to believe in the future profitability of innovative companies subsided and the
economy declined. The unraveling of these companies was also spurred by the discovery
of fraud that resulted in accounting restatements. Enron was found to have utilized special
purpose vehicles to hide significant amounts of its debt from the market. WorldCom
brazenly inflated its profits by misclassifying what were clearly expenses. High-level
executives at both companies were convicted of criminal securities fraud and sentenced
to substantial prison terms. Though it is difficult to deny that there was significant fraud
at both of these companies, there might be an argument that some of their troubles were
the result of the misfortune of significant market shifts that caused substantial stock price
declines.
While the deflation of the internet bubble was an important reason for the increase in
very large securities class action settlements, it was not the only cause. Many significant
securities class actions were filed prior to the collapse of the internet bubble. These cases
often alleged earnings manipulation by companies that were often acknowledged by
restatements. Securities class actions were filed against companies restating their earnings,
such as Cendant, HealthSouth, Rite Aid, and Sunbeam, prior to 2000. Each of these cases
resulted in a settlement of more than $300 million (Park 2014, 610).
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The number of accounting restatements significantly rose in the period after the
PSLRA. A study by the United States Government Accountability Office reported that
the number of restatement announcements by public companies rose from 92 in 1997 to
225 in 2001; and reached 523 in 2005 (US Government Accountability Office 2006, 12).
The same study found that the percentage of listed public companies restating their earn-
ings rose from 8 percent in the period 1997–2001 to 16 percent in 2002–5 (US Government
Accountability Office 2006, 12). The size of restatements also increased significantly,
ranging into the billions of dollars for some companies: Xerox inflated its earnings by
$1.5 billion dollars, WorldCom inflated profits by $11 billion, Qwest inflated its revenues
by $3.8 billion (Park 2009, 54).
One explanation for the rise in restatements was greater SEC scrutiny of earnings
reports. In a famous 1998 speech at NYU Law School, Chairman Arthur Levitt famously
highlighted what he called the “earnings game,” where companies manipulated revenue
rules to meet earnings projections (Levitt 1998). Soon after, as might have been predicted
after a policy-setting speech by its chairman, SEC enforcement activity targeted public
company accounting. The number of SEC enforcement actions relating to financial
reporting rose from 79 in 1998 to 199 in 2003 (US Government Accountability Office
2006, 43). The SEC also began asserting its power to assess penalties more aggressively
with regard to larger public companies (Cox & Thomas 2005). The SEC made it clear
that it would evaluate financial misstatements based on a broader qualitative materiality
standard that did not rely on strict numerical cutoffs (SEC 1999). The increasing threat
of SEC scrutiny, coupled with a much broader materiality standard for financial mis-
statements, likely contributed to companies voluntarily restating their earnings. Thus, the
rise in securities class actions alleging restatements likely reflected not only an increased
incentive to allege restatements in private securities class action complaints, but also a
greater opportunity to do so as the number of restatements grew.
Restatements increased not only in number, but also in size. Multibillion-dollar
restatements became more common. As a result, the potential damages that could
be attributed to the fraud also grew. As restatements became larger, they potentially
affected the solvency of even large public corporations. Enron and WorldCom are both
examples of companies that filed for bankruptcy after a substantial restatement. The
number of large public companies that filed for bankruptcy rose from 20 in 1995 to 97
in 2001 (LoPucki Bankruptcy Research Database). The percentage of securities class
actions involving a bankrupt company rose from approximately 15 percent in 1996 to 25
percent in 2001 (Park 2013, 561). It is worth noting that the impact of a fraud resulting
in bankruptcy would have a permanent rather than temporary impact on the company’s
stock price.
The increase in the severity of fraud after the PSLRA is roughly reflected by an increase
in cases in which bondholders received part of the recovery. Because bondholders have
bankruptcy priority over shareholders, only a fraud that threatens the solvency of the
company will significantly affect bond prices. When there is such a substantial fraud, bond
investors often have a right to bring a securities class action. From 1996 to 2000, only 3
percent of securities class action settlements involved some recovery by bondholders.
From 2001 to 2005, almost 8 percent of securities class action settlements resulted in a
bondholder recovery. Additionally, 19 of the largest 30 settlements from 1996 to 2005
involved a bondholder recovery (Park 2014).
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An argument might be made that there was a causal link between events protecting
defendants from securities fraud liability and the increase in accounting restatements.
Auditors were shielded by not only the PSLRA, but also the Supreme Court’s 1994 deci-
sion in Central Bank v. First Interstate Bank.5 That decision eliminated Rule 10b-5 aiding
and abetting liability, making it more difficult for plaintiffs to sue secondary actors such
as auditors. Without the deterrent of Rule 10b-5, auditors may have perceived that they
would not be held responsible for failing to stop questionable accounting by their clients
(Coffee 2004). However, it is unlikely that auditor attitudes changed so quickly that these
developments can be said to have caused a rise in restatements.
Regardless of the cause of the increase in restatements, securities class actions changed
in response to the increased scrutiny of public company accounting. The typical defend-
ant named in such a case is not necessarily an emerging technology company, but can
be an established public corporation from a wide variety of industries. Cases are more
typically triggered by a significant accounting error or SEC investigation rather than
solely by a drop in the stock price. Many cases target permanent declines in value rather
than temporary stock price fluctuations.
5. IMPLICATIONS FOR THE FUTURE OF SECURITIES CLASS

ACTIONS
The increasing severity of fraud after the PSLRA changed not only the type of securities
class actions that were brought, but also what we might think of as the typical securities
class action. It is now difficult to describe all securities class actions as reflecting strike
suits against emerging technology companies. Instead, they often target hard evidence of
fraud that can result in real destruction in value. Regardless of whether these restatements
reflected an increase in fraud, courts believed that they did and became less likely to
dismiss securities class actions that they perceived to be meritorious.
Cases such as Enron and WorldCom now provide “paradigm cases” that can be utilized
in defending the need for securities class actions. Constitutional law scholars use that
phrase in noting how constitutional provisions can be directed at vivid examples of
governmental abuse (Rubenfeld 2005). Similarly, examples of meritorious securities class
actions can be a powerful argument for maintaining private causes of action for securities
fraud. While severe frauds will not always be as common as they were in the early part of
the twenty-first century, securities fraud that results in the failure of a significant public
company is now more than an abstract possibility.
Because the existence of a restatement in itself does not establish that there was a
securities fraud, an argument could be made that the surge of litigation arising out of
such restatements did not reflect real fraud. Restatements often reflect accounting issues
that result from innocent error rather than as part of a scheme to defraud investors. Class
action attorneys may have exploited the rise in restatements to bring cases against com-
panies that did not truly commit fraud. Though the SEC does not have a profit motive,
it may have political incentives to bring cases showing it is tough on accounting fraud.
5
511 U.S. 164 (1994).
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Even if these restatement cases did not truly reflect an increase in fraud, it is undeniable
that the perception of increasing fraud affected how certain actors viewed the securities
class action. Many courts believed that there was a wave of severe fraud. Judge Gerard
Lynch, a former Columbia Law School professor, noted in an opinion in the Global
Crossing case, that “plaintiffs have alleged a fraud of a magnitude only rarely seen—at
least until recent years.”6 Some courts responded with a greater willingness to find that
complaints sufficiently alleged fraudulent intent. For example, the Southern District of
New York loosened the standard for finding whether an auditor acted with scienter with
respect to severe frauds. As one judge noted, “[a]llegations of particularly large frauds
might go far toward creating a compelling inference of auditor scienter based on reckless-
ness even where actual knowledge of the fraud by the defendant auditor is not alleged.”7
When judges are confronted with severe fraud, there is evidence that they decide cases
differently. A prior analysis of securities class actions involving a bankrupt company
showed that judges are less likely to dismiss such cases, which are more likely to result in
a substantial settlement (Park 2009). The higher rate of success for these cases persists
even after controlling for obvious indicia of the merit of the case, suggesting that the
bankruptcy in itself influences the decisions of courts and parties. Judges may be using
a heuristic where they view suits in which the fraud is severe to be more likely to reflect a
good claim. This might be irrational, but it also may reflect the practical wisdom of judges.
In the wake of an era of severe fraud, it should not be surprising that the fraud-on-
the-market presumption survived the 2014 Halliburton v. Erica John Fund appeal. The
Supreme Court did not take the opportunity to revisit its creation of the presumption,
relying largely on the principle of stare decisis. Perhaps the case for overruling the fraud-
on-the-market presumption would have been stronger if there had not been so many cases
where securities class actions appeared to have substantial merit. Though the Supreme
Court explicitly denied any consideration of policy in deciding Halliburton,8 the many
examples of securities class actions addressing what seemed to be severe frauds made
it difficult for Halliburton to establish that fraud-on-the-market cases are completely
without any purpose.
It is telling that criticism of the securities class action has shifted from the claim that
they are meritless to more abstract arguments about whether they effectively compensate
investors. Rather than criticizing them as strike suits, scholars who are skeptical of
securities class actions have focused on whether investors need protection from fraud
given their ability to diversify. For secondary market suits, commentators have argued
that Rule 10b-5 recoveries are circular in that investors bear part of the cost of their own
compensation. Securities class actions have also been criticized for ineffectively deterring
fraud because liability most often falls on the entity rather than the individuals who actu-
ally commit the fraud (Coffee 2006; Rose 2008).
6
In re Global Crossing, Ltd. Securities Litig., 322 F. Supp. 2d 319, 347 (S.D.N.Y. 2004).
7
In re IMAX Sec. Litig., 587 F.Supp.2d 471, 484?85 (S.D.N.Y. 2008).
8
It is worth noting that Chief Justice Roberts, in particular, has been willing to invest sub-
stantial amounts in individual stocks. In order to participate in a case, he sold more than $250,000
in Microsoft stock (Sherman 2016). As a substantial holder of individual stocks, Chief Justice
Roberts might find the argument that a rational investor will choose to invest in index funds to be
unpersuasive.
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These arguments may be theoretically compelling, but they may not be persuasive to
judges and legislators who lived through the Enron and WorldCom era of securities fraud.
Just as the abstract argument of deterrence voiced by supporters of securities class actions
prior to the PSLRA was unsuccessful without clear examples of cases with merit, abstract
arguments of circularity may not gain much policy traction when defenders of secondary
market class actions can point to the scores of such cases where the merit seemed clear. While
securities class actions do not deter or compensate perfectly, what cause of action does?
The success of the securities class action post-PSLRA does not mean that additional
reform is unnecessary. A large settlement may indicate that a case had merit, but it also
might be the result of considerations unrelated to the true merit of the case. Private class
action attorneys have incentives to bring cases whenever there is an appearance of fraud.
There may be a danger of overenforcement where securities class actions are filed at a
higher rate than is optimal (Rose 2008). The fact that the severity of fraud appears to have
increased post-PSLRA does not necessarily mean that more cannot be done to ensure that
securities fraud causes of action are not abused.
The incidence of severe fraud began declining toward the latter part of the 2000s. The
number of securities class actions has decreased, even with the significant stock price
drops of the 2008–9 financial crisis. Future work should examine why more securities
class actions were not filed in the wake of an economic decline that eclipsed the collapse
of the internet stock bubble. One possible explanation is that the number of multibillion-
dollar restatements declined beginning in 2006. From 2007 through 2009, there were no
accounting restatements that exceeded $1 billion (Audit Analytics 2014, 13). Securities
class actions are no longer routinely filed in the wake of a stock price decline, but are more
likely to be triggered by an accounting restatement.
6. CONCLUSION
The success of the post-PSLRA litigation directed at what was believed to be a period
of severe fraud has likely secured the survival of the securities class action for another
generation. The narrative of the strike suit against a technology company may have been
true before the PSLRA, but it has been displaced in part by examples of securities class
actions that provide investors with a remedy for the worst frauds. Though it has survived
for now, there is still much work to do in ensuring that securities class actions target real
cases of fraud. The securities class action will continue to evolve, and courts, scholars,
and policymakers have much work to do in ensuring that such actions will be effective in
addressing severe frauds.
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Participation in Securities Class Actions, 9 J. Empirical Leg. Stud. 368–92 (2012).
Lynn Lopucki, Bankruptcy Research Database, http://lopucki.law.ucla.edu/tables_and_graphs/Filings_by_year.
pdf (last visited Mar. 7, 2017).
Amanda M. Rose, Reforming Securities Litigation Reform: Restructuring the Relationship between Public and
Private Enforcement of Rule 10b-5, 108 Colum. L. Rev. 1301–64 (2008).
Jed Rubenfeld, Revolution by Judiciary: The Structure of American Constitutional Law (2005).
Joel Seligman, The Merits Do Matter, 108 Harv. L. Rev. 438–57 (1994).
SEC Staff Accounting Bulletin: No 99, 17 CFR Part 211 (Aug. 1999).
Mark Sherman, Chief Justice John Roberts Sold More than $250,000 in Microsoft Stock that Will Allow Him to
Take Part in a Supreme Court Case, U.S. News & World Rep. (Feb. 4, 2016 3:23AM), www.usnews.com/news/
politics/articles/2016-02-04/roberts-sold-more-than-250-000-in-microsoft-stock.
Spiess, K. & Paula A. Tkac, The Private Securities Litigation Reform Act of 1995: The Stock Market Casts Its
Vote. . . 18 Managerial & Decision Econ. 545–61 (1997).
U.S. Gov’t Accountability Office, GAO-06-678, Financial Restatements Update of Public Company
Trends, Market Impacts, and Regulatory Enforcement Activities (2006).
M4633-GRIFFITH_t.indd 38 30/10/2018 08:16

3. The shifting raison d’être of the Rule 10b-5 private
right of action
Amanda Marie Rose
A research handbook on shareholder litigation would be incomplete without a treatment

of the Rule 10b-5 private right of action, often called the most important liability provi-
sion in the federal securities laws (Prentice 1997; Thel 2014). If importance is measured
in terms of total dollars recovered and total amount of judicial and scholarly attention
spent on a cause of action, then this assertion is undeniably correct. Private Rule 10b-5
suits constitute nearly half of all class actions filed in federal court (Coffee 2006),
claim a disproportionate amount of judicial time and attention due to their procedural
complexity, and are responsible for the “vast majority” of money involved in class action
settlements (Fitzpatrick 2010)—averaging more than $5 billion annually for the past ten
years (Bulan et al. 2015). Private Rule 10b-5 suits have also inspired volumes of academic
literature, much of it focused on their social function (or lack thereof, depending on the
author’s perspective). The purpose of this chapter is to introduce readers to this aspect of
the Rule 10b-5 literature, which is best understood in light of the historical and doctrinal
evolution of Rule 10b-5.
Toward that end, section 1 begins at the beginning, recounting the origins of the
Rule 10b-5 private right of action. It explains how, in the early years, the private right
served to promote the goals of corrective justice and deterrence in much the same way
as the common law fraud cause of action. Section 2 discusses how Rule 10b-5’s doctrinal
evolution served to unmoor it from its common law roots, facilitating the emergence of
the “fraud-on-the-market” (FOTM) class action that characterizes private Rule 10b-5
litigation today. Section 3 explains why FOTM class actions are more difficult to reconcile
with corrective justice and deterrence theory than the early Rule 10b-5 suits, situating the
scholarly debates over the social desirability of private Rule 10b-5 enforcement within this
theoretical framework. Section 4 briefly concludes.
1. THE EARLY YEARS
In 1942 the Securities and Exchange Commission (SEC) exercised its authority under
Section 10(b) of the Securities and Exchange Act of 1934 to promulgate Rule 10b-5.1
In relevant part, Rule 10b-5 renders it unlawful for any person “to make any untrue
statement of a material fact or to omit to state a material fact necessary in order to make
1
Section 10(b) provides that “[i]t shall be unlawful for any person . . . [t]o use or employ, in
connection with the purchase or sale of any security . . . any manipulative or deceptive device or
contrivance in contravention of such rules and regulations as the Commission may prescribe.” 15
U.S.C. § 78j(b).
39
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the statements made, in the light of the circumstances under which they were made, not
misleading . . . in connection with the purchase or sale of any security.”2 At the time of
its adoption, Rule 10b-5 “had no relation in the commission’s contemplation to private
proceedings” (Freeman 1967). Instead, its purpose was merely to close a loophole in the
SEC’s securities fraud enforcement authority, allowing the SEC to pursue fraud commit-
ted in connection with the purchase as well as the sale of securities. Previously enacted
rules prohibited only the fraudulent sale of securities, or applied only to brokers and
dealers.3
The period of exclusive government enforcement of Rule 10b-5 proved short lived,
however. Not long after its adoption, the federal judiciary recognized a private right
to sue under Rule 10b-5. The first case to do so was Kardon v. National Gypsum Co.,
decided by the District Court for the Eastern District of Pennsylvania in 1946.4 Kardon
was subsequently followed by “an overwhelming consensus of the District Courts and
Courts of Appeals,”5 and by the Supreme Court a quarter century later in Superintendent
of Insurance v. Bankers Life & Casualty Co.6
Kardon’s rationale was that “the disregard of the command of a statute is a wrongful
act and a tort,” entitling the injured party to compensation.7 The Supreme Court has since
rejected this approach to the implication of private rights to sue in favor of one focused
on Congressional intent.8 The existence of several express private causes of action in the
federal securities laws would almost certainly preclude any inference that in 1934 Congress
intended to create a private right to sue to enforce rules promulgated under Section 10(b)
(Grundfest 1994). But even though Kardon would not have been decided the same way
under modern precedents, “the existence of a private cause of action for violations of
[Rule 10b-5] is now well established” and has been repeatedly reaffirmed.9
In Kardon and other early cases, the implied right under Rule 10b-5 operated as
essentially a federalized version of the common law fraud cause of action. The service
of process provisions attached to Rule 10b-5 were more generous, but otherwise there
was little difference between Rule 10b-5 and common law fraud claims. The elements of
a private Rule 10b-5 claim were interpreted more or less coextensively with the e lements
of a common law fraud claim—requiring, inter alia, a plaintiff to prove actual reliance
on the defendant’s misstatements (Rose 2015). Typical factual allegations were also
2
17 C.F.R. § 240.10b-5.
3
See Exchange Act Release No 3230, 7 Fed. Reg. 3804, 3804 (May 21, 1942).
4
69 F. Supp. 512, 513–14.
5
Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 79 (2006) (internal quotation
marks omitted).
6
404 U.S. 6, 13 n.9 (1971).
7
69 F. Supp. at 513.
8
See Alexander v. Sandoval, 532 U.S. 275, 286–88 (2001) (discussing the evolution of the
Court’s jurisprudence on implied private rights of action).
9
Ernst & Ernst v. Hochfelder, 425 U.S. 185, 196 (1976); see also Herman & Maclean v.
Huddleston, 459 U.S. 375, 380 (1983) (“The existence of this implied remedy is simply beyond
peradventure”). Indeed, Congress has enacted significant pieces of legislation that acknowledge
the existence of the right. See, e.g., Pub. L. No 104-67, Sec. 101(a)–(b), §§ 21D, 27, 109 Stat. 737,
737, 743 (codified as amended at 15 U.S.C. §§ 77z-1, 78u-4 (2006)); Pub. L. No 105-353, Sec. 101(a)
(2), 101(b)(2), § 21D, 27, 112 Stat. 3227, 3230, 3233 (codified at 15 U.S.C. §§ 77z-1, 78u-4).
M4633-GRIFFITH_t.indd 40 30/10/2018 08:16

The Rule 10b-5 private right of action 41
similar—both types of suit tended to involve face-to-face dealings and privity of contract
between the plaintiff and the defendant (Langevoort 2010).10 Neither type of claim was
susceptible to aggregation via anything remotely similar to the modern optout class
action. Not surprisingly, then, the early version of the Rule 10b-5 private right could be
justified in much the same way as the common law fraud cause of action: as serving (to
some extent at least) the goals of both corrective justice and deterrence.
1.1 Corrective Justice
The leading deontological defense of American tort law is based on corrective justice
theory. Corrective justice is served when a wrongdoer is made to make whole the party
they have wronged for the harm caused. The “duty to rectify is based not on the fact of
injury but on the conjunction of injury and wrongdoing”; in other words, the “injurer
must do wrong [] as well as do harm [], and the victim must be wronged [] as well as
harmed” (Posner 1981).
Early Rule 10b-5 cases brought against individual defendants clearly fit this mold, as
did their common law counterparts. Again, these cases typically involved a defendant who
stood in privity with the plaintiff, having either sold the plaintiff securities at a fraudulently
inflated price or purchased securities from the plaintiff at a fraudulently deflated price.
The defendant’s gain therefore approximated the plaintiffs’ loss. So whether defendants
were forced to disgorge their profits or pay compensatory damages, the cases resulted in
wrongdoers making whole their victims, consistent with corrective justice ideals.
Early fraud cases involving corporate defendants, whether brought under Rule 10b-5
or the common law, fit less comfortably with traditional notions of corrective justice.
Corporations are not themselves moral agents capable of doing “wrong.” Nor did
corporate liability in such cases turn on whether the shareholders standing behind the
corporate fiction acted in a morally blameworthy manner. Instead, it was strictly imposed
upon a showing of culpability by the corporate agent responsible for the misstatement
or omission, under common law principles of respondeat superior liability.11 As Ernest
Weinrib (Weinrib 1995, 186) has explained:
Since corrective justice is the normative relationship of sufferer and doer, respondeat superior fits
into corrective justice only if the employer can, in some sense, be regarded as a doer of the harm.
Corrective justice requires us to think that the employee at fault is so closely associated with the
employer that responsibility for the former’s acts can be imputed to the latter.
Weinrib points to the preconditions for respondeat superior liability—viz., that the agent
responsible for the harm (1) was an employee subject to the employer’s control (rather
than an independent contractor) and (2) committed the act in the scope of employment
(rather than within an independent course of conduct not intended by the employee to
10
Suits by clients against broker-dealers represent another paradigmatic early Rule 10b-5 case.
Such suits are outside the scope of this chapter.
11
The common law doctrine of respondeat superior liability has long been applied in Rule
10b-5 cases, notwithstanding the 1934 Act’s express provision imposing liability on “control
persons” (Prentice 1997).
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serve any purpose of the employer)—as creating the conditions under which it might be
appropriate to treat the employer as if it were a “doer” of the harm, and thus morally
responsible.
Weinrib’s account provides at least a plausible corrective justice defense of the early
Rule 10b-5 cases brought against corporate defendants. When corporate defendants were
sued in these early cases, they typically stood in privity with the plaintiffs—having either
issued securities to, or repurchased securities from, those plaintiffs (Langevoort 2010).12
So the corporate defendants (and, ultimately, their shareholders) directly benefited from
the fraud, such that it was arguably appropriate to treat the corporation as the “doer” of
the fraud committed by the corporate agent.
1.2 Deterrence
The leading utilitarian defense of American tort law is grounded in deterrence theory.
According to this theory, law should incentivize socially efficient behavior, with the
ultimate goal of maximizing social welfare (Coase 1960; Calabresi 1970; Landes & Posner
1987).
Securities fraud creates no social benefits but creates real social costs. For example, it
increases the cost of capital, upsets the efficient allocation of economic resources in the
economy, and may entice wouldbe victims to incur deadweight costs in an effort to avoid
being victimized (Fox 2009a). To the extent that early private Rule 10b-5 cases operated
to discourage people from committing fraud or from taking inefficient measures to
protect themselves from becoming fraud victims, then, it could potentially be defended
on deterrence grounds—only potentially, because the costs created by the liability system
must also be taken into account. To be justified under deterrence theory, a liability regime
must save more in social costs than it creates in enforcement costs; optimal deterrence is
achieved when the sum of those costs is minimized.13
Early cases against individual defendants, whether brought under Rule 10b-5 or
the common law, likely helped to discourage securities fraud. By threatening wouldbe
fraudsters with personal liability, these cases made committing fraud less profitable on
an expected value basis. To be sure, looked at in isolation the damage awards threatened
by these early private suits would have been inadequate to fully deter. While the actual
remedy imposed would work to roughly offset the gain to the defendant, the likelihood
that suit would be brought and relief awarded was less than 100 percent. Thus, the
specter of private liability alone could not have been expected to completely eliminate the
incentive to commit securities fraud. But private liability was not (and has never been)
the only source of sanction for securities fraud: the possibility of criminal punishment,
civil fines imposed by public authorities, and reputational costs must also be factored into
the wouldbe fraudster’s cost–benefit analysis.
12
See also Joseph v. Farnsworth Radio & Television Corp., 99 F. Supp. 701, 706 (1951) (“As to
the corporate defendant, there is no allegation of its involvement in either a purchase or sale of
stock and, this indispensable ingredient lacking, its motion to dismiss . . . must be granted without
leave to plead over”).
13
To be truly optimal, the liability regime must also minimize social costs relative to other
possible forms of legal intervention (Shavell 2004).
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In light of these alternative sanctions, perhaps more important to the deterrence justi-
fication for early private Rule 10b-5 liability was the promise of compensation it held out
to potential victims.14 By promising potential victims compensation for fraud losses, early
Rule 10b-5 cases served to discourage potential victims from taking socially inefficient
measures to protect themselves from fraud. Notice that this could be achieved even if the
defendant made to pay the sanction were not the wrongdoer, just as the goal of deter-
ring would-be fraudsters could be achieved even if the injured party did not receive the
sanction. Granting victims the right to sue wrongdoers, in other words, is not inherently
required by deterrence theory; who prosecutes wrongdoers, and who compensates victims,
depends instead on context-specific efficiency considerations. By contrast, “corrective
justice repudiates reasons for liability that are normatively relevant to either of the parties
in isolation from the other” (Weinrib 2011).
For this reason, early securities fraud suits brought against corporate defendants
are easier to defend under a deterrence theory than under a corrective justice theory.
The deterrence theorist is not bothered by the lack of culpability on the part of the
corporate defendant, he cares only whether exposing the corporate defendant to liability
furthers efficiency goals. Respondeat superior liability has the potential do so in a few
well-recognized ways.15
First, when liability forces an employer to internalize the social costs of its agent’s
delicts, it creates incentives for the employer to invest a socially efficient amount in internal
controls to prevent those delicts. Of course, a corporate employer is not a natural person
but rather a legal fiction, one characterized by a separation of ownership from control.
As its residual claimants, it is ultimately the shareholders of the corporation who bear
the cost of corporate-level liability. A more precise statement of what respondeat superior
liability is hoped to do in the corporate context, then, is to incentivize shareholders to use
the corporate governance tools available to them to push managers to take efficient steps
to deter misconduct within the organization. A second oft-cited efficiency justification
for respondeat superior liability flows from the reality that the employees responsible for
a harm might be judgment proof; in light of this, respondeat superior liability can help
assure potential victims that they will be compensated if harmed, thereby reducing their
incentive to invest in precautions. Finally, it has been argued that respondeat superior
liability can increase social welfare by serving essentially an insurance function, shifting
the risk of loss from a less to a more efficient risk bearer.
Each of these economic justifications for corporate liability could be invoked to defend
early Rule 10b-5 cases, just as they could be invoked to defend traditional common
law fraud cases. Recall that in these early cases the corporation’s shareholders typically
benefited from the fraud because the corporation had issued securities to, or repurchased
securities from, the plaintiff. If not held liable for such fraud, shareholders might not
only cause their firms to underinvest in efforts to prevent it, but might actively encourage
it. Second, the increased potential for compensation likely encouraged potential victims
14
Potential victims could also seek redress under the common law of fraud, but state law
service of process provisions stood as an obstacle in certain cases.
15
The discussion that follows is necessarily simplified; for more rigorous analyses of the
potential efficiency of vicarious liability see Kornhauser 1981; Kornhauser 1982; Sykes 1984; Sykes
1988; Arlen 1994; and Arlen & Kraakman 1997.
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to rely on their counterparty’s statements with less perceived need to invest in expensive
verification efforts or to take other precautions. Finally, these early suits may have resulted
in efficient risk shifting, as they typically served to spread the losses of a single or discrete
set of plaintiffs across a larger group of corporate shareholders.
Nothing has been said thus far about the costs of the early Rule 10b-5 private liability
system, which, as noted at the outset, must be accounted for in the deterrence equation.
These costs include both the direct costs of litigating cases as well as potential overdeter-
rence costs. Fraud liability can produce overdeterrence costs when potential defendants
react to the fear of erroneous prosecution and legal error. Such fear might lead potential
defendants to spend more time and money than is socially useful verifying the accuracy
of disclosures, for example. It might also prompt them to withhold information that could
be helpful to investors, out of fear it will be deemed misleading, or, conversely, to bury
investors in an avalanche of trivial information, out of fear that its omission will give rise
to liability. Fraud liability can also produce overdeterrence costs even if only meritorious
cases are anticipated, if it is vicariously imposed on employers and expected sanctions
are set above fraud’s social costs; this would incentivize rational employers to overinvest
in fraud prevention measures relative to what is socially optimal.
While it is difficult to know for sure, the costs generated by private Rule 10b-5 enforce-
ment in the early years were probably not significant, or at least not so great as to dwarf
its deterrence benefits. The measure of damages used in these cases may have been a good
proxy for the social costs of the fraud, or at least not wildly in excess. Moreover, given that
the defendants in these cases stood in privity with the plaintiffs, use of either a disgorge-
ment or out-of-pocket measure of damages was necessary to eliminate the defendant’s
gain from the fraud. In addition, the American Rule for attorney’s fees, combined with
the traditional common law restrictions which applied to these claims—such as the need
to prove actual reliance and damages—likely served to discourage frivolous litigation
(Stewart & Sunstein 1982).
2. THE BASIC METAMORPHOSIS
In the decades following Kardon, doctrine evolved in such a way as to unmoor the private
Rule 10-5 cause of action from its common law roots. These changes facilitated the
emergence of the “fraud-on-the-market” (FOTM) class action that dominates private
Rule 10b-5 litigation today. This section describes the development and key characteristics
of the FOTM class action. The following section 4 explains why FOTM class actions are
more difficult to reconcile with corrective justice and deterrence theory than the early Rule
10b-5 suits, situating the scholarly literature regarding the social desirability of private
Rule 10b-5 enforcement within this theoretical framework.
2.1 Doctrinal Innovation
The first doctrinal development of note was the abandonment of any privity requirement.
Beginning in the 1960s, courts began to recognize the right of plaintiffs to sue defendants
under Rule 10b-5 even if the defendant was neither a counterparty to the plaintiff’s trade
nor a contemporaneous trader (Langevoort 2010). Thus, courts interpreted Rule 10b-5
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as permitting suit by a secondary market purchaser or seller against a nontransacting

corporate defendant for misstatements or omissions made by the corporation’s agent,
assuming (at first, at least) that the plaintiff actually relied upon those misstatements in
entering into the secondary market transaction.
The need to prove actual reliance was the next feature of the common law to be
modified. In Basic v. Levinson the Supreme Court recognized a presumption of reliance
in private Rule 10b-5 cases involving securities that trade in efficient markets.16 According
to Basic, plaintiffs are entitled to this presumption if they can show that: (1) the alleged
misrepresentation was publicly known; (2) it was material; (3) the stock traded in an
efficient market; and (4) the plaintiff traded the stock between the time the misrepresenta-
tion was made and when the truth was revealed. The presumption Basic endorses is not
that the plaintiffs actually relied on the alleged misstatement itself, but rather that they
relied on the integrity of the stock’s market price, which is itself presumed to have been
distorted by the fraud through the operation of the efficient capital markets hypothesis.
The reliance presumed by Basic is therefore “fundamentally different” from the reliance
that had traditionally been required in common law fraud cases (Fox 2005).
Basic, combined with the Supreme Court’s earlier recognition of a presumption of
reliance in omission cases,17 thus extended the right to sue nontransacting corporate
defendants under Rule 10b-5 to all secondary market purchasers of the company’s stock,
at least if that stock was listed on an exchange and actively traded. This includes passive
investors who pay no attention to corporate disclosures and thus would be unable to
state a common law fraud claim. Of course, most passive investors have (and, according
to modern portfolio theory, should have) only a small amount invested in any particular
firm. Therefore, it would be uneconomical for most passive investors to enforce this right
in an individual suit. But another innovation served to remove this barrier to enforcement.
Revisions to the Federal Rules of Civil Procedure introduced in 1966 made it possible for
plaintiffs to aggregate claims in an optout class action under Rule 23(b)(3), assuming that
common issues predominate over individualized ones. Allowing investors to access this
procedural device was a major goal of the Supreme Court’s decision in Basic.18 By elimi-
nating the need for plaintiffs to prove individual reliance, that decision both expanded the
universe of investors who can state a claim and facilitated the aggregation of their claims
via the class action.
2.2 FOTM Class Actions: Some Key Characteristics
Thus was born the modern “FOTM class action”, which is defined here to mean a Rule
10b-5 class action brought on behalf of secondary market traders against a nontransact-
ing public company defendant for alleged misstatements or omissions by corporate
agents, upon which the plaintiff class did not directly rely. The FOTM class action bears
little resemblance to early Rule 10b-5 cases or to traditional common law fraud cases.
In addition to involving an expanded set of plaintiffs and defendants, an altered set
16
485 U.S. 224 (1988).
17
Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972).
18
See Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2408 (2014).
M4633-GRIFFITH_t.indd 45 30/10/2018 08:16

of elements, and the aggregation of claims—as described below—FOTM class actions

involve defendants with different motives, raise different stakes, and create different incen-
tives to sue and settle than existed in the early years of private Rule 10b-5 enforcement.
When a fraud case involves privity of dealing between the plaintiff and the defend-
ant, there is no mystery concerning the defendant’s probable motive. It is obvious why
individual defendants selling (or buying) securities for their own account would lie to
plaintiffs in an attempt to inflate (or deflate) the securities’ perceived value: every dollar
the plaintiff loses in the transaction goes into the defendant’s pocket. The owners of a
corporation that is selling (or buying) securities for its own account similarly benefit; thus,
a corporate agent loyal to shareholder interests might be inclined to mislead when the
company is engaged in a primary issuance or share buyback.
In FOTM cases, however, privity of dealing is missing; moreover, corporate defend-
ants are typically not involved in any contemporaneous trading. Thus, the corporation’s
shareholders as a class have no obvious motive to support the fraud.19 As for the cor-
porate agents responsible, their most probable motive is a self-serving one: to hide poor
performance, thus allowing them to game incentive compensation programs and avoid
other forms of shareholder discipline. Indeed, most scholars today conceive of fraud-on-
the-market as a form of agency cost.20 Nevertheless, the corporate agents responsible for
fraud-on-the-market are still treated as having acted within “the scope of employment”
and thus their corporate employer remains liable for their actions under the doctrine of
respondeat superior.
The absence of privity in FOTM suits also operates to sever the connection that
existed in early Rule 10b-5 cases between the plaintiffs’ loss and the defendant’s gain. In
a FOTM suit, the class members’ losses are other secondary market traders’ gains, and
the defendants’ gains—to the extent there are any—are something altogether different.
Disgorgement and compensatory damages, while roughly interchangeable in early Rule
10b-5 cases, are therefore dramatically different remedies in the FOTM context, with the
latter dwarfing the former in magnitude. The courts have endorsed the compensatory
measure in FOTM suits, such that plaintiffs stand to recover their full out-of-pocket losses
attributable to the fraud, with no offset for the gains to their innocent trading counterpar-
ties (Langevoort 2010). This, when combined with Basic’s extension of the right to sue
under Rule 10b-5 to nonreliers and the availability of class treatment, results in enormous
and unprecedented potential liability.21
This expanded liability in turn creates a very strong incentive for entrepreneurial
attorneys to bring FOTM class actions on investors’ behalf, given that attorneys’ fees
19
Only the subset of shareholders intending to sell their shares at the time of the fraud would
clearly benefit. Of course, scenarios could be imagined wherein a nontrading corporation and its
shareholders would benefit from FOTM; my point is simply that the strong motive to commit fraud
that is present in every privity of dealing case is lacking in the FOTM context.
20
Examples include Arlen & Carney 1992; Pritchard 1999; Macey 1991. A competing behavio-
ral account has also been advanced (Langevoort 1997).
21
It has been observed that FOTM damages “can be staggeringly large, usually far in excess
of any benefit the defendants hoped to gain from the misrepresentations or concealment”;
“multibillion-dollar cases are not infrequent, and hundred-million-dollar cases are ordinary”
(Langevoort 2010).
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are driven, to a significant extent, by recovery size. It also affects the quality of cases:
the larger the potential payout, the more willing a rational plaintiffs’ lawyer is to pursue
a case with a smaller likelihood of success. Conversely, the enormous liability threatened
creates a very strong incentive for defendants to settle FOTM class actions—even cases
they believe are weak, given the uncertainty that surrounds some of Rule 10b-5’s elements
and the unpredictability of juries (Rose 2017).22 Indeed, gambling with such enormous
potential liability at trial is something that corporations almost never do; empirical
studies confirm that FOTM class actions that are not dismissed pretrial settle in all but
the very rarest circumstance.23 This has the potential to fuel an unvirtuous cycle, as the
settlements prevent judicial clarification of Rule 10b-5’s uncertain elements and make
the filing of borderline suits more attractive to plaintiffs’ counsel. Congressional concern
that the “merits don’t matter” in FOTM settlements led to the enactment of the Private
Securities Litigation Reform Act of 1995 (PSLRA).24 Among other things, the PSLRA
adopted reforms that make pretrial dismissal of FOTM class actions easier for defendants
to achieve.25
When FOTM class actions result in settlement rather than dismissal, the corporation
almost always pays the entire settlement amount, either directly or through insurance;
contribution by individually named defendants—the corporate agents actually responsi-
ble for the alleged fraud—is extremely rare.26 The fact that corporate defendants tend to
exclusively fund settlements is a very important characteristic of FOTM suits. It means,
of course, that public company shareholders are the ones who ultimately pay, which has
given rise to the familiar observation that there is a “circularity” involved in FOTM class
actions.
This circularity exists at the micro and macro level. In a particular case some portion
of the class will be on both sides of the “v,” as some class members will continue to hold
shares in the company who in turn pays the settlement. Some portion of the class, in other
words, will effectively fund a portion of their own recovery (Cox 1997). On the macro
level, over time diversified public company shareholders will likely find themselves on the
paying end of FOTM suits as often—if not more often—as they find themselves on the
receiving end, even if they do not stand on both sides in particular cases (Coffee 2006). 27
22
Other factors may also influence settlement, such as the personal interests and risk aver-
sion of the agents who control the corporation’s litigation decisions and insurance coverage
considerations.
23
Less than 1 percent of securities class action filings from 1997 to 2015 reached a trial verdict
(Aganin 2015).
24
Pub. L. No 104-67, 109 Stat. 737 (codified as amended in scattered sections of 15 U.S.C.
and 18 U.S.C.). The quoted phrase is attributable to an influential—albeit controversial (Seligman
1994)—article by Professor Janet Cooper Alexander (Alexander 1991).
25
For an overview, see Rose 2008.
26
An empirical study of securities class actions filed between 2006 and 2010 found that outside
directors contributed in none of the settled cases, and officers contributed in only 2 percent
(Klausner et al. 2013).
27
As Professor Langevoort has explained, inactive investors who pursue “buy and hold strate-
gies make it somewhat more likely that they will be non-trading shareholders of an issuer defendant
(and suffer their share of the resulting loss) than members of the plaintiff class who stand to gain
from the settlement or judgment” (Langevoort 1996).
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Thus, diversified investors may not, in the grand scheme, benefit from FOTM settlements
on a net basis, particularly once litigation costs are taken into account.
A related macro point focuses not on the circularity of settlement payments at the back
end of litigation but on the out-of-pocket losses passive shareholders can be expected
to incur from secondary market fraud on the front end. As Daniel Fischel and Frank
Easterbrook first observed, secondary market traders lose when they purchase securities
at an artificially inflated price, but they profit when they sell at an artificially inflated
price (Easterbrook & Fischel 1985); therefore, well-diversified investors’ out-of-pocket
gains and losses from secondary market fraud may likewise tend toward zero over time
(Mahoney 1992; Alexander 1996; Grundfest 2014).
The circularly related claims described above are sometimes overstated.28 A perfect
netting of settlement payouts, or of fraud gains and losses, will not occur vis-à-vis
individual diversified investors, even if it occurs vis-à-vis diversified investors as a class
(Evans 2015). Nor will it occur to the extent that there is insider trading. Moreover, not
all public company shareholders are diversified.29 Stated more modestly, however, the
circularity claims are unassailable. It is clear that: (1) the net out-of-pocket losses suffered
by a diversified investor over time due to FOTM will likely be far less than the investor’s
total out-of-pocket losses; and (2) over the long haul, a diversified investor will likely pay
out, as an owner of settling corporate defendants, a significant percentage of what it
recovers in FOTM litigation.
3. THE SOCIAL FUNCTION OF THE MODERN RULE 10B-5

CLASS ACTION: AN INTRODUCTION TO THE SCHOLARLY
DEBATE
With the foregoing characteristics of modern Rule 10b-5 litigation in mind, let us return
to the topic of social purpose. Whereas the early version of the private right under Rule
10b-5 found support in corrective justice and deterrence theory, can the same be said of
private Rule 10b-5 enforcement today? This section takes up that question, using it as
a vehicle for understanding the main scholarly debates surrounding the social worth of
FOTM class actions.
3.1 Corrective Justice
As explained in section 1, the essence of corrective justice theory is that a wrongdoer is

made to make whole their victim. Early Rule 10b-5 cases involving individual defendants
could persuasively be defended on this ground. Those involving corporate defendants
could also be reconciled with corrective justice theory, but only if the corporation could
properly be characterized as the “doer” of the agent’s act of fraud—a plausible leap when,
28
For scholarly critiques of the circularity arguments, see Evans 2007; Park 2009; Dubbs 2009;
Spindler 2016.
29
For a discussion of the function of corporate liability for securities fraud in firms with
concentrated ownership structures, see Gelter 2013.
M4633-GRIFFITH_t.indd 48 30/10/2018 08:16

as was typical in the early cases, the corporation itself stood in privity with the plaintiff
and thus benefited directly from its agent’s fraudulent communications.
As explained in the last part, FOTM class actions result in corporate rather than
individual liability in all but the rarest cases. Moreover, corporate defendants in FOTM
suits typically do not stand in privity with the plaintiffs and typically have not engaged in
any trading in their own shares contemporaneous with the fraud. Most scholars therefore
believe that FOTM is typically motivated by the selfish desires of disloyal corporate
agents, who wish to hide their poor performance from shareholders. In light of this, it is
hard to view the corporation and ultimately its shareholders as “doers” of the fraud—they
are more plausibly characterized as among its victims.
Thus, the corrective justice case for FOTM class actions is difficult to make, and there
are few scholars today who seek to defend FOTM class actions on this basis (Burch
2007).30 If compensation is being paid to injured parties by someone other than the
wrongdoer—or other than someone who should properly be held accountable for the
wrongdoer’s conduct—then it needs to find support under some theory other than cor-
rective justice. The usual candidate is deterrence theory, which is taken up below.
3.2 Deterrence
As explained in section 1.2, holding a corporation strictly liable for its agent’s delicts under
the doctrine of respondeat superior is potentially consistent with deterrence theory to the
extent that it forces cost internalization, discourages victim precautions, and/or reduces
riskbearing costs through loss shifting. In a deterrence framework, these benefits must
be weighed against the costs of the system, including overdeterrence costs. As discussed
later in the chapter, whether FOTM class actions in fact produce these benefits or, assum-
ing they do, whether the costs of the liability system outweigh the benefits created, are
the meta questions that expressly or implicitly animate much of the scholarly literature
focused on Rule 10b-5.
3.2.1 Forced cost internalization

If the threat of respondeat superior liability is to promote socially efficient corporate
investments in fraud prevention, the expected sanction must approximate the expected
social costs of the harm sought to be prevented. Only then will the specter of liability
prompt the desired level of firm investment. In the FOTM context, many scholars
believe that this precondition is not satisfied. Whereas in the early Rule 10b-5 cases the
out-of-pocket damages measure may have been a good proxy for the social costs of the
harm—or at least coextensive with the defendants’ gain from engaging in the fraudulent
transaction—the same cannot be said in the FOTM class action context. Many scholars
believe that awarding out-of-pocket damages to all secondary market purchasers vastly
overstates the social costs of FOTM, even when discounted to reflect the probability of
nondetection; moreover, it likely vastly overstates the gain (if any) to the corporation
resulting from the fraud (Easterbrook & Fischel 1985; Langevoort 1996; Alexander
30
For a challenge to the widespread view of passive investors as “innocent” when it comes to
FOTM, see Mitchell 2009.
M4633-GRIFFITH_t.indd 49 30/10/2018 08:16

1996). This has led to a variety of academic proposals aimed at correcting the problem
by replacing the out-of-pocket measure with better tailored substitutes. For example,
Donald Langevoort and Janet Cooper Alexander have argued for a system of civil fines
(Langevoort 1996; Alexander 1996), and Adam Pritchard has argued for the adoption of
a disgorgement measure of damages (Pritchard 2008).31
A more fundamental challenge to this rationale for FOTM class actions flows from
the fact that forced cost internalization may simply be unnecessary. To the extent that the
characterization of FOTM as an agency cost is correct, shareholders have natural incen-
tives to use the tools of corporate governance available to them to try to prod managers
to invest firm resources in its prevention (Rose 2014). This has led to a recharacterization
of the purpose of FOTM class actions—rather than serving to force the corporation
to internalize costs, FOTM class actions might be thought of as a tool in shareholders’
corporate governance toolkit.32 For example, this author has argued that FOTM suits
might be thought of as a way for shareholders to outsource the monitoring of corporate
agents (Rose 2014). Under this conception, the class action bar—lured by the prospect
of large attorneys’ fees—is delegated the job of detecting FOTM; once the discovered
fraud is revealed through the filing of a class action complaint, shareholders may in turn
impose punishment as appropriate on the responsible individuals (with the assistance
of market forces and perhaps public enforcement authorities). The threat of this might
in turn deter corporate agents from committing FOTM in the first place and encourage
boards to put in place good internal controls to prevent it. Viewed this way, it is not
troubling that FOTM class actions are ultimately funded by innocent shareholders, as
this is a feature of corporate governance generally. Nor is it troubling that FOTM class
actions do not directly impose punishment on corporate officers—their function is mainly
informational. What is troubling under this view, however, is the inability of shareholders
to vote to shield a company from the reach of FOTM class actions if they so choose, a
right that some scholars have advocated should be afforded them (Bratton & Wachter
2011; Pritchard 2008). Similarly troubling are statistics suggesting that FOTM class
actions do a poor job of discovering frauds not previously made public through other
means (Dyck et al. 2010) and, as discussed infra, generate significant deadweight costs.
Thus, the efficiency of using FOTM class actions as an informational device is highly
questionable (Rose 2014; Bratton & Wachter 2011; Rose & Squire 2011).
Assuming that there are externalities from FOTM that public company shareholders
do not naturally internalize,33 or do not otherwise internalize via the threat of public
enforcement or market sanction,34 at least two further challenges to the forced cost-
internalization rationale for FOTM class actions have been raised. The first flows from
31
Easterbrook & Fischel have also suggested a rule of the wrongdoer’s profits for secondary
market fraud (Easterbrook & Fischel 1985). A related concern noted in the literature is that it is
difficult for corporate defendants to predict expected damages (Alexander 1996).
32
For a critical assessment of some variants of this argument, see Bratton & Wachter 2011.
33
For a description of the costs securities fraud can impose on parties other than investors, see
Velikonja 2013.
34
One empirical study found that a firm’s reputation losses as a result of financial fraud
“exceeded the legal penalty by over 7.5 times, and . . . the amount by which firm value was artifi-
cially inflated by more than 2.5 times” (Karpoff et al. 2008).
M4633-GRIFFITH_t.indd 50 30/10/2018 08:16

the circularity claims discussed in the last part. To the extent that shareholders expect
to be on the receiving end of FOTM class action settlements as often as the paying end,
the threat of those settlements will do little to incentivize them to encourage corporate
investments in fraud prevention measures (Rose & Squire 2011). In this scenario, they will
only truly be forced to internalize the deadweight litigation costs associated with FOTM
class actions. It would be fortuitous indeed if those costs happened to approximate the
externalities generated by FOTM.
The second flows from the reality that litigation costs, as well as the actual settlement
payments in FOTM suits, are mostly paid through insurance, such that the costs share-
holders are forced to bear as a result of FOTM class actions are largely transformed into
the ex ante payment of insurance premiums. Empirical studies by Tom Baker and Sean
Griffith find that insurers attempt to price policies on the basis of risk (Baker & Griffith
2007a), but that “there is not a large marginal difference between the . . . premiums paid
by a well-governed firm relative to a poorly governed firm” (Baker & Griffith 2007b).
Moreover, insurance companies do little to monitor or otherwise influence a corporation’s
fraud prevention efforts to manage litigation risk over the life of the policy (Baker &
Griffith 2007b). Thus, the prevalence of insurance may dampen the deterrence potential
of FOTM litigation.
3.2.2 Discouragement of victim precautions

As explained in the previous section, the promise of compensation that corporate liability
offers potential plaintiffs might also promote efficient outcomes to the extent that it
discourages investors from taking socially inefficient steps to protect themselves from
fraud, including, in the extreme, dropping out of the capital markets altogether. Several
challenges have been raised to this rationale for FOTM class actions, as well.
The most fundamental challenge is premised on Fischel & Easterbrook’s observation
about the circularity of secondary market fraud gains and losses. The claim is that, to
the extent that diversified investors’ losses from secondary market fraud are largely offset
by gains, those investors have little incentive to incur costs to avoid it in the first place.
Thus, promising them compensation is unnecessary (or at least unwarranted in light of
the transaction costs associated with litigation) (Pritchard 2015). James Spindler has
recently questioned the logic of this argument, emphasizing that everyone would prefer to
win more than they lose from secondary market fraud (Spindler 2016). In the absence of
compensatory FOTM class actions, his argument proceeds, more passive investors would
choose to adopt active investment styles in an effort to be a net winner from FOTM.35
An independent challenge to this rationale is presented by studies suggesting that
investors recover only a small percentage of their out-of-pocket losses in FOTM class
actions.36 If expected recoveries are negligible, then the specter of FOTM class actions will
do little to dampen investors’ incentives (whatever those incentives might otherwise be) to
protect themselves from FOTM. Solutions to this problem are provided in the literature,
35
Information traders should be compensated for fraud losses (Fisch 2009), but FOTM class
actions are a poor device for delivering compensation to this subset of investors. For a fuller discus-
sion of this point, see Rose 2014 at 1244 n.38, and references cited therein.
36
For a discussion of these studies, see Evans 2007.
M4633-GRIFFITH_t.indd 51 30/10/2018 08:16

and vary depending on its presumed source. One explanation for inadequate recoveries is
lawyer–client agency costs; thus we might understand the voluminous literature on how
to better align the interests of class counsel with those of the class as responsive to this
critique.37 Another possible explanation is that Congress and the courts have made it too
difficult for plaintiffs to prevail in Rule 10b-5 cases, with the obvious solution being a
rollback of the barriers that have been erected (Sale 1998).
A final challenge to this rational for FOTM class actions points to alternative sources,
real or hypothetical, for FOTM victim compensation. For example, scholars have pointed
to the Fair Funds provision in the Sarbanes–Oxley Act of 2002 (Rose 2008). This provi-
sion permits the SEC to itself deliver compensation to injured investors in cases where it
has obtained relief. Whether one views this as a sufficient source of victim compensation
depends on one’s views about not only the need for compensation in the first instance, but
also the efficacy of public versus private enforcement. As another example, Alicia Davis
Evans has argued for the creation of an investor compensation fund, to be paid for by a
tax on securities transactions, which she argues would be a better alternative to FOTM
class actions as a source of victim compensation (Evans 2007).
3.2.3 Reduction of riskbearing costs

Corporate liability also has the potential to increase social welfare to the extent that it
operates to shift the risk of loss to parties who are better able to bear it. Many scholars
disregard this rationale for FOTM class actions, arguing that shareholders can more
cheaply reduce their FOTM riskbearing costs through diversification: by investing only a
small amount in many firms, diversified investors avoid the risk of suffering a large out-
of-pocket fraud loss and they also set themselves up to experience offsetting gains from
FOTM (Arlen & Carney 1992; Fox 2009b). Not every scholar agrees that diversification
moots the insurance case for FOTM class actions. For example, James Park has argued
that FOTM suits might serve a useful insurance function due to the limits of diversifica-
tion (Park 2009). Like Park, Alicia Davis Evans argues that diversification is inadequate
to protect against the risk of significant losses attributable to FOTM, although as noted
above, she believes that an investor compensation fund could more efficiently compensate
investors for FOTM losses than FOTM class actions do (Evans 2007). The costs of
FOTM class actions are considered next.
3.2.4 Costs of FOTM class actions

Even if FOTM class actions produce social benefits in some or all of the manners
described above, the matter of cost must be considered before a conclusion can be reached
about their efficiency. Indeed, most critics of FOTM class actions concede that they may
produce some deterrence benefits—or at least concede the impossibility of disproving
otherwise—but nevertheless argue that the costs of FOTM class actions likely dwarf these
benefits.38 A proper deterrence accounting would factor in the costs which FOTM class
37
Examples include Coffee 1983; Coffee 1986; Macey & Miller 1991.
38
For example, Professor Langevoort has remarked that “[e]ven if we concede some residually
desirable, insurance-like, compensatory element to the current regime, it is dwarfed by the transac-
tion costs involved” (Langevoort 1996).
M4633-GRIFFITH_t.indd 52 30/10/2018 08:16

actions impose on the judiciary and litigants, including time and distraction on the part
of corporate personnel. It would also include an estimate of overdeterrence costs, which
are likely far greater than in the early years of private Rule 10b-5 enforcement.
Recall that in a regime of vicarious liability, overdeterrence costs can result if corporate
sanctions are set too high—leading to a potential overinvestment of firm resources in
fraud prevention—or if legal error is feared. As already noted, many scholars have argued
that the damages threatened in FOTM class actions likely vastly exceed the true social
costs of FOTM, something that was likely not true in the early years and which has
prompted scholarly reform proposals. Moreover, the enormous damages threatened by
FOTM class actions may encourage the filing of borderline suits and, in a vicious cycle,
their settlement (assuming survival past a motion to dismiss). An ostensible desire to
reduce overdeterrence costs has led to both Congressional and judicial efforts to increase
defendants’s ability to secure early dismissal of low-merit suits. The scholarly literature
examining the merits of FOTM suits, as well as the effect of these reform efforts, is
abundant.39
A final, additional factor that must be considered in a deterrence analysis is whether
alternative enforcement mechanisms could generate a greater net savings in social costs
than the existing FOTM class action regime. Scholars have argued that a variety of such
mechanisms exist or could be created. For example, many have argued that a system
focused more on individual liability would produce greater social welfare gains (Arlen &
Carney 1992; Fox 2009a; Booth 2007), and have offered suggestions for how the current
FOTM class action regime might be reformed to achieve this result (Langevoort 2007;
Coffee 2006; Pritchard 2008). Other scholars have pointed to enhanced public enforce-
ment efforts as a better alternative to FOTM class actions (Rose 2010; Bratton & Wachter
2011). A variety of other proposals in this spirit exist (Fox 2009a; Rose 2008; Pritchard
1999; Evans 2007).
4. CONCLUSION
The Rule 10b-5 private right of action has changed considerably since first implied in
1946. While the early version of the right could find an easy defense under traditional cor-
rective justice and deterrence rationales for liability, its modern incarnation—the FOTM
class action—cannot. This chapter has offered a historical and theoretical context for
understanding the voluminous body of scholarship examining the contemporary social
function of private Rule 10b-5 enforcement.
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Examples include Johnson et al. 2007; Choi 2006; and Choi 2004.
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PART II
SHAREHOLDER DERIVATIVE
SUITS
M4633-GRIFFITH_t.indd 57 30/10/2018 08:16

4. The (un)changing derivative suit
Jessica Erickson*
1. INTRODUCTION
The past 25 years brought great upheaval in shareholder litigation. The Private Securities
Litigation Reform Act of 1995 (“PSLRA”) upended securities class actions.1 As a result
of this legislation, institutional investors now play a far more prominent role in these cases
(Choi, et al. 2005), but also face procedural hurdles nearly unprecedented in our legal
system (Erickson 2016). More recently, the number of merger class actions skyrocketed,
as shareholders began to challenge nearly every significant merger or acquisition, often
in multiple jurisdictions across the country (Sinha 2016). To curb these suits, courts
announced increased scrutiny of settlements and invited companies to limit these suits in
their governing documents.2 These legal innovations are fundamentally changing the way
that shareholders litigate these types of claims.
During this same time period, however, a third category of shareholder litigation—
shareholder derivative suits—has largely flown under the radar. There has been no major
federal or state legislation targeting derivative suits. Courts have not announced any
special scrutiny of settlements in these suits. And corporations have not rushed to include
new procedures for these suits in their charters or bylaws.3 The upheaval in other types of
shareholder lawsuits has largely missed derivative suits.
One might surmise that derivative suits have escaped scrutiny because they do not
raise the same problems as securities class actions and merger class actions. Yet empirical
evidence shows the opposite. More than 70 years of studies have consistently found that
derivative suits face deep and systematic problems (Wood 1944; Romano 1991; Erickson
2016). Few derivative suits end with monetary settlement. Instead, most derivative suits
end with the plaintiff corporation agreeing to make fairly insignificant changes to its
corporate governance practices (Romano 1991; Erickson 2016). Despite their modest
benefits, these suits remain profitable for plaintiffs’ attorneys, with the median fee award
close to a million dollars (Erickson 2016). Derivative suits have stayed under the radar,
but not because they are working well.
Instead, derivative suits have failed to attract attention for far more banal reasons.
Unlike securities class actions, derivative suits are primarily filed under state law, so
* I would like to thank Verity Winship and participants at the Fourth Annual Workshop for
Corporate & Securities Litigation for helpful comments on an earlier draft of this chapter.
1
15 U.S.C. § 78u-4 (2016).
2
See In re Trulia, Inc. S’holder Litig., 129 A.3d 884 (Del. Ch. 2016).
3
As explained below, litigation-limiting provisions are sometimes worded broadly enough
to include derivative suits, but the impetus behind the provisions is the problems in merger class
actions. Derivative suits are just swept into broadly worded provisions aimed at another set of
problems.
58
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The (un)changing derivative suit 59
Congress alone cannot fix the problems. Unlike merger cases, these problems have also
been fairly consistent, so there has not been a sudden change to draw lawmakers’ atten-
tion. And unlike both of the previous types of suit, they have been subject to relatively
minor reforms over the years, creating a sense that the problems have been addressed.
And yet they haven’t. Franklin Wood conducted the first empirical examination of
derivative suits in 1944, focusing his review on suits filed in New York state courts (Wood
1944). Since then, a number of other studies have examined derivative suits from different
angles.4 Conducted over more than 70 years, these studies reached the same basic conclu-
sions. There were differences at the margins—derivative suits in Delaware, for example,
look better than derivative suits filed elsewhere (Thompson & Thomas 2004)—but
overall, the story is one of high costs and low rewards for plaintiff corporations and their
shareholders.
This chapter argues that the time has come for the legal system to reexamine its
approach to derivative suits. There are at least three ways that the legal system can bring
more scrutiny to these suits. First, judges can examine settlements in derivative suits more
closely, using the same heightened scrutiny many judges are now using in merger litiga-
tion. Second, corporations and their shareholders can engage in self-help by including
litigation-limiting provisions in their charters and bylaws. Third, legislatures can adopt
new statutes or rules implementing new heightened procedures in these suits, such as
heightened pleading or fee shifting.
The chapter proceeds as follows. Section 2 explores the empirical history of derivative
suits, exploring the longstanding problems in these suits. Section 3 explains why these
problems have been so persistent, contrasting the legislative and judicial inaction in
derivative suits with the significant reform efforts in securities class actions and merger
cases. Section 4 concludes by describing a new approach to derivative suits, one that
envisions a new approach for judges, corporations, and legislatures. When it comes to
derivative suits, seventy years of problems is enough.
2. THE MORE THINGS CHANGE. . .
A lawyer who picked up Franklin Wood’s 1944 study of derivative suits would be forgiven
for thinking that the study described the current state of affairs. Just as in 1944, derivative
suits today seldom end with meaningful financial recoveries for the plaintiff corporation.
Instead, in many instances, the primary beneficiaries of these suits are the lawyers who file
them. This section describes the empirical research regarding derivative suits over the past
4
Among the major study of derivative suits are Franklin Wood’s study of derivative suits in
New York state court in the 1940s (Wood 1944), Thomas Jones’ examination of derivative suits
filed in the 1970s (Jones 1980), Roberta Romano’s 1991 study of derivative suits filed against public
companies (Romano 1991), Randall Thomas and Robert Thompson’s 2004 study of derivative
suits filed in Delaware (Thomas & Thompson 2004), my 2010 study of derivative suits filed in
federal court (Erickson 2010), and my coauthored study with Stephen Choi and Adam Pritchard of
the interplay between securities class actions and derivative suits (Choi et al., 2018). Other studies
examine particular aspects of derivative litigation, most notably Minor Myers’ review of SLC
decisions (Myers 2009).
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70 years, explaining how little things have changed over this time period. It then explores
the bright spots where derivative suits have brought value despite the empirical criticism.
2.1 Seventy Years of Problems
2.1.1 Few financial recoveries

Most lawsuits boil down to money—the plaintiffs want to recover money, the defendants
do not want to pay money, and the judge ultimately allocates the money. Derivative suits
do not fit this mold. For more than 70 years, researchers have repeatedly found that
a surprisingly small percentage of derivative suits end with cash payments to plaintiff
corporations or their shareholders.
The first major study of shareholder derivative suits was conducted in 1940 by Franklin
Wood, who was hired by the Chamber of Commerce of the State of New York (Wood
1944). Mr Wood examined derivative suits filed in New York state and federal court
between 1932 and 1942. He found recoveries for the plaintiff in only 46 of the 573 suits
involving public companies. He also found that the typical settlement was worth less than
3 percent of the damages alleged in the complaint. He concluded that “[t]he outstanding
fact derived from this survey is the large preponderance of unsuccessful and unfounded
stockholder derivative actions” (p.112).
Professor Roberta Romano reached a similar conclusion approximately forty-five years
later, stating that “[s]hareholder-plaintiffs . . . have abysmal success in court [and] the
proportion of derivative suits with a cash payout to shareholders is significantly lower
than that of class actions.” (Romano 1991, 60). Examining shareholder suits filed from
the late 1960s through 1987, she found that only 12 derivative suits out of a total of 128
resolved suits ended with the corporations or its shareholders receiving any monetary
recovery.5 On average, these settlements averaged $0.18 a share ($0.15 net of attorneys’
fees), representing only 2 percent of the stock price on the day prior to filing. Moreover,
the average recovery in the derivative suits was approximately half of the recovery in the
class actions in her study and represented a far smaller percentage of firm assets.
I conducted the most recent study of derivative suits, focusing on suits filed in federal
court in the mid-2000s (Erickson 2010). Of the 141 suits filed on behalf of public com-
panies in this study, only 22 (16 percent) ended with the corporation or its shareholder
receiving a meaningful financial benefit. Only 13 of these cases involved the typical cash
payment often seen in other types of lawsuits. In other cases, the defendants agreed to
reprice their stock options or otherwise alter their financial relationship with the corpora-
tion. Moreover, nearly all of the cases with monetary settlements involved allegations that
the defendants had backdated stock options. These cases dominated the business press
5
It is difficult to determine an exact percentage of the derivative suits in this study that ended
with a monetary recovery. Professor Romano states that only 12 derivative suits in the study ended
with a monetary recovery, but she does not break out the total number of derivative suits in the
study. A study of shareholder suits filed in the 1970s found a larger percentage of suits ending with
a monetary recovery (Jones 1980). This study, however, was not based on a random sample of suits.
His original data set included a random sample of 190 companies, but he then added 15 companies
to the sample that he knew had been named in major shareholder lawsuits, skewing the results of
the study.
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during the relevant time period, but they were not representative of more classic derivative
suits. In the more typical suits that did not involve allegations of backdating, only one
ended with the plaintiff corporation receiving a cash payment. In short, this study found
relatively few monetary settlements, and the cases that did end with monetary settlements
tended to involve very different allegations than the more typical derivative suits.
Although these studies stretch over nearly 70 years, they reach the same conclusion.
Derivative suits, unlike most lawsuits, rarely end with the plaintiff receiving money.6
2.1.2 Many nonmonetary settlements

The far more common outcome in these suits is a nonmonetary settlement in which the
plaintiff corporation agrees to change its own corporate governance practices, often in
fairly minor ways. These settlements seem to be a recent invention because they are not
mentioned in Franklin Wood’s 1944 study.
By the 1990s, however, these settlements had become standard practice. In her study,
Professor Romano found that nonmonetary settlements were more than twice as common
as monetary settlements (Romano 1991). She stated: “while it is impossible to value the
benefits from structural settlements with any precision, the gains seem inconsequential.”
For example, several of the settlements involved changes to the composition of the board,
which Professor Romano notes is a “potentially important reform,” yet she found the
specific changes in the settlements at issue “cosmetic.” She stated that the other reforms
involved “even more cosmetic organizational change” (p.63). She hypothesized that the
nonmonetary settlements were used primarily to justify the award of attorneys’ fees to
plaintiffs’ counsel.
The findings in my study two decades later were largely consistent (Erickson 2010).
Approximately 24 percent (34 of the 141) of the derivative suits filed on behalf of
public companies ended with nonmonetary relief. And, as in the Romano study, these
settlements rarely appeared significant. A close examination of the settlements revealed
several common problems. First, many of the reforms had little to do with the alleged
problems that led to the litigation. Second, the reforms were fairly uniform from case to
case, regardless of the underlying allegations in the suit. Third, these common reforms
had questionable value, with empirical studies showing many of them to be ineffective in
promoting shareholder value. Taken together, this data suggests that corporate govern-
ance reforms are often window dressing, allowing defendants to settle derivative suits
cheaply while giving plaintiffs’ attorneys a basis to recover fees.
2.1.3 High fees and low stakes

Scholars have long noted that derivative suits involve significant agency costs (Macey &
Miller 1991; Coffee 1986). The plaintiff corporation is the real party in interest, and any
recovery goes to the corporation.7 In practice, however, the corporation does not control
6
Ironically, one other type of lawsuit in which nonmonetary settlements are common is merger
cases, where for many years it has been common for the corporation to agree to make relatively
insignificant supplemental disclosures in exchange for dismissal of the suit. Just as with share-
holder derivative suits, these nonmonetary settlements have been roundly criticized.
7
See In re Wal-Mart Stores, Inc. Del. Derivative Litig., Case No 7455-CB, 2016 WL 2908344,
at 16 (May 13, 2016).
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the litigation because the board of directors, which normally makes litigation decisions
for the corporation, is often implicated in the alleged misconduct and therefore cannot
make unbiased decisions about the litigation.8 As a result, derivative suits are typically
controlled by a representative shareholder and his or her attorney.
This relationship has long been subject to criticism. Franklin Wood, for example, color-
fully claimed that “[t]his shoddy burlesque of a professional relationship to clients makes
the ambulance-chaser by comparison a paragon of propriety” (Wood 1944, 49). He based
this critique on the low ownership of many representative shareholders in the plaintiff
corporation. It is difficult to collect empirical data regarding average ownership stakes
because representative plaintiffs are typically not required to disclose this information
to courts. Anecdotal evidence, however, suggests that many plaintiffs own relatively few
shares in the plaintiff corporation. As an example, Wood describes the briefs from one
case, which made clear that “in the event of success the five plaintiffs stood to gain, by
theoretical appreciation of the value of their stock, the respective amounts of $3.57, $.41,
$2.41, $.17, and $.65” (Wood 1944). My study similarly found that “although derivative
plaintiffs rarely disclosed their precise ownership interest in the plaintiff corporations,
few shareholders appeared to own a significant stake in these corporations” (Erickson
2010, 1765).
This state of affairs may slowly be changing. More recent empirical evidence suggests
that institutional investors are participating in a greater percentage of derivative suits.
Approximately one third of the derivative suits filed on behalf of public companies in my
study were filed by institutional investors (Erickson 2010). These financial institutions
were almost all public pension or labor funds, rather than more traditional financial
institutions. These institutional investors were far more common in the cases involving
the alleged backdating of stock options, suggesting that they are drawn to the bigger,
higher quality cases.
Perhaps over time, the rise of institutional investors will change the state of play in
derivative litigation. For the time being, however, attorneys control most derivative suits,
and these suits remain quite profitable for them. Professor Romano found that plaintiffs’
attorneys received an average of $1.45 million in cases ending with monetary settlements
and $287,000 in cases ending with nonmonetary settlements (Romano 1991). This dispar-
ity had increased twenty years later. My study found that the median fee in cases ending
with monetary settlements was $6.65 million, while the median fee in cases ending with
nonmonetary settlements was only $460,000 (Erickson 2010). These figures reflect courts’
recognition that nonmonetary settlements are less valuable to plaintiff corporations than
traditional monetary settlements, but they also demonstrate that both types of settlements
are profitable for attorneys.
2.1.4 Tagalong to other suits

Derivative suits may not fare well when examined on their own, but they fare even worse
when examined within the broader context of corporate litigation. No form of corporate
litigation, including shareholder derivative suits, exists in a vacuum. In the wake of
corporate wrongdoing, shareholders and the government have an array of litigation
8
See Ryan v. Gifford, 918 A.2d 341, 352 (Del. 2007).
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options available to them, including shareholder derivative suits, securities class actions,
SEC enforcement actions, criminal investigations, and ERISA class actions (Erickson
2011). When compared to these other litigation options, shareholder derivative suits look
even worse.
This comparison is fairly new. The older research on derivative suits did not examine
them in relation to other types of litigation. In my study examining derivative suits filed in
the mid-2000s, however, I also examined the other lawsuits that arose out of the underlying
allegations (Erickson 2011). I found that nearly 95 percent of the shareholder derivative
suits filed on behalf of public companies were accompanied by at least one parallel lawsuit
or government investigation. More than 80 percent of the public company derivative suits
were accompanied by two or more parallel lawsuits or government investigations. Overall,
these companies faced a median of four different types of litigation arising out of the
same underlying event. Corporate law, it seems, leaves few stones unturned when it comes
to litigating corporate misconduct.
Moreover, the study found that shareholder derivative suits were typically less effective
than these other options. The median settlement amount in the parallel securities class
actions was $18 million. Not one of the shareholder derivative suits in my study settled
for anything close to this number (Erickson 2011).9 It might be that shareholder derivative
suits earn their keep by focusing more on individuals, given that securities class actions
are typically aimed at the corporation itself. Yet it is hard to argue that derivative suits
are accomplishing much on that front either. In the relatively few derivative suits that
ended with financial settlements, the individuals named as defendants rarely contributed
any money (Erickson 2010). Moreover, shareholder derivative suits are not the only suits
that target individuals. The Securities & Exchange Commission and the Department of
Justice also target the specific individuals who committed the wrongdoing at issue, often
with more success. In short, in the hierarchy of corporate lawsuits, shareholder derivative
suits may well be at the bottom.
A recent and more extensive study confirms this conclusion (Choi, et al. 2017). This
study started with a sample of 582 securities class actions filed against public companies
between July 1, 2005 and December 31, 2008 and then examined all derivative and
class action lawsuits arising out the same underlying allegations. This study made three
important findings. First, nearly half (45.4 percent) of the securities class actions had a
parallel derivative suit or class action, with most of these parallel suits filed in the federal
courts. Second, the evidence suggests that attorneys in parallel suits cherry pick the most
promising securities class actions when deciding which suits to file. Third, attorneys
who frequently file parallel suits are more likely to obtain lower monetary recoveries
for their clients. They are also more likely to agree to settlements involving corporate
governance reforms. At the same time, however, these attorneys receive higher attorneys’
fees and expenses, at least as a ratio of the attorneys’ fees and expenses awarded in the
9
This is not to say that derivative suits never settle for substantial sums of money. Indeed, Part
II(B) describes a few of the sizable settlements that have occurred in derivative suits over the past
several years. The point here, however, is that large financial settlements are relatively uncommon
in derivative suits, whereas they occur relatively frequently in the other types of suit that arise out
of the same underlying events.
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a ccompanying securities class action. In short, these attorneys deliver less to shareholders,
but get more for themselves.
These studies reinforce the longstanding concerns about derivative suits. Although
these suits typically challenge the same underlying allegations as securities class actions or
other types of litigation, they return much less value to corporations or their sharehold-
ers. The empirical evidence suggests that attorneys are often using derivative suits not to
uncover new types of misconduct or to advance new theories of liability, but rather to
obtain a share of the attorneys’ fees.10
2.2 Bright Spots among the Criticism
Despite this criticism, there are some bright spots in the empirical record. First, the prob-
lem itself is fairly limited. Unlike the recent spike of merger cases, there has never been
a similar explosion of derivative litigation. In my survey of derivative suits in the federal
courts, I found that only 126 public companies had been named as plaintiffs in derivative
suits during the one-year period covered in the study (Erickson 2010). This number is
not insignificant—at the time of this study, derivative suits were likely the most common
type of shareholder lawsuit, outpacing both securities class actions and acquisition class
actions.11 Even still, however, only a small percentage of the 4,700 public companies listed
on US stock exchanges at the time faced such a suit—a conclusion reached by other stud-
ies as well (Romano 1991). Along similar lines, Randall Thomas and Robert Thompson
found that approximately 30 shareholder derivative suits are filed per year in the Delaware
Court of Chancery (Thompson & Thomas 2004). In other words, shareholder derivative
suits may not offer many benefits, but their costs are relatively minor.
Another bright spot concerns geography. Even within the relatively small world of
shareholder derivative suits, some jurisdictions seem to attract better suits. Randall
Thomas and Robert Thompson examined shareholder derivative suits filed in the
Delaware Court of Chancery in 1999 and 2000 (Thompson & Thomas 2004). Although
most of the settlements in these suits were nonmonetary, the authors found that these
settlements often returned “very real gains” to the plaintiff corporations (p.1779), chal-
lenging the “traditional story” that derivative suits “almost never produce real recovery
for shareholders” (p.1774). Even this study, however, did not paint shareholder derivative
suits in a completely positive light. Of the cases that ended before the study closed,
approximately two thirds were dismissed without the plaintiff corporation receiving any
relief. In short, Delaware has a better track record than other jurisdictions when it comes
to shareholder derivative suits, although even this court still experiences many of the same
problems that plague derivative suits more widely.
In addition, shareholder derivative suits have shone in addressing particular types of
corporate misconduct, most recently the backdating of stock options. In the mid-2000s,
it was revealed that many companies had backdated their stock options, allowing them to
10
Randall Thomas and Robert Thompson have developed a similar theory in connection with
multijurisdictional litigation (Thomas & Thompson 2012).
11
As most readers know, this soon changed as shareholders started to file an increasing
number of merger class actions (Sinha 2016).
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manipulate their value. The derivative suits filed in the wake of these revelations ended far
more favorably for plaintiff corporations than more traditional derivative suits. My study,
for example, found that 40 percent of stock option suits ended with the plaintiff corpora-
tion obtaining a meaningful financial benefit, compared to only 2 percent of the other
suits in the study (Erickson 2010). Other studies have found that shareholder derivative
suits were a better vehicle to address these allegations than securities class actions, a head
to head comparison that derivative suits rarely win (Fuerman 2016).
Finally, sprinkled among the more negative news about derivative suits are cases in
which the plaintiff corporation unquestionably received real value. In 2013, for example,
News Corporation received a $139 million settlement for claims related to the company’s
use and attempted coverup of illegal reporting tactics.12 In 2014, Activision Blizzard
received $275 million in connection with a derivative suit challenging the company’s
purchase of 50 percent of its outstanding shares from its controlling shareholder.13 And
in 2015, Freeport-McMoRan Copper & Gold Inc. agreed to a $137.5 million settlement
to resolve claims that the company overpaid in its purchase of two companies as a result
of conflicts of interest among the board.14 These settlements, and others like them, reveal
that the derivative suits can bring real value to corporations.
As this discussion illustrates, derivative suits have a silver lining. The empirical record
overall is largely negative, but even the most ardent critics of derivative suits would likely
concede that these suits have some value. This concession complicates the reform agenda.
If derivative suits had no silver lining, states could eliminate them without a second
glance, leaving the enforcement of corporate law to other vehicles. By acknowledging
that these suits have value, however, the legal system must go down the trickier path of
sorting the good cases from the bad. Section 3 explores why the system has not embraced
this challenge so far.
3. WHY DERIVATIVE SUITS HAVE ESCAPED SCRUTINY
If the problems in derivative suits have been obvious for so long, why has the legal
system not tried harder to solve them? This section argues that there are at least four
reasons. First, unlike merger litigation, there have not been any dramatic changes that
have drawn lawmakers’ attention to these suits. Second, because these suits are not
concentrated in any single court, there is no one legislature or set of judges that is
uniquely motivated to take on the problem. Third, most of the parties in these suits
are happy with the status quo and therefore are not pressing for reform. Finally, many
states adopted a number of procedural reforms several decades ago, and although
these reforms have been largely ineffective, they make lawmakers wary about piling on
additional procedural hurdles.
12
See, e.g., News Corporation Form 8-K (May 6, 2013) (announcing settlement of derivative
claims).
13
See, e.g., Tom Hals, Judge Oks Activision $275 million shareholder settlement, $72 million for
lawyers, Reuters (May 20, 2015).
14
See, e.g., Jonathan Stempel, Freeport-McMoRan in $137.5 million settlement over purchases,
Reuters (Jan. 15, 2015).
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3.1 No Perceived Crisis
One possible reason that shareholder derivative suits have not come under greater scrutiny
is that these suits have presented more or less the same problem for the past 70 years. The
problems have not been identical for this time period, of course. There are likely more
derivative suits that serve as tagalong suits to securities class actions and other types of
lawsuits today than there were in Franklin Wood’s time. And, in the plus column, there
were not $275 million settlements in 1944 either. But the more fundamental problem of
derivative suits ending with low-value settlements that do not benefit corporations or their
shareholders has been a persistent problem for many decades.
This fact distinguishes shareholder derivative suits from the other common form
of shareholder litigation brought under state law—merger litigation. For a long time,
merger litigation, like derivative suits, largely flew under the radar. To the extent that
these cases got any attention at all, the attention was largely positive. For example, a
2004 study concluded that, although merger cases were more common than previously
recognized, these suits did not bear the same hallmarks of litigation agency costs as other
types of shareholder litigation (Thompson & Thomas 2004). Specifically, this study
found that merger cases often resulted in larger settlements and lower attorneys’ fees
as a percentage of the amount recovered than these other suits. As a result, the authors
recommended caution when lawmakers considered reforms that might impact these suits.
All of this changed in the late 2000s, as other chapters in this book discuss in greater
detail. Whereas shareholders challenged only 44 percent of larger mergers and acquisitions
in 2007, this number grew to 93 percent by 2014 (Sinha 2016). As these suits became nearly
ubiquitous, the criticism grew as well. Lawyers and scholars pilloried the rise in litigation as
a “deal tax” plaguing corporate America.15 And Delaware courts agreed, issuing a series of
decisions that rejected “peppercorn” settlements that offered little value to shareholders.16
In justifying this new approach, the Delaware Court of Chancery held that “far too often
such litigation serves no useful purpose for stockholders. Instead, it serves only to generate
fees for certain lawyers who are regular players in the enterprise of routinely filing hastily
drafted complaints on behalf of stockholders . . . settling quickly on terms that yield
no monetary compensation to the stockholders they represent.”17 Judges in many other
jurisdictions soon followed Delaware’s lead.18 In the wake of these decisions, the number
of merger cases has fallen, although perhaps not as much as Delaware judges had hoped
(Griffith 2016).
In hindsight, this backlash seems inevitable. And maybe it was, given the extreme
15
See Emily V. Burton et al., Reducing the “Deal Tax”: Delaware’s Recent Scrutiny of
Nonmonetary Settlements, 2015 BUS. L. TODAY 1 (2015).
16
See, e.g., In re Trulia, Inc. S’holder Litig., 129 A.3d 884, 894 (Del. Ch. 2016); In re Riverbed
Technology, Inc. Stockholders Litig., C.A. No 10484–VCG, 2015 WL 5458041, at *2 n.6 (Sept. 17,
2015); In re TPC Group Inc. S’holders Litig., C.A. No 7865–VCN, 2014 WL 5500000, at 3 n.19
(Oct. 29, 2014).
17
See, e.g., In re Trulia, Inc. S’holder Litig., 129 A.3d 884, 891–92 (Del. Ch. 2016).
18
See In Re: Walgreen Co. S’holder Litig., 832 F.3d 718 (2016); Corwin v. British Am. Tobacco
PLC, No 14 CVS 8130, 2016 WL 635191 (N.C. Super. Ct. 2016); Vergiev v. Aguero, et al., No
L-2776-15 (N.J. Super. Ct. 2016). But see Gordon v. Verizon Communications, Inc., Case No
653084/13, N.Y. App. Div. (Feb. 2, 2007).
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nature of the problem. But the problem still had to reach an almost comical level—93
percent of large mergers and acquisitions challenged in court, most of them in multiple
jurisdictions—before there was any systematic response from courts. Judges in Delaware
and elsewhere had always policed these lawsuits on a case-by-case basis, but it took a true
crisis for judges to mobilize in a coordinated fashion.19
Derivative suits have never faced such a crisis. Sometimes derivative suits look par-
ticularly bad, and sometimes they look particularly good, but they never experienced the
extreme change that merger litigation did. As a result, it has been easier for them to fly
under the radar of meaningful reform.
3.2 No Judicial or Legislative Champion
This lack of meaningful reform has been exacerbated by the fact that derivative suits do
not have a natural judicial or legislative champion. Derivative suits are scattered across
the country in both state and federal courts, making it difficult for a single jurisdiction to
adopt effective reform.
Again, derivative suits are different in this respect than merger litigation. It is important
not to overstate this point, as merger cases became infamous over the past decade for
their multijurisdictional nature. A 2013 study, for example, found that 62 percent of deals
were challenged in more than one court, and these cases were litigated in courts across
the country, from New York City to Harris County, Texas and Santa Clara, California
(Koumrian 2014). But, despite this geographical diversity, Delaware remained a key
battleground for these suits. The vast majority of deals were still challenged in Delaware,
even if they were also filed elsewhere, giving Delaware at least some consistent authority
over these suits (Koumrian 2014).
In the high water years of merger litigation, Delaware found a way to increase this
authority. In a now famous decision, the Delaware Court of Chancery invited companies
to include forum selection provisions in their governing documents.20 A significant
number of companies accepted this invitation; by 2014 nearly half of merger cases
were filed only in Delaware and approximately 90 percent either only in Delaware or in
Delaware and another jurisdiction (Sinha 2016).
The fact that so many merger cases are filed in Delaware is significant for two reasons.
First, Delaware judges see enough of these cases to understand the more systemic issues
associated with them. If a given judge handles only a few merger cases a year, it is difficult
for that judge to know if the cases before them are representative of merger cases more
generally. In contrast, a judge who sees these cases day in and day out will have a more
nuanced understanding of the broader issues. Second, Delaware judges are in a better
position to address these issues. These judges can announce general rules, as the Delaware
Court of Chancery did in Trulia, without worrying that these rules will impact only a
small fraction of the cases. The same is true for lawmakers—a state’s legislature will only
19
As discussed below, a similar argument can be made about securities class actions in the
mid-1990s. With respect to these cases, the crisis may have been more manufactured than real, but
it still took a perceived crisis to get the legislature to act.
20
See In re Revlon, Inc. S’holders Litig., 990 A.2d, 940, 960 (Del. Ch. 2010).
M4633-GRIFFITH_t.indd 67 30/10/2018 08:16

feel the pressure to address a given type of lawsuit if the state sees enough of these cases
to make reform worth the legislature’s time.
Derivative suits are far more dispersed geographically, which makes it more difficult
for individual judges to both understand and address the issues with these cases. The
traditional view was that most derivative suits, like most merger class actions, were filed in
Delaware. More recent research, however, suggests that a significant percentage of these
cases are filed in federal court (Erickson 2010). Within the federal system, these cases are
relatively dispersed (Erickson 2010).
Researchers also have no idea how many derivative suits are filed in state courts other
than Delaware. Most state dockets are not online, making it difficult both to know how
many cases are filed in state court and to understand how these cases may be different
from those filed in Delaware or in federal court. For example, it is likely that state courts
see more derivative suits filed on behalf of private companies or smaller public companies,
and these suits may differ from derivative suits filed on behalf of large public companies.
The fact that scholars cannot study these cases means that it is difficult to understand
these differences. And regardless of how these suits might vary, the fact that there is no
single jurisdiction or court in which individual judges preside over a significant number
of derivative suits makes it tough for judges to understand or address problems.
Moreover, Delaware is unlikely to be a savior in this area because, as discussed above, the
cases that are filed in Delaware look different than the cases filed elsewhere. The most recent
empirical study focusing on derivative suits in Delaware suggests that these cases are less
likely to end in nonmonetary settlements, and the nonmonetary settlements that Delaware
does see are more likely to include meaningful reforms (Thompson & Thomas 2004). As a
result, Delaware judges have less incentive to adopt systematic rules for these suits.
3.3 No Advocate around the Settlement Table
An additional reason why derivative suits have long managed to fly under the radar is
that no one is motivated to press for reform. Again, a comparison with other types of
shareholder litigation helps illustrate this point. In securities class actions, companies
had a strong financial incentive to lobby Congress because typical settlements in these
cases were in the millions of dollars. In merger cases, as discussed, there were rarely
multimillion-dollar settlements, but these suits became so ubiquitous that they nonethe-
less got business groups’ attention. These examples suggest that judges and lawmakers
take action when the amounts at stake cause defendants to press for reform or the sheer
number of suits becomes impossible to ignore.
Derivative suits do not fit either criteria. First, the amount at stake in these suits is
rarely significant enough to cause corporations or their executives to lobby for reform.
As detailed above, these suits typically end with plaintiff corporations agreeing to make
fairly trivial changes to their corporate governance practices. These changes impose little
cost on corporations, who often would have adopted the same reforms anyway (Erickson
2010). Additionally, these suits generally impose no costs whatsoever on the individual
defendants in the suits, even though they are the ones who allegedly engaged in the wrong-
doing. Individual defendants can get out of the suits by letting their insurance company
pay their legal fees and the corporation make the necessary governance reforms. The suits
may be a nuisance, but they are not an expensive nuisance.
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Second, although derivative suits are relatively common, they never saw the same spike
in filings that prompted reform of merger cases. Moreover, derivative suits are frequently
filed at the same time as other, potentially more costly litigation related to the same events.
Given the higher stakes in these other lawsuits, corporations and their executives are typi-
cally focused more on those lawsuits than the tagalong derivative claims. As a result, even
after the suits are over, neither plaintiff corporations nor their executives are motivated
to press for reform.
In theory, shareholders might have an incentive to press for reforms to protect their
investment in the plaintiff corporations. Yet the shareholders who serve as representative
plaintiffs in these suits usually own too little stock in the plaintiff corporation to ensure
that settlements are in the best interests of these corporations. And institutional investors
who may own more stock in the plaintiff corporation rarely file these suits. As a result,
they likely do not see a financial or institutional reason to devote their own time to
reforming this corner of the law.
The final set of participants in these suits—attorneys—similarly has little incentive
to press for reform because attorneys benefit from these suits, even if their clients do
not. Plaintiffs’ attorneys are entitled to compensation in derivative suits as long as the
settlement provided “substantial benefit” to the plaintiff corporation,21 a point which
the parties typically stipulate in the settlement agreement and that is rarely questioned by
the court. Similarly, these suits can be lucrative for defense attorneys, given the number
of parties who need separate representation and the possibility of representing corporate
boards or committees of these boards in related internal investigations.
Legal reform occurs when someone advocates for it. With securities class actions,
corporate America put tremendous pressure on Congress to adopt new restrictions on
these suits.22 With merger class actions, the problem became so obvious that judges and
other commentators could not help but take steps to address it.23 With derivative suits,
however, the problems have never reached the level where those impacted by the suits felt
moved to advocate for comprehensive reforms. As we shall see, however, this does not
mean that states have been completely passive in responding to these suits.
3.4 Ineffective Procedural Reforms
The prior section argues that derivative suits have escaped major legislative and judicial
scrutiny. That does not mean, however, that these suits have escaped all reform efforts over
the past 70 years. Derivative suits are subject to a host of procedural requirements that
21
See In re Johnson & Johnson Derivative Litig., 900 F. Supp. 2d 467, 488 (D.N.J. 2012) (“Case
law makes clear that corporate governance reforms, unaccompanied by monetary damages, may
form the basis for an attorney’s fee award where the reforms confer a ‘substantial benefit’ on the
plaintiff corporation”).
22
See, e.g., H.R. Rep. No 104-369, at 31 (1995) (“Congress has been prompted by significant
evidence of abuse in private securities lawsuits to enact reforms to protect investors and maintain
confidence in our capital markets”).
23
See In re Trulia, Inc. S’holder Litig., 129 A.3d 884, 887 (Del. Ch. 2016) (discussing “concerns
that scholars, practitioners and members of the judiciary have expressed that these settlements
rarely yield genuine benefits for stockholders and threaten the loss of potentially valuable claims
that have not been investigated with rigor”).
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do not apply to other types of civil lawsuits. This section explores these requirements and
explains why they are unlikely to solve the problems.
Before getting into the specific procedural requirements, however, it is worth discuss-
ing what these requirements should aim to do. All procedural rules are designed to sort
the good cases from the bad, allowing meritorious claims to go forward while barring
meritless ones (Erickson 2016). In general, procedural rules are transsubstantive, with
the same procedures applying in all civil cases,24 and the legal system generally believes
that transsubstantive rules do a decent job of sorting meritorious cases, at least in most
areas of the law. Yet, although transsubstantive rules may work as a general matter, they
sometimes cannot address the challenges associated with specific types of claims.25 As a
result, lawmakers often adopt heightened procedural rules that apply only in these cases.26
The goals of these heightened procedures, however, are the same as the goals of other
procedural rules—to accurately sort cases with merit from those without. Accordingly, in
assessing the heightened procedural rules applicable in shareholder derivative suits, it is
appropriate to ask if they are accomplishing this goal.
These rules tend to fall into two categories. The first category includes rules that make
it more difficult for all shareholders to file derivative suits, while the second gives power
to corporate boards and committees to control these suits. As discussed presently, neither
type is likely to sort the meritorious derivative suits from the meritless ones, at least in
a way that would prevent many of the meritless suits from being filed in the first place.
The first type of procedural rules—those that make it more difficult for all shareholders
to file derivative suits—have been common since at least the publication of the Wood
Report. Following publication of this report in 1944, many states adopted bond require-
ments, which require plaintiffs (or permitted courts to require plaintiffs) to post a bond
with the court to indemnify the corporation against any expenses, including attorneys’
fees, incurred in successfully opposing a derivative suit. The primary objective of these
statutes was to discourage actions by shareholders with only a small stake in the corpora-
tion, an aim that was furthered by a common exemption if the plaintiffs held more than
five percent of the corporation’s stock.
These statutes were initially viewed as the “death knell” for derivative suits (Ferrera,
et al. 2013). As commentators have noted, however, these statutes had little impact on
24
See Fed. R. Civ. P. 1 (“These rules govern the procedure in all civil actions and proceedings
in the United States district courts, except as stated in Rule 81”).
25
Derivative suits are an appropriate area for heightened procedural reforms because they
suffer from greater cost asymmetries than other types of civil litigation. Plaintiffs will typically
not file lawsuits that they do not expect to win because their expected costs to litigate the suit will
exceed their likely monetary gains from the suit. In derivative suits, as well as other types of cost
asymmetric cases, however, the defendant’s costs to litigate the case far exceed the plaintiff’s costs.
In these cases, the plaintiff may well file a case they do not expect to win simply because they know
it will be cheaper for the defendant to enter into a settlement rather than defend against the claims.
As a result, the normal procedural reforms may not be enough to solve the problems.
26
See, e.g., Private Securities Litigation Reform Act of 1995, 15 U.S.C.A. § 78u-4 (2015)
(imposing heightened pleading, discovery stays, and mandatory Rule 11 reviews on securities class
actions); Prison Litigation Reform Act, 42 U.S.C. § 1997e(a) (2015) (adopting heightened proce-
dures for prisoner claims); N.C. R. Civ. P. 9(j) (adopting heightened procedural rules in medical
malpractice cases).
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the filing of meritless derivative suits. Shareholders were able to easily avoid them by
pleading a federal cause of action or getting a judicial waiver (Cary & Eisenberg 1980).
Moreover, at a more fundamental level, these statutes are likely a poor sorting mechanism
of meritless and meritorious claims. Plaintiffs who are able to plead a federal claim or
get a waiver from a sympathetic judge can evade the requirement. Other plaintiffs, even
those with meritorious claims, may be reluctant to file suit either because they cannot
come up with the money to post the bond or they fear the ever present risk that a judge
or jury will not agree with their assessment of the claims and thus they will be forced to
surrender their bond.
Oklahoma recently adopted a similar requirement that is styled as a feeshifting statute
rather than a bond requirement. Under section 18-1126 of the Oklahoma Code, losing
parties in derivative suits are now required to pay their opponents’ expenses, including
attorneys’ fees.27 This new rule applies to both losing plaintiffs and defendants, but it is still
a striking departure from the American rule, which requires both sides to pay their own
expenses. Representative shareholders receive only their pro rata share in the recovery if
they win,28 but under the Oklahoma statute would be forced to pay all of the defendants’
costs if they lose. This imbalance of risk and reward will likely deter most shareholders of
Oklahoma corporations from filing a derivative suit, regardless of the merits of the suit.
In short, therefore, whether styled as a bond requirement or a feeshifting statute, rules that
discourage all derivative plaintiffs from filing suit do little to sort the good cases from the
bad.
The second type of procedural hurdle common in derivative suits gives more power to
plaintiff corporations to control these suits. In most jurisdictions, before filing a derivative
suit, the derivative plaintiff must make a demand on the corporation’s board of directors,
requesting that the board itself file the suit.29 Some states allow the plaintiff to avoid
this requirement if the derivative plaintiff alleges with particularity that demand would
have been futile.30 Alleging futility is no easy task, however, and courts are required to
dismiss claims that do not comply with the demand requirement or adequately allege
futility. Even if the plaintiffs survive the demand requirement, they quickly face another
hurdle. The corporation can then appoint a committee of independent directors, called a
27
See Okla. Stat. tit. 18, § 1126 (“In any derivative action instituted by a shareholder of a
domestic or foreign corporation, the court having jurisdiction, upon final judgment, shall require
the nonprevailing party or parties to pay the prevailing party or parties the reasonable expenses,
including attorney fees, taxable as costs, incurred as a result of such action”).
28
And even then, shareholders only benefit indirectly from derivative suits, because the
recovery goes to the plaintiff corporations. Shareholders benefit to the extent that the value of their
stock increases as a result of the litigation.
29
See, e.g., Del. Ct. Ch. R. 23.1(a) (“The complaint shall also allege with particularity the
efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors
or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not
making the effort”); Fed. R. Civ. P. 23.1 (“The complaint must . . . state with particularity . . . any
effort by the plaintiff to obtain the desired action from the directors or comparable authority and,
if necessary, from the shareholders or members; and the reasons for not obtaining the action or not
making the effort”).
30
See, e.g., In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 120 (2009) (“Where,
as here, a plaintiff does not make a pre-suit demand on the board of directors, the complaint must
plead with particularity facts showing that a demand on the board would have been futile”).
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special litigation committee or SLC, to review the allegations in the derivative complaint
and determine whether the suit is in the best interests of the corporation.31 If the SLC
determines that the suit is not in the plaintiff corporation’s best interests, it will recom-
mend that the court stay or dismiss the suit.
In theory, these requirements seem better equipped than the other procedural rules
described above to sort cases with merit from those without. If the case has merit
and thus will lead to a recovery for the corporation, the corporation should want the
case to proceed. If, on the other hand, the case does not have merit and thus will not
lead the corporation to recover money, the corporation should move to dismiss it. In
practice, however, these rules have not solved the problems associated with derivative
suits. Empirical studies have found that shareholders rarely make demands on the
corporation, routinely claiming instead that such demands would be futile (Erickson
2010). Although corporations often contest this claim, it is rarely dispositive in the
litigation. The same goes for special litigation committees. Corporations often form
an SLC, but the SLC’s report does not necessarily end the litigation (Erickson 2010;
Myers 2009).
Why haven’t these procedural hurdles done more to corral derivative suits? One pos-
sibility is that it is more costly for plaintiff corporations to comply with and/or fight
over these procedures than to simply settle the cases. SLC investigations are expensive
and incredibly time-consuming for corporate directors, who have to conduct an in-depth
investigation into the allegations made in the suit as well as the suit’s costs and benefits
for the corporation. Briefing battles over the demand requirement are less costly, but still
require lawyers to fight over whether the plaintiffs can survive this hurdle. Settlements,
on the other hand, are relatively inexpensive, especially nonmonetary settlements that
require corporations to make modest changes to their corporate governance practices.
As a result, corporations may rationally decide that it is cheaper to settle these cases than
fight to enforce the procedural requirements.
As this discussion illustrates, derivative suits have long had their problems, and courts
and lawmakers have long tried to fix these problems, albeit with procedural reforms that
are ill equipped to address the specific challenges that these suits present. The next ques-
tion is whether the legal system can better address the challenges in these suits.
4. TOWARD A NEW APPROACH TO DERIVATIVE SUITS
After 70 years of documented problems with derivative suits, the time has come to
address these issues. This section outlines three possible approaches to overhauling
these suits. First, judges can use greater scrutiny in reviewing proposed settlements
in these suits. Second, corporations and their shareholders can engage in self-help
by including litigation-limiting provisions in their governing documents. Finally,
legislatures can take matters into their own hands by adopting heightened procedures
to apply in these cases.
31
See Zapata Corp. v. Maldonado, 430 A.2d 779,788 (Del. 1981).
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4.1 Judicial Oversight
Judges play a crucial role in improving the effectiveness of derivative suits. Under Rule 23.1
of the Federal Rules of Civil Procedure, judges must approve all settlements of derivative
suits. This rule is intended to “discourage the private settlement of a derivative claim
under which a shareholder-plaintiff and attorney personally profit to the exclusion of the
corporation and the other shareholder.”32 This concern is reflected in the current data
on derivative suits. As discussed previously, these suits frequently end with nonmonetary
settlements in which the corporation receives little of value, but the plaintiffs’ attorney
receives a six-figure fee. Despite the problems with these settlements, judges routinely
rubberstamp them. In short, these are exactly the types of settlements that judges should
review more closely, and yet they don’t.
Judges could improve the functioning of derivative suits by rejecting meritless set-
tlements. This enhanced scrutiny could take different forms. For example, judges could
simply scrutinize all proposed settlements in derivative suits more closely, asking hard
questions about the merits of the claims and the benefits of the relief. Alternatively,
courts could adopt more standardized rules or presumptions to help standardize their
review. One such change could be a rebuttable presumption against nonmonetary
settlements, forcing litigants to explain precisely how the settlement benefits plaintiff
corporations and their shareholders to overcome this presumption. Along similar lines,
judges could insist on closer links between the “ask” and the “get,” comparing the
nonmonetary reforms in the settlements to those requested in the complaint. Such review
would force plaintiffs’ attorneys to decide up front what types of reforms will address
the alleged wrongs, rather than coming up with a list of reforms on a more ad hoc basis
at the settlement table.
This judicial oversight is increasingly common in other types of shareholder lawsuits.
As discussed previously, shareholders used to challenge nearly all large mergers and
acquisitions (Sinha 2016). As with derivative suits, these merger class actions typically
ended with nonmonetary settlements and usually additional and arguably unnecessary
disclosures about the transaction. Anxious to eliminate what was seen as a “deal tax”
on mergers and acquisitions, the Delaware Court of Chancery announced that it would
start to scrutinize nonmonetary settlements far more closely.33 The Court promised that
it would “disfavor” disclosure-only settlements that did not involve “plainly material”
information.34 Courts reviewing derivative suit settlements could follow the Delaware
Court of Chancery’s lead, rejecting corporate governance settlements in derivative suits
unless they involve “plainly beneficial” corporate governance reforms.
Increased judicial scrutiny is unlikely to be an easy fix. First, it will be difficult to get
judges to change their normal practice of rubberstamping settlements. Judges have busy
dockets, and they are not looking for additional work. Most judges also do not handle a
significant number of derivative suits, so they may not be familiar with the problems in
these suits or the need for greater judicial oversight. Unlike merger class actions, which
32
Fed. R. Civ. P. 23.1(c).
33
See In re Trulia, Inc. S’holder Litig., 129 A.3d 884, 898 (Del. Ch. 2016).
34
Ibid.
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were always relatively concentrated in Delaware, there is no single state or federal court
that has primary jurisdiction over derivative suits.
Second, even if a few judges start to crack down on these suits, there is little to stop
plaintiffs’ attorneys from filing elsewhere. Most derivative suits can be filed in multiple
forums, so attorneys can choose forums where they think their suits will receive less
scrutiny. Delaware has seen this backlash in the wake of its increased scrutiny of merger
cases, with more cases being filed outside of Delaware (Myers 2014). Yet the strategies
being used in merger class actions may help here as well. The Delaware Court of Chancery
invited corporations concerned about forum shopping in merger cases to include forum
selection provisions in their charters or bylaws, giving corporations more control about
where they are sued and what type of oversight these cases will receive.35 Many of these
provisions are written broadly to sweep in all fiduciary duty suits, including derivative
suits.
Moreover, even if not all judges bring greater scrutiny to these cases, even a few judges
can still have a significant impact. Right now, derivative suits fly almost entirely under the
judicial radar. As a result, attorneys do not fear that a judge will reject their settlement,
even if the settlement does not benefit the plaintiff corporation. If a few judges who
routinely handle these cases started to scrutinize these settlements more closely, it could
have a ripple effect in other jurisdictions. This strategy on its own is unlikely to solve all
of the problems in derivative suits, but it would be a helpful start.
4.2 Corporate Self-Help
Corporations themselves also have the ability to reform derivative suits. In recent years,
corporations have started to experiment with litigation-limiting provisions in their
corporate charters and bylaws. As discussed previously, many corporations have adopted
provisions specifying Delaware or another jurisdiction as the exclusive forum for litigating
internal corporate claims. A smaller number of corporations have experimented with
other procedural provisions, including feeshifting bylaws (Bainbridge 2016), which were
later banned by the Delaware General Assembly.36
To date, most of the discussion concerning these bylaws and charter provisions has
related to their impact on merger class actions. But these provisions also have the ability
to reshape derivative litigation. A provision, for example, that bars a company from
agreeing to a nonmonetary settlement in any shareholder suit, including a derivative suit,
could eliminate the incentive to file many of these suits. This point recognizes the parties’
incentives at different points in time. Ex post, nonmonetary settlements make sense. After
a case has been filed, both parties have an incentive to agree to a nonmonetary settlement.
Even if the corporation does not think the claims have merit, it is often cheaper for the
35
As discussed in the next section, forum selection clauses are also not a panacea because
corporations can simply waive them when they think that a different forum will bless a settlement
that their prechosen forum would not.
36
See Del. Code, tit. 8, § 109(b) (“The bylaws may not contain any provision that would impose
liability on a stockholder for the attorneys fees or expenses of the corporation or any other party
in connection with an internal corporate claim, as defined in § 115 of this title.”); Del. Code, tit. 8,
§ 102(f) (same in charters).
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company to pay a small amount of money to settle the suit rather than pay to take the
case to trial. Ex ante, however, companies may be willing to tie their own hands. Doing so
will constrain their options if they are sued, but it should also reduce the likelihood that
they will be sued in the first place.
Similarly, companies may be able to adopt provisions that will subject derivative
suits to more scrutiny (Winship 2016). For example, companies could adopt minimum
ownership requirements, barring shareholders from filing derivative suits if they have
only a miniscule stake in the company. Alternatively, companies could adopt heightened
pleading requirements, prohibiting claims that do not include particularized allegations
of wrongdoing. Potentially, companies could also experiment with mandatory cost shar-
ing in discovery, requirements that companies first use Section 220 to review books and
records, and enhanced standing requirements.
This strategy does raise concerns because directors have their own conflicts of interest
in adopting these provisions. As discussed previously, directors are common defendants
in derivative suits. As a result, although they are supposed to be unbiased guardians of
the corporate interest, they will inevitably be influenced by concerns about their own self-
interest. Accordingly, they have an interest in barring all shareholder litigation, regardless
of its merit. If the goal of procedure is to sort the cases with merit from those without,
there is reason to doubt that directors will act solely with this goal in mind.
So far, courts have been relatively unconcerned about these potential conflicts of inter-
est. In ATP Tour, Inc. v. Deutscher Tennis Bund,37 the Delaware Supreme Court held that
litigation-limiting charter and bylaw provisions are generally valid. The Court did retain
the right to review these provisions on an as applied basis to determine whether they are
“adopted by the appropriate corporate procedures and for a proper corporate purpose.”38
Although this standard might prohibit a board from adopting protective procedures after
its members have been sued, it does not account for the more pervasive structural biases
that exist when boards adopt procedures that will govern claims that may later be filed
against them.
As a result of this structural bias, courts may be warranted in using a stricter standard
of review to evaluate litigation-limiting bylaw provisions.39 Courts typically use the defer-
ential business judgment rule to review board decisions.40 When the independence of the
board is in question, however, courts use an enhanced standard of review, subjecting the
decision to greater scrutiny.41 Some scholars have suggested that courts should recognize
the structural bias inherent in the adoption of these provisions and therefore use such an
enhanced standard in reviewing litigation-limiting bylaw and charter provisions (Kaufman
& Wunderlich 2015). Rather than simply asking whether these provisions reflect directors’
37
ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 559 (Del. 2014).
38
See ibid.
39
Shareholders must approve litigation-limiting provisions in the charter, while directors
alone can amend the bylaws. As a result, bylaw provisions deserve greater scrutiny than charter
provisions.
40
Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457 (2011) (“Delaware has three tiers of
review for evaluating director decision-making: the business judgment rule, enhanced scrutiny, and
entire fairness. The business judgment rule is the default standard of review”).
41
See ibid.
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business judgments, courts could probe more deeply, examining the likely impact of the
provision. Specifically, courts should ask whether the provision is likely to reduce the
number of frivolous claims while preserving meritorious claims. A provision that simply
reduces the number of lawsuits, meritless and otherwise, should not pass muster.
4.3 Legislative Intervention
Legislatures could also use targeted procedural rules to improve the functioning of deriva-
tive suits. This approach would not be without controversy. One of the guiding rules of
the American judicial system is that procedural rules should be transsubstantive—that is,
the same rules should apply in all civil cases. As a result, the federal courts as well as most
state courts have a uniform set of procedural rules that apply regardless of the nature of
the claim.42
Derivative suits, however, already fall outside the transsubstantive model. Rule 23.1 of
the Federal Rules of Civil Procedure includes specialized procedures for derivative suits,
and many states have similar rules for derivative suits filed in their courts.43 Settlements
in civil cases typically do not require judicial approval, but settlements in derivative suits
do.44 The complaints in most civil cases do not have to be signed by the plaintiff, but
complaints in derivative suits do.45 And plaintiffs in most civil cases do not need to make
a prefiling demand, but derivative plaintiffs do.46 In other words, there is already a long
tradition of specialized procedural rules for derivative suits.
These specialized rules reflect the fact that derivative suits face different challenges
than other types of civil cases. These suits are not controlled by the real party in interest.
Additionally, the option for nonmonetary settlement in these suits makes it relatively easy
for plaintiffs’ attorneys to structure settlements that benefit themselves at the expense
of the plaintiff corporation. As a result, these cases require enough special oversight to
justify a departure from the transsubstantive norm.
Yet perhaps legislatures have not gone far enough in adopting heightened procedural
rules. Existing rules do require judicial approval of settlements, but as discussed previ-
ously, most judges are not subjecting these settlements to significant scrutiny. The demand
requirement mandates that plaintiffs present their claims to the plaintiff corporation
before filing them, unless such presentment would be futile, but the evidence suggests that
this requirement is not doing enough to sort the good claims from the bad. It may be time
for legislatures to take a fresh look at the heightened procedures in their legislative toolbox
and explore how they might better crack down on the abuses in these suits.
42
See, e.g., Fed. R. Civ. P. 1 (“These rules govern the procedure in all civil actions and proceed-
ings in the United States district courts, except as stated in Rule 81”); Rules of the S. Ct. of Va. 3.1
(“These Rules apply to all civil actions, in the circuit courts, whether the claims involved arise under
legal or equitable causes of action, unless otherwise provided by law”).
43
See, e.g., N.Y. Business Corp. Law § 626 (setting out special procedures for derivative suits
under New York law); Cal. Corp. Code § 800 (same).
44
Fed. R. Civ. P. 23.1(c) (“A derivative action may be settled, voluntarily dismissed, or compro-
mised only with the court’s approval”).
45
Fed. R. Civ. P. 23.1(b) (stating that derivative complaints must be “verified”).
46
Fed. R. Civ. P. 23.1(b)(3).
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For example, legislatures might subject derivative suits to heightened pleading stand-
ards. These pleading standards could require shareholders to include particularized
allegations supporting an inference that the named defendants breached their fiduciary
duties to the corporation. Such provisions would not be without controversy. Yet the
normal objection to heightened pleading standards is that plaintiffs lack access to the
relevant facts. In most cases, this is a valid concern because plaintiffs are typically not
entitled to discovery until after they have survived a motion to dismiss. In derivative
suits, however, shareholders can request access to the corporation’s books and records
before filing suit. Under Section 220 of the General Corporation Law of Delaware, for
example, as long as shareholders have a credible reason to suspect misconduct, they can
get sweeping access to emails, memoranda, and other internal documents that they can
then use to support their claims.47
Additionally, legislatures could explore limited feeshifting and cost sharing proposals.
The Delaware legislature recently prohibited feeshifting provisions in corporate charters
or bylaws because these provisions were inherently onesided.48 They made representative
shareholders liable for 100 percent of the defendants’ fees if the suit was unsuccessful,
even though these shareholders would only receive their pro rata share of the recovery if
the suit was successful. This situation threatened to make it financially perilous for share-
holders to file these claims (Lebovitch & van Kwawegen 2016). Given that these provisions
were drafted by corporate directors (that is, the likely defendants in any derivative suit),
it is not surprising that they were so onesided.
Yet feeshifting proposals need not be so extreme. For example, instead of making
representative shareholders liable if the suit is unsuccessful, lawmakers could require
their attorneys to pay the defendant’s legal fees if the suit is unsuccessful (Erickson 2016).
These potential losses could be offset by higher fees awarded to plaintiffs’ attorneys in
successful suits. This more moderate proposal could make it more costly for attorneys to
file frivolous claims, but also more lucrative to file meritorious claims.
Legislative action along these lines is more promising than corporate self-help in at
least three ways. First, legislators do not have the same structural biases as corporate
directors because legislators, unlike directors, are unlikely to be defendants in derivative
suits. Second, legislative action covers all companies incorporated in a given jurisdiction,
so any new procedures adopted by the legislature will apply to a wide range of companies.
In contrast, a corporate board can only adopt procedures for their particular company,
forcing each company to reinvent the procedural wheel. Finally, rulemaking is within the
legislative wheelhouse. The federal government has an existing structure in the Federal
Civil Rules Advisory Committee to evaluate and craft procedural rules. Although many
47
Del. Code, tit. 8, § 220(b); see also Melzer v. CNet Networks, Inc., 934 A.2d 912, 917 (2007)
(“Before shareholders may inspect books and records, they must . . . a proper purpose for seeking
inspection”).
48
See Del. Code, tit. 8, § 109(b) (“The bylaws may not contain any provision that would impose
liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party
in connection with an internal corporate claim, as defined in § 115 of this title”); Del. Code, tit.
8, § 102(f) (“The certificate of incorporation may not contain any provision that would impose
liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party
in connection with an internal corporate claim, as defined in § 115 of this title”).
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states do not have standing committees devoted to procedure, state legislatures are still
used to drafting and assessing laws that impact the legal system.
This is not to say that legislatures are a procedural panacea. They are subject to capture
and lobbying by the lawyers on either side who may be impacted by these proposals.
Moreover, as the experience of the PSLRA demonstrates, there is a risk that they will not
take the time to do the type of nuanced reflection and consultation that good procedural
rules require. And legislatures may not be interested in taking on this issue. As discussed
in section 3, derivative suits have long flown under the radar, so they are not likely to be
high on many lawmakers’ list of priorities.
In the end, it seems likely that there is not a single solution to the problems posed by
derivative suits. These suits need comprehensive reform, ideally through a combined effort
of courts, corporate boards, shareholders, and legislatures. Through this combined effort,
the legal system might finally solve the problems that have long plagued these suits.
5. CONCLUSION
More than 70 years ago, Franklin Wood declared that “the great preponderance” of
derivative suits are “unfounded and speculative” (Wood 1944, 9). Scholars today make
the same claim. Yet despite longstanding concerns about these suits, little action has
been taken. Derivative suits are still filed by shareholders with little stake in the company.
Most derivative suits still end with nonmonetary settlements that offer little benefit to the
plaintiff corporation. And an increasing number of derivative suits serve as tagalong cases
to larger securities class actions, offering little additional value to shareholders.
This chapter argues that the legal system should conduct a wholesale reexamination
of its approach to derivative suits. The current approach of leaving derivative suits in
the hands of plaintiffs’ attorneys and corporate boards is not working. Instead, judges,
shareholders, and legislatures should all play an increased role in these suits, rejecting
meritless settlements and developing better ex ante procedural rules to sort the good
cases from the bad. If the legal system embraces this approach, perhaps we will not still
be lamenting the problems with derivative suits in another 70 years.
BIBLIOGRAPHY
Bainbridge, S., Fee-Shifting: Delaware’s Self-Inflicted Wound, Delaware Journal of Corporation Law 40 (2016),
851–76.
Cary, W. & Eisenberg, M., Cases and Materials on Corporations (5th ed. 1980).
Choi, S., Fisch, J., & Pritchard, A., Do Institutions Matter? The Impact of the Lead Plaintiff Provision of the
Private Securities Litigation Reform Act, Washington University Law Quarterly 83 (2005) 869–904.
Choi, S., Erickson, J., & Pritchard, A., Piling On: An Empirical Study of Parallel Derivative Suits, Journal of
Empirical Legal Studies 14 (2017) 653–82.
Coffee, Jr, J., Understanding the Plaintiff’s Attorney: The Implications of Economic Theory for Private
Enforcement of Law through Class and Derivative Actions, Columbia Law Review 86 (1986), 669–727.
Erickson, J., Corporate Governance in the Courtroom: An Empirical Analysis, William & Mary Law Review 51
(2010), 1749–1831.
Erickson, J., Overlitigating Corporate Fraud: An Empirical Analysis, Iowa Law Review, 97 (2011), 49–99.
Erickson, J., The Market for Leadership in Corporate Litigation, University of Illinois Law Review [2015],
1479–1528.
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Erickson, J., Heightened Procedure, Iowa Law Review 102 (2016), 61–120.
Fisch, J., Griffith, S., & Solomon, S., Confronting the Peppercorn Settlement in Merger Litigation: An Empirical
Analysis and a Proposal for Reform, Texas Law Review 93 (2015), 557–624.
Ferrera, R., Abikoff, K., & Gansler, L., Shareholder Derivative Litigation: Besieging the Board (Law Journal
Seminars-Press 2013).
Fuerman, R., Securities Class Actions Compared to Derivative Lawsuits: Evidence from the Stock Option
Backdating Litigation on Their Relative Disciplining of Fraudster Executives, Journal of Forensic and
Investigative Accounting 8 (2016), 198–217.
Griffith, S., Correcting Corporate Benefit: How to Fix Shareholder Litigation by Shifting the Doctrine on Fees,
Boston College Law Review 56 (2015), 1–59.
Griffith, S., Private Ordering Post-Trulia: Why No Pay Provisions Can Fix the Deal Tax and Forum Selection
Provisions Can’t, in The Corporate Contract in Changing Times, Steven Davidoff Solomon and Randall S.
Thomas, eds (2017).
Jones, T., An Empirical Examination of the Incidence of Shareholder Derivative and Class Action Lawsuits,
1971–1978, Boston University Law Review 60 (1980), 306–30.
Kaufman, M. & Wunderlich, J., Paving the Delaware Way: Legislative and Equitable Limits on Bylaws after ATP,
Washington University Law Review 93 (2015), 335–77.
Koumrian, O., Settlements of Shareholder Litigation Involving Mergers and Acquisitions—Review of 2013
M&A Litigation, Cornerstone Research (2014).
Lebovitch, M. & van Kwawegen, J., Of Babies and Bathwater: Deterring Frivolous Stockholder Claims Without
Closing the Courthouse Door to Legitimate Claims, Delaware Journal of Corporation Law 40 (2016), 491–540.
Macey, J. & Miller, G., The Plaintiffs’ Attorney’s Role in Class Action and Derivative Litigation: Economic
Analysis and Recommendations for Reform, University of Chicago Law Review, 58 (1991), 1–117.
Myers, M., The Decisions of Corporate Special Litigation Committees: An Empirical Investigation, Indiana Law
Journal 84 (2009) 1309–36.
Myers, M., Fixing Multi-Forum Shareholder Litigation, University of Illinois Law Review [2014] 467–551.
Romano, R., The Shareholder Suit: Litigation Without Foundation?, Journal of Law, Economics, and
Organization 7 (1991), 55–87.
Sinha, R., Shareholder Litigation Involving Acquisition of Public Companies: Review of 2015 and 1H 2016
M&A Litigation, Cornerstone Research (2016).
Thompson, R. & Thomas, R., The New Look of Shareholder Litigation: Acquisition-Oriented Class Actions,
Vanderbilt Law Review 57 (2004) 131.
Thompson, R. & Thomas, R., The Public and Private Faces of Derivative Lawsuits, Vanderbilt Law Review 57
(2004), 1747–793.
Thompson, R. & Thomas, R., A Theory of Representative Shareholder Suits and Its Application to Multijurisdic
tional Litigation, Northwestern Law Review 106 (2012) 1753–1819.
Winship, V., Shareholder Litigation by Contract, 96 Boston University Law Review 481 (2016), 485–542.
Wood, F., Survey and Report Regarding Stockholders’ Derivative Suits (1944).
M4633-GRIFFITH_t.indd 79 30/10/2018 08:16

5. Claim character and class conflict in securities
litigation
Richard A. Booth*
1. INTRODUCTION
In a typical securities fraud class action (SFCA) arising under SEC Rule 10b-5—where
the plaintiff class comprises investors who bought during the fraud period—the measure
of damages is the difference between the price paid by a given investor and the corrected
price after the truth comes out (Booth 2004).1 But the price of a stock may fall for many
reasons, some of which are not actionable. For example, if the price of a stock falls solely
in tandem with a marketwide or industrywide decrease in equity prices, buyers have no
claim. On the other hand, there are several different company-specific reasons why the
price of a stock may fall that may be actionable. For example, expected return may be
revised downward; or the perceived risk associated therewith may increase, thus entailing
an increase in the cost of equity capital—the applicable discount rate; or it could be that
* Thanks to the participants in the 2016 Corporate & Securities Litigation Workshop: Eric
Chiappinelli, Stephen Choi, James Cox, Jessica Erickson, Jake Fedechko, Hon. James Gale, Matteo
Gargantini, Martin Gelter, Sean Griffith, Lawrence Hamermesh, Charles Korsmo, Hon. Travis
Laster, Ann Lipton, Minor Myers, James Park, Poonam Puri, Hon. Ruth Ronen, Amanda Rose,
Megan Shaner, Charles Silver, Eric Talley, Urska Velikonja, David Webber, Verity Winship, Chao
Xi.
1
To be precise, the law provides that damages are limited to the difference between the price
paid or received by the plaintiff investor and the average closing price over the 90 days following
corrective disclosure. Securities Exchange Act of 1934 (Exchange Act) § 21D(e). See also In re
Cendant Corporation Litigation, 264 F.3d 201, 241–42 (and note 24) (3d Cir. 2001) (discussing cal-
culation of damages and estimation of aggregate). Although this provision (added to the Exchange
Act by the Private Securities Litigation Reform Act (PSLRA) of 1995) states that it applies to cases
in which the plaintiff seeks to establish damages by reference to the market price of a security, it
implicitly approves the standard measure of damages. The discussion herein assumes that the fraud
involves the cover-up of bad news and thus that the plaintiff class comprises buyers. It is quite
possible for fraud to involve the coverup of good news and for the class to comprise sellers. But bad
news fraud is much more common. Indeed, my own research indicates that fewer than 1 in 50 cases
is a good news case. Thus, it is odd that some of the most important judicial decisions have involved
good news fraud. See Basic, Inc. v. Levinson, 485 U.S. 224 (1988); SEC v. Texas Gulf Sulphur Co.,
401 F.2d 833 (2d Cir. 1968). To be clear, the focus here is on claims involving outstanding stock and
arising under SEC Rule 10b-5. For the most part, the discussion herein does not apply to claims
arising under the 1933 Act in which the defendant company has issued stock and the remedy is
essentially one of disgorgement (even though a parallel claim under Rule 10b-5 may be asserted in
such cases). See Herman & MacLean v. Huddleston, 459 U.S. 375 (1983). As discussed further later
in the chapter, claims relating to already outstanding stock (such as where the company has issued
a false press release) are ultimately based on the timing of disclosure. The claim is that if accurate
information had been disclosed in a timely fashion, buyers (or sellers) would not have suffered a
loss (or missed a gain).
80
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Claim character and class conflict 81
the company suffers a significant onetime cash outflow. These causes of loss may or may
not be actionable under Rule 10b-5, depending on whether management has misrepre-
sented the relevant facts.
In addressing the need to plead and prove loss causation, the Supreme Court has quite
clearly stated that the loss suffered by a buyer must have resulted from the misrepresenta-
tion giving rise to the SFCA:
When the purchaser subsequently resells such shares, even at a lower price, that lower price may
reflect, not the earlier misrepresentation, but changed economic circumstances, changed investor
expectations, new industry-specific or firm-specific facts, conditions, or other events, which
taken separately or together account for some or all of that lower price . . . Other things being
equal, the longer the time between purchase and sale, the more likely that this is so, i.e., the more
likely that other factors caused the loss.2
Thus, it matters what causes stock price to change. Moreover, in the wake of Halliburton
II, defendant companies may oppose class certification by showing lack of price impact.3
As a result, the question of why stock price fell now arises very early in a SFCA. So a
court may need to parse the elements of price decrease.
Until now, the courts (and litigants) have generally failed to notice that the cause of a
loss may result in a claim that is properly seen as belonging to the corporation—a deriva-
tive claim—rather than a direct claim belonging to individual buyers.
For example, a onetime cash outflow may be the result of bad luck, such as a freak
accident, which is not actionable standing alone. But if management covers up the event,
resulting in an eventual SEC fine and substantial attendant legal expenses, the decrease
in stock price will reflect not only the cost of the accident itself but also the SEC fine and
legal expenses.
It is well settled that stockholders who bought after the accident but before its disclo-
sure would have a (direct) claim based on the entire decrease in stock price.4 But it also
seems quite clear that the corporation would have a (derivative) claim to the extent of its
loss from the fine and the legal expenses although not the cost of the accident itself (Booth
2009; Strine, et al. 2010).5
2
See, e.g., Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342–3 (2005).
3
Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2404 (2014) (Halliburton II).
4
See, e.g., Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27 (2011) (company made public
statements predicting growth in revenues knowing that several consumers claimed to have suffered
injuries from using product); Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007)
(company made public statements that demand remained strong for product when demand was in
fact waning); Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005) (company made public
statements predicting approval of medical device despite knowledge to the contrary).
5
Although the business judgment rule precludes director and officer liability in many situa-
tions, it does not extend to legally prohibited actions. See, e.g., Joy v. North, 692 F.2d 880 (2d Cir.
1982) (derivative action to recover losses based in part on violation of lending limits); Miller v.
American Telephone & Telegraph Co., 507 F.2d 759 (3d Cir.1974) (derivative action based illegal
campaign contribution in form of forgiven debt). It is not necessary to assume that management
misconduct rises to the level of a prohibited act in order to overcome the business judgment rule
even if the corporation has adopted an exculpatory charter provision under DGCL 102(b)(7). The
law is quite clear that if the corporation suffers harm as the result of management misconduct
accompanied by scienter, the business judgment rule does not apply. See In re Goldman Sachs
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To be clear, the market reacts quickly—especially to bad news—and market price will
adjust to reflect the possibility and probability of loss even though the cash outflow will
come later (Alexander 1994; Cornell & Rutten 2006; Lev & de Villiers 1994; DeBondt &
Thaler 1985, 1987).6 In other words, upon disclosure of the freak accident and its coverup,
market price can be expected to adjust not only for the direct loss from the event but also
for the fines and legal expenses that are likely to follow. In short, the loss happens all at
once (although it may vary in magnitude over time as the market learns more about the
merits).
The key point for present purposes is that part of the loss suffered by buyers is in fact
a loss suffered by the corporation and thus all of its stockholders. In other words, there is
a derivative claim imbedded in the larger decrease in stock price.
The obvious question is: How should we handle the competing direct claims of buyers
(under Rule 10b-5) and the derivative claims of the corporation (under state law)? The
prevailing practice is to give priority to the direct claims of buyers (and often to settle
the derivative claim for non-monetary governance reforms of dubious value). But this
approach makes no sense and indeed may do more harm than good.
First (and foremost), by settling the corporate claim first, stockholders in the aggregate
would be restored to the same position as if there had been no fraud. Moreover, recovery
by the corporation would reduce the remaining claim of buyers (if any) based on the
happenstance of buying just before disclosure of the loss.
In contrast, to settle the buyer claims first out of corporate funds (as under Rule 10b-5)
is both to deny recovery on the corporate claim to nonbuyer holders and to magnify the
loss they suffer by further reducing stock price. In other words, nonbuyer holders pay
twice.
To confuse matters still further, if the corporation does later recover on its claim, buyer-
holders also benefit. In effect, buyer-holders enjoy a double dip if the corporation later
recovers again for the portion of the loss it suffered in the first place. Moreover, since the
corporation will also have a claim based on the further loss it suffers from the payout to
settle buyer claims, the double dip becomes in effect a quadruple dip.
All of these problems disappear if we handle the corporate claim first. Indeed, the law
is quite clear that derivative claims should give rise to recovery by the corporation rather
than by individual stockholders and should take precedence over direct claims in cases
Group Shareholder Litigation, 2011 Del. Ch. LEXIS 151, aff’d, sub nom. SEPTA v. Blankefein,
44 A.3d 922 (Del., 2012); In re American International Group, Inc., Consolidated Derivative
Litigation, 965 A.2d 763, 799 (Del. Ch. 2009). Moreover, it is also clear that deception constitutes
actionable misconduct even in the absence of a stockholder vote (assuming the corporation suf-
fers quantifiable harm). See Malone v. Brincat, 722 A.2d 5 (Del. 1998) (stockholder plaintiff can
demonstrate a breach of fiduciary duty by showing that the directors deliberately misinform[ed]
stockholders about the business of the corporation either directly or by a public statement); In re
infoUSA, Inc. Shareholders Litigation, 953 A.2d 963, 990 (Del. Ch. 2007) (directors violate fiduci-
ary duty where it can be shown that they issued communication with the knowledge that it was
deceptive or incomplete since stockholders are entitled to honest communication from directors
given with complete candor and in good faith even in the absence of a request for stockholder
action).
6
Needless to say, this assertion presupposes basic market efficiency (at least informational, if
not fundamental). But if anything the market seems to overreact to bad news.
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of conflict.7 So it is all the more curious that the law has evolved as it has to emphasize a
class action remedy rather than a derivative remedy.
The one issue that remains is the claim by buyers that they would not have suffered
the loss directly attributable to the freak accident itself if the news thereof had not been
covered up by management. Clearly, the corporation itself has no claim for this loss. So
the claim (if any) must be direct if only by process of elimination. But if this is the only
loss suffered by investors, there is a serious question whether the law should provide any
remedy at all. As in musical chairs, this loss is a loss that someone will suffer. Investors in
the aggregate will lose what they will lose. Que sera sera.
Moreover, a diversified investor is just as likely to sell an overpriced stock as to buy
one. Over time, gains (from losses avoided) and losses (from untimely purchases) wash
out. In other words, investors can protect themselves against this risk—and can do so
for free—by holding an index fund (for example). In contrast, the loss that gives rise to a
derivative claim cannot be diversified away. There is no windfall gain from the opposite
of fraud or other management misconduct—which always gives rise to a loss.8 So the
only real loss for most investors is the derivative loss that cannot be diversified away
(Booth 1998).
The foregoing analysis applies ceteris paribus to the other sources of loss noted above—
a reduction in expected return or an increase in the discount rate. Some such events just
happen, while others can be traced to fraud or other management misconduct. The losses
that just happen or those that can be traced to management decisions protected by the
business judgment rule are losses that someone must suffer. And the risk of such losses can
always be diversified away because they will be offset by unexpected gains under the law
of large numbers.9 But the avoidable losses that happen only because of fraud or manage-
ment misconduct cannot be diversified away because they are never offset by gains from
the absence thereof. Coincidentally, these losses all give rise to derivative claims. Thus, the
only claims that really matter are claims that belong to the corporation, which suggests
that SFCAs should properly be litigated as derivative actions.
Finally, and perhaps needless to say, the aggregate price decrease in any given case may
comprise changes in several of these factors, giving rise to a combination of direct and
derivative claims that may be difficult to sort out. Under federal law, all of these losses
are glommed together into one big cause of action as long as management has deceived
investors (with scienter) as to any one factor of loss, and buyers can recover the entire
difference between purchase price and corrected price (at least in theory).
7
FRCP 23(b)(3) states that a class action for damages may be certified only if the trial court
finds “that a class action is superior to other available methods for fairly and efficiently adjudicat-
ing the controversy.” If a derivative action is an equally good (or better) way to resolve the matter,
FRCP 23 itself requires that the matter be tried as a derivative action.
8
There is no potential for gain from nonfraud as there is from good luck. In other words, a
diversified investor may enjoy a gain on the stock of a company whose sales are more robust than
expected—a gain that offsets the loss from a company whose results are disappointing. But there
is no potential for offsetting gain just because a company avoids fraud claims and unexpected
outflows of cash or an increase in its cost of capital from a loss of trust in management.
9
Admittedly, a freak accident cannot be offset by the absence thereof. But a windfall is always
possible. Although the two are not exactly symmetrical, the more important point is that fraud and
misconduct are avoidable and always operate to reduce return.
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But because the only claims that really matter derive from losses suffered by the corpo-
ration, it is ultimately quite simple to fix the problem by recasting SFCAs as derivative
actions—a solution that (again) turns out to be dictated by settled rules of civil procedure
anyway.10
2. VALUATION FACTORS
Since a share of stock represents a fractional ownership interest in the issuing corpora-
tion, share price depends on three factors as reflected in the basic formula for going
concern value (GCV):
VALUE = (RETURN / DISCOUNT RATE) + CASH
To restate the formula in terms of share price:
SHARE PRICE = (RETURN PER SHARE / DISCOUNT RATE) +

CASH PER SHARE
Note that the term discount rate goes by many different names, including cost of equity
(COE) or sometimes capitalization rate. But whatever the name used, it is equal to the
rate of return required by investors (the market) in light of the risk inherent in the subject
company. Thus, I use the term required rate of return (RRR) herein.11
Needless to say, it can be difficult to determine what each of these inputs should be in
any real world case. But for present purposes we need not worry about how to measure
these factors. All that matters is the relationship.
It is helpful to consider a simple example: Suppose that Acme Blasting Cap Corporation
(ABC) trades for $25 per share based on expected return of $2.00 per share with RRR
equal to 10% and excess cash of $5.00 per share. Plugging these numbers into the formula:
SHARE PRICE = 2.00 / (0.10) + 5.00 = 20.00 + 5.00 = 25.00
With this formula in mind, we can isolate three distinct types of events that might cause
a decrease in the stock price of ABC: (1) a decrease in expected return, (2) an increase in
RRR, or (3) a decrease in cash. It is entirely possible for any one of these causes to occur
alone or for two or all three to occur together.
For example, suppose that ABC loses a major customer and that as a result expected
return decreases from $2.00 per share to $1.50 per share. Other things equal, stock price
should fall:
SHARE PRICE = 1.50 / (0.10) + 5.00 = 15.00 + 5.00 = 20.00
10
See note 7 supra.
11
RRR is my own invention (as far as I know), but it is closely akin to internal rate of return
(IRR), which is widely used in the world of finance.
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Or suppose that ATF announces that it is conducting a major study focusing on the
possibility of adopting new regulations with the result that investors now demand a 12
percent return from ABC:
SHARE PRICE = 2.00 / (0.12) + 5.00 = 16.67 + 5.00 = 21.67
Or suppose that an ABC delivery truck explodes in a freak accident that results in a
lawsuit that is settled for an amount equal to $3.00 per share (but that the circumstances
of the accident are so bizarre that it does not affect expected return or RRR):
SHARE PRICE = 2.00 / (0.10) + 2.00 = 20.00 + 2.00 = 22.00
None of the above events would give rise to a claim by investors under federal law in the
absence of some sort of misrepresentation (plus scienter). But suppose the CEO of ABC
states during a quarterly conference call that he expects earnings to remain stable for the
foreseeable future even though he knows that a major customer has cancelled a contract
(as in the first example above). When the truth comes out, the price of ABC stock drops
dramatically:
SHARE PRICE = 1.50 / (0.12) + (5.00 – 3.00) = 12.50 + 2.00 = 14.50
Note that the total price decrease of $10.50 per share is attributable to changes in all three
of the valuation factors: expected return, discount rate, and cash. Of the aggregate loss,
$5.00 is attributable to a decrease in expected return, $3.00 is attributable to a decrease in
cash (from the prospect of fines and legal expenses), and the remaining $2.50 is attribut-
able to an increase in RRR (from a loss of trust in management).12
Under federal law, a buyer can recover individually—in a direct class action—for the
entire loss, even though the parts of the loss attributable to a decrease in cash and an
increase in RRR are derivative losses suffered by the corporation.
3. LOSS CAUSATION
Although a loss can always be traced to a change in one of the three valuation factors
described above, the precise cause of the loss as to a given factor may vary. Considered in
isolation, some causes may be actionable, while others may not. Or the loss from a given
factor may be a mixture of the two.
3.1 Cash Outflow
As for cash, the price decrease may be attributable to a freak event and thus not actionable.
Or the cash loss may come from the prospect of a fine by the SEC, expenses of defense, or
12
Specifically, the new EPS of $1.50 at a discount rate of 10 percent would have given a GCV
of $15.00. But at the new 12 percent discount rate, $1.50 gives a GCV of $12.50 thus accounting
for $2.50 of the total decrease.
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the likelihood of a SFCA and settlement thereof. Presumably, these losses are actionable
since they arise from management malfeasance. In the absence of scienter there would be
no fine or settlement. So the central point for present purposes is that if the cash loss is
actionable it is almost certainly derivative.
Note that the last form of loss—from a SFCA settlement—is peculiar in that it results
from an effective transfer of funds from the corporation (and thus holders) to buyers, with
the effect that the market price of the subject stocks falls more than it otherwise would
depending on the number of damaged shares represented in the plaintiff class. One might
say that the cure is worse than the disease—or at least that it is part of the disease. Many
scholars refer to this problem as circularity—thus focusing on the fact that holders pay
buyers. But that appellation fails to capture the price effect—which I call feedback. Again,
the market reacts immediately to the prospect of these outflows. Even if the payout will
come months (or years) in the future, informed investors will reckon that the value of a
share is net of the present value of such items (Alessi 2001; Booth 2007).13
3.2 Discount Rate
As for discount rate, the increase may be attributable to an increase in risk perceived by
the market, for example, because customer relationships in the industry seem to be less
stable than previously thought or because investors have lost trust or confidence in ABC
management. If the former, the increase in discount rate will likely affect other companies
in the industry (though possibly to varying degrees) and thus is probably not actionable.
(Moreover, investors can hedge away such risks with diversification.) If the latter, the
change is likely to be a company-specific one that affects only ABC. While it is possible
that a company-specific increase in the cost of capital may occur because of some peculiar
risk factor applicable only to one company, it seems unlikely that there are many such
business risks (other than in an industry with only one company). Thus, it seems likely
13
As I have shown elsewhere, the feedback effect depends on the number of damaged shares
(absolute turnover during the fraud period) (Booth 2007). To be specific, the effect in bad news
cases—where the plaintiff class comprises buyers—is to magnify the damage claim according to
the following formula:
damage claim (%) = simple loss (%) / (1.00 minus absolute turnover (%))
Thus, where stock price would have fallen by (say) 10 percent as a matter of fundamentals, the loss
will be magnified to 20 percent if the plaintiff class comprises 50 percent of the shares. The problem
is that it is impossible to determine the percentage of damaged shares before claims are filed
(although there are numerous quack theories that claim to do so). Needless to say, this complicates
settlement negotiations. On the other hand, there is every reason to think that the market is pretty
good at estimating this number. See generally James Suroweicki, The Wisdom of Crowds (2004).
It is important to emphasize that in relatively uncommon good news cases, the calculus of loss is
different. First, feedback operates negatively to reduce the loss suffered by sellers. See Richard A.
Booth, The End of the Securities Fraud Class Action as We Know It, 4 Berkeley Bus. L.J. 1 (2007).
The same is true for other cash outflows (such as from fines and legal expenses) as well as the cost
of capital. Thus, it is little wonder that there are so few good news cases since all of the forces that
militate to magnify the loss in a good news case operate in the opposite way in good news cases.
Indeed, it is conceivable that good news fraud could result in a stock price decrease under perfect
storm conditions.
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that a company-specific increase in the cost of capital almost always flows from a loss of
trust.14 If so, the loss is quite clearly derivative. But in the unlikely case that management
has covered up a peculiar business risk, clearly the company itself has no claim. So the
claim (if any) must be direct.15 Again, multiple forces may be at work.
3.3 Expected Return
As for return, the loss attributable thereto is almost always a loss that will happen irrespec-
tive of any misrepresentation.16 In the example, it stems from the ordinary business risk
that a customer may cancel a contract. Thus, it is a risk that investors freely assume when
they invest. (And again, it is a risk that can be diversified away.)
On the other hand, lower return may sometimes be caused by management misconduct.
For example, management might fail to perform as agreed on a contract or may misrepre-
sent product quality, thus prompting customers to cancel otherwise binding commitments
that have been booked as sales. If so, the loss should give rise to a derivative action. But in
the more likely case that the loss stems from bad business luck, clearly the company has
no claim. Thus, if buyers have a claim because the facts have been covered up, the claim
must be direct.
Again, under Rule 10b-5, a defrauded buyer may recover the entire difference between
purchase price and corrected price (at least as a matter of law) if the loss from any one
factor can be traced to a misrepresentation. But note that losses from cash outflows and
increases in cost of capital are almost always derivative, while the portion of any loss that
is not derivative is attributable to a risk that can be diversified away—the revelation of pre-
viously unknown business risks or a reduction in expected return from bad business luck.
Moreover, in any meritorious case—one that can withstand a motion to dismiss—some of
the loss is almost certainly derivative. Since such a case will always have settlement value,
some of the loss will always be attributable to the prospect of cash outflow. Thus, buyers
14
Presumably, a corporation’s reputation for candor may have an effect on its cost of capital.
There has been a good deal of scholarship about the importance of trust in corporation law
(Akerloff 1970; Blair & Stout 2001; Ribstein 2001; Rock & Wachter 2001).
15
See In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106, 2009 Del.
Ch. LEXIS 25 (distinguishing business risk and the duty to manage it from the risk of illegal
conduct and the duty to monitor compliance). Compare American International Group, Inc.
Consolidated Derivative Litigation, 965 A.2d 763 (Del. Ch. 2009) (finding in contrast to Citigroup
that a complaint alleging a pervasive fraudulent scheme was sufficient to withstand a motion to
dismiss). Although the phrase business risk may seem internally redundant, I use it here as distinct
from reputational risk to distinguish between losses that may flow from new information about the
risk inherent in a line of business (and a concomitant increase in the cost of capital) from increases
in the cost of capital attributable to a loss of trust in management because of misconduct. I suspect
that the Citigroup court was struggling to make the same distinction.
16
Many courts characterize such loss as resulting from price inflation. See, e.g., Ludlow v. BP,
PLC, 800 F.3d 674 (5th Cir. 2015). But the word inflation connotes that management has done
something to cause a positive increase in stock price. It is much more common for management
merely to have covered up the truth so as to delay the inevitable. See, e.g., In re Time Warner
Securities Litigation, 9 F.3d 259 (2d Cir. 1993). Cf. Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S.
336 (2005) (rejecting idea that buyer can recover upon proof of price inflation without price impact
upon corrective disclosure).
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can have no claim unless the company has at least one claim. So it is difficult to see how
the courts can avoid analyzing claims as outlined here.17
4. ACTIONABLE LOSSES
Legal scholars differ as to whether all of these elements of loss should be recover-
able consistent with the loss causation requirement in an action arising under Rule
10b-5.18
On the one hand, Allen Ferrell and Atanu Saha have argued that the loss from fines,
defense costs, and presumably feedback cannot be recovered because such losses are not
caused by the offending misrepresentation. Rather, such losses should be seen as collateral
damage (or ancillary damages, in the words of others). According to Ferrell and Saha,
the only actionable loss comes from a decrease in return or an increase in the discount
rate stemming from misrepresented risk factors—what one might call fundamental losses
(Ferrell & Saha 2007).
Similarly, other scholars have noted that stock prices tend to overreact to corrective
disclosure (Alexander 1994; Cornell & Rutten 2006; Lev & de Villiers 1994; DeBondt &
Thaler 1985, 1987). In other words, stock price tends to fall more than it should based on
the specific content of new (negative) information. Thus, these scholars have argued that
the excess loss—dubbed crash damages—should not be recoverable.
To be sure, studies show that stock price tends to recover from such overreaction.
Accordingly, under Section 21D of the Exchange Act (added by PSLRA in 1995),
damages are calculated based a 90-day average of closing prices following corrective
disclosure (Booth 2004). But it is also possible that some (or much) of crash loss is
attributable to other factors (such as feedback) from which there is no reason to expect
any bounceback.
On the other hand, Barbara Black has argued that excess price decreases attributable
to a loss of trust or confidence in management should be recoverable as reputational dam-
ages. In essence, her argument is that such damages are proximately caused by the fraud
even though the offending misrepresentation may have related to projected earnings (for
example) rather than management integrity (Black 2009).
As a matter of tort law, these other forms of loss are usually called consequential
damages—as they have been by several courts in SFCAs.19 It is blackletter law that
consequential damages may be recovered if the underlying tort is intentional. Since fraud
under Rule 10b-5 requires scienter, it would seem to follow that consequential damages
should be part of the award.20
17
Incidentally, the requirement that all misrepresentations be pleaded with particularity (as
added by PSLRA) should facilitate distinguishing among various sources of loss.
18
In contrast, all losses can be recovered under Securities Act §11. There is no loss causation
requirement. Indeed, there is no adjustment for market losses.
19
The classic example (in contract law) is Hadley v. Baxendale, 156 Eng. Rep. 145 (Ex. Ch.
1854). A closely related question is whether losses from the materialization of an undisclosed or
misrepresented risk can be recovered. This issue is discussed in detail in section 6.
20
See W. Page Keeton, et al., Prosser and Keeton on Torts §110 (5E 1984).
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In the end, this controversy is about proximate cause. Ferrell and Saha (and others)
think consequential damages are too remote. They also argue that reputational damages
should be seen as resulting from a separate misrepresentation as to management integrity
or internal controls. But as Black points out, Congress (in PSLRA) apparently endorsed
a damages formula based on total price decline (albeit as measured by a 90-day average
of closing prices following corrective disclosure). She also points out that the fraud on the
market (FOTM) doctrine is based on the notion that investors should be able to rely on
the integrity of the market price (and presumably management). Moreover, the Supreme
Court has held on at least two occasions that false statements of opinion by management
may be actionable.21 And Congress has reinforced these ideas in the Sarbanes–Oxley Act
(SARBOX) by requiring management regularly to certify the internal controls that assure
accurate reporting, together with the financial statements themselves.22 Thus, there is
ample reason to think that both Congress and the courts see consequential damages as
recoverable.
Although Black seems to have the better argument (at least as to reputational damages),
she acknowledges that such damages affect all stockholders—both buyers and holders—
and thus might be precluded from being recovered because only buyers (or sellers) may
recover under the Blue Chip Stamps rule.23 In response, Black argues that this judgemade
standing rule is intended to thwart fabricated claims such as by nontraders who claim
they would have bought or sold but for a misrepresentation—and not to limit recovery
by traders with standing to sue.24
5. DIRECT AND DERIVATIVE CLAIMS
Although the argument from standing is twisted at best, it reveals a fatal flaw in the
arguments of both sides of this debate, to wit, that reputational damages affect all
stockholders in the same way: Whereas only buyers usually have standing to complain
about the substance of a false projection of earnings (since holders are already holders
and cannot claim reliance), reputational damages affect all stockholders in the same way
and to the same extent. The implication is that any recovery for reputational damages
should come from a derivative action by which the corporation recovers—presumably
21
See Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 111 S.Ct. 2749 (1991); Omnicare,
Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318, 191 L. Ed.
2d 253 (2015).
22
These latter points also answer the argument that management is under no general obligation
to disclose its own failings. See Santa Fe Industries, Inc. v. Green, 430 U.S. 462 (1977). Thus, there
can be no entitlement to underlying facts. See In re Time Warner, Inc. Securities Litigation, 9 F.3d
259 (2d Cir. 1993).
23
See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975).
24
See Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71 (2006). Moreover, the
argument that buyers cannot recover for reputational damages because holders have no standing
to sue seems disingenuous at best. Indeed, Black concludes that arguments seeking to limit the
measure of damages for securities fraud stem from a persistent distrust of SFCAs and the danger
of open-ended damages for claims of dubious merit—problems that Black (and others) see as
having been addressed by Congress in PSLRA.
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from the individual wrongdoers. Moreover, the same goes for the other forms of collateral
damage described by Ferrell and Saha, particularly consequential losses from fees, fines,
and feedback.
Thus, the debate over proximate cause turns out to be a red herring—albeit one that
provides an important clue about how to resolve the controversy. The problem of what
elements of consequential damages are properly within the scope of damages in a SFCA is
a problem because the answer is NONE. All such damages are suffered by the corporation
and should be recoverable (if at all) by the corporation in a derivative action. In other
words, both sides are wrong in the debate over consequential damages.25
Perhaps the best way to see this distinction is to ask what the price decrease would be in
the absence of any fraud—if the truth had been disclosed in a timely manner. The answer
is that the price would have fallen by just the amount that Ferrell and Saha describe as the
recoverable amount. In other words, stock price will fall by this amount simply because
of the new information.
If this is the only loss suffered by investors, there is a serious question whether the law
should provide any remedy at all. Investors in the aggregate will lose what they will lose.
Thus, in a world with SFCAs, buyers may end up better off than they would have been
in the absence of fraud since they can recover for their entire loss (at least as a matter of
law) including those portions thereof that would have happened one way or the other.
Indeed, this is the essence of the overdeterrence that many legal scholars cite as the biggest
problem with SFCAs.26
Moreover, investors in the aggregate are worse off than they would be without a remedy
because the settlement payment by the defendant company reduces company value dollar
for dollar, while a significant portion thereof goes to the plaintiff lawyers. And the value
of the defendant company is further reduced by its own costs of defense. Thus, the
plaintiff class is never made whole, while holders suffer additional loss to the extent of
the settlement and the costs of defense. If we assume that most investors are diversified
(as they are), it seems clear that they would forgo any such remedy if they could vote
to change the law. In effect, SFCAs provide a form of insurance that nobody wants or
needs—like an extended warranty on a toaster.27
25
Note that the debate is not entirely symmetrical. Black focuses only on reputational damages,
which she thinks flow directly (enough) from the fraud to be recoverable. Black does not discuss
nonreputational consequential damages. But Ferrell and Saha argue that other losses baked into
the total price decrease—such as from the prospect of fines—are also off limits. As they see it, the
only recoverable losses are those that flow from a decrease in return or a company-specific increase
in discount rate (because of misrepresented company-specific risk) since these are the losses that
are traceable to misrepresentation of such facts.
26
Although often made, the overdeterrence argument is it is not always well explained. Indeed,
one might argue that fraud cannot be overdeterred. But aside from the fact that fraud may be too
strong a word for the offense, one problem with overdeterrence is that it makes management too
reluctant to share information that might turn out to be incorrect and results in a circle-the-wagons
mentality when controversies arise.
27
To extend the metaphor, the premiums on this insurance are paid by a tax on returns.
Assuming aggregate annual SFCA settlements of about $5B and total market capitalization of
about $25T, SFCAs are equivalent to a tax on returns of 2 BP. But if we include expenses of defense
and forgone derivative recovery the total swing is probably about $10B and equivalent to a tax on
returns of 4 BP. And that does not include the cost of business failures. By comparison, the annual
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To be sure, a buyer who pays a too-high price for a stock during the fraud period will
be better off if she has a remedy—and will profess to favor the extant system ex post.
But if she is diversified, she is just as likely to sell an overpriced stock as to buy one. Over
time, gains and losses wash out. Thus, from an ex ante perspective, even undiversified
stock-pickers may oppose SFCAs because even they may pay more often as holders than
they recover as buyers.28
The bottom line is that SFCAs are nothing more than a system for redistributing
stockholder wealth. As Joseph Grundfest has said, securities fraud class actions move
money around for the benefit of those who move the money around.29
So Ferrell and Saha are correct that buyers should be precluded from recovering
collateral damages. But they are correct for the wrong reason. Proximate cause is not
the problem. Rather, the problem is that all of the other sources of nonfundamental loss
give rise to claims that belong to the corporation—claims that should be the subject of a
derivative action.
Moreover, such claims will arise in every case in which the market thinks there is a
meritorious claim that will survive the motion phase of litigation (or that will give rise to
an enforcement action by the SEC or criminal action by the DOJ).30 Since all such claims
will have settlement value, the stock price of the defendant company can be expected to
decrease by some amount in excess of fundamental damages. If not, it must mean that
the market thinks the claim (if any) will fail.
Thus, the market provides a reliable signal as to whether there is actionable fraud.
Market price—or, more precisely, changes in market price—should indicate whether or
not a supposed misrepresentation was material and made with scienter.31 There should be
no claim unless stock price falls by more than it should based on new information about
company-specific factors.32 In other words, there should be no claim if there is no col-
lateral damage. For example, if the market thinks the CEO simply made a mistake—got
it wrong as a matter of business judgment—the market may conclude that no action is
expense ratio on SPDRs—one of the most popular ETFs tracking the S&P 500—is just under
10BP. Given that many investors subscribe to the idea that the best way to maximize return is to
minimize expenses, SFCAs thus represent a significant drain on returns.
28
Note that the average fraud period is about 300 days whereas the average holding period for
a stock is about two years (as measured by mutual fund turnover), suggesting that most investors
are more likely to be holders rather than buyers in most cases.
29
See Kevin LaCroix, Private Securities Litigation: Important Deterrent or Wasteful Churn?
The D&O Diary (Regulatory Reform, Securities Litigation), October 26, 2008. www.dandodiary.
com/2008/10/articles/securities-litigation/private-securities-litigation-important-deterrent-or-was
teful-churn/.
30
Compare with Amanda M. Rose’s suggestion that SEC should act as a gatekeeper for private
securities litigation (Rose 2008).
31
To be sure, stock price may decrease to a degree because the market believes that a frivolous
action will be filed. But there is little reason under PSLRA to think that plaintiffs often file actions
that are utterly without merit.
32
Several scholars have suggested that we should rely on market prices to determine
materiality—if only because lack of a statistically significant price change would seem to indicate
that that a particular item of information simply did not matter to the market. But I am not aware
of anyone else who has suggested that scienter can be determined in the same way.
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warranted or that an action if filed will be dismissed for failure to state a claim.33 If the
market does not punish the company, why should the law do so?34
6. BUSINESS RISK, REPUTATIONAL LOSS, AND

MATERIALIZATION OF RISK
Although the market should tell us whether a company is likely to suffer litigation or
enforcement costs in the form of an excess decrease in cash value, it is less clear whether
the market will send an unambiguous signal about company-specific changes in discount
rate. Ferrell and Saha argue that changes from concealed company-specific risks and the
additional decreases in stock price attributable thereto are appropriately recoverable in
a Rule 10b-5 action. But they disagree with Black that changes from a loss of trust or
confidence in management should also be recoverable.
The problem is that such a loss may result from bad news regardless of whether or not
management has misrepresented business risks. If the bad news reveals a risk that was
known to the market all along but underappreciated and underpriced (such as from the
loss of a major customer or even a freak accident), presumably no one should recover. But
if management somehow concealed this business risk, its revelation would give rise to a
fundamental loss of the sort Ferrell and Saha see as properly within the scope of recover-
able damages in a direct action by buyers. On the other hand, if the loss comes from an
increase in the discount rate because the market has loss trust in management simply
because it covered up the fact of lower expected earnings, the loss should properly be seen
as derivative—a loss that would not have happened but for management misconduct. And
of course, the loss may come from a mixture of the two. So how can we tell the difference
between these two sources of loss?
The answer is that an increase in discount rate attributable to previously unknown risks
inherent in the business is likely also to affect other companies in the same industry. So it
seems unlikely that a company-specific increase in discount rate will obtain except where
attributable to a loss of trust or confidence, because increases from other sources are
33
Cf. Lev & de Villiers 1994, at 30–33 (suggesting that business judgment rule would preclude
award of consequential damages in many cases). Incidentally, the possibility that we might rely
on the market to signal scienter (or materiality) suggests that the PSLRA provision precluding
discovery during the pendency of a motion to dismiss makes a good deal of sense. Since (prospec-
tive) decreases in cash from fees, fines, and feedback may be a significant factor in aggregate loss,
it is important to minimize the upfront expenses of defense in order to get the clearest possible
signal from the market. In the absence of such a rule we would expect the market to react simply
because a defendant company has been sued, because every defendant company would be put to
the considerable expense of preparing a defense and responding to plaintiff demands for discovery.
34
One obvious response to this idea is that the law and the market are two different things. The
fact that the market fails to react is no reason to conclude that there is no fraud. So why should we
trust the market? The answer is that securities laws are intended to protect the market. If the market
does not care, the law should not care. It does not follow that we should look to the market to tell
us if we should worry about product liability claims or environmental harms. Although the market
may well be a good indicator of likely success, it tells us nothing about the merits of such claims.
The signal is all the more reliable in the context of SFCAs only because some investors stand to
recover ultimately from other investors.
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likely to affect the entire industry and thus to be netted out in any event study.35 Again we
can trust the market. If market prices for similar companies fall by a similar amount, the
claim should be dismissed. Only if the defendant company suffers a loss that is greater
than other comparable companies should the claim proceed.36
In addition, some of the loss may come from materialization of risk. For example, in the
securities litigation that followed the Deepwater Horizon explosion, plaintiffs argued that
BP had misrepresented its policies and practices related to offshore drilling.37 Although
market price reflected known risks, it did not reflect concealed risks (the known unknown,
as Donald Rumsfeld would have called it). When the explosion occurred, the market
allegedly discovered that BP had covered up some of this risk. But of course, much of the
price decline also came from the prospect of cash outflows in connection with cleanup,
repairs, fines, settlements, and so forth—expenses that are likely to be suffered by any oil
company at some point. As BP argued (among other things), buyers of BP stock should
recover at most the difference in preexplosion price that would have obtained if the market
had known that the risk was greater, but should not be able to recover the much greater
loss attributable to the explosion itself. Needless to say, plaintiffs argued that they should
recover their entire loss, including the consequential damages from materialization. In the
end, the court avoided the question by declining to certify the class on the dubious theory
that class membership could not be ascertained because some class members might have
bought the stock even at higher risk levels and would thus be precluded from recovering for
materialization while other class members would not have bought even at a lower price and
thus should be able to recover their entire loss. Needless to say, this theory is at odds with the
rationale for FOTM. And never mind that all buyers suffered the lesser loss (Booth 2015).
More pertinent for present purposes, the case illustrates the central point here that
the courts must consider the component factors of loss in order to craft the appropriate
remedy. In the case of BP, it might be possible to calculate the actionable loss by netting
out the projected cash outflows from the explosion as well as changes in discount rates
experienced by comparable companies. While these calculations may be difficult to do
with any precision, at least the approach is principled. Finally (but perhaps needless to
say), the calculation serves to emphasize the differing character of the component factors
35
This also addresses a potential shoot-the-messenger problem—the possibility that the first
company to disclose a previously unknown industry-specific risk will be held liable for any loss net
of changes in the market as whole. For example, in Pfeiffer v. Toll, 989 A.2d 683 (Del. Ch. 2010),
defendants misrepresented the number of visitors to model homes built by Toll Brothers in the
months leading up to the 2008 crash of the housing market and sold about $615 million of their
own stock before corrective disclosure—upon which the stock price fell by 42 percent from its
high during the fraud period. A comparable homebuilder stock (Horton) fell by about 15 percent
during the same period (from July to December 2005) while the S&P 500 rose by 2 percent during
the same period. While it is possible that the decrease in Horton shares was triggered in part by Toll
disclosures, the plaintiffs in the Toll SFCA should have a claim at most for the 27 percent difference
between the Toll loss and the loss suffered by Horton (assuming it is a comparable company and
unaffected by its own company-specific news) plus the 2 percent difference in marketwide prices (as
adjusted for risk (beta)).
36
This is precisely what event studies should reveal: Only such losses as exceed market and
industry losses can be recovered. To be sure, this approach may not work in a single-company
industry and may be difficult to apply to a company involved in several lines of business.
37
See Ludlow v. BP, PLC, 800 F.3d 674 (5th Cir. 2015).
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of loss. While the loss from materialization and industrywide increases in the cost of capi-
tal should be seen as ordinary business risks, the remaining loss from a company-specific
increase in the cost of capital should be seen as derivative. To be sure, it is possible that
some of the cash outflow from materialization can be traced to actionable management
misconduct (such as knowing failure to monitor compliance with the company’s own
rules). But if so, the action would remain derivative in character.
7. FUNDAMENTAL DAMAGES REVISITED
Aside from the fact that much of the claim in any meritorious SFCA is derivative and
should be so handled (as a matter of law), litigating such claims as derivative actions
would solve the circularity and feedback problems. Again, since the corporation pays in a
successful SFCA, stock price declines more than it otherwise would. So holder losses are
magnified by the remedy itself—adding insult to injury. In effect, holders pay buyers and
lose twice—once from the payout to buyers and once again from the loss of a derivative
recovery. Needless to say, this magnification of the loss exacerbates the overdeterrence
problem.
Again, in the absence of fraud, no one has a claim just because stock price falls. The
fundamental loss is a loss that will happen to someone. Everyone understands that it is the
risk you take as an investor. So to permit buyers to recover their entire loss is to make them
better off than they would have been in the absence of fraud. In contrast, the prospect of
a derivative action against individual wrongdoers should be plenty of deterrence. Indeed,
if the analysis here is correct, derivative actions should provide optimum deterrence.
The question remains: What should be done about the fundamental loss suffered by
buyers? If they do recover in a direct action against the corporation—albeit after resolution
of derivative claims—such recovery will reintroduce feedback, undoing at least some of
the benefit of proceeding by derivative action in the first place. There are several solutions.
One possibility is individual recovery.38 Some portion of the derivative award (or
settlement) may be paid to buyers. To be sure, some courts have been reluctant to permit
individual recovery seemingly out of an overriding sense of propriety or cosmic order.
But there is nothing to prevent a corporation from agreeing (say) to buy back the shares
of class members.39 On the other hand, one could also argue that if the corporation is not
made whole, individuals should not recover.
Another possibility is that the law should decline to provide a remedy for such
38
See Perlman v. Feldmann, 219 F.2d 173 (2d Cir.1955); ALI, Principles of Corporate
Governance 7.18 (court may order pro rata recovery in a derivative action if equitable and
adequate provision made for creditors of the corporation). But Delaware case law strictly forbids
direct stockholder recovery in a derivative action. See Bokat v. Getty Oil Co., 262 A.2d 246
(Del.1970); Keenan v. Eshleman, 2 A.2d 904 (Del. Ch. 1938). See also Bangor Punta Operations,
Inc. v. Bangor & Aroostook Railroad Co., 417 U.S. 703 (1974) (same). On the other hand, a court
may order rescission or inclusion of minority stockholders. See, e.g., Jones v. H. F. Ahmanson &
Co., 460 P.2d 464 (1969).
39
A useful comparison is to James Park’s argument that payout by a corporation to settle a
SFCA is akin to non pro rata repurchase of shares (Park 2009).
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fundamental losses. Again, as in musical chairs, the loss is one that someone will suffer.
Investors in the aggregate will lose what they will lose. They are no better off because
they have a remedy. Indeed, they are worse off since the settlement payment by the
defendant company reduces company value dollar for dollar, but a significant portion
thereof goes to the plaintiff lawyers. And the value of the defendant company is further
reduced by its own costs of defense. Thus, the plaintiff class is never made whole, while
holders suffer additional loss to the extent of the settlement and the costs of defense. If
we assume that most investors are diversified (as they are), it seems clear that they would
forgo any remedy in such circumstances if they could somehow vote to change the law.
For diversified investors, losses from untimely purchases are offset by gains from lucky
sales. So there is no real need for individual recovery (Booth 2012; Cox & Thomas 2006;
Rubenstein 2001).
To be sure, buyers in the example above would have bought at $20 rather than $25 if the
truth had been known to the market (focusing on return alone). So there is an argument to
be made that buyers should recover.40 But the fraud (so-called) consists only in shifting the
loss from one set of investors to another because of a delay in disclosure. Indeed, to the
extent that claims arise from voluntary misstatements of fact (as opposed to appearing in
a filed document), it is often difficult to say when any given item of bad news should have
been disclosed. The fraud period depends on the happenstance of a misrepresentation
without which the truth may have remained undisclosed indefinitely. So it is often not
clear that buyers during the fraud period would have paid a lower price but for the fraud.
In any event, the only real loss for most investors is the loss that cannot be diversified
away. As it happens, the losses that will happen anyway can be diversified away because
they will be offset by unexpected gains under the law of large numbers. But the avoidable
losses that happen only because of management misconduct cannot be diversified away
because they are never offset by gains from good behavior. These losses all give rise to
derivative claims (if any).
8. CONCLUSION
The loss suffered by buyers in a typical securities fraud class action may come from several
distinct sources, including lower expected return, or a higher cost of capital, or onetime
outflows of cash, or a combination thereof, all of which are quickly impounded in market
price even though prospective. Under federal securities law (Rule 10b-5), a buyer may
recover the entire difference between purchase price and market price after correction.
But some of this loss should properly give rise to a derivative claim on behalf of the
corporation (and all stockholders) rather than a direct claim on behalf of a buyer class.
In addition, some sources of stock price decrease are losses that would happen even in the
40
It could also be argued that buyers would not have bought if they had known the truth. See
Ludlow v. BP, PLC, 800 F.3d 674 (5th Cir. 2015). If so, they would have suffered no loss at all and
thus should be able to recover the entire difference between purchase price and corrected price.
On the other hand, this argument is somewhat inconsistent with the fraud on the market doctrine,
which effectively presumes that buyers are pricetakers who would have bought when they did in
reliance on the integrity of market prices.
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absence of fraud. Thus, for buyers to recover for such a loss is to restore them to a better
position than if there had been no fraud, resulting in overdeterrence. Moreover, investors
can protect themselves against such losses through diversification. In contrast, the extra
loss that derives from fraud or misconduct—loss over and above the loss from bad busi-
ness luck—cannot be diversified away, because such losses can result only in a decrease in
stock price. Although stock price may sometimes increase because of good business luck,
there is no potential for gain from the absence of fraud or misconduct. The bottom line
is that the only losses that really matter are those that are nondiversifiable—which losses
also happen to be derivative.
The question is why the courts have failed to characterize investor claims properly. The
answer is a combination of historical factors, conflicts of interest, and market failures.
The most promising solution seems to be for index funds acting on behalf of investors to
intervene to oppose certification. Index investors who trade infrequently—and only for
purposes of portfolio balancing—lose more as holders (because the corporation pays)
than they recover as buyers. They should oppose a direct class action remedy in favor of
a derivative remedy by which the corporation recovers to the extent of actionable losses
that give rise to a decrease in stock price. The same is true for diversified investors in
general, who comprise a large majority of investors. And because it is impossible to sort
investors who would thus oppose a direct buyer remedy from those who may favor such
a remedy, the courts should decline to certify securities fraud class actions on grounds of
class conflict. Rather, such actions should be recast as derivative actions, which constitute
a superior form of class remedy under established rules of civil procedure, because they
benefit all stockholders proportionally and only for nondiversifiable losses.
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6. Illegality and the business judgment rule
Charles R. Korsmo
This chapter argues that corporate officers and directors should not, as a matter of
corporate law, face greater judicial scrutiny in stockholder suits simply because they have
caused the company to violate the criminal or civil law. The treatment of stockholder
suits seeking to hold directors liable for causing the company to commit illegal acts is
a matter of longstanding controversy. The topic has rarely been the focus of sustained
scholarly attention, and has been marked by a general failure to articulate compelling
policy grounds for allowing stockholders to sue directors for illegal actions and for apply-
ing a more stringent standard of review than for other stockholder suits. Technological,
economic, and legal developments, however, make it increasingly likely the issue will take
on increased salience in the near future, and that, without a change in legal doctrine,
stockholder suits challenging illegal actions could become a significant obstacle to many
socially beneficial advances.
1. INTRODUCTION
Corporate lawbreaking can take an enormous variety of forms, ranging from environ-
mental and labor law violations, to antitrust, to bribery, to fraud, to regulatory violations
of bewildering diversity. It is altogether unsurprising that, at some level, illegal corporate
actions are disfavored by the law. Corporations that violate the law are subject to criminal
and civil liability, including fines and even the “death penalty” of losing their corporate
charter. Individuals within the corporation—including directors and officers—who are
personally involved in illegal activity can themselves face personal sanctions, including
imprisonment (Beveridge 1996). None of this is particularly startling or controversial.
Once one moves out of the realm of criminal and civil law, however, and into the realm
of corporate law proper, easy certainties melt away. It remains reasonably clear, as a
matter of positive law, that illegal activity is also disfavored as a matter of corporate law.
As a result, business decisions involving illegal actions are, in theory, subject to greater
judicial scrutiny. In Delaware, for example, illegal acts are nonexculpable and fall outside
of the protection of the Business Judgment Rule. Beyond these bare doctrinal bones,
however, it is unclear exactly what obligations directors have to stockholders to obey the
law, where those obligations originate, and when and how stockholders can block illegal
actions or hold directors personally liable for undertaking them.
Scholars have proposed a number of theories of director liability, with varying degrees
of descriptive plausibility. But a compelling prescriptive argument for using stockholder
suits as a mechanism of substantive law enforcement has been elusive. At the same time,
influential expositors of the otherwise ascendant contractarian view of corporate law
have long argued—apparently unsuccessfully—that law enforcement concerns should,
in most situations, play no role at all in corporate law (Easterbrook & Fischel 1982). If
98
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Illegality and the business judgment rule 99
illegal actions harm the company, the argument goes, any duty to obey the law should
be subsumed under a more general duty to maximize the firm’s value. If illegal actions
benefit the company, whatever duties were breached could not have been duties owed to
the stockholders.
In the absence of consensus on the appropriate role of corporate law in policing
illegality, the doctrine has unavoidably remained muddy. While not ideal, this has long
been a tolerable state of affairs. In a world where corporate lawbreaking is a reliably bad
thing, stockholder litigation is simply one more arrow in the quiver of deterrence, though
perhaps a bent one. Indeed, the bulk of the commentary on the topic appears to consist of
proposals for making stockholder litigation a more effective deterrent against corporate
illegality.
New developments, however, threaten to make untenable the uncertainty surrounding
corporate directors’ obligation to obey the law. Chief among these developments are
new technologies—autonomous vehicles, for example—that could well render existing
regulatory regimes grossly inefficient. At the same time, over the past several decades, an
increasing number of laws and regulations have had a revenue-raising or protectionist
component in addition to any traditional health or safety function. Such laws are espe-
cially likely to be socially inefficient. In a related development, many startups have begun
to make violating, and ultimately changing, socially inefficient regulations a central part of
their business model—a practice recently dubbed “regulatory entrepreneurialism” (Barry
& Pollman 2017). We stand on the brink of a new world, where corporate lawbreaking
may be both hugely profitable and, more importantly, often socially beneficial. In such a
world, stockholder litigation seeking director liability for illegal actions threatens to be a
formidable obstacle to progress, with few if any countervailing benefits.
This chapter has three aims, and proceeds in three parts. Section 2 summarizes the
law—such as it is—surrounding director liability for corporate illegality, and argues that
this law is an undertheorized muddle. Section 3 argues that leaving the law in such a
state will soon become untenable, as important instances of profitable, and often socially
desirable, corporate lawbreaking are set to proliferate in the immediate future. Section
4 considers stockholder suits as a check on illegal activity. Section 5, in closing, offers
tentative thoughts on how relevant legal doctrine should be reformed, and argues that
stockholder suits are unlikely to play any beneficial role in policing corporate compliance
with external legal obligations.
This chapter will not exclusively focus on Delaware law. In fact, much of the relevant
case law originates in New York, though Delaware of course looms large, as home to the
majority of economically significant companies.
2. DIRECTORS’ DUTY TO OBEY THE LAW
Over the past century, the nature of corporate law regarding illegal activity has progressed
from simple and misguided to convoluted and misguided. In the early years of corporate
law, the treatment of illegal activities was straightforward. Corporations were considered
public entities, and the right to incorporate was considered a dispensation from the state,
granted in order to achieve public purposes that were specified at the time of incorpora-
tion. As a result, a corporation’s legal authority was limited to those powers specifically
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enumerated in the corporate charter. Because illegal actions fell outside of the powers that
could be enumerated, they were simply treated as “a subset of the larger category of ultra
vires activities” (Greenfield 2001, 127).
Not only were ultra vires activities void and subject to injunction, but individual
directors could be “compelled to make good on the loss” occasioned by acting beyond
their legal powers (Clark & Marshall 1901). As the famous 1909 case Roth v. Robertson
demonstrated, a director could originally be held personally liable even where the illegal
activity benefited the company, and even where stockholders had consented to the illegal
actions. The company in Roth operated an amusement park that violated New York’s Blue
Laws by operating on Sundays. The company’s directors—after consulting with the stock-
holders—caused $800 to be paid as hush money to a blackmailer who threatened to report
the Blue Law violation. This illegality was clearly intended to, and probably did, benefit
the company, as it made a substantial portion of its profits on Sundays. Nonetheless, a
minority stockholder brought a derivative suit. The court found the blackmail payments
illegal and therefore ultra vires, and forced the controlling director to reimburse the
company the $800. While this regime may have functioned to deter illegality, the incentive
structure it created was bizarre: the stockholders first profited from the illegal activity and
then were also able to recover the costs associated with the illegal activity.
The ultra vires doctrine slowly eroded in the early decades of the twentieth century.
It was largely replaced—at least in terms of its internal governance function—by the
fiduciary duties of care and loyalty with which we are familiar today, coupled with a norm
of stockholder wealth maximization. As traditional ultra vires doctrine ebbed, however,
limits on corporate lawbreaking were left in an awkward limbo. The prevailing consensus
appears to have been that illegality remained off-limits to corporations. Midcentury
treatises frequently referenced a “duty of obedience” in addition to care and loyalty, which
apparently included a requirement of obedience to the law (Ballantine 1946; Knepper
1973). The contours of this duty, though, remained decidedly fuzzy, with no clear answer
to the many questions surrounding who could enforce the duty, the proper standard of
review, and the appropriate remedies. Today, as one scholar recently noted, “corporate law
treatises no longer mention the duty of obedience” (Palmiter 2010, 463).
Modern courts have retained the traditional antipathy toward illegality, but have strug-
gled to fit it into the framework of fiduciary duty and stockholder wealth maximization.
One of the earlier modifications is the so-called net loss rule, which bars director liability
unless the plaintiff can demonstrate that the illegal activity caused a net harm to the
company (Rapp 2001). The rule first arose in New York around midcentury, and was later
adopted by Delaware as well. On its face, the net loss rule is logical for at least two reasons.
First, it eliminates the anomalous result from Roth, where the stockholders were able to
benefit from the illegal activity and also recover any losses. Second, it brings illegal activity
within the broader mandate to maximize stockholder wealth and only allows stockholders
to recover where a duty owed to them was arguably breached.
Indeed, the net loss rule, taken to its logical conclusion, can be seen as subsuming the
old duty of obedience within the duty of care. And, in fact, contractarian scholars have
reached this logical conclusion, arguing that “[m]anagers have no general obligation to
avoid violating regulatory laws, when violations are profitable to the firm” and “not only
may but also should violate the rules when it is profitable to do so” (Easterbrook & Fischel
1982, 1177, n.57). Easterbrook and Fischel would exclude laws that are malum in se (evil
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in itself, as distinguished from evil only because it is prohibited), though it is not readily
apparent why the distinction should matter in this context.
In any event, the law has not taken up the contractarians on this point. The ALI’s
Principles of Corporate Governance explicitly “rejects any cost-benefit justification for
lawbreaking and, by way of illustration, forbids a trucking corporation to instruct its
drivers to exceed the speed limit to improve corporate profits” (Beveridge 1996, 731). The
Third Circuit, applying New York law in Miller v. AT&T, held that even when “commit-
ted to benefit the corporation, illegal acts may amount to a breach of fiduciary duty,”
without specifying which duty it might breach. In 2003, in Guttmann v. Huang, 823 A.2d
492, 506 n.34 (Del. Ch. 2013), Vice Chancellor Strine—now Chief Justice of the Delaware
Supreme Court—wrote that “one cannot act loyally as a corporate director by causing
the corporation to violate the positive laws it is obliged to obey,” suggesting that illegal
actions should be treated as a breach of the duty of loyalty. In Stone v. Ritter and the
Disney cases, the Delaware courts treated intentional illegal acts as a species of bad faith,
which Stone made clear was also to be treated as a subset of the duty of loyalty. Yet duty
of loyalty is an awkward fit where directors make a decision to break the law in order to
benefit the corporation, rather than to benefit themselves personally.
Neither Delaware’s courts nor those of any other jurisdiction have had occasion in
recent decades to clarify the source of directors’ duty to obey the law, or to specify how
exactly personal liability can be established (Uebler 2008; Coffee 1977). A few things,
however, are relatively clear. First, the business judgment rule does not protect decisions
involving illegality. This has been clear at least since the famous case of Shlensky v.
Wrigley in the 1960s, and also follows from treating illegality as a species of duty of loyalty
violation. Second, greater judicial scrutiny will be applied to special litigation committee
recommendations to dismiss a derivative action involving illegal activity. In particular,
under the standard that has grown out of Zapata v. Maldonado, Delaware courts are
permitted to exercise their own business judgment in deciding whether to accept the SLC’s
recommendation. Again, illegal activity is subject to greater scrutiny, as Zapata instructs
the Court of Chancery to consider whether “public” considerations—such as a desire to
punish and deter illegal actions—weigh against agreeing to dismiss the suit.
The actual substance of the greater scrutiny for illegality remains fuzzy. In a typical
duty of loyalty case where the business judgment rule does not apply, the burden is on
the defendants to demonstrate entire fairness to the corporation. This standard does not
map cleanly onto claims involving illegal activity, where the defendants may have been
acting perfectly selflessly in attempting to maximize profits. What would fairness mean in
this context? That the illegality did not actually harm the company? That it was not really
illegal? That it was not clearly illegal at the time the directors acted? That the directors
behaved reasonably, either in thinking that what they were doing was not illegal, or in
thinking that what they were doing would benefit the stockholders?
Two things are reasonably clear. First, even disinterested board decisions involving
illegality are potentially subject to greater judicial scrutiny—and judicial second-
guessing—than other disinterested board decisions. Second, because derivative actions
alleging illegality are not blocked by the business judgment rule and are more difficult for
an SLC to dispose of, such actions are more likely to survive past the motion to dismiss
and summary judgment stages, thus creating enormous settlement leverage. That such
suits have hitherto been rare may stem from the scarcity of situations where corporate
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lawbreaking is both out in the open and profitable. Section 3, however, suggests that such
situations are set to become much more common.
3. THE COMING WAVE OF (BENEFICIAL?) CORPORATE

LAWBREAKING
Most laws are not profitable to break. Where there is a general consensus that a certain
activity—say, dumping garbage in a river—is socially harmful, legislators and regulators
attempt to set the penalties for the activity at such a level as to make the activity unprofit-
able. This is not to say that corporations will never break the law, but corporate criminality
is unlikely to be pervasive, and unlikely to be profitable in the long run. As a result, in
most situations, both stockholders within the firm and society at large historically had an
interest in deterring boards from making illegal decisions.
That may be beginning to change. The change is driven by at least three interrelated
developments. First, the number of crimes that would traditionally be considered malum
prohibitum, rather than malum in se, has increased dramatically in recent decades.
In addition to any traditional public welfare rationale, many of these laws also serve
as government revenue generating measures, or protectionist measures for politically
influential groups, or both. Second, an increasing number of companies—particularly
startups—are making breaking the law, or “regulatory entrepreneurialism,” an explicit
part of their business model. Finally, and relatedly, technological advances are rendering
some old laws grossly inefficient.
The explosion of criminal and regulatory law over the past 50 years is no secret. There
is no shortage of commentary decrying the runaway proliferation of criminal statutes and
regulations, and the tendency of these new laws to be malum prohibitum (Reynolds 2013;
Cottone 2014). Much of this regulatory activity has come to function—whether it was
intentionally designed to or not—as a revenue source for governmental agencies. To take
a single well-known example, ticket revenue for traffic and parking violations has come to
be an important source of revenue for local governments in recent years, with some esti-
mates showing that nationwide revenues exceed $300,000 per traffic enforcement officer.
Similarly, municipalities generate large revenues from automated red light and speed cam-
eras, despite mixed evidence on whether the cameras improve traffic safety. Protectionist
measures such as restrictive zoning and occupational licensing have also multiplied. More
than 30 percent of American workers are now subject to occupational licensing, up from
less than 5 percent in the 1950s. While some zoning and licensing restrictions can easily be
justified by traditional health and safety concerns, some cannot—occupational licensing
for hairbraiders is one common example.
One characteristic that all of these laws have in common is that they are unusually likely
to be socially inefficient. Rather than being designed to be efficient, they are designed—at
least in part—to transfer wealth to influential political constituencies: existing property
owners in the case of restrictive zoning; existing businesses in the case of occupational
licensing; the government itself in the case of traffic laws. Again, traffic laws serve as a
simple example. Studies consistently find that virtually nobody follows the speed limit, and
that as many as 85 percent of drivers routinely exceed it. One plausible explanation is that
speed limits are kept artificially low precisely in order to generate greater ticket revenue.
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As anyone familiar with the nation’s experience with Prohibition can attest, inefficient
laws create a wealth of profit opportunities. And, indeed, a number of businesses have
emerged to take advantage of these profit opportunities. A few well-known examples will
suffice as illustrations. Ridesharing services such as Uber and Lyft seek to profit largely
by circumventing inefficient, protectionist taxi licensing laws. Short-term rental networks
such as Airbnb seek to profit, in part, by circumventing restrictive zoning rules and regu-
lation of the hotel and rental industries. Online fantasy sports sites such as DraftKings
profit by circumventing gambling laws intended, at least in part, to protect existing casino
operators. In some cases, intentionally breaking the law is a core part of the business
model. While these businesses may or may not ultimately seek to gain legal acceptance, in
the meantime they frequently operate in open defiance of the law. Uber, for example, has
reportedly ignored cease and desist demands from transit regulators and even reimbursed
drivers who have been fined by authorities (Barry & Pollman 2017).
Professors Barry and Pollman have labeled these businesses “regulatory entrepreneurs,”
and suggest that their actions have the “potential to combat socially efficient laws.” As
they point out, “the political economy literature has long observed that some laws and
regulations provide concentrated benefits to particular interest groups, while imposing
diffuse costs on the public” (p.391). Regulatory entrepreneurs can potentially combat this
dynamic both by becoming a counterbalancing interest group themselves, and by rallying
and organizing their customers into a cohesive political force.
Advancing technology is the third factor that is making profitable—and even
beneficial—corporate lawbreaking more likely. The networking technology behind the
companies mentioned above is an obvious example, and readers can undoubtedly come
up with others on their own. I wish to focus on a slightly different example, involving
autonomous vehicles, or self-driving cars. Though this is only a single example, it is an
enormously important one, as such technology promises to be revolutionary and to
confer radical improvements in safety and quality of life. The National Highway Traffic
Safety Administration estimated that the economic toll from traffic accidents was
$871 billion in 2010 alone. Even small improvements in safety would have enormous
real-world impact, and with an estimated 90 percent of accidents caused by human
error, the potential savings are vast, even leaving aside expected reductions in traffic
congestion.
An interesting problem has emerged, however, in early road-testing of autonomous
vehicles by companies such as Google, Audi, and Delphi. While the self-driving cars
themselves have almost never been directly at fault in causing an accident, they have thus
far been involved in roughly twice as many accidents per mile driven as human-driven
vehicles. Almost all of these accidents occur when a human driver rearends the autono-
mous vehicle. The problem is that the autonomous vehicles are programmed to slavishly
follow the traffic laws. They never speed. They never do a rolling stop at a stop sign. They
never accelerate through a yellow light. And it turns out that slavishly following the traf-
fic laws—at least in a world where nobody else does—is not such a safe choice. Indeed,
trying to merge at 55 mph with highway traffic going 65 mph, or slamming on the brakes
at a yellow light, is quite hazardous. At least until autonomous vehicles have the roads
to themselves—with none of those pesky human drivers—safety could be significantly
improved by programming the cars to violate the traffic laws in much the way most human
drivers do.
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Apart from the engineering problems involved, the legal difficulty is this: What risk of
personal liability should a director of a company which manufactures autonomous vehi-
cles face if she decides to improve safety by programming the vehicles to break the law?
The question is bound up with the question of how liability will be assigned for accidents
involving autonomous vehicles. The present system—largely relying on driver-purchased
no-fault insurance—makes little sense where the “driver” is increasingly irrelevant.
Instead, a growing consensus suggests that manufacturers of autonomous vehicles should
face something approaching strict liability for accidents involving their vehicles. Indeed,
a number of leading manufacturers, including Volvo, Google, and Mercedes Benz, have
already proposed offering warranties, voluntarily accepting liability for any accidents
caused by their self-driving systems. Such a system makes a great deal of sense, in that it
places liability on the party in the best position to take measures to reduce accidents, and
also the party best placed to spread the costs of accidents by including them in the price
of the vehicle or taking out insurance, or both.
Consider, however, the following scenario. Google programs its self-driving cars to
violate the speed limit, and also indemnifies drivers against loss. These measures are
intended to improve safety and increase sales of the car, maximizing stockholder wealth.
Later, one of Google’s cars causes an accident while speeding, causing $100,000 in
damages. Google indemnifies the owner of the car, and pays the $100,000 in damages.
A Google stockholder, owning 100 shares, sues to recover the $100,000 by holding the
directors personally liable. The plaintiffs’ attorney argues that the loss to the corporation
was caused by illegal activity—speeding—that was deliberately authorized by the board,
and thus that the board’s decision is not protected by the business judgment rule. What
result? This question is addressed in section 4.
4. RECONSIDERING STOCKHOLDER SUITS AS A CHECK ON

ILLEGAL ACTIVITY
The problem at this point should be reasonably clear. When, if ever, would a court
considering a stockholder suit be justified in applying greater judicial scrutiny to a board’s
decision to break the law? For simplicity of expression, I will focus in this section on the
lack of business judgment rule protection for board decisions involving illegality. But the
arguments made will apply also to the myriad other ways the law applies greater scrutiny
to illegality.
At least two potential rationales for greater scrutiny exist. First, we might think that
illegal actions are unusually likely to harm stockholders, in which case greater scrutiny
may be justified in order to better enforce the board’s internal duty to maximize stock-
holder wealth. Second, we might think that even illegal actions that benefit stockholders
are likely to be socially harmful, and that stockholders can function as private attorneys
general, supplementing what would otherwise be underenforcement of the board’s duty
to satisfy its external duty to follow the law. Even if either of these rationales were once
persuasive, they are both severely undercut by the changes described in the last section.
A number of articles have attempted to clarify and locate the duty of directors to obey
the law (Beveridge 1996; Rapp 2001; Uebler 2008; Palmiter 2010). Probably the most
successful conception of the duty to obey the law is as a holdover from the old ultra
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vires doctrine. This conception finds textual support in corporate codes that empower
corporations to engage in any “lawful activity,” which carries with it the implication that
unlawful activities are beyond the power of the corporation. In addition, most corporate
charters, even where they do not limit the powers of the board to any specific purpose,
include provisions restricting the corporation to “any lawful business” or some equivalent
language. This internal restraint lends support to the idea that the duty to obey the law
is also an internal duty—above and beyond the duties of care and loyalty. The logical
conclusion is that unlawful decisions are a breach of duty owed to the corporation and
the stockholders, and are a proper subject for derivative actions.
Few scholars, however, have offered sustained analysis as to what beneficial role
stockholder litigation can be expected to play in either enforcing the law or increasing
stockholder wealth. An exception is Professor Greenfield, who in a 2001 article attempted
to explain why various stakeholders—including stockholders—would want a rule against
intentional lawbreaking by the board. Many of the reasons he offers—that managers’
and directors’ incentives, risk-preferences, and time-horizons may differ from those of
the stockholders; that managers and directors may underestimate risks and overestimate
benefits—prove too much, as they are hardly unique to illegal decisions. If taken seriously,
these considerations would argue against judicial deference across a broad swath of
corporate decisionmaking.
Greenfield, however, makes two arguments for scrutiny that arguably apply with special
force to illegal decisions. First, he argues that illegal decisionmaking will, by its very nature,
be more difficult for stockholders to monitor, because illegal acts will generally have to
be hidden. Second, he argues that “illegal acts will be of dubious benefits to the firm in
most cases” (p.1342) and will “tend to harm the long-term interests of the firm” (p.1336).
And, indeed, earlier research has suggested that illegality is rarely profitable and is often
the result of an agency problem within the firm (Alexander & Cohen 1999). In essence,
these arguments suggest that an easily applied brightline rule—no illegality—performs
adequately, and that a more finegrained standard requiring case by case adjudication is
unnecessary.
These arguments are greatly weakened in the context of regulatory entrepreneurialism.
First, the lawbreaking of regulatory entrepreneurs is hardly a secret, but rather is a central
feature of the business plan. Similarly, for self-driving cars, the behavior of the autopilot
algorithms and any resulting liability will be matters of intense public scrutiny. Second,
it can no longer be blithely assumed—if it ever could—that breaking the law will harm
the firm or the stockholders. Again, where breaking the law is central to the business
plan—either in an effort to get the law changed, or because the law simply functions as a
tax on profitable activity—it is entirely possible that illegal activity will benefit the firm.
To be sure, directors could err, and end up breaking the law in ways that ultimately hurt
stockholders. But that is always a possibility with any risky business decision, and no
reason to allow courts to secondguess boards where they otherwise would not.
A final possibility is that stockholder suits can serve as supplemental law enforcement,
helping to deter illegal corporate conduct that may be profitable for the firm but detri-
mental to society as a whole. This intuition seems to tacitly underlie many discussions
of judicial scrutiny of illegal board decisions, and is explicitly invoked by Professor
Greenfield. By making an activity illegal in the first place, he argues, society has “deter-
mined that the costs of certain acts—whether speeding or fraud or murder—outweigh the
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benefits of such acts from society’s perspective” (p.1325). As such, stockholder suits can
serve as a possible corrective to underenforcement of criminal and civil law. Of course,
given the dynamics of most stockholder litigation, the plaintiffs’ attorneys who actually
control derivative litigation make for singularly unpromising agents of public welfare
(Korsmo & Myers 2014). The lack of any significant derivative actions holding directors
personally liable for illegal decisions suggests that such actions do not serve any valuable
law enforcement function.
More to the point, however, with the growth of protectionist and revenue-oriented
regulation, and with the advent of disruptive technology such as self-driving cars, it is
no longer safe to assume that corporate illegality will be harmful on the net level. Much
corporate illegality is harmful, of course, but that can always be addressed more directly
by increasing criminal and civil penalties to the point where it is no longer profitable.
Given the potential for regulatory entrepreneurialism to reform socially inefficient laws,
increased judicial scrutiny of illegal action is as likely to stymie beneficial reform as it
is to stamp out destructive lawbreaking. Whatever justifications may once have existed
for treating illegal decisions differently as a matter of corporate law, they are no longer
compelling.
The example of self-driving cars is once again instructive, and by itself an important
instance of the broader problem. Again, consider a manufacturer of autonomous vehicles
that has programmed its cars to violate inefficient traffic laws in order to increase safety,
and has agreed to indemnify buyers for any accidents. These measures, though they
include deliberate flouting of the law, are both socially beneficial and likely to be profit-
able to manufacturer’s stockholders. If, however, the board’s decisions were challenged in
a derivative suit, they would not be entitled to the protection of the business judgment
rule, and even an independent special litigation committee’s recommendation to dismiss
would come under significant scrutiny.
Without the protection of the business judgment rule, it is unclear what precisely the
standard of review would be. At the very least, however, the board would presumably be
required to demonstrate that the company suffered no net harm, and perhaps might need
to persuade the court that no broader public policy concerns justified liability either. In
any case, significant discovery would be required, with the attendant expense. At best, the
outcome would be a settlement with plaintiffs’ attorneys for the nuisance value of their
claim. At worst, fearing liability, the directors would—as manufacturers of autonomous
vehicles have so far done—program their vehicles to follow the law even where doing so
led to more accidents.
5. CONCLUSION
The corporate law doctrines surrounding board decisions involving illegality have long
been mostly wrongheaded, but mostly harmless. In the near future, they will grow even
more wrongheaded, but will no longer be harmless. Instead they will threaten to throw
up barriers to welfare-enhancing technological developments, and to economic and
political developments that could otherwise lead to reform of inefficient laws. Increased
judicial scrutiny of illegal decisions, as a matter of corporate law, was never likely to be a
particularly useful tool of public policy. In today’s world, such scrutiny is more likely to
M4633-GRIFFITH_t.indd 106 30/10/2018 08:16

have perverse consequences than beneficial ones. Illegality, by itself, should not trigger
liability or increased scrutiny as a matter of corporate law.
BIBLIOGRAPHY
Alexander, Cindy R. & Cohen, Mark A. (1999). “Why Do Corporations Become Criminals? Ownership, Hidden
Actions, and Crime as an Agency Cost,” Journal of Corporate Finance, 5: 1.
Ballantine, Henry W. (Revised ed. 1946). Ballantine on Corporations.
Barry, Jordan M. & Pollman, Elizabeth, “Regulatory Entrepreneurship,” 90 Southern California Law Review
383, 391 (2017).
Beveridge, Norwood P. (1996). “Does the Corporate Director Have a Duty Always to Obey the Law?” DePaul
Law Review, 45: 729–80.
Clark, William L. & Marshall, William L. (1901). A Treatise on the Law of Private Corporations.
Coffee, Jr, John C. (1977). “Beyond the Shut-Eyed Sentry: Toward a Theoretical View of Corporate Misconduct
and an Effective Legal Response,” Virginia Law Review, 63: 1099.
Cottone, Michael (2014). “Rethinking Presumed Knowledge of the Law in the Regulatory Age,” Tennessee Law
Review, 82: 137–66.
Easterbrook, Frank H. & Fischel, Daniel R. (1982). “Antitrust Suits by Targets of Tender Offers,” Michigan
Law Review, 80: 1155.
Greenfield, Kent (2001). “Ultra Vires Lives! A Stakeholder Analysis of Corporate Illegality (with Notes on How
Corporate Law Could Reinforce International Law Norms),” Virginia Law Review, 87: 1279–1379.
Knepper, William E. (2d ed. 1973). Liability of Corporate Officers and Directors.
Korsmo, Charles R. & Minor Myers (2014). “The Structure of Stockholder Litigation: When Do the Merits
Matter?” Ohio State Law Journal, 75: 829–901.
Palmiter, Alan R. (2010/2011). “Duty of Obedience: The Forgotten Duty,” New York Law School Law Review,
55: 457–78.
Rapp, Geoffrey (2001). “On the Liability of Corporate Directors to Holders of Securities for Illegal Corporate
Acts: Can the Tension between the ‘Net-Loss’ and ‘No-Duty-To-Disclose’ Rules Be Resolved,” Fordham
Journal of Corporate and Financial Law, 7: 101–29.
Reynolds, Glenn H. (2013). “Ham Sandwich Nation: Due Process When Everything Is a Crime,” Columbia Law
Review Sidebar, 113: 102–8.
Uebler, Thomas A. (2008). “Shareholder Police Power: Shareholders’ Ability to Hold Directors Accountable for
Intentional Violations of Law,” Delaware Journal of Corporate Law, 33: 199–221.
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PART III
MERGER LITIGATION
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Section A
Managing Multijurisdictional Litigation
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7. Fighting frivolous litigation in a
multijurisdictional world
Adam Badawi
1. INTRODUCTION
Delaware courts have recently shown an increased resolve to limit what many view as
frivolous litigation. This fortitude is most evident in the crackdown on disclosure-only set-
tlements that the In re Trulia and In re Riverbed decisions have initiated.1 The justification
for these approaches is easy to see, at least from an ex post perspective. When plaintiffs’
lawyers are only able to secure additional deal disclosures that are unlikely to affect how
shareholders vote, it is hard to understand why they should get a fee for doing so and why
defendants should get a global release for agreeing to pay that fee.2 Instead, it appears
that these settlements allow class counsel to use the leverage they have to slow or imperil
a deal to extract a rent while also providing defendants insulation from further scrutiny
at a relatively cheap price.
But looked at from the standpoint of competition among states for corporate charters,
these issues become murkier. Part of Delaware’s comparative corporate advantage is its
place at the forefront of corporate law production.3 Much of this production comes from
its courts, which have been deciding cases on bleeding edge corporate issues for decades.
This ability to innovate has depended on a constant stream of new cases. If plaintiffs do
not file complaints in Delaware—or if a preclusive judgment has been issued in another
state by the time a case makes it to Delaware—the resulting lack of corporate law
production could pose a threat to Delaware’s standing as the preeminent jurisdiction for
corporate law in the United States.
This chapter asks whether Delaware’s recent attempts to limit frivolous cases are likely
to be sustainable given its commitment to being at the vanguard of corporate law produc-
tion. The question is a complicated one because it turns on a number of issues that are
difficult to quantify. I focus here on two of those issues. The first, and perhaps the most
important one, is how evident it is to plaintiffs’ lawyers that a case has substance at the
time those lawyers file the case. If it is more or less apparent whether a case is meritless
after a brief glance, the confident rejection of fees in Trulia and Riverbed-like cases is
unlikely to imperil Delaware’s ability to stay at the forefront of corporate law. But if
1
In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (2016); In re Riverbed Technology,
Inc., Stockholders Litigation, 2015 WL 5458041.
2
As the court in Trulia explained: “Members of this Court also have voiced their concerns
over the deal settlement process, expressing doubts about the value of relief obtained in disclosure
settlements, and explaining their reservations over the breadth of the releases sought and the lack
of any meaningful investigation of claims proposed to be released.” 129 A.3d at 895–96.
3
See, e.g. William J. Carney, The Production of Corporate Law, 71 S. Cal. L. Rev. 715 (1998).
110
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Fighting frivolous litigation 111
merit is difficult to ascertain until lawyers are able to learn more about the underlying
facts, disallowing fees when the benefit produced by the case are questionable could lead
to good cases leaving Delaware. Those cases will therefore not contribute to the future
development of Delaware law.
The issue of merit is inextricably intertwined with the role that multijurisdictional litiga-
tion plays as a potential threat to Delaware’s place in the corporate law world. If Delaware
raises the threshold that is necessary to merit a fee award in merger cases, plaintiffs will
naturally look elsewhere.4 If this means losing relatively uninteresting cases—such as
high premium mergers negotiated at arm’s length—there should be little concern that
Delaware will miss out on the difficult matters that can lead to innovative change. But the
availability of other jurisdictions can compound the issues that come alongside increasing
the threshold results that plaintiffs must show to have fees approved.
The ongoing Walmart litigation provides an object lesson in these dangers. This dispute,
which involved allegations that the Walmart board ignored reports that employees of
Walmart’s Mexican subsidiary were bribing foreign officials, gives the Delaware courts the
potential to make an important ruling on the scope and content of directors’ oversight
duties. The Delaware plaintiffs heeded warnings by the Chancery that derivative cases
like this one faced dismissal if plaintiffs did not use their books and records inspection
rights to ensure that the case had merit.5 While the plaintiffs were litigating these Section
220 inspection rights, an alternative set of plaintiffs filed a related suit in Federal Court
in Arkansas. When that suit got dismissed on demand excusal grounds, the defendants
went to Delaware to get the Delaware case dismissed on the basis of issue preclusion. The
Chancery Court agreed to do so.6 While the litigation remains ongoing, the mere fact that
Delaware may lose the case shows the dangers of increasing legal thresholds: those cases
can get resolved in other jurisdictions, thus depriving Delaware of important grist for the
corporate law mill.
A second, albeit less important, factor that can be affected by the Trulia-like cases is
the financing of plaintiffs’ law firms. In order to bring cases—both good and bad—the
4
It is possible that forum selection clauses in a Delaware corporation’s charter would ostensibly
require that litigation take place in Delaware. But these provisions provide no guarantees. Other
states may refuse to enforce the provision—as has happened in at least one case (see Galaviz v. Berg,
763 F. Supp. 2d 1170 (N.D. Cal. 2011))—or, more perniciously, firms may waive the Delaware-
only requirement. Firms are, of course, more likely to waive this requirement when a potentially
meritorious case can be quickly resolved through unsearching litigation in a non-Delaware state. See
Alison Frankel, How corporations can game their own forum selection clauses, http://blogs.reuters.
com/alison-frankel/2015/11/17/how-corporations-can-game-their-own-forum-selection-clauses/
(November 17, 2015).
5
For an overview of the § 220 litigation see Wal-Mart Stores, Inc. v. Indiana Electrical Workers
Pension Trust Fund IBEW, 95 A.3d 1264 (2014). The Chancery is not shy about encouraging
this sort of diligence. One relatively well-known admonishment of plaintiffs to make use of their
books and records rights is Chancellor Chander’s comment in Beam ex rel. Martha Stewart Living
Omnimedia, Inc. v. Stewart, 833 A.2d 961, 981-82 (2003): “It is troubling to this Court that . . .
litigants continue to bring derivative complaints pleading demand futility on the basis of precious
little investigation beyond perusal of the morning newspapers . . . If the facts . . . could have been
ascertained through more careful pre-litigation investigation, the failure to discover and plead
those facts . . . results in a waste of resources of the litigants and the Court.
6
In re Wal-Mart Stores, Inc. Delaware Derivative Litigation 2016 WL 2908344 (2016).
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economics of a given firm must be sustainable. It is a well-worn technique for plaintiffs’

firms to use smaller cases of questionable merit to help build a war chest to finance larger
cases. This strategy, which may be a necessary evil, becomes more difficult when courts
refuse settlements or otherwise place limits on what they view as potentially meritless
litigation. Without the ability to build a war chest, these firms’ ability to litigate the better
cases to completion becomes strained. Defendants surely know this and can use their
leverage in these situations to produce lower settlements and earlier phases in litigation.
Plaintiffs’ firms may be able to adapt by, for example, diversifying the types of cases that
they litigate or, increasingly, by turning to litigation financing firms. Nevertheless, the
possibility of long stretches of time with no income from Delaware cases may threaten
the viability of some plaintiffs’ firms maintaining a robust Delaware practice.
The remainder of this chapter works through how each of these two factors may affect
the ability of Delaware courts to limit what they view as frivolous litigation. The chapter
ends by placing this discussion in the context of the interest group analysis that has long
been a leading framework for analyzing the development of Delaware corporate law.
2. MERIT THRESHOLDS AND MULTIJURISDICTIONAL

LITIGATION
While evidence is necessarily preliminary, it appears that Trulia and Riverbed have started
to stem the tide of merger cases in Delaware. Plaintiffs now appear to be filing merger chal-
lenges elsewhere, or not at all. Cain et al. show that while the percentage of merger lawsuits
that produced at least one Delaware case hovered between 51 and 61 percent between
2011 and 2015,7 for 2016 that number came in at 32 percent.8 While identifying causation
is always difficult, it is not unreasonable to believe that some of this precipitous drop is
due to the substantially diminished prospects of obtaining a legal fee in merger lawsuits.9
What is more difficult to know is what the net effect of this shift will be. As Cain et al.
suggest, deterring plaintiffs from filing in Delaware means some meritless suits will be
filed elsewhere.10 But it is also possible that some nonmeritless suits—and potentially the
types of cases that allow the Chancery Court and the Delaware Supreme Court to provide
guidance on emerging corporate governance practices—will also migrate to other jurisdic-
tions. That possibility presents a danger to Delaware’s position as the leading jurisdiction
for corporate law and, relatedly, as the top destination for incorporations.
7
Matthew D. Cain, Jill Fisch, Steven Davidoff Solomon, and Randall S. Thomas, The
Shifting Tides of Merger Litigation 21–22, available at: papers.ssrn.com/sol3/papers.cfm?abstract_
id=2922121 (2017).
8
Ibid at 22.
9
Although the potential for obtaining an attorneys’ fee from a settlement that only produces
additional merger disclosures has diminished, there is still a possibility that the plaintiffs’ lawyers
can obtain a so-called mootness fee. This fee, which Trulia expressly authorizes, allows the defend-
ant board and the plaintiffs to agree to a payment that compensates the plaintiffs for obtaining
additional disclosures that moot the litigation. The primary difference between a nondisclosure
settlement and a mootness fee is that mootness fees do not provide a global release for all merger-
based claims against the defendant directors.
10
Ibid at 43.
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This threat means it is quite important to get a sense of how Trulia and Riverbed will
affect the thinking of lawyers who are contemplating bringing a lawsuit in Delaware.11 If a
suit’s merit is evident from the outset, that suggests that Delaware may not lose too many
important cases. The plaintiffs’ attorney who observes how meritorious a given case may
be can then make a choice of jurisdiction based on that information. And there may be
something to this account. Those who practice and comment on mergers and acquisitions
litigation can identify the leading indicators of a strong case. For example, the presence of
a controlling shareholder or of a management sponsored buyout means that the princi-
pals in the case may have been particularly motivated by their own self-interest. Likewise,
the existence of a low premium in a deal may signal that the target’s board did not comply
with their fiduciary duties when negotiating the deal.12 If these signals are strong ones,
then the Trulia/Riverbed regime may accomplish the goal of deterring meritless litigation
in Delaware.13
But there are some reasons for caution about the reliability of these signals in merger
litigation. Lawyers typically need to decide whether to file merger challenges in short
order, and this need to move quickly necessarily diminishes the time that plaintiffs have to
investigate merit. That merit is not always apparent in short order.14 If Delaware refuses
to authorize fees in cases that ultimately turn out to have little, or questionable, merit,
lawyers may rationally decide to file cases where they have uncertain information outside
of Delaware.15 And they are particularly likely to do so if they believe that the other
jurisdictions will tend to approve settlements in these situations.
There is a potential lesson in Delaware courts’ experience of trying to deter frivolous
11
The concerns about Delaware law and how it affects attorney strategy are not the only—or
even the paramount—concerns with this development. As Dari-Mattiacci and Talley argue, there
is a set of conditions under which the turn away from disclosure-only settlements can discourage
the willingness of potential buyer’s to make bids. Insofar as the goal of Delaware merger law is
to maximize the wealth of target shareholders, this is an obvious concern. See Dari-Mattiacci,
G. and E. Talley. 2016. “Do Disclosure-Only Settlements in Merger Objection Lawsuits Harm
Shareholders?” Working paper. Columbia Law School.
12
See Boris Feldman, Litigating Post-Close Mergers, available at: corpgov.law.harvard.
edu/2012/11/09/litigating-post-close-merger-cases (describing “situations where objective factors
suggest a lack of merit to the claims: e.g., high premium; no contesting bidders; overwhelming
shareholder approval; customary deal terms”).
13
The conventional wisdom that third party mergers are highly unlikely to be problematic may
very well be correct. But there is some evidence that high quality plaintiffs’ firms do sometimes file
complaints in third-party cases. See Adam B. Badawi and David Webber, Does the Quality of the
Plaintiffs’ Law Firm Matter in Deal Litigation?, 41 J. of Corp. L. 359 (2015) (showing that high
quality firms file a substantial number of complaints in third-party cases). While one should not
infer too much from this mere fact, one possible interpretation is that high quality lawyers believe
that some third party mergers may be worth further investigation.
14
As then-Chancellor Strine explained in awarding a very large attorneys’ fee in the Southern
Peru Copper case: “[The plaintiffs] advanced a theory of the case that [I] was reluctant to embrace.
I denied their motion for summary judgment. I . . . gave [them] a good amount of grief that day
about the theory. [The theory] faced some of the best lawyers I know . . . and won.” Americas
Mining Corporation v. Theriault, 51 A.3d. 1213, 1256 (2012).
15
This decision may be rational because the expected value of bringing cases with high value
signals in Delaware and low value signals elsewhere is higher than other approaches. It could be
that the expected value of other strategies is not much different, but because of a combination of
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derivative lawsuits. For some time, the judges of the Chancery Court have strongly encour-
aged shareholder plaintiffs to use their rights under Delaware General Corporate Law
Section 220. That statute permits shareholders to initiate legal action to obtain documents
and records that are “necessary and essential” to the shareholder’s purpose. While bringing
a Section 220 action prior to filing a derivative lawsuit is not an ironclad necessity, plaintiffs
who do not do so face a substantial risk that their lawsuit will be dismissed.16
This requirement played a key role in the litigation related to allegations that the board
of Walmart failed to exercise oversight over one of the company’s Mexican subsidiaries
that was alleged to have engaged in extensive bribery of government officials. These allega-
tions resulted in 15 separate lawsuits being filed in Delaware and Arkansas. Some of the
Delaware plaintiffs—informed by then-Chancellor Strine that a failure to do an adequate
investigation would likely result in his granting a motion to dismiss—initiated a Section
220 action to obtain internal documents related to the allegations.17 That action took three
years to resolve and included an appeal to the Delaware Supreme Court.18
In the interim, the federal Arkansas plaintiffs pressed forward without making a
records request and without waiting for the outcome of the Delaware action. The
Arkansas court determined that demand would not have been futile in the case and,
accordingly, dismissed the lawsuit.19 With the Arkansas judgment in hand, the defend-
ants then sought to have the Delaware action dismissed on the basis of issue preclu-
sion. In a May 2016 opinion, Chancellor Bouchard agreed, finding that the Arkansas
plaintiffs were adequate representatives for the shareholders.20 As a consequence of this
process, Delaware faced the potential loss of an opportunity to determine whether these
very serious allegations against the directors of one of the largest corporations in the
United States implicated the oversight duties that the directors owe to the corporation
and its shareholders.
The Delaware Supreme Court may have revived this opportunity when it unanimously
reversed Chancellor Bouchard’s opinion in January of 2017.21 The basis for the decision
was that the Chancellor’s opinion paid insufficient attention to the potential federal due
process rights of the Delaware plaintiffs. The Supreme Court’s opinion called on the
Chancellor to address the argument used in an earlier Chancery Court opinion, In re
EZCORP Inc. Consulting Agreement Deriv. Litig., 130 A.3d 934 (Del. Ch. 2016).22 In that
case, Vice Chancellor Laster held that a derivative plaintiff does not become a party to
the litigation until that party gains the authority to represent the corporation by surviving
a motion to dismiss.
If Vice-Chancellor Laster’s view on this point solidifies as a matter of Delaware
risk aversion and uncertainty in Delaware, plaintiffs’ attorneys prefer litigating cases with high
uncertainty outside of Delaware.
16
See supra note 5.
17
California State Teachers’ Retirement System v. Alvarez, 2017 WL 239364 (2017) at *1.
18
See Wal-Mart Stores, Inc. v. Indiana Elec. Workers Pension Trust Fund IBEW, 95 A.3d 1264
(2014).
19
In re Wal-Mart Stores, Inc. S’holder Deriv. Litig., 2015 WL 1470184, at *1 (W.D. Ark, 2015).
20
In re Wal-Mart Stores, Inc. Delaware Derivative Litigation, 2016 WL 2908344 (Del Ch.
2016).
21
See Alvarez supra note 17 at *5–6.
22
Ibid at *7–8.
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corporate law, potentially impactful cases like the Walmart derivative litigation will be at
substantially less risk of slipping from Delaware’s grasp. But retaining these cases this way
will come with the potential for significant costs. Under this rule, Delaware corporations
could be subject to successive waves of derivative lawsuits over the same matter. That
would revive the threat of nuisance litigation that Delaware seems to want to snuff out
through the Trulia line of cases.
This suite of difficult choices can be traced, at least to some extent, to the insistence
that derivative plaintiffs do more to investigate claims prior to filing. As the ongoing
saga of the Walmart case shows, that demand may be too dear an ask in an environ-
ment of intense multijurisdictional litigation. Requiring more work prior to filing will
naturally produce delays in litigation. During the interim created by that delay, cases
in other jurisdictions might move along more rapidly. If these cases are important for
development of corporate law, Delaware risks losing its edge as the leading jurisdiction
for corporate law in the United States.23 My point here is not that this state of affairs
is obviously worse than a world where Delaware does not press derivative plaintiffs to
perform a decent amount of pre-suit investigation. Rather, the point is that this world
is not obviously better than one that tolerates some amount of meritless litigation. To
put it another way, even from Delaware’s perspective, the optimal amount of frivolous
lawsuits is unlikely to be zero.
There is a potential lesson in this account for Delaware’s newfound determination to
clamp down on disclosure-only merger settlements. The available evidence suggests that
Trulia and Riverbed have led to the predictable exodus of cases to other jurisdictions.24
There may be several dynamics leading to these choices. The rosy scenario is that potential
plaintiffs know shortly after a deal announcement whether the case has merit or not and
they can choose to not file the meritless cases in Delaware.25 But a more troubling account
is possible. Plaintiffs may know relatively little about a case’s merit at the time of filing
and file outside of Delaware because they are confident of at least some compensation if
there turns out to be little to the case.
In the latter scenario, those lawsuits filed elsewhere may become a problem for
Delaware. Just as in the Walmart context, there is a risk that those cases will proceed
quickly and a preclusive ruling or settlement will be entered into before the Delaware
suits gets filed.26 In that situation, even if the investigation finds something meritorious,
it may not matter.27 The lawsuit will not get filed in Delaware and the Delaware courts
23
While the risk is particularly acute when, as in the Walmart case, the alternative jurisdiction
dismisses the case, this risk can also occur if the competing jurisdiction allows the case to move
forward at a rapid clip. In that situation, a Delaware court needs to decide whether to stay the
Delaware case or allow the competing cases to proceed.
24
See supra note 7.
25
Some of these cases are presumably being filed in other jurisdictions, but some of them may
not be getting filed at all.
26
The same thing can happen, of course, even if a Delaware case gets filed sometime after the
initial non-Delaware suit. Depending on the timing, the other case could be so far along that the
Delaware case has little or no impact on the ultimate outcome.
27
One express justification that Chancellor Bourchard used in Trulia was the argument by a
Delaware practitioner that good cases may get settled out before all the facts come to light. See
Trulia at 895 (citing Joel Edan Friedlander, How Rural/Metro Exposes the Systemic Problem of
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will not have a chance to say anything about the case. If Delaware loses cases in this way,
there is a risk that Delaware will lose an opportunity to stay on the cutting edge of leading
corporate law matters. That potential for ossification may pose a threat to Delaware’s
place as a leader in corporate practice.
As stated at the outset, the danger posed by this threat depends, in large measure, on
when the merits of a case become evident. If readily observable factors such as deal pre-
mium and the presence of a controlling shareholder are highly reliable indicators of merit,
this problem is unlikely to be large. Plaintiffs can bring meritorious cases in Delaware and
Delaware will then get to pass judgment on the important corporate law issues of the day.
But if investigations need some time to sort through complex disclosures or to conduct
some discovery to determine if they are meritorious, the Trulia framework presents some
risk. Plaintiffs may choose to forgo Delaware because if these investigations turn up only
some minor disclosure problems, they will get nothing for the effort. That possibility is
likely to drive those plaintiffs elsewhere.
3. FUNDING LITIGATION
Though boards and defense lawyers may sometimes lament the tactics of plaintiffs’
lawyers, a healthy plaintiffs’ bar is a necessary part of Delaware’s corporate ecosystem.
Maintaining that health requires that the enterprise be financially viable, which can be
challenging for plaintiffs’ firms. It can be a long time between judgments and settlements
and those droughts can make it difficult to keep together the large teams of lawyers that
are necessary to perform high caliber plaintiffs’ work. This fact is well known to the
defense bar, which may sometimes drag cases on so that, among other reasons, plaintiffs’
attorneys begin to feel the squeeze between paychecks.28
While plaintiffs’ firms may have some financing options, the payouts that disclosure-
only lawsuits provide some level of income smoothing for the lumpy earnings that are a
fact of life for the plaintiffs’ bar. The lack of that income smoothing may pose a threat to
the health of the plaintiffs’ bar. To be sure, there is some risk that overindulging plaintiffs
will lead to a parasitic rather than healthy relationship between that bar and other
Disclosure Settlements, 40 Del. J. Corp. L. 877 (2016)). That piece argues that the Rural/Metro case
almost did not produce an important decision because the initial plaintiffs’ counsel were willing to
settle for increased disclosure. It was only because other plaintiffs objected that the court did not
approve the settlement.
It is hard to see why the Rural/Metro case justifies the Trulia standard. In Rural/Metro, the
system worked. The concern is that there are other cases where the disclosure-only settlement
prevented an important case from moving forward. It is, naturally, difficult to develop informa-
tion on that point. Moreover, it is not clear that Trulia would even solve this problem because
other jurisdictions may approve a disclosure-only settlement before the Delaware case can be
developed.
28
See, for example, Peter A. Bell and Jeffrey O’Connell, Accidental Justice: The Dilemmas of
Tort Law 113–14 (1997) (“Defense attorneys often proceed slowly, to stretch out litigation, in the
knowledge that delays in the receipt of compensation put pressure on plaintiffs to accept lower
settlements in order to get needed cash”).
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prominent Delaware players.29 But there is a potentially plausible set of conditions where
setting the threshold for policing settlements somewhere below the line set by Trulia may
better sustain the health of the Delaware corporate law ecosystem.
The admittedly rosy scenario required for this approach to be correct would entail
a group of plaintiffs’ firms who act in good faith and conduct diligent investigations
both before and after filing a merger challenge. When investigations turn up potentially
problematic behavior by firm fiduciaries, the subsequent cases may provide the raw
material that Delaware courts need to stay on top of current corporate law issues. But
these cases may be relatively rare. And that might mean that even plaintiffs’ firms acting
in good faith—to the degree that they specialize in this type of litigation—will go a long
time between paydays if these are the only merger cases that produce a return. That situ-
ation may threaten the viability of this practice area. An alternative would be to provide
a modest return when the investigation does not yield a juicy case. As long as the awards
in the better cases adjust downwards to account for providing a settlement in the modest
cases, the ex ante expected value of a case can be maintained, with the added benefit of
smoothing income in a way that provides more practice stability.
Of course, this sort of income smoothing is not the only way a law firm might deal
with these financing challenges. There are at least two other approaches that a firm could
explore to address substantial droughts between awards. One is to diversify its practice.
By branching out beyond merger litigation a plaintiff-focused firm may be able to obtain
some level of internal income smoothing. There is some evidence that plaintiffs firms have
the ability to react to legal changes in this way. For example, when the Private Securities
Litigation Reform Act made it more difficult to bring securities lawsuits, plaintiffs firms
reacted by branching out into corporate law litigation.30 One plausible rationale for this
approach was that filing corporate lawsuits helped to smooth out income for firms that
specialized in securities class actions because settlements and awards from that practice
became more lumpy post-PLSRA.
There are, of course, some natural limitations on the ability to diversify. If the practice
areas of lawyers are not at least somewhat complementary, it is unlikely that there will be
large gains from joining forces to create diversification. Partners in a law firm must do
some monitoring of each other, if only to determine how to split the fruits of a partner-
ship. If one partner does family law and another does criminal appellate work, it may be
difficult to convince each other that it just happened to be a down year that produced
low billings rather than a lack of effort. That problem may not be as pressing when one
partner does criminal trial work and the other does criminal appellate work.31
29
An explicit concern in Trulia was the nonadversarial nature of many disclosure-only settle-
ments. Trulia, 129 A.3d at 893–94. Once the parties have agreed to the additional disclosures, both
the plaintiffs and the defendants have an interest in seeing the settlement approved (as is true in
any settlement hearing). But this point is collateral to the one that I make here. If initial discovery
indicates issues that go beyond disclosure matters, any settlement or judgment is likely to look
much different than a disclosure-only case.
30
John Armour et al., Delaware’s Balancing Act, 87 Ind. L. J. 1345, 1380 (2012).
31
A leading academic rationale for law firm mergers is the potential it creates to leverage
intraclient referral networks. See Forrest Briscoe and Wenpin Tsai, Overcoming Relational Inertia:
How Organizational Members Respond to Acquisition Events in a Law Firm, 56 Adm. Sci. Quar.
408 (2011). While plaintiffs’ firms may merge for other reasons, given the traditionally disparate
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In the context of merger litigation, these sorts of synergies are likely to come from other
plaintiff-side firms working in the corporate and securities space. If the firms specializing
in merger litigation need to find a way to smooth their income, a merger with a securities
firm might accomplish that goal. But, of course, as mentioned above, some of these
securities firms have already branched out into Delaware plaintiffs’ work. That history
might mean that these opportunities are slim.
Merging, however, may be an extreme solution to the problem of sporadic paydays
becoming even more sporadic. A simpler way to smooth income would be to obtain
financing from a bank, as many defense firms do. While it is difficult to obtain much
information about this practice, it does appear that financial institutions tend to shy away
from lending to plaintiffs’ firms. It is hard to know precisely why this is the case, but the
speculative nature of plaintiffs’ work may create substantial information asymmetries that
make traditional lending difficult.
Whatever the reason, most lending to plaintiffs’ firms happens through specialty
lenders that engage in litigation finance. These firms typically employ large numbers
of lawyers, a fact that may help to minimize the information asymmetries that would
otherwise exist. To the degree that profitable opportunities still exist in merger
litigation, it may be possible that plaintiffs’ firms can use this method of financing
to maintain a stable practice. But absent these opportunities, raising merit thresholds
may pose a threat to the business model. Weakening this practice area may also mean
a loss of some of the more meritorious cases to the potential detriment of the health
of Delaware law.
4. INTEREST GROUPS, MULTIJURISDICTIONAL

LITIGATION, AND SOME CONCLUDING THOUGHTS
By now it is an old saw that corporations and the Delaware bar are the primary interest
groups in the political economy of Delaware’s corporate law.32 While the passage of 102(b)
(7) in the wake of Smith v. Van Gorkom is perhaps the most well-known example of this
dynamic, these interests have played a role in the more recent battles over cost shifting
and forum selection provisions. A simplified version of this theory suggests that Delaware
enjoys a significant competitive advantage in the provision of corporate charters. The
Delaware bar is aware of this advantage and knows that it can extract some rents before
corporations will seek to incorporate in another jurisdiction.
The debate over merger litigation has been couched in these terms at times. The chief
complaint of many critics was that the practice of suing on every deal created a “merger
nature of class action plaintiffs, intrafirm client referral networks are unlikely to generate a lot of
new business for these firms. It is possible, however, that the need to develop relationships with
institutional investors, in order to have a chance of becoming a lead plaintiff in federal securi-
ties and Delaware shareholder litigation, may create a situation where merging to expand these
networks makes sense for plaintiffs’ lawyers.
32
See Jonathan R. Macey and Geoffrey P. Miller, Toward an Interest-Group Theory of
Delaware Corporate Law, 65 Tex. L. Rev. 469 (1987).
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tax” that nearly all buyers had to pay.33 Putting aside that this tax was more or less a
rounding error in deals of any significant size, this critique had some traction in the
run-up to the Riverbed and Trulia decisions. Some of the complaints about this “tax”
came from the corporate interests that are on one side of the interest group theory.34 The
beneficiaries of this practice were the plaintiffs’ and defense lawyers who generated fees
from the voluminous litigation produced by the sue-on-every-deal phenomenon. Though
there is no indication in these opinions that the judges of the Chancery Court were think-
ing in these express terms, Riverbed and Trulia can be seen, at least in the short term, as a
win for the corporate interests and a loss for the Delaware bar.
It is worth wondering, however, about the potential losses to Delaware that may
occur through its desire to increase the amount of presuit investigation that plaintiffs
conduct. If, as the discussion above suggests, this tightening could send meritorious cases
elsewhere, the potential impairment to the health of Delaware law that could adversely
affect both sets of interests. But there is a problem insofar as the continuing vitality of
Delaware law is in some sense a public good. Corporations and the Delaware bar both
benefit from the continued development of Delaware corporate law and neither group
can be readily excluded from the gains associated with that development. As one might
expect, if these interests can receive the gains without paying for them they will be more
than happy to do so.
Any development that limits the possibility of shareholder class actions is likely to
please the corporate side of the ledger. For that reason, Delaware firms almost certainly
welcome the Trulia and Riverbed. Things are a bit more complex for the Delaware bar.
Being involved in an innovative case can bring with it tremendous rewards (or not, if the
lawyers wind up on the losing side).35 But even with significant internalization of the
benefits, some of the positive effects will spillover. Moreover, some of these lawyers will
have an opportunity to pursue both innovative and nuisance litigation outside of the state.
That possibility will limit the fervor of their complaints about lost opportunities to sue
in Delaware.
All of these reasons contribute to the potential underproduction of corporate law
innovation. And this, ultimately, is how raising the threshold of lawsuits could threaten
33
See, e.g., Joel C. Haims and James J. Beha, II, Recent Decisions Show Courts Closely
Scrutinizing Fee Awards in M&A Litigation Settlements 1 (2013) (arguing that the existing dis-
closure-only settlement regime has essentially become a tax on every deal), available at www.mofo.
com/files/Uploads/Images/130418-In-the-courts.pdf, archived at http://perma.cc/9NBW-VL2S.
34
See The Trial Lawyers’ New Merger Tax: Corporate Mergers and the Mega Million-Dollar
Litigation Toll on Our Economy, U.S. Chamber Inst. for Legal Reform (Oct. 24, 2012), www.
instituteforlegalreform.com/resource/the-trial-lawyers-new-merger-tax-corporate-mergers-and-the-
mega-million-dollar-litigation-toll-on-our-economy.
35
For an example of these large rewards look no further than Southern Peru Copper, Americas
Mining Corp. v. Theriault, 51 A.3d 1213 (2012) (approving an attorneys’ fee of more than $300
million). But in many of the boundary-pushing cases, the plaintiffs’ side receives nothing for their
efforts. As an example, take the relatively recent MFW Case, where the Delaware Supreme Court
determined that a controlling shareholder transaction would be subject to the business judgment
rule if the board delegates decision making power to an independent and well functioning special
committee and holds a majority of the minority vote. See Kahn v. M & F Worldwide Corp., 88
A.3d 635 (2014). That case marked a significant change, but it did not produce any gain for the
plaintiffs or their attorneys.
M4633-GRIFFITH_t.indd 119 30/10/2018 08:16

the vitality of Delaware’s corporate law. The corporations will not miss the litigation that
is necessary to keep Delaware law current and the Delaware bar has imperfect incentives
to press to keep potentially strong cases in Delaware.
This potential threat is, of course, speculative. But the overarching point is there is a set
of conditions where doing what seems obviously correct—raising the threshold to recover
fees in merger litigation—may have unanticipated consequences. And those consequences
are adverse ones for Delaware. Whether they will come to pass is difficult to predict. As
I argue above, the factors that will determine the impact of Trulia and Riverbed include
some hard-to-observe variables. Should good cases begin to seep out of Delaware in a way
that affects its ability to innovate, it is worth the reminder that doing what seems right and
correct can produce outcomes that are hard to anticipate and not necessarily desirable.
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8. Addressing the “baseless” shareholder suit:
mechanisms and consequences
James D. Cox
In the realm of public corporations, shareholder suits, whether in the form of a class
action, in the form of a derivative suit, or simply maintained individually, are widely
regarded as a menace. Furthermore, this view exists regardless whether the suit invokes
state fiduciary duty claims or allegations of fraud under the federal securities laws.
Representative suits are especially suspect, in large part because of the well-understood
weak incentives of the suit’s litigants, particularly plaintiff’s counsel, to take full measure
of the suit’s merits when deciding to prosecute, defend and settle the action (Coffee 1986).
By far the greatest concern for shareholder suits is that they are lawyer driven. Invariably
the suit is maintained on a contingency fee, so it is plaintiff’s counsel who has “skin
in the game.” Thus, there are numerous accounts of how such a lawyer-driven process
systematically enriches that profession, with scant evidence of complementary benefits
to the corporation or shareholders whose benefits the norms invoked in such suits are
intended to protect (Winter 1993). Whereas for securities class actions there is a formal
mechanism to anoint as the lead plaintiff the claimant with the largest stake in the suit’s
outcome, state law representative actions measure the plaintiff’s adequacy hardly at all,
requiring little more than the plaintiff’s ability to make “mist on a mirror,” that is, be
living and have some cognitive abilities but no sophistication whatever regarding the suit’s
theories or claims. And even this low standard does not apply when the shareholder suit
is maintained individually.
A further consideration with shareholder suits is the nature and magnitude of potential
externalities that accompany them. The externalities considered here are not the direct
costs of litigation. Initiating suits and defending them are both inherently expensive
regardless of whether the suit is a shareholder suit or otherwise. What is different with
respect to litigation externalities in the case of a shareholder suit is the suit’s hydraulic
pressure on the board of directors’ pursuit of what it believes is the best interests of the
corporation. Indeed, it is not just the hydraulics of the suit, but also the nonproportional
costs of the plaintiff and the corporation. To illustrate, assume the shareholder claims
management’s proxy statement was materially misleading because it omitted certain infor-
mation bearing on the transaction which the board received from its investment banker.
The costs incident to the suit to this point are sunk costs from the plaintiff’s counsel’s
perspective; the situation is quite to the contrary for defense counsel. Defending against
the plaintiff’s request for discovery and a preliminary injunction entails cost X. There is
the collateral cost, Y, to the defendants if either motion is lost, as the value of the claim
inherently increases with each victory scored by the plaintiff; a similar consideration arises
if the defense is not confronted with a request for preliminary relief, but the defendant
is weighing whether to make a motion to dismiss. Losing that motion adds value to the
plaintiff’s claim. Moreover, uncertainty related to the suit’s outcome may well create
121
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uncertainty for the transaction itself. This risk is greater when the suit challenges not dis-
closure, but rather the board’s procedures for approving the transaction, such as whether
the board should have “shopped the firm” before inking the deal. Even a slight chance that
the board will have to renegotiate the transaction imposes costs on the corporation and its
shareholders. These costs are disproportionately large given their consequential effects on
the plaintiff shareholder. The path forward is to locate steps which the plaintiff’s counsel
can support that yield Z, where Z is less than the combined value of X and Y. This indeed
is the process that is played out with some regularity.
This chapter examines several mechanisms—pretrial hearings, the derivative suit’s
demand requirement, and settlements—that exist for screening shareholder suits.1
Screening serves a dual purpose: discarding meritless suits and enabling, indeed strength-
ening, meritorious suits so that injuries can be prevented or compensated. The review
reflects that the picture is not complete, as many shareholder suits fall within screening
mechanisms that elicit the least trust: approval of termination through settlement.
1. THE DEMISE AND RESURRECTION OF SCREENING IN

SECURITIES FRAUD SUITS
One mechanism to screen litigation for suits unworthy of further scrutiny by the court
is for the presiding court to conduct a minitrial of the suit. This section describes the
various substantive doctrines that have developed in the securities law areas that embrace
just such an approach.
Early in the life of the FRCP 23, the fount of the modern class action, the Supreme
Court in Eisen v. Carlisle & Jacquelin2 addressed whether a court can assess the merits of a
suit as part of its administration of the class action. The issue was how to handle notice of
the case to approximately six million class members. The district court certified the suit as
a class action, permitting notice through publication to most class members, but holding
that the cost of notice could be shifted to the defendant if, following a preliminary hear-
ing, the court believed there was a strong likelihood of success.3 The circuit court reversed
the ruling,4 and the Supreme Court affirmed the circuit’s decision, reasoning as follows:
We find nothing in the language or history of Rule 23 that gives a court any authority to conduct
a preliminary inquiry into the merits of a suit in order to determine whether it may be maintained
as a class action. Indeed, such a procedure contravenes the Rule by allowing a representative
plaintiff to secure the benefits of a class without first satisfying the requirements for it. He is
1
This chapter does not weigh, and therefore takes no position, regarding the benefits of
existing judicial screening mechanisms against reform measures such as introducing some form of
fee-shifting as a prophylaxis against baseless suits (Choi 2016).
2
417 U.S. 156 (1974).
3
Eisen v. Carlisle & Jacquelin, 52 F.R.D. 253 (S.D.N.Y. 1971). Following a mini-trial, the court
assigned 90 percent of the cost of notice to the defendants based on its finding after a hearing that
more likely than not the class would prevail on the merits. Eisen v. Carlisle & Jacquelin, 54 F.R.D.
565 (S.D.N.Y. 1972).
4
Eisen v. Carlisle & Jacquelin, 479 F.2d 1020 (2nd Cir. 1973).
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Addressing the “baseless” shareholder suit 123
thereby allowed to obtain a determination on the merits of the claim on behalf of the class
without any assurance that a class action may be maintained.5
The reference to “whether it may be maintained as a class action” appears to be more

sweeping than the issue before the court: whether the court could delve into the merits to
determine who should bear the cost of imparting notice to class members. Nonetheless,
Rule 23 itself makes no reference to the merits being a factor in considering whether a
suit can be brought on behalf of a class. A key consideration in the Court’s reasoning
was concern that a preliminary hearing on the merits could prejudice the case against
the defendant; among its concerns was that the hearing could occur without the rules of
evidence and procedure applying.6
Five decades later, Eisen cannot be seen as barring pretrial involvement of the court
on the merits in ways that heavily bias the case’s outcome. In the case of securities fraud
litigation, courts regularly engage in pretrial evaluations of the facts that clearly enter the
realm of assessing key components of the plaintiff’s suit. In the area of suits under the
antifraud provision, this regularly occurs with respect to the several substantive questions:
the materiality of the misrepresentation, whether the misrepresentation was committed
with scienter, and causation.
The sine qua non of any securities misrepresentation action is that the defendant made
an alleged omission or misstatement that is material. While materiality is understood as
a mixed question of law and fact,7 the courts over the past 30 years have developed a
number of doctrines that render materiality more a question of law than one of fact. These
developments have allowed the central element, materiality, to be addressed in pretrial
motions. Doctrines that enable courts to handle materiality as a legal rather than a factual
question are the truth on the market defense,8 the doctrine of puffery,9 and exculpation of
forward-looking statements if accompanied by meaningful cautionary language.10 Thus,
in deciding whether the truth on the market defense has been established, courts consider
a range of external facts, such as public analysis on the same topic by independent
analysts,11 to reach a conclusion as to whether the independent reports correct the defend-
ant’s announcement that the plaintiff alleges to be materially misleading. With the puffery
defense, courts assess whether the misrepresentation, although incorrect, would not be
considered important by the reasonable investor who knows that generalized statements
of optimism are customarily made in such transactions even though the optimism is not
factually based.12 In deciding whether a statement was qualified by meaningful cautionary
5
Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177–78 (1974).
6
Ibid at 178.
7
TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438 (1976).
8
See e.g., Wielgos v. Commonwealth Edison Co., 892 F.2d 509 (7th Cir. 1989).
9
See e.g., ECA v. J.P. Morgan Chase, 553 F.3d 187, 196 (2d Cir. 2009).
10
See e.g., Kaufman v. Trump’s Castle Funding, 7 F.3d 357 (3d Cir. 1993); see also Securities
Exchange Act Section 21E(c)(1)(A)(i), 15 U.S.C. § 78u-5(c)(1)(A)(i).
11
See e.g., In re Apple Computer Sec. Litig., 886 F.3d 1109 (9th Cir. 1989) (company’s claims
of performance of a new computer product were offset by numerous industry reports the comput-
ers underperformed the manufacturer’s claims).
12
See Eisenstadt v. Centel Corp., 113 F.3d 738 (7th Cir. 1997) (statement that efforts to
sell the firm were going well not misleading when there were no significant third party buyers
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language, courts by necessity probe deeply into all of the case’s facts, because what is
meaningful entails an understanding of the company’s operations when the challenged
forward statement was made.13 In each of these dimensions of the materiality inquiry,
courts are deeply entwined with the case’s merits.
A further platform for trial courts to assess the overall strengths of a case is provided
by the Supreme Court’s recent decision in Omnicare, Inc. v. Laborers District Council
Construction Industries Pension Fund.14 The case focused on what the plaintiff must allege
regarding the defendant’s awareness when pursuing an opinion statement made in a
registration statement for a public offering; the issue in Omnicare, Inc. was a difficult one
because under the securities laws the security’s issuer has absolute liability for material
misrepresentations contained in its registration statement. In the registration statement
for its public offering, Omnicare stated that it believed its business practices and customer
contracts complied with the law. They did not; the shares covered by the registration
statement lost their value when Omnicare ultimately disclosed extensive illegal conduct
in the promotion and operation of its business; and a class action ensued by investors in
the registered shares.
Omnicare Inc. resolved the dispute of whether the expression of an opinion could be
a materially misleading fact by focusing on whether the opinion statement was defective
because it omitted facts needed to render the opinion of compliance from itself being
materially misleading.15 Evaluating whether this occurred necessarily involved a sweeping
inquiry into what Omnicare’s officers knew and when they had such knowledge. The
allegations in the complaint were the principal basis for the inquiry but, most importantly,
it is an inquiry that invites the court to draw inferences from the facts set forth in the com-
plaint. Courts applying Omnicare have done so by evaluating the overall strength of the
central allegation: was the defendant’s professed opinion materially misleading because
of what was known and not disclosed? Thus, judicial doctrine has once again evolved to
define an element of the case that necessarily provides a pretrial mechanism by which the
court gains perspective on the suit’s merits.
The heightened pleading requirement introduced by the Private Securities Litigation
Reform Act requires that, in addition to pleading scienter with particularity, the com-
plaint’s facts establish a strong inference that the defendant’s alleged misrepresentation
was committed with knowledge or recklessness.16 This requires that the facts more likely
than not establish a reasonable or permissible inference that the defendant acted with sci-
enter; the Supreme Court defined the requisite strength of the inference to be that which
is “cogent and compelling, thus strong in light of other explanations.”17 The Supreme
Court’s reasoning reflects awareness that the approach will necessarily involve courts in
making judgments about the case. For example, the Court defended its approach against
the claim it would usurp the jury’s role; it reasoned that when applying the heightened
as court reasoned such statements are understood to mean only that efforts to sell the firm are
proceeding).
13
See Asher v. Baxter Int’l, Inc., 377 F.3d 727 (7th Cir. 2004).
14
135 S. Ct. 1318 (2015).
15
Ibid at 1327–29.
16
See Securities Exchange Act Section 21D(b)(2), 15 U.S.C. §78u-4(b)(2).
17
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308. 324 (2007).
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pleading requirement the court is bound to accept the truthfulness of the facts alleged,
whereas when the jury considers their truthfulness, so much remains for the jury (assum-
ing the pleadings withstand the motion to dismiss).18 Nonetheless, a court’s consideration
whether alleged facts establish an inference that the defendant acted with scienter, and
its evaluation of the strength of that inference, necessarily draws the presiding judge into
assessing the case’s strengths, even though factual allegations are not being questioned.
Courts are drawn even more deeply into the suit’s merits when addressing causation
questions. In securities class actions, causation arises with respect to two distinct moments:
the class certification stage and the motion to dismiss stage. Reliance is an element in
private securities suits under the antifraud provision. When the suit alleges a public com-
pany committed a material misrepresentation, however, reliance by investors is addressed
through the fraud on the market approach, which requires evidence supporting the claim
that the class’ investors were justified in relying on the security’s price being impacted by
a material misrepresentation.19 Because the fraud on the market presumption of reliance
can only arise when the security trades in a market that bears qualities consistent with an
efficient market, a good deal of the litigants’ effort in such cases is devoted to establishing
that such conditions exist so that the class can be certified. Courts resolve this question
through a hearing where evidence from both sides is presented,20 generally in the form of
detailed reports and testimony from the forensic economists retained by both sides of the
dispute. Ultimately, findings on this question are reached21—findings that invariably shed
a good deal of light on, if not resolve, the central claim that the misrepresentation had a
material impact on the security’s price during the class action period.
The presiding court is further drawn into the securities fraud case by the need for the
plaintiff to allege that the misrepresentation caused the plaintiff to incur an economic loss.
Thus, even if the plaintiff successfully alleges that a material misrepresentation affected
the security’s price, the suit is dismissed absent factual allegations that the security’s price
corrected upon disclosure of the truth.22 Courts therefore inquire into whether there was
an economic loss as a consequence of the misrepresentation; this inquiry invariably pulls
the court into facets of the misrepresentation and into whether there was a corrective
statement. These assessments are deeply factual inquiries and entail the court assessing
the overall strength of the case.
Thus, the Supreme Court’s post-Eisen holdings on how to approach the heightened
pleading requirement and causation in securities suits very much embrace the trial court’s
deep involvement in the suit’s facts at the pretrial stage. Depending on the individual case,
this involves varying perspectives for the presiding court to assess the suit’s qualities,
18
Ibid at 328.
19
Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014).
20
Most courts at least begin with factors set forth in Cammer v. Bloom, 711 F. Supp. 1264
(D. N.J. 1989) (setting out several factors, including percentage of market shares traded weekly,
analyst following, presence of market makers, whether company is eligible to use SEC Form S-3
when undertaking a public offering, and responsiveness of security’s price new information). The
last consideration invariably is the most important focus, and where the litigants depend on their
forensic economists.
21
See e.g., In re Initial Public Offering Sec. Litig., 471 F.3d 24 (2d Cir. 2006).
22
Dura Pharms., Inc. v. Broudo, 544 U.S. 336 (2005).
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indeed overall merits. What is different from Eisen is that today’s foci are substantive ele-
ments that are central to the case, whereas Eisen’s focus was on resolving an administrative
question: Who should bear the cost of notice to class members. Nonetheless, the merits
of federal securities fraud suits are today regularly evaluated by the court.
2. RAISING THE COST TO LITIGATE
Economics 101 teaches us that one way to dampen demand for something is to raise its
cost. The question is whether this works for discouraging the consumption of securities
litigation as it did for reducing the consumption of fountain drinks. We can see several
of the initiatives introduced by the Private Securities Litigation Reform Act of 1995 as
significantly raising the cost to maintain securities fraud suits. Most prominent among
these developments is the Act’s introduction of a heightened pleading requirement whereby
allegations involving scienter must not only be pled with particularity but the alleged facts
must establish a strong inference that more likely than not the defendant committed the
misrepresentation with the requisite scienter.23 Greatly complicating the plaintiff’s establish-
ment of a strong inference of fraud is the PSLRA’s discovery bar until pretrial motions have
been resolved.24 In combination, the suit’s counsel frequently must engage in costly pre-suit
investigative efforts to discover what the actors in the fraud knew and when they knew it.25
As seen in the preceding section, not all the burdens faced by plaintiff’s counsel can
be attributed to the PSLRA; courts have been busy raising the costs to maintain suits
against public companies for materially misleading reports and announcements. Recall
that for such open-market fraud cases the plaintiff must set forth affirmative allegations
that the alleged misrepresentation caused an economic loss,26 and when the transaction
occurs in a public market the plaintiff must establish that the market in which the security
trades has features consistent with the security’s price likely being impacted by a material
misrepresentation.27 Each substantive requirement increases the costs of litigating for
plaintiff’s counsel, who must retain a forensic economist to meet these requirements—a
very expensive undertaking.
Even though these procedural and substantive developments have increased the cost
23
See Exchange Act Section 21D(b)(2), 78 U.S.C. §78u-4(b)(2).
24
See Exchange Act Section 21D(b)(3)(B), 15 U.S.C. §78u-4(b)(3)(B).
25
Another consequence of costs, and procedures, introduced by the PSLRA is increased
concentration among plaintiff law firms that handle securities matters. This concentration reflects
the necessity of a plaintiff law firm developing and sustaining relationships with labor and pension
funds to be able to earn the opportunity to be lead counsel in securities class actions. The PSLRA
introduced a process for selecting the “lead plaintiff ” whereby the court entertains petitions from
purported class members to serve as the lead plaintiff of the class; the PSLRA provides a strong
presumption that the most adequate plaintiff is the petitioner with the largest loss. Once selected,
the lead plaintiff then selects the class’ counsel. Plaintiff firms therefore must engage in substantial
efforts to win the confidence of large numbers of such institutional investors if the firm wishes to
participate in securities class actions involving significant losses. These dynamics have essentially
driven smaller plaintiff firms from this area of practice (Thomas & Thompson 2012).
26
See Dura Pharms. Inc. v. Broudo, 544 U.S. 336 (2005).
27
See Halliburton Co. v. Erica P. John Fund, Inc., 124 S. Ct. 2398 (2014).
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to maintain securities fraud actions, and particularly those alleging open-market frauds
that are prosecuted as a class action, the data is not convincing that it has reduced the
number of securities class action suits. During the most recent five-year period (2011–15),
an average of 221 such actions were filed each year (NERA 2015, fig. 1); this compares
with an average of 200 yearly filings in the five years (1991–5) preceding the PSLRA being
enacted and the 220 filings in the first five years of the act’s existence (1996–2000) (NERA
2007, 2). Moreover, in the most recent five-year period average settlements have increased
to $42.6 million,28 over average settlements of $6.6 million in 1996–2000 (NERA 2015,
fig. 24), while the median settlements increased from $7.14 million to $8.7 million—up
about 22 percent (NERA 2015, fig. 26).
The data does show that the PSLRA and other developments have adversely impacted
the success of filed securities class actions. Evidence of the impact of the heightened
pleading requirement, and no doubt how its satisfaction is hobbled by the discovery bar,
is the significant increase in dismissal rates for securities suits following the PSLRA. In
1996, a year after Congress introduced a variety of procedural changes intended to reduce
the frequency of securities suit, 43 securities class actions were dismissed; in 2013, in an
era when about 10 percent fewer securities class actions were being filed, eighty suits
were dismissed (NERA 2015, at 28). Overall, approximately 42 percent of filed securities
class actions are dismissed in response to defendant’s motion to dismiss or motion for
summary judgment (NERA 2015, at 28). Because suits are maintained on a contingency
fee basis, the increase in dismissal rates following the PSLRA means that firms are today
encountering much higher sums of unreimbursed costs than was the case when the plead-
ing standard was lower and there was a bar to discovery during the pretrial motion period.
Overall, the number of dismissals reflects a drift upward for each year since 1995, now
constituting about 100 dismissals a year, whereas the five-year average for 1996–2000 was
59 cases per year (NERA 2015, fig. 19; Cornerstone 2016, at 13).29 Recall that the number
of filings during this five-year period was nearly identical to that for the most recent five-
year period. This observation is further documented by studies of the dramatic increase
in dismissal rates following enactment of the PSLRA (NERA 2014, 28).
The process of counting filings and evaluating dismissal rates is a very noisy one by
which to discern the impact of legislative and doctrinal developments, even though there
is a good deal of intuitive appeal for having raised the cost to initiate securities fraud
actions. The data does tell us that the risk of a public company being the target of a secu-
rities class action continues to rise each year, driven by the sharp decline in the number
of listed companies while the number of filed suits, as seen above, has remained fairly
constant (Cornerstone 2015, 9). The number of filings, dismissal rates, and settlements is
impacted by clustering of types of misconduct that underlie the suit, such as the financial
reporting abuses of 1999–2001, the tsunami of option backdating cases, or various suits
involving financial products that became worthless in the financial crisis. Even regulatory
developments, such as at first strengthening the auditor’s attestation of internal controls
then weakening those obligations, can be seen as changing management conduct, with
28
Each comparative dollar figure reference in this chapter is inflation-adjusted to 2014 dollars.
29
The Cornerstone report observes that the dismissal rate for suits within three years of their
filing was 47 percent in 2012, but was a staggering 56 percent in 2006.
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consequential effects on the quality of financial reporting and ultimately the instances of
suits for alleged abuses in reporting. Also, the infrequent recovery of large sums on behalf
of the class may suggest the presence of a lottery effect that attracts the risk-preferring
plaintiff’s counsel. These, and likely many other considerations, should qualify the eco-
nomic thesis that raising the cost to maintain such suits will reduce the suits to the optimal
level. At the same time, the initiatives can be seen as introducing significant additional
costs to maintain such actions, with the consequential effect that the real question is
not how many suits have been filed or how many were dismissed under the current legal
regime, but rather what those numbers would have been had the PSLRA and doctrinal
developments related to class certification and loss causation not existed. It is in this area
that evidence of rising dismissal rates and relatively flat filings support our intuition that
raising the cost of the activity most likely does reduce its frequency.
A final review of the data offers a positive view of the impact of various legal develop-
ments. To be sure, we find that the overall number of securities class action filings has
remained constant, despite a marked decline in the number of listed companies and an
increase in dismissal rates. While this may suggest unresponsiveness to rising costs of
prosecuting the suits, it may be qualified by considering that the concentrated plaintiff
law firms operate on a portfolio basis. Thus, while they have certainly experienced greater
costs and more dismissals in the past three decades, their median recoveries are higher
than they were in the five-year period before the PSLRA. Thus, we may surmise that, on
a portfolio basis, firms have improved in terms of selecting suits likely to generate returns
to justify the risks that exist in today’s securities class action environment. Overall,
the above data does not appear to make a convincing case that screening of cases has
necessarily occurred in connection with changing the cost to engage in shareholder suits.
3. SCREENING VIA THE DEMAND REQUIREMENT
The line of first defense for the derivative suit has long been the demand requirement
(Cox & Hazen 2010, at § 15.7). Unless excused, the derivative suit plaintiff must direct
to the corporation’s board of directors a formal request that the corporation initiate suit
against the proposed defendants for misconduct allegedly committed that harmed the
corporation. Three decades ago derivative suits existed only in those limited instances in
which a demand was excused on grounds of futility, which was variously defined by the
states (Cox & Hazen 2010, at 152–58); to make a demand was to admit that the board of
directors enjoyed the presumption of independence to determine whether pursuit of the
suit was in the corporation’s interest. As such, the board’s predictable response—rejecting
the necessity of a suit—enjoyed the substantial presumptions accorded board decisions
by the Business Judgment Rule. Moreover, in the unlikely event that the board believed
misconduct had occurred, the corporation would pursue the matter, most likely via a set-
tlement with the malefactor. Either case, an excused demand meant there was no vitality
to the matter being pursued derivatively.30
30
See e.g., Sohland v. Baker, 15 Del. Ch. 431. 443 (Del. Ch. 1927) (reasons for directors’ refusal
to pursue the suit need not be considered).
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In the ensuing decades, the demand requirement has been cast differently, so that it is
no longer an impregnable bulwark. It is with some irony that weakening of the demand
requirement can be linked to efforts that began in the 1980s to expand its reach to
demand-excused cases. Delaware and New York were early jurisdictions to embrace the
view that a board that itself lacked independence to assess the corporate interest served
by a derivative suit could nonetheless bestow that power on a committee of independent
directors, even a committee whose members were recruited to the board and appointed
to the committee by the interested directors.31 However, neither jurisdiction accorded
unwavering deference to the anointed committee’s perspective, recognizing that standards
of good faith and independence were required.32 The basis for only qualified deference
being accorded the committee directors’ judgment is best captured in the famous observa-
tion in Delaware’s leading decision, “there but for the grace of God go I.”33 Scholars, as
well as the then ongoing American Law Institute “corporate governance project,” raised
concerns regarding the structural bias that could likely impact the outcome of a director’s
decision when asked to stand in judgment of claims asserted against a colleague by a
faceless outsider.34
As scholars considered this dynamic, they also reasoned that the multiple considera-
tions that support the great deference accorded director decisions regarding the firm’s
business under the Business Judgment Rule do not apply when the directors’ decision
is whether a suit should proceed against a colleague. Directors’ toolkit includes skills in
finance, marketing, and management; the derivative suit judge lacks comparable training
or experience in these areas. Hence, deference to the directors on such matters is not just
understandable but a desideratum. Moreover, second guessing by courts on business mat-
ters is believed to be inconsistent with nurturing risk taking, a quality believed necessary in
the commercial world. Were courts not guided by the strong presumption of the Business
Judgment Rule, there would be a great fear of hindsight bias; in the world of business
bad things can happen, but not necessarily because of ineptitude or negligence on the
part of the decision maker. The high presumption of propriety insulates boards from the
ill-effects of hindsight bias (Eisenberg & Cox 2014, at 625). And a consequence of a court
substituting its judgment for a business decision is that the directors would be held liable
for the decision if the court later determines that the decision was unwise.
Thus we see there are multiple considerations that support the high presumption of
propriety embodied in the Business Judgment Rule. Courts came to understand that
these considerations are absent when reviewing the board or committee’s assessment of
charges against a colleague. If the court disagrees with the dismissal recommendation of
directors, the consequence is that the derivative suit is not dismissed, it continues; most
importantly, the court’s disagreement with the directors on the question whether the
suit should proceed does not impose liability on the directors whose decision the court
supplanted. Thus, a non-deferential court’s review and reversal of a board decision not to
31
See e.g., Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (Del. 1981); Auerbach v. Bennett,
393 N.E.2d 994 (N.Y. 1979).
32
430 A.2d at 788–89; 393 N.E.2d at 996.
33
430 A.2d at 787.
34
See ALI, 2 Principles of Corporate Governance; Analysis and Recommendations § 7.03(a)
(1994).
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embrace the derivative suit cannot be expected to chill director risk taking in business mat-
ters or discourage individuals from their willingness to serve. The impact of not accepting
a board or committee’s dismissal recommendation is on the suit’s defendant and not the
deciding directors. Moreover, in reviewing the dismissal recommendation, the court is
drawing on its own toolbox—the likely merits of a case and also whether the facts have
been sufficiently investigated—not the more foreign questions of finance, marketing, or
management. The issues posed in considering the board or committee’s dismissal recom-
mendation are those that are fairly steady fare in the trial court. For these reasons, nearly
half of the states have embraced a universal demand approach whereby the derivative suit
plaintiff must make a demand in all cases. But also, even in demand-futility jurisdictions,
the demand made and rejected no longer elicits unquestioning deference. Treatment of
the demand requirement today reflects a process that invites a fulsome analysis of the
corporate interest likely to be served by the suit, an analysis that is fed by the adversarial
nature of the proceeding.
The case law is now replete with decisions probing, albeit mostly around the edges, the
derivative suit’s merits. The states are divided between universal demand (where, with rare
exceptions, the derivative suit plaintiff must lodge a demand with the corporation and
await a response before commencing the suit) and demand-futility jurisdictions. Delaware
is a leader among the latter, so that to escape making a demand, the plaintiff must set forth
with particularity facts that create a reasonable doubt of the directors’ independence.
The plaintiff has the burden of persuasion in establishing demand futility, and reviewing
courts, as is typical with reviews of dismissals, draw all reasonable inferences from the pled
facts in determining whether the plaintiff has met its burden. The distinction between
universal demand and demand-futility jurisdictions may be that the latter entails greater
inefficiency. This at least is the position taken by the American Law Institute, whose ear-
lier work provided the momentum for universal demand. The ALI reasoned that universal
demand is efficient because it avoids litigation occurring within litigation.
Delaware requires more than evidence of a longstanding business and personal relation-
ship between the director and the suit’s defendant to establish a lack of independence. This
standard was applied recently in Delaware County Employees Retirement Fund v. Sanchez,35
where the Delaware Supreme Court emphasized that a friendship extending five decades
should be seen differently than one that was not so long, and also that much of the director’s
income was dependent on the suit’s defendant.36 However, reflecting on the degree of scru-
tiny that occurs, the Delaware Supreme Court concluded that absent substantial economic
dependence, longtime personal relationships will not alone rob directors of their independ-
ence when considering the corporation’s interest served by a pending derivative suit.37
In Rosenbloom v. Pyott the Ninth Circuit, applying Delaware law, also believed the
plaintiff had created a reasonable doubt that the directors of Allergan lacked independ-
ence to assess a derivative suit, and thus held it was error to dismiss the suit for the
plaintiff’s failure to make a demand on the company’s board of directors.38 Allergan
35
124 A.3d 1017 (Del, 2015).
36
Ibid at 1022–23.
37
Beam v. Martha Stewart, 845 A.2d 1040 (Del. 2004).
38
765 F.3d 1137 (9th Cir. 2014).
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produced the well-known drug Botox. For years, Allergan, Inc.’s board of directors
pursued a number of initiatives designed to promote off-label sales of Botox, its main
product, even though such off-label sales were illegal; indeed, the board had received
several warnings from the Food and Drug Administration that Allergan’s practices vio-
lated the law. As a consequence of allegations first lodged in qui tam suits that ultimately
attracted government actions, Allergan paid a total of $600 million to settle the civil and
criminal actions. Shortly after these settlements, derivative actions were filed alleging that
Allergan’s directors were liable for violations of various state and federal laws, as well as
for breaches of their fiduciary duties to Allergan, in connection with the firm’s pursuit
of off-label sales of Botox. The suit’s plaintiffs, however, did not make a demand, so the
issue was whether demand was excused on the basis that the plaintiff had successfully
alleged facts with particularity that created a “reasonable doubt” that the directors were
“disinterested or independent.”39 The Ninth Circuit held that such a doubt was created
by allegations showing a substantial likelihood the directors were liable in failing to act
when they had a duty to act.40
The Ninth Circuit closely considered numerous facts set forth by the plaintiff and
concluded that the allegations at least established a reasonable doubt regarding the
director’s independence. In considering whether the board lacked independence, the
court dove deeply into facts bearing not only on whether they were independent but
more particularly on when they lacked independence because they breached their duty to
Allergan. Pyott reviewed an array of facts the panel believed supported claims of probable
board misbehavior by its members’ purposeful inaction where action was required. The
facts also supported the view that the directors had pursued a business strategy premised
on illegal conduct. Among the facts evaluated for competing inferences were: the board
had adopted a four-year plan that gave top priority to maximizing off-label uses known
to be prohibited for its dominant product, Botox; the company continued funding of
organizations Allergan controlled that promoted off-label uses of Botox and reviewed
their promotional materials; the board regularly received reports linking rising sales of
Botox with off-label sales; the board received one FDA warning against its practice of
off-label sales and several other warnings with parallel warnings; the board made off-label
sales of Botox a priority and engaged in these practices for more than a decade.41 Based
on these facts, the court concluded:
Plaintiffs’ particularized factual allegations . . . suffice to show that the Board either did nothing
despite actual or constructive knowledge of wrongdoing at Allergan, or knowingly adopted a
business plan premised on illegal conduct. In either case, Allergan’s directors violated their duty
of loyalty and would face a substantial likelihood of liability; in the latter case, they would also
have forfeited the protection of the business judgment rule.42
Left unsaid in both Sanchez and Pyott is whether the plaintiff’s victory in each case
may be shortlived; conflicted directors who are not successful in scuttling the derivative
39
See Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984).
40
765 F.3d at 1151.
41
Ibid at 1151–59.
42
Ibid at 1159.
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suit through the demand requirement may, as has happened in the celebrated Delaware
decision Zapata Corp. v. Maldonado,43 resurrect the demand requirement by empaneling
a special litigation committee. When this occurs, the good faith and independence of the
committee, including the process for the committee’s formation, is closely scrutinized.
Boland v. Boland Trane Assoc., Inc.44 is an excellent recent illustration of scrutiny of a
dismissal recommendation of a special litigation committee; it is especially illuminating
because it applies not the more scrutinizing review standard in Zapata Corp. but a stand-
ard that requires the business judgment rule to be extended to reasoning and conclusions
reached by the committee.45
In Boland, Maryland’s high court reviewed a recommendation of a committee that a
derivative suit be dismissed. It held it was incumbent on the corporation to explain why
it had appointed the individuals appointed to the committee.46 This inquiry was part of
the overall requirement that the committee must be independent and have acted in good
faith. In making this inquiry, the committee members were not accorded a presumption of
independence. Independence required “that no substantial business or personal relation-
ships impugned the SLC’s independence or good faith.”47 If this information is set forth,
the plaintiff is accorded an opportunity to challenge the assertions and the rebuttal tested
by standards applied in motions for summary judgment. Moreover, the committee has the
burden of establishing that it reached its decision by employing methodologies and rea-
soning that were reasonable under the circumstances. Of significance, the court held that
the committee enjoyed no presumption of propriety with respect to the methodologies it
employed to carry out its investigation of the facts it relied on to support its conclusion.
On the other hand, substantive conclusions the committee drew from the facts were held
to be within the protective reach of the business judgment rule. The court proceeded to
review its investigation and concluded there were serious deficiencies in the committee’s
investigation and, thus, concluded it was an error for the trial court to have granted sum-
mary judgment to the defendant.
Consider that a recent Delaware decision involving a demand made and rejected follows
the same line of inquiry as Boland regarding the director’s good faith as that followed in
universal demand jurisdictions. Ironworkers District Council of Philadelphia and Vicinity
Retirement & Pension Plan v. Andreotti,48 while not evaluating either the substance of the
suit’s allegations or the board’s conclusions for rejecting the presuit demand, nonetheless
closely evaluated the board’s process of investigating to determine if the board’s rejec-
tion was “taken in good faith and absent gross negligence.”49 The court’s focus was on
43
430 A.2d 779 (Del. 1981).
44
423 Md. 296, 31 A.3d 529 (2011).
45
As a technical matter, Zapata’s approach is assumed to be more probing than the Auerbach
standard because under Auerbach there is still space for the business judgment rule’s presump-
tion to support the committee’s recommendation. However, the distinction between Zapata and
Auerbach, as illustrated in Boland, is at best razor thin since challenges to methodology via the
committee’s good faith is sufficiently openended to allow conclusions drawn from the facts to be
recast as a matter of incompleteness of the inquiry rather than a suspected error in judgment.
46
Boland v. Boland Trane Assoc., Inc., 423 Md. 296, 31 A.3d 529 (2011).
47
423 Md. at 341; 31 A.3d at 556.
48
2015 Del. Ch. LEXIS 135 (2015), aff’d without opinion, 132 A.3d 748 (2016).
49
Ibid at *27.
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the detailed process the board employed that followed the well-paved path of internal
investigations: a nearly 200-page report prepared by independent counsel that was not
shown to be less than inclusive. The report was prepared by outside counsel and was
relied upon by the board. The court observed that, had there been gaps in the report that
supported an inference of gross negligence in its preparation, dismissal of the derivative
suit would not be appropriate. The most vulnerable point of Andreotti’s analysis was not
whether the report was sufficiently detailed and comprehensive, but whether the report’s
facts supported the substantive judgment made by the board in reliance on the report.
Andreotti arose from DuPont Corporation being adjudged liable to Monsanto for
$1.2 billion in a jury trial for violating its patent licensing agreement with Monsanto.
The trial court further sanctioned DuPont by requiring it to pay Monsanto’s litigation
costs, reasoning that the defense to the suit was not in good faith. The verdict was upheld
on appeal and the appellate court also observed that DuPont had litigated in bad faith.
Several derivative suits ensued, demanding that the corporation investigate and pursue
claims against responsible officers and directors. The extensive investigation process
that supported the report appears beyond question. The report, however, was only part
of the inquiry; the court also weighed the conclusion reached by the board in reliance
on the report, particularly the key conclusion there was no breach of fiduciary duty
(despite the imposition of substantial damages on DuPont for the conduct carried out
on its behalf). Vice-Chancellor Glasscock examined the dissonance between the report’s
findings and the damages awarded by the district court.
The jury returned an enormous verdict—more than $1 billion—for Monsanto’s patent
claims, which verdict was pending appeal at the time of settlement. It is not possible, on
the facts pled in the Complaint, to determine the ultimate cost to DuPont of this verdict,
subsumed as it was in the Settlement, which obviated an appeal, surrendered the antitrust
allegations, settled the litigation, and gave the company new rights to use Monsanto
technology, in return for $1.75 billion over ten years. The Committee found the detriment
of the jury verdict, in light of the appeal and the Settlement, to be virtually zero. One can
take exception with the opinion without doubting the good faith of the Board’s decision
to rely on the Committee’s recommendation that it was not worthwhile to proceed with
fiduciary duty litigation against “at least some” employee or board member, for the
reasons discussed above.50
From the perspective of evaluating the suit’s merits prior to full trial, it is hard to envi-
sion how scrutiny of the complaint could be closer than that undertaken in Andreotti, a
demand-required case.
4. SCREENING VIA APPROVAL OF SETTLEMENT
As seen above, securities fraud suits and derivative suits provide their own mechanisms
for pretrial scrutiny that naturally draw the court into assessing the suit’s merits. What
is missing from the spheres of the above described mechanisms is direct nonsecurities
fraud actions. A principal illustration of such a claim is a class action alleging an injury
50
Ibid at *39–40.
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suffered by shareholders because of alleged director and officer misconduct in connection

with a merger whereby shareholders receive too little for their shares. Just such a case is
Trulia Inc., discussed presently. Another example is a challenge to defensive maneuvers
employed by a corporation that allegedly prevented an above market takeover bid for the
firm. For such suits, the traditional pretrial opportunities for review are the motions for
summary judgment, motion to dismiss, and requests for a preliminary injunction.
Over the years, the Delaware courts have greatly intensified their pretrial scrutiny of
the suit’s merits when considering the defendant’s motion to dismiss. A recent study by
Professors Lawrence Hamermesh and Michael Wachter reflects the importance of this
screening process in shareholder suits:
[T]he Delaware Court of Chancery’s increasingly muscular reliance on extrinsic facts in resolving
motions to dismiss demonstrates that the motion to dismiss is being increasingly relied upon as
an efficiency-promoting substitute for a trial, in which, despite the absence or paucity of formal
discovery, the court is able to rely on a reasonably substantial factual record, at least where
(1) there is no indication or assertion by the plaintiff that information presented from outside
the four corners of the complaint is disputable in a relevant way, and (2) substantial relevant
information is available through publicly available sources, stockholder inspection rights, or
voluntary production by the corporation. (Hamermesh & Wachter 2017)51
Outside of Delaware, the motion to dismiss continues to be a weak medium for screening
self-dealing matters, such as those that arise in the acquisitions litigation. And, when in
a particular case the central facts are disputable, the motion to dismiss even in Delaware
proves to be a porous mechanism for pretrial screening. Consider the challenges the
defense faces in addressing a claim that management has undertaken a defensive maneu-
ver or there is a sale of control transaction; in Delaware, when such a claim is made the
burden of proof shifts to management to demonstrate it acted reasonably. This does
provide an opportunity for the defense to detail the steps taken by the management;
however, the plaintiff can survive the motion upon a bare showing of fairly neutral
facts—the engagement of a defensive maneuver or a change of control transaction when
the defendant is unable to introduce indisputable facts supporting the reasonableness of
management’s actions. Thus in a leading defensive maneuver case, the issue was whether
the board, in the face of a hostile bid, had met its fiduciary obligations when it placed
approximately 16 percent ownership in the hands of a friendly party, adopted a poison
pill, applied the pill in a discriminatory manner to prefer one bidder over another, and
engaged in a repurchase program. In denying the defendant’s motion to dismiss, the
court reasoned:
51
In Delaware the complaint can be dismissed only where the court determines with “reason-
able certainty” that the plaintiff could prevail on no set of facts that may be inferred from the
complaint. Delaware Rule 12(b)(6). See, e.g., Malpiede v. Townson, 780 A.2d 1075, 1082–83 (Del.
2001) (plaintiff is entitled to all reasonable inferences that logically flow from the face of the com-
plaint). The complaint must, however, set forth “well-pleaded allegations” which requires specific
allegations of fact and conclusions supported by the alleged facts. See, e.g., Solomon v. Pathe
Communications Corp., 672 A.2d 35, 38 (1996) (locating this standard as being inherent notice
pleading). However, in the close analysis of Delaware cases, Professors Hamermesh and Wachter
show that the Delaware judiciary increasingly considers a wide range of information before the
court in determining whether the complaint sets forth a “reasonable conceivable” claim.
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[A]s the terminology of enhanced judicial scrutiny implies, boards can expect to be required
to justify their decision making, within a range of reasonableness, when they adopt defensive
measures with implications for control. This scrutiny will usually not be satisfied by resting on
a defense motion merely attacking the pleadings.52
Thus, in the heightened scrutiny realm, where the burden of explanation is placed on
management, bright-line legal rules, such as whether the acts taken by the defendant were
defensive maneuvers53 or that the transaction’s structure triggered Revlon considerations,54
a premium should be placed on the defendant’s setting forth detailed facts supporting the
reasonableness of management’s actions.
The reasonable probability of ultimate success requirement for a preliminary injunction
can provide a better platform for screening suits than ruling on motions to dismiss.55 For
example, in instances of an alleged disclosure violation, the reasonable probability stand-
ard calls on courts to determine a variety of questions such as what was disclosed and the
types of disclosures companies need not make generally,56 or in a specific context.57 There
are considerations of the collateral consequences of such an order, however, that regularly
weigh against such relief. For example, in cases where material misrepresentations are
alleged, while as a policy matter there is a preference toward ordering disclosure ex ante
rather than determining damages ex post,58 this preference is substantially qualified by
52
In re Santa Fe Pac. Corp. S’holder Litig., 669 A.2d 59, 72 (Del. 1995) (reversal of lower
court’s grant of defendant’s motion to dismiss); see also, In re Ebix, Inc. S’holder Litig., No CV
8526-VCN, 2016 WL 208402, at 18 (Del. Ch. Jan. 15, 2016) (“The activation of heightened scrutiny
poses a systematic difficulty for defendants seeking dismissal under Court of Chancery Rule 12(b)
(6), given the limited record from which they might draw to demonstrate reasonableness”).
53
See, e.g., Gantler v. Stephens, 965 A.2d 695, 705 (Del. 2009) (affirming grant of motion to
dismiss on ground the board had not engaged in acts that were defensive).
54
See e.g., In re Santa Fe Pac. Corp. S’holder Litig., 669 A.2d 59, 71 (Del. 1995) (no facts
pleaded indicating transaction posed a change of control so that Revlon should apply).
55
See La. Mun. Police Employees’ Ret. Sys. v. Crawford, 918 A.2d 1172, 1185 (Del. Ch.
2007) (to obtain preliminary injunction plaintiff must demonstrate (1) a reasonable probability of
ultimate success on the merits at trial, (2) that failure to issue an injunction will result in immediate
and irreparable injury before final hearing, and (3) that the balance of the hardships weighs in
the plaintiff’s favor). These factors, however, are greatly impacted by the court’s concern for the
collateral consequences of granting a preliminary injunction that stops or retards the transaction’s
occurrence. For example, in cases where material misrepresentations are alleged, there is a theoreti-
cal preference toward ordering disclosure ex ante rather than determining damages ex post. See
In re Staples, Inc. S’holder Litig., 792 A.2d 934, 960 (Del. Ch. 2001). However, this preference is
substantially qualified by concern that the admittedly value-increasing transaction may disappear
in the face of the resulting delay of or uncertainty regarding approval. See McMillan v. Intercargo
Corp., C.A. No 16963, 1999 WL 288128 at 4 (Del. Ch. May 3, 1999) (“The threat of Intercargo
losing its only offer if the court issues an injunction is real, and it far outweighs the risks created by
denying injunctive relief ”).
56
See Arnold v. Soc’y for Savings Bancorp, 650 A.2d 1270, 1280 (Del. 1994) (Delaware does
not require disclosure of unreliable or speculative information).
57
See e.g., In re Netsmart Techs., Inc. Shareholder Litig., 924 A.2d 171, 203-04 (Del. Ch. 2007).
Hence, when a transaction is stated to have been adjudged fair by an investment bank, the Delaware
court lists a range of collateral disclosures that must be made such as the valuation methods used,
the key inputs into the determination as well as the range of ultimate values.
58
See In re Staples, Inc. Shareholder Litig., 792 A.2d 934, 960 (Del. Ch. 2001).
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concern that the admittedly value-increasing transaction may disappear in the face of the
resulting delay or uncertainty of approval.59
Professors Hamermesh and Wachter find that in Delaware, when a preliminary injunc-
tion is sought, the pretrial screening process occurs not in considering that motion but
earlier, in addressing the plaintiff’s motion to expedite discovery. In these proceedings,
they report, the Delaware courts engage in scrutiny of the allegations and a rich array of
facts that is indistinguishable from the approach followed when considering the defend-
ant’s motion to dismiss (Hamermesh & Wachter 2017).
The settlement process is by far the weakest of all the screens. This is because it has
long been understood that the court is greatly disabled by the proceeding not being
adversarial; as Judge Henry Friendly wisely observed, “[o]nce a settlement is agreed, the
attorneys for the plaintiff stockholders link arms with their former adversaries to defend
the joint handiwork.”60 Just such an absence of the adversarial process is illustrated by In
re Trulia, Inc. Stockholder Litigation.61 The complaint alleged that the directors breached
their fiduciary duties in approving a merger with a single bidder that allegedly failed to
obtain the highest exchange ratio for the shareholders.62 Opposing counsel reached an
agreement in time for several supplemental disclosures to be added to the proxy statement
circulated among the shareholders; the merger was ultimately approved by 79.52 percent
of the shares entitled to vote (99.15 percent of the votes cast).63 In addition to agreeing
to the supplemental disclosures, the defendants agreed not to oppose a fee request not in
excess of $375,000.64 The parties then sought approval of the settlement that released any
other claims that could be brought against the company’s directors. Chancellor Bouchard
closely examined each of the supplementary disclosures regarding distinct features of
the valuation process used by the investment bank in its fairness opinion to the board.
He found the supplementary disclosures were not meaningful in light of all the other
information the company disclosed regarding the valuation process,65 and he therefore
rejected the settlement, thereby leaving the suit where it had started—a bald accusation
of breach of fiduciary obligation. In reaching this conclusion, he offered the following
approach:
[P]ractitioners should expect that disclosure settlements are likely to be met with continued
disfavor in the future unless the supplemental disclosure addresses a plainly material misrepre-
sentation or omission, and the subject matter of the proposed release [from further liability] is
59
See McMillan v. Intercargo Corp., C.A. No 16963, 1999 WL 288128, at *4 (Del. Ch. May 3,
1999) (“The threat of Intercargo losing its only offer if the court issues an injunction is real, and it
far outweighs the risks created by denying injunctive relief ”). A very different problem confronts
the plaintiff and the court when disclosure violations are alleged that the defendant subsequently
mooted by making supplementary disclosures. In this instance, lacking an opinion, a norm was not
generated by the court, but clearly there is the basis for inviting an inquiry into causal connection
to the suit as well as the probable benefits of the resulting benefit. See Tandycrafts, Inc. v. Initio
Partners, 562 A.2d 1162 (Del. 1989) (upholding award of fees in such a case).
60
Allegheny Corp. v. Kirby, 333 F.2d 327, 347 (2d Cir. 1972).
61
129 A.3d 884 (Del. Ch. 2016).
62
Ibid at 889.
63
Ibid.
64
Ibid.
65
Ibid at 899–907.
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narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty
claims concerning the sale process, if the record shows that such claims have been investigated
sufficiently.66
The weakness of the settlement proposed in Trulia Inc. is how the settlement terms varied
remarkably from the misconduct alleged in the complaint. Such dissonance between the
gravamen of the complaint and settlement are inconsistent with the settlement being
remedial. This lack of connection, however, was not explored in Trulia, Inc. Had the
court linked the settlement to the complaint that established its jurisdiction, it could have
considered how the remedy of disclosure of facts surrounding a fiduciary’s breach of
duty, as was proposed in Trulia, Inc., sits poorly with corporate fiduciary duty principles.67
To be sure, a universal feature of fiduciary obligations is the duty of candor. The director’s
obligations, however, compel more than disclosure and include the affirmative obligation
to act in the interests of the corporation and its shareholders. To this end, the miscon-
duct alleged in Trulia, Inc. was not any want of disclosure—this was not alleged in the
complaint—but rather that the directors failed to take steps to secure a higher exchange
ratio.68 Because nondisclosure was not a part of the claimed breach by the defendants,
settlement in which only disclosure is obtained naturally invites skepticism.
Further irrelevance between the disclosure provided in the proposed settlement and
the misconduct alleged in the complaint arises from Delaware’s approach to ratification
of misconduct. A fiduciary’s breach can be approved by shareholders following full
disclosure; however, under the strict equitable ratification approach followed in Delaware,
any such shareholder approval must occur in a vote distinct from the one in which they
approve the transaction, such as the merger in Trulia, Inc.69 Because the parties did not
agree to the shareholders voting separately to ratify the directors’ conduct, the disclosures
to which they agreed were not a step toward excusing the alleged breach by the directors.
Independent of the court’s rejection of the proposed settlement, because the disclosures
provided no additional information that was meaningful to shareholders, the court should
have raised another basis to reject the settlement: the terms of the settlement were non-
responsive to the alleged misconduct alleged in the suit.
It is a matter of speculation what the Chancellor’s approach would have been had the
accord reached between the attorneys required, instead of disclosure, a slightly greater
percentage than otherwise necessary to approve the transaction. This remedy entails
more than disclosure, but with no other suitor in the wings and an above-market offer
66
Ibid at 898.
67
Further disquiet with disclosure being the relief sought in the settlement is that there does
not appear to ever have been a request for a preliminary injunction seeking disclosure before the
shareholders voted. The record recounts how the parties reached an agreement on supplementary
disclosures without such a motion and, for that matter, without the defense raising a motion
to dismiss. Thus, the defense sought the plaintiff’s cooperation in settling the matter before the
transaction was closed and proceeded to court only after the transaction had been approved (with
the supplementary disclosures the court considered not meaningful).
68
This point is emphasized by Chancellor Bouchard in his careful qualification of the scope of
the case’s holding. He states that the review standard embraced in Trulia, Inc. is limited to instances
in which the complaint does not raise a “plainly material” misrepresentation. Ibid at 898.
69
See Gantler v. Stephens, 965 A.2d 695 (Del. 2009).
M4633-GRIFFITH_t.indd 137 30/10/2018 08:16

before the shareholders, a modest increase in the vote needed would have been akin
to a peppercorn settlement. Clearly the court’s cynicism for settlements should not be
isolated to disclosure-only settlements. Nonetheless, because in Trulia Inc. there was no
earlier opportunity for the court to evaluate the suit’s merits with the intensity that we
see with the demand requirement or the dominant elements in securities fraud actions,
settlements without these presuit evaluations result in shareholder disputes being resolved
without adversaries. When this happens, the court finds itself in the awkward position of
not knowing whether it is participating in an error, be that error approving the end of a
potentially valuable suit or awarding counsel for maintaining a valueless suit.
5. CONCLUSION
The PSLRA and judicial doctrines have provided means for federal courts to evaluate the
likely strengths of private securities lawsuits. The modern applications of the derivative
suit demand requirement, even in demand-futility jurisdictions, also provide the presiding
court with an intense development of the case’s pivotal facts as a result of an adversarial
process. Orphaned in this process are settlements that occur outside these spheres of these
screening mechanisms. Trulia Inc. reflects angst, albeit only partially, over this lacunae.
Chancellor Bouchard’s opinion nonetheless shines a bright light, joining that of others,
on the perniciousness of disclosure-only settlements. This concern is likely too narrow.
The focus would better be with the entire process of settlement. Left in Trulia Inc.’s wake
will be inventive attorneys, plaintiffs’ and defendants’ attorneys, who can be expected to
substitute for disclosure-only settlements other forms of milquetoast remedies, most likely
tweaks to governance procedures. Where this occurs, the court will again be faced with
considering what mechanisms allow it to determine whether the proposed settlement is fair
and adequate. It may well be that the court’s earlier engagement through considering the
demand requirement—if the suit is a derivative—or its consideration of the motion to dis-
miss or motion to expedite discovery provide background to consider the settlement, and
particularly the likelihood that the suit has been adequately represented. When this does
not occur, as was very much the case in Trulia Inc., because of the unqualified dependence
of the presiding court on an adversarial process, the court should not distinguish between
disclosure-only settlements and settlements that do not produce tangible rewards to the
corporation or the class when asked to approve a settlement. Absent meaningful benefits to
the corporation, the court should resort to a prophylaxis: it should deny the award of any
fees. The same lack of adequacy of representation should also cause the court to withhold
its approval of the settlement; certainly this is the desired result if the court is aware that
litigation involving similar claims is proceeding in other forums. Leaving the parties where
the court found them is justified when the court has a basis to believe the interests of the
corporation or shareholders have not been adequately represented.
BIBLIOGRAPHY
Choi, A., 2016, “Optimal Fee-Shifting Bylaws,” working paper, available at https://ssrn.com/so13/papers.
cfm?abstract_id=2840947.
M4633-GRIFFITH_t.indd 138 30/10/2018 08:16

Coffee, Jr, J., 1986, “Understanding the Plaintiff’s Attorney: The Implications of Economic Theory for Private
Enforcement of Law Through Class and Derivative Actions,” 86 Columbia Law Review 669.
Comoli, R. & Starykh, S., NERA Economic Consulting, Recent Trends in Securities Class Action Litigation:
2013 Full-Year Review (Jan. 14, 2014).
Comoli, R. & Starykh, S., NERA Economic Consulting, Recent Trends in Securities Class Action Litigation:
2014 Full-Year Review (Jan. 20, 2015).
Cornerstone Research, Securities Class Action Filings 2015 Year in Review (2016).
Cox, J. & Hazen, T., Treatise on the Law of Corporations § 2:4 (3d ed. 2010).
Eisenberg, M. & Cox, J., 2014, Business Organizations Cases and Materials (11th Unabrd. ed.).
Hamermesh, L. & Wachter, M., 2017, “The Importance of Being Dismissive: The Efficiency Role of Pleading
Stage Evaluation of Shareholder Litigation,” 42 Journal of Corporate Law 597.
Plancich, S., Saxton, B., & Starykh, S., NERA Economic Consulting, 2007 Year End Update: Recent Trends in
Shareholder Class Actions (Dec. 2007).
Thomas, R. & Thompson, R., 2012, “A Theory of Representative Shareholder Suits and Its Application to
Multijurisdictional Litigation,” 106 Northwestern Law Review 1753.
Winter, R., 1993, “Paying Lawyers, Empowering Prosecutors, and Protecting Managers: Raising the Cost of
Capital in America,” 42 Duke Law Journal 945.
M4633-GRIFFITH_t.indd 139 30/10/2018 08:16

9. Who collects the deal tax, where, and what
Delaware can do about it
Sean J. Griffith and Anthony Rickey*
1. INTRODUCTION
At some point during the past decade, US merger litigation came to be dominated by
nuisance claims. By 2009, 85 per cent of all public deals over $100 million had attracted at
least one lawsuit, up from a historical average of 30–40 percent (Cain & Solomon, 2015).
For the five years that followed, the percentage of such deals attracting litigation hovered
between 90 and 95 percent (Cain & Solomon, 2016). The cases were standard nuisance
fare (Rosenberg & Shavell, 1985, 2006): most plaintiffs settled before a judicial review of
the merits, and the stockholder class received no monetary relief. Instead, the cases set-
tled for supplemental disclosures in a proxy statement (Daines & Koumrian, 2013; Cain
& Solomon, 2016). These ‘disclosure settlements’ resulted in court-approved awards of
fees to plaintiffs’ attorneys, but there is no evidence that they altered voting patterns or
benefited stockholders in any way (Fisch, Griffith, & Solomon, 2015). With the expecta-
tion that they could extract settlement value from virtually every suit, plaintiffs’ lawyers
brought suit in essentially every deal.
By 2015, criticism of this system had become widespread, and a few cases in New York
and Delaware hinted that change was coming. Finally, in January 2016, the Delaware
Court of Chancery issued its opinion in In re Trulia, holding that disclosure settlements
in Delaware would be subject to exacting scrutiny and likely rejected unless class plaintiffs
were able to extract disclosures that were “plainly material” in nature.1 The decision
included a sharp critique of standard practices in merger litigation and an expression of
continued disfavor for such settlements in Delaware.
The response to Trulia has been swift. In the wake of the decision, several tentative set-
tlements were scuttled in favor of voluntary dismissal.2 Moreover, plaintiffs brought fewer
lawsuits. In the first half of 2016, only 64 percent of all deals over $100 million attracted
claims (Cornerstone, 2016a). Although this is a decline of one third from the high point
of nuisance litigation, it is still roughly double the historical average.
* This chapter reflects legal developments through mid-2017. The authors wish to thank
participants at the 2016 Conference on Corporate & Securities Litigation, University of Illinois
College of Law, for valuable comments on an earlier draft of this chapter. Thanks also to Miranda
Lievsay (FLS’17) for invaluable research assistance.
1
In re Trulia, Inc. S’holder Litig., 129 A.3d 884 (Del. Ch. 2016). Sean Griffith filed an amicus
curiae brief in the Trulia case.
2
See, e.g., In re Health Net, Inc. Stockholders Litigation, C.A. No 11349-VCL (consol.)
(Dismissal Order 1/25/16); Cohen v. Christopher [Mueller Industries], C.A. No 11189-CB
(Dismissal Order 1/25/16); Widlewski v. Carson et al. [GrafTech], C.A. No 11086-VCL (Dismissal
Order 1/27/16).
140
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Who collects the deal tax 141
The most striking change since Trulia, however, has been the tendency for merger
litigation to be brought outside of Delaware. In the fourth quarter of 2015 and the first
half of 2016, the percentage of litigated deals with claims filed in Delaware fell by more
than half—to 26 percent from 61 percent over the prior three months (Cornerstone,
2016a). Similarly, in the first half of 2016, complaints involving Delaware-incorporated
targets were filed in Delaware just 36 percent of the time, down from 74 percent of the
time in 2015 (Cornerstone, 2016a). However, merger lawsuits filed in federal court began
increasing in the second half of 2015 (Cornerstone, 2016b), and by all accounts continued
to grow robustly in 2016 (Boettrich & Starykh, 2017; Cain et al, 2017; Cornerstone, 2017).
These patterns hint at a sorting of merger claims in the wake of Trulia. It may be that
nuisance claims, defined here as claims brought with an expectation that they will settle
for supplemental disclosures and attorneys’ fees, are brought in an alternative jurisdiction
while claims with the potential for significant damages awards continue to be brought in
Delaware. But how does this sorting occur? Commentators have suggested a “two-tier”
plaintiff’s bar, consisting of nuisance filers on the one hand, and firms seeking significant
damages awards on the other (Friedlander, 2016). Other studies of the merger litigation
bar find evidence that higher quality firms litigate more aggressively and produce better
outcomes (Krishnan, Solomon, & Thomas, 2015) and link law firm quality to case selec-
tion (Badawi & Webber, 2015). What these studies have in common is a tendency to divide
the plaintiffs’ bar into white hats (firms seeking real relief) and black hats (firms content
with nuisance settlements). The post-Trulia pattern of much (but not all) merger litigation
being filed outside of Delaware suggests a sorting mechanism in which the black hats seek
alternative jurisdictions while the white hats stay put.
But is this really the case? Does the division of the plaintiffs’ bar into white hats and
black hats match reality? Do white hats typically file inside Delaware while black hats
typically file elsewhere? And have these patterns really changed since Trulia?
This chapter attempts to answer these questions empirically by observing whether
‘white hat’ firms adopt different strategies within and outside of Delaware. To do so, we
develop a handcollected data set of merger litigation resulting in nonmonetary recoveries
from 2009 through 2016. Using disclosure settlements as our proxy for nuisance litigation,
we look to see whether there are differences in how and where white hats and black hats
engaged in nuisance litigation. We examine where these firms tend to bring and settle
merger claims and look for changes in these patterns since Trulia.
Despite assertions to the contrary, we find no pure “white hat” firms, although the “top
tier” of the plaintiffs’ bar does appear to seek disclosure settlements with less regularity.
Moreover, these firms tend to bring disclosure settlements at least as often, and in some
cases dramatically more often, outside of Delaware. As nuisance lawsuits migrate away
from Delaware, this suggests that even the “white hat” firms may be tempted to pursue
disclosure settlements in other jurisdictions, particularly where fees in the high six or low
seven figures remain available.
This is a problem for Delaware. The state’s attempt to solve the nuisance litigation
problem through a combination of Trulia and forum selection bylaws has produced, at
best, limited results.3 Delaware’s corporations remain subject to merger-related lawsuits,
3
See generally Sean J. Griffith, Private Ordering Post-Trulia: Why No Pay Provisions Can Fix
M4633-GRIFFITH_t.indd 141 30/10/2018 08:16

but with less oversight from Delaware courts. We argue, however, that Delaware courts can
do something about black hat firms masquerading as white hat firms simply by asking
tough questions in appointing leadership and in reviewing settlements. They should also
take into account the shades of gray when the adequacy of plaintiff’s counsel is made an
issue.
2. DELAWARE, DISCLOSURE SETTLEMENTS, AND TRULIA
In spite of being one of the smallest US states, both by size and population, Delaware is
the leading jurisdiction of incorporation of the largest companies in America.4 More than
half of all public companies and an even larger share (65.6 percent) of all Fortune 500
companies are incorporated in Delaware (Bebchuck & Hamdani, 2002; Bullock, 2014).
The comparative advantage of Delaware has long been thought to be the quality of its
corporate law, especially its judiciary (Black, 1990). The Delaware statute is, in general,
enabling rather than mandatory (Romano, 1989). As a result, the limits of what corpora-
tions may do are set by judicial interpretations of fiduciary duty (Fisch, 2000; Rock,
1997). The result is a body of precedent that is both deep and flexible (Kamar, 1998).
Additionally, because Delaware has retained the distinction between its equity and
law courts, it can ensure that most corporate governance matters are reviewed by a small
number of judges—the five members of the Court of Chancery. Contrast this with the
approach of New York State, which abolished its chancery court in 1846, transferring
equity jurisdiction to its trial court of general jurisdiction, the New York Supreme Court.5
As a result of this choice, corporate disputes litigated in New York State can be heard
by any one of literally hundreds of different trial court judges.6 Because Delaware main-
tained a small equity court, its judges became repeat players in corporate law disputes,
developed expertise in complex corporate matters, and, because they were few in number,
retained the ability to coordinate. The small scale of Delaware’s corporate bar also means
that lawyers become repeat players, developing lasting reputations based on the quality
of their work.
A significant portion of the claims that come before the Delaware judiciary are class
action complaints involving mergers and acquisition transactions. Because these claims
are brought in the form of class actions, they cannot settle without a judicial hearing on
the fairness of the settlement (Rubenstein; Court of Chancery Rule 23(e)). At the fairness
hearing, the Delaware Court of Chancery reviews the proposed settlement with a view
toward protecting the interests of absent class members. As part of this process, the court
the Deal Tax and Forum Selection Provisions Can’t, in The Corporate Contract in Changing
Times, Solomon & Thomas, eds (2017); William B. Chandler III & Anthony A. Rickey, The Trouble
with Trulia: Re-evaluating the Case for Fee-Shifting Bylaws as a Solution to the Overlitigation of
Corporate Claims, in Can Delaware Be Dethroned? Evaluating Delaware’s Dominance of
Corporate Law, Anabtawi, Bainbridge, Kim & Park, eds (2017).
4
Delaware ranks 45th out of 50 for population and 49th for size (total area). See United States
Census Bureau, www.census.gov.
5
New York State Constitutional Convention of 1846.
6
See New York State Unified Court System, www.nycourts.gov.
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reviews both what the plaintiff class has given up in the settlement (the “give”) as well
as the relief the plaintiff class has received in settlement (the “get”).7 As already noted,
at least until Trulia, the most common form of consideration to stockholders in merger
settlements was supplemental disclosures in the proxy statement. In exchange for this, the
stockholder class released the right to litigate any and all claims, “known and unknown,
ripe and unripe,” relating to the facts underlying the merger (Griffith & Lahav, 2013).
The breadth of this release encompassed not only state law fiduciary duty claims but also
federal securities claims and antitrust claims—in other words, “blanket protection against
any type of recovery.”8
For a time, Delaware courts accepted such disclosure settlements as a routine means
of concluding merger litigation (Friedlander, 2016). For example, in 1996 the Court of
Chancery approved a disclosure settlement over a strong stockholder objection, holding
that “two or three possibly material facts” in the supplemental disclosures provided “some
benefit” to the plaintiffs’ class.9 By the mid-1990s, such settlements had become routine.10
It had not always been so. An earlier line of authority, never challenged or overruled,
had conditioned settlement approval on a stringent review of the underlying merits of
the claim. In the mid-1960s, the Court of Chancery approved a derivative suit settlement
involving the Chrysler Corporation only after an exhaustive process, including extensive
presettlement discovery and elaborate confirmatory discovery, a stockholder vote in
favor of settlement, the appointment of an amicus curiae to analyze the settlement and
the underlying claims, and a fairness hearing at which witnesses were called.11 On appeal
of the Court of Chancery’s approval of the settlement, the Delaware Supreme Court
7
In re Activision, 2015 WL 2438067, at *12–13 (Del. Ch. May 21, 2015) (quoting In re Resorts
Int’l S’holders Litig. Appeals, 570 A.2d 259, 266 (Del. 1990)).
8
Acevedo v. Aeroflex Hldg. Corp., C.A. No 9730–VCL, at 66 (Del. Ch. July 8, 2015)
(Transcript).
9
In re Dr. Pepper/ Seven Up. Cos., Inc. S’holders Litig. 1996 WL 74214, at *4–*5 (Del. Ch.
Feb. 27, 1996), aff’d 683 A.2d 58 (Del. 1996) (table) (emphasis added).
10
Solomon v. Pathe Communications Corp., 1995 WL 250374, at *4 (Del. Ch. Apr. 21, 1995),
aff’d, 672 A.2d 35 (Del. 1996) (“It is a fact evident to all of those who are familiar with shareholder
litigation that surviving a motion to dismiss means, as a practical matter, that economically rational
defendants . . . will settle such claims, often for a peppercorn and a fee”). Although in context
the “peppercorn” idea reflected Chancellor Allen’s concern with advancing claims too easily
beyond the motion to dismiss, thereby creating pressure on defendants to settle nonmeritorious
claims, the idea was turned on its head and used as a theory to justify approving the settlement of
nonmeritorious claims. See, e.g., Riverbed, 2015 WL 5458041, at *5 (“To use the expression first
made in this context by Chancellor Allen, the Plaintiffs have achieved for the Class a peppercorn, a
positive result of small therapeutic value to the Class which can support, in my view, a settlement,
but only where what is given up is of minimal value”); In re Amylin Pharm., Inc. S’holders Litig.,
C.A. No 7673-CS, at 28, 30 (Del. Ch. Feb. 5, 2013) (Transcript) (“I remember [Chancellor Allen]
once approving a settlement that basically he approved it because virtually any peppercorn of value
to the class would support the release because the claims were so insubstantial. . ..This settlement is
skating through on the barest of margins”); In re Talbots, Inc. S’holder Litig., C.A. No 7513-CS, at
11, 15 (Del. Ch. Dec. 16, 2013) (Transcript) (“I’ll approve this settlement on the Chancellor Allen
peppercorn theory . . . This is also, to be honest, the kind of case where I could have simply not
approved the settlement . . . because the social utility of cases like this continuing to be resolved in
this way is dubious”).
11
Dann v. Chrysler, 198 A.2d 185, 193 (Del. Ch. 1963).
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s eparated the issues of settlement approval and attorneys’ fees into two different opinions.
The first, Hoffman v. Dann (“Hoffman”), dealt only with the conduct of the fairness hear-
ing and the standard for settlement approval.12 The second, Chrysler v. Dann (“Chrysler”),
concerned only the question of attorneys’ fees.13
In Hoffman, the central question was the merits of the settlement. Several objectors
had argued that the settlement could not be approved because there was no merit to any
of the underlying claims. The parties argued in response that one claim had sufficient
merit to support the settlement. The Supreme Court held that in order for the settlement
to be approved, there had to be at least one meritorious claim. Otherwise, the Court
wrote, settlement would amount to “nothing more than a buying-off of the plaintiffs for
the dismissal of worthless claims . . . an undesirable [practice that] Rule 23(c) . . . was . . .
specifically designed to end.”14 The court underscored the importance of a meritorious
underlying claim in Chrysler, holding that “[a] claim is meritorious within the meaning
of the rule if it can withstand a motion to dismiss on the pleadings [and] if, at the same
time, the plaintiff possesses knowledge of provable facts which hold out some reasonable
likelihood of ultimate success.”15
Although the Delaware courts went through a period of approving settlements without
applying stringent scrutiny to the materiality of disclosures,16 the principles propounded
in Hoffman and Chrysler were never overruled.17 Moreover, the willingness of Delaware
courts to accept disclosure settlements came at a time when the form and frequency of
merger litigation was materially different from what it has since come to be. Recognizing
Delaware’s role in the proliferation of nuisance claims, the Delaware Court of Chancery
in 2015 began to apply greater scrutiny to disclosure settlements and require a stronger
showing of materiality.18 These decisions culminated in the court’s definitive statement on
disclosure settlements in Trulia.
12
205 A.2d 343, 345 (Del. 1964), cert. denied 380 U.S. 973 (1965).
13
223 A.2d 384 (Del. 1966).
14
Hoffman, 205 A.2d at 352 (upholding the Court of Chancery’s opinion finding of a single
meritorious claim). Accord Allied Artists Picture Corp. v. Baron, 413 A.2d 876, 879 (Del. 1980)
(“[T]his Court has been concerned with discouraging baseless litigation (see [Chrysler]) and has
adhered to the merit requirement”).
15
Chrysler at 387.
16
See supra note 9 and accompanying text.
17
The Court of Chancery may seem to suggest in Cox Communications that the court need
make no finding of merit in order to approve a settlement. 879 A.2d 604 (Del. Ch. 2005) (“Cox”).
However, Cox, like the Dann litigation, had bifurcated settlement approval and attorneys’ fees, and,
because the objector previously conceded that “the settlement was favorable,” the only live issue
in Cox was fees. Ibid, at 639. See also C.A. No 613-N, Letter from Kevin G. Abrams to VC Strine
(May 16, 2005) (citing Hoffman in service of the argument that Chrysler did not require a merits
filter at settlement because Chrysler only addressed fees). Cox thus can be seen as holding merely
that the “pleading-stage viability’ of the claim should have been raised at the settlement approval
stage, not in awarding attorneys’ fees. Cox at 639 (“To have an objector come forward and concede
that the settlement was favorable but contest the fee under [Chrysler] would be inequitable and
serve no proper purpose”).
18
The 2015 Court of Chancery cases include: Acevedo v. Aeroflex Hldg. Corp., C.A. No
9730–VCL, at 73 (Del. Ch. July 8, 2015) (Transcript) (refusing to approve a disclosure settlement
with “precisely the type of nonsubstantive disclosures that routinely show up in these types of
settlements”); In re Aruba Networks, Inc. Stockholder Litigation, Consol. C. A. No 10765-VCL,
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Like most disclosure settlements, the plaintiffs in Trulia initially challenged process and
price but shifted to challenging the adequacy of disclosure once the preliminary proxy
statement was filed, and as in most such cases, the plaintiffs ultimately resolved all claims
for supplemental disclosures and no payment to the plaintiff class.19 After critiquing the
incentive system that generates such claims as a matter of course, Chancellor Bouchard
announced that henceforth the Delaware Court of Chancery would no longer rubber-
stamp disclosure settlements. Instead,
[P]ractitioners should expect that disclosure settlements are likely to be met with continued disfa-
vor in the future unless the supplemental disclosures address a plainly material misrepresentation
or omission . . . In using the term ‘plainly material,’ I mean that it should not be a close call that
the supplemental information is material as that term is defined under Delaware law.20
In reaffirming a high standard of materiality as the basis for scrutinizing and ultimately
rejecting disclosure settlements, Trulia announced that such routine settlements are no
longer welcome in Delaware.21
at 73 (Del. Ch. Oct. 9, 2015) (Transcript) (refusing to approve settlement and finding inadequate
representation as a result of filing litigation when “there wasn’t a basis to file in the first place” and
then failing to aggressively litigate when discovery turned up potentially valuable information); In
re Riverbed Technology, Inc. Stockholders Litigation, 2015 Del. Ch. LEXIS 241, at **20 (Del. Ch.
Sept. 17, 2015) (approving settlement but noting that “If it were not for the reasonable reliance of
the parties on formerly settled practice in this Court . . . the interests of the Class might merit rejec-
tion of a settlement encompassing a release that goes far beyond the claims asserted and the results
achieved”). Prior Delaware cases expressing scrutiny concerning settlement practices include: In re
Transatlantic Holdings S’holders Litig., No 6574-CS (transcript) (Del. Ch. Mar. 8, 2013) (refusing
to approve settlement for lack of “any real investigation,” disclosure of additional background
information, and overwhelming vote in favor of the transaction); In re Medicis Pharmaceutical
Corp. Shareholder Litigation, CA No 7857-CS, transcript at 24 (Del. Ch. Feb. 26, 2014) (refusing
to approve settlement and noting that “giving out releases lightly is something we’ve got to be care-
ful about”); Rubin v. Obagi Medical Products, Inc., C.A. No 8433-VCL transcript at 8 (Del. Ch.
Apr. 30, 2014) (refusing to approve settlement and noting that “there are unknown unknowns in
the world, and the type of global release . . . in this case and [similar] disclosure settlements provides
expansive protection for the defendants against a broad range of claims, virtually all of which have
been completely unexplored by plaintiffs”); In re Theragenics Corp. Stockholders Litigation, C.A.
No 8790-VCL, transcript at 69 (Del. Ch. May 5, 2014) (refusing to approve settlement and noting
that “when a fiduciary action settles, I have to have some confidence that the issues in the case were
adequately explored, particularly when there is going to be a global, expansive, all-encompassing
release given”).
19
Trulia, 129 A.3d at 887 (describing the case as one wherein “[t]he only money that would
change hands is the payment of a fee to plaintiffs’ counsel”).
20
Ibid at 898–99 (emphasis added, citations omitted).
21
Since Trulia, the Court of Chancery has approved a number of disclosure settlements, but
only where the Court found that at least one of the disclosures offered as settlement consideration
was plainly material. See In re BTU Int’l, Inc. S’holders Litig., C.A. No 10310-CB (Del. Ch. Feb.
18, 2016) (Transcript); In re NPS Pharm. S’holders Litig., C.A. No 10553-VCN (Del. Ch. Feb. 18,
2016) (Transcript); In re Regado Biosciences, Inc. S’holder Litig., C.A. No 10606-CB (Del. Ch. July
27, 2016) (Transcript).
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3. WHY WHAT HAPPENS OUTSIDE OF DELAWARE SHOULD

MATTER TO DELAWARE
Disclosures settlements may, however, still be welcome elsewhere. Merger claims can
typically be brought and settled in any one of three places: the state of incorporation,
the headquarters state, or federal court. Trulia announced a new Delaware procedure for
addressing disclosure settlements, and the dynamics of the Court of Chancery suggest
that it will be applied consistently inside Delaware. There is no assurance, however, that
Trulia will be applied consistently or at all in alternative jurisdictions. The flight of filings
from Delaware in the wake of Trulia suggests that litigants are actively seeking alternative
jurisdictions.
The Delaware judiciary now disfavors disclosure settlements because routinely approv-
ing nuisance settlements “undercuts Delaware’s credibility as an honest broker in the legal
realm.”22 But now that Trulia has set forth a standard in Delaware, should the state be
concerned about the conduct of merger litigation outside of Delaware? Should Delaware
be bothered if litigants—wearing white, black, or gray hats—take disclosure settlements
to other courts for approval?
We suggest that the answer is yes. Delaware should be concerned, because litigants’
ability to take settlements elsewhere, even where companies have adopted forum selection
provisions, means that the state may be unable to protect either its corporations from
nuisance litigation or the stockholders of those corporations from losing potentially
valuable rights in exchange for meaningless relief (Griffith, 2017). Moreover, such tactics
provide a vehicle, at least in theory, for other states to challenge Delaware’s franchise if
another state can provide a similar degree of certainty in corporate law while removing
the threat of nuisance lawsuits.23
Whether the migration of post-Trulia merger cases threatens Delaware’s domi-
nance in corporate law may depend on whether only weak claims are filed elsewhere.
Although prior commentators have warned that alternative fora threaten “the viability
of Delaware’s Court of Chancery’s current status as ‘the Mother Court of corporate
law’” (Armour, Black, & Cheffins, 2012) and risk making Delaware corporate law ‘less
developed’ and ‘less coherent’ and its judges less expert (Kahan & Rock, 2009), there is
little danger of these consequences if only nuisance claims exit the state. Because nuisance
claims tend to settle before courts make any merits determinations, they make little, if
any, law. Moreover, it seems likely that the quality and coherence of Delaware corporate
law would be improved if the Court of Chancery’s caseload held a greater proportion
of seriously litigated cases, rather than rote settlement approvals. Once freed from the
time and distraction of nuisance litigation, Delaware judges would have more time and
opportunity to focus on complex issues of law.
This assumes, however, that plaintiffs’ attorneys are consistently able to identify, ex
22
Aeroflex at 66. See also Trulia, 129 A.3d at 894 (suggesting that Delaware has played a role,
through the approval of disclosure settlements and with broad releases, in causing “deal litigation
to explode in the United States beyond the realm of reason”).
23
See Dan Awrey, Blanaid Clarke, & Sean J. Griffith, Resolving the Crisis in U.S. Merger
Regulation: A Transatlantic Alternative to the Perpetual Litigation Machine, 35 Yale Journal on
Regulation 1 (2018).
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ante, which cases will become nuisance lawsuits and which will not. So long as cases
brought outside Delaware continue to follow the pattern described in Trulia—quick set-
tlements reached after cursory discovery—the pattern above may hold true. If plaintiffs
begin to identify potentially meritorious claims during expedited discovery, however, and
those in turn are litigated in postclosing actions, Delaware may stand to lose “good” cases
as well as bad.
At least in the short run, the flight of nuisance litigation to alternative fora does not seem
to imperil Delaware’s status as the preeminent state of incorporation. For another state
to challenge Delaware’s dominance, it would almost certainly need to offer a substantive
law that appeals to either managers or stockholders sufficiently to induce them to relocate
the firm to the other state. But the creation of a substantive alternative to Delaware would
be difficult to craft from a judicial policy of approving disclosure settlements or ruling
on predominantly nuisance claims. Moreover, any opinion rendered by the alternative
jurisdiction can only have the effect of improving Delaware law, since desirable innovation
would become a part of Delaware law, while misapplications or misinterpretations could
be swiftly disavowed (Griffith & Lahav, 2013). Nor does Delaware have much to fear from
cases brought in federal court. Although the federal government poses a real threat to
Delaware when it comes to legislation and preemptive rulemaking (Roe, 2003), as long as
there is no federal incorporation option, Delaware retains its primacy as a jurisdiction of
incorporation. Indeed, considering the savings of judicial resources and administrative
costs, it seems Delaware only gains if the nuisance claims go away while the damages
cases remain.
But this account also depends on it being predominantly nuisance claims that settle
in the alternative jurisdiction, while legitimate damages claims remain in or are brought
back to Delaware. Although Delaware courts retain some procedural controls to direct
this sorting of cases—such as the use of the forum non-conveniens doctrine, expedited
discovery, and formal or informal communications with the judge in the alternative juris-
diction (Griffith & Lahav, 2013)—much of the sorting depends on the parties themselves.
Some have suggested that exclusive forum provisions are a useful tool in this regard,
allowing defendants to avoid meritless claims altogether by requiring class plaintiffs
to bring claims in Delaware. Nevertheless, forum selection provisions remain largely
untested, particularly with regard to federal claims.24 Moreover, while it is reasonable to
suppose that defendants will use exclusive forum provisions to move meritorious cases
back to Delaware, there are also good reasons to suspect that they will use the provisions
strategically to funnel claims to jurisdictions where they can still achieve a broad release in
exchange for a disclosure settlement (Griffith, 2017). The risk, in other words, is not that
strong claims will be litigated elsewhere, but that strong claims will be settled elsewhere as
though they were nuisance claims.
24
In the wake of Trulia, several class plaintiffs have challenged mergers by forgoing traditional
state law fiduciary claims in favor of federal securities causes of action, particularly where the target
corporation has adopted a forum selection bylaw. See, e.g., Complaint, Paprakis v. Skullcandy, Inc.,
et al., Case No 2:16-cv-00810-BCW (D. Utah July 19, 2016).
M4633-GRIFFITH_t.indd 147 30/10/2018 08:16

4. AN EMPIRICAL INVESTIGATION OF THE “TWO-TIER”

PLAINTIFFS’ BAR
While it is clear why defense counsel would be happy to settle potentially serious dam-
ages claims for meaningless disclosures, it is less clear why plaintiffs’ counsel would ever
seek a nuisance settlement if they had a potentially valuable damages claim. One thesis,
put forward by a prominent member of the plaintiffs’ bar, is that there are two business
models pursued by plaintiffs’ firms before the Court of Chancery (Friedlander, 2016).
According to this theory, “[o]ne tier of law firms pursued disclosure settlements as a busi-
ness model. Another tier of law firms never presented disclosure settlements to the Court
of Chancery, and instead brought Revlon cases with the objective of seeking significant
monetary recovery and/or significant non-monetary relief ” (Friedlander, 2016: 905).
Friedlander (ibid) suggests that the first business model “puts a premium on maximiz-
ing the number of disclosure settlements and minimizing the costs associated with each
settlement,” while the second requires a law firm to “devote significant resources to
each case.” In theory, “[a] law firm representing stockholder plaintiffs in the Court of
Chancery generally employs one model of litigation or the other.” Friedlander suggests
that appointment of lead counsel in class litigation in the Court of Chancery should be
guided by these tiers, with preference given to the top tier (ibid at 909).
However, Friedlander’s evidence in support of a “two-tier” plaintiff’s bar is more
qualitative than quantitative. He does not specifically identify the universe of “top tier”
firms or present systematic data regarding firms’ involvement in disclosure settlements.
Moreover, he limits his consideration to the Delaware Court of Chancery, without
considering how the national law firms in his tiers might operate outside the First State.
There is another possibility, consistent with a two-tier plaintiff’s bar but without the
black hat/white hat dichotomy. Delaware’s preeminence in corporate law and litigation
ensures that the Court of Chancery addresses a broad portfolio of cases annually,
with potential for significant payouts. Certain types of merger litigation—for instance,
where there is a controlling shareholder—may have a greater fee potential than others.
Combined with the small size of the plaintiff’s bar and frequency of repeat players, a
reputation as a “white hat” or “top tier” firm in Delaware may be potentially lucrative,
because it allows a “white hat” firm to succeed in leadership contests for more valuable
cases. “Black hat” or “second tier” firms would then be left to choose among cases with
a small chance of a significant monetary settlement, but a large chance that a firm would
earn back its lodestar (at least prior to Trulia).
If Delaware’s “two-tier” bar is a result of this reputational dynamic, one might expect to
see “top tier” law firms more willing to pursue disclosure settlements outside of Delaware,
while eschewing them in the Court of Chancery. In other words, while “black hats” would
wear black hats everywhere, “white hats” in Delaware might change their colors when
settling cases outside the state.25 If correct, this dynamic would have implications for how
25
Indeed, some have suggested that firms may switch hats depending upon whom their client
is—driving harder bargains for institutional lead plaintiffs, but accepting disclosure settlements
for non-institutional class representatives. See David H. Webber, “Private Policing of Mergers and
Acquisitions: An Empirical Assessment of Institutional Lead Plaintiffs in Transactional Class and
Derivative Actions,” 38 Del. J. Corp. L. 907 (2014).
M4633-GRIFFITH_t.indd 148 30/10/2018 08:16

Delaware courts should consider leadership contests, providing courts with a tool to affect
the litigation of disclosure settlements outside their own jurisdiction.
4.1 Methodology
To test this theory, we compiled a set of more than 150 cases in which plaintiffs presented
disclosure settlements in state and federal courts.26 The data was collected primarily by con-
ducting searches of trial court documents available on Bloomberg Law, Westlaw and Lexis
between 2009 and 2016. These results were crosschecked and supplemented by searching for
disclosure-only settlements listed in LexisNexis’s Class Action Settlement database as well as
by running a search based on the 35 most common law firms produced in the original search
results. Only disclosure settlements where a final court order was electronically available were
included in the data set. We have included cases where disclosure settlements were presented
by a plaintiff, even if those settlements were not ultimately approved by the reviewing court.
This methodology likely understates the participation of law firms in disclosure
settlements. Many states do not make trial court documents available online, so many
jurisdictions may not be included in our data set. Moreover, the frequency of multiforum
litigation will contribute to an undercount of law firm participation. For instance, if Firm
A sues in Delaware and Firm B sues in Kansas, and the case settles in Delaware, Firm B
may not be mentioned on the Delaware papers (where the settlement is presented), even
though they may share in the attorneys’ fees.
4.2 Results
With regard to Friedlander’s lower tier firms (“black hats”), our data largely supports his
thesis. There are a number of firms which frequently present disclosure settlements inside
and outside of Delaware. Following the Trulia opinion, these firms have predominantly
migrated their disclosure cases outside of Delaware (Cain et al. 2017). Collectively, these
firms were involved in a majority of the disclosure settlements captured in our database.
The results for the top tier or “white hat” firms, however, are not fully consistent with
Friedlander’s thesis. Instead, we found that several “white hat” national firms pursued
disclosure settlements outside of Delaware. Indeed, one such firm pursued three times
as many disclosure settlements in other jurisdictions as they did in Delaware during the
period of our study, although most other “white hat” firms that pursued disclosure set-
tlements outside of Delaware participated in three or fewer such settlements. Collectively
we found seven instances in which top tier national plaintiffs’ firms participated in
disclosure settlements in Delaware between 2009 and 2015, but 18 instances of the same
firms presenting disclosure settlements to courts outside the First State over the same
period.27 Given the fact that many state courts may be underrepresented in our data set,
the difference may be even starker than these data suggest.
26
For purposes of this chapter, a “disclosure settlement” is a settlement in which class members
receive supplemental disclosures before a deal closes, and may receive other nonmonetary consid-
eration (such as reduced breakup fees or other deal terms), but no additional cash distribution.
27
Because firms often present settlements jointly, in compiling this figure, we include each
M4633-GRIFFITH_t.indd 149 30/10/2018 08:16

However, disclosure settlements pursued by the “top tier” law firms did tend to differ
qualitatively. Several of these firms eschewed disclosure-only settlements in favor of
settlements for disclosures plus other “therapeutic” relief. Nevertheless, none of these
therapeutic settlements appear to have won any additional money for the shareholder
class (such as, for example, an increase in the deal price).
This data demonstrates that the dividing line between “white hat” and “black hat” firms
is not as clear as Friedlander suggests. Even “white hat” plaintiffs firms may negotiate,
agree to, and seek fees for disclosure settlements in M&A litigation. Moreover, they do so
more often when their cases are not before the Court of Chancery.
If we are correct, and firms seek a “white hat” perception in the Court of Chancery
because there is a value to reputational capital that does not accrue in other courts, this
provides Delaware courts with an unusual opportunity to discourage meritless claims and
affect the course of litigation outside of their ordinary jurisdiction. As explained pres-
ently, Delaware courts can, and should, consider the behavior of supposedly “white hat”
firms when they pursue Delaware cases in other forums—and refuse to give the sheriff’s
badge to firms that switch hats when they go out west.
5. WHAT DELAWARE CAN DO
As the Court of Chancery recognized in Trulia, disapproval of nuisance suits could

simply cause plaintiffs (and defendants seeking a swift end to litigation) to seek other
jurisdictions. Although Chancellor Bouchard voiced the hope that other jurisdictions
would follow Trulia, few courts outside Delaware have addressed the case, especially in the
absence of an objector (Chandler & Rickey, 2017). In one notable exception, the United
States Court of Appeals for the Seventh Circuit, in an opinion by Judge Posner, adopted
the Trulia standard for review of disclosure settlements in a case involving both state law
and federal securities claims.28
As discussed above, the flight of disclosure cases from Delaware poses potential
risks to its franchise and its status as the dominant jurisdiction in corporate law. Yet
Trulia appears to be encouraging plaintiffs to seek other jurisdictions, and to challenge
corporate mergers in securities cases rather than traditional corporate governance class
actions.
Delaware’s dominance as a venue for incorporation, however, gives its courts a number
of means of influencing plaintiff behavior far beyond its own borders. Based on the data
above, we suggest two.
5.1 Consider Actions Taken outside of Delaware when Awarding Lead Counsel Roles
Although the number of cases filed in Delaware has declined since Trulia, so long as the
cases that remain hold significant settlement or judgment value for plaintiff’s counsel,
plaintiff’s firm appearance as a separate instance, such that a settlement involving Firm A and
Firm B would count twice.
28
See In re Walgreen Co. S’holder Litig., 832 F.3d 718 (7th Cir. 2016).
M4633-GRIFFITH_t.indd 150 30/10/2018 08:16

then the court’s ability to designate lead plaintiffs provides a considerable carrot. Indeed,
even in the absence of nuisance suits likely to lead to disclosure settlements, Delaware
courts retain a set of corporate governance cases that can be lucrative for plaintiff’s
counsel despite the absence of a monetary return to class members.29
There are signs that the Delaware courts are already using these cases to influence the
behavior of plaintiff’s counsel. Delaware courts have asked plaintiffs to submit affidavits
summarizing their litigation track records, and appointed counsel at least in part on the
basis of counsel to litigate cases to money judgments or monetary settlements.30 These
leadership contests, to the extent that they award leadership to firms with a track record
for money judgments, can be seen as a method of rewarding “white hats” and disincentiv-
izing “black hats.”
Our data suggests that Delaware courts could use a similar technique to influence
the behavior of class counsel when they litigate in other jurisdictions by more closely
examining litigation strategy in non-Delaware cases when the Court awards leadership
positions. Plaintiffs’ counsel who do not bring nuisance litigation, or disclosure settle-
ments, outside of Delaware could be given preference in leadership contests over those
who do—ensuring that counsel do not change hats when litigating elsewhere.
In particular, we suggest that the Court should ask counsel seeking leadership positions
in class or derivative actions questions such as:
● How many settlements has a firm settled for nonmonetary recoveries in Delaware?
Outside of Delaware?
● Since 2016, has the firm presented disclosure settlements for approval outside of
Delaware, particularly in cases involving Delaware corporations? If so, has it cited
Delaware authority to a non-Delaware court? Did that authority include Trulia?
● How many of the firm’s non-Delaware settlements have drawn objections during
the settlement process? Did any of those objections rely on Trulia? Have they been
sustained?
Such questions would cause purportedly “white hat” firms to expect to lose lucrative
lead plaintiff positions if they did not fairly present Delaware authority to non-Delaware
courts.
Similar inquiries could be employed to deter “black hat” firms from seeking either
settlement approval or class certification. In both cases, approval requires a finding that
the representative parties will adequately represent the interest of the class.31 Class certi-
fication or a settlement may be rejected where plaintiff’s counsel do not provide adequate
representation to the class.32 Based on the answers to the questions above, the Court of
29
See, e.g., Order and Final Judgment, Espinoza v. Zuckerberg, C.A. No 9745-CB (Del. Ch.
Mar. 30, 2016) (awarding $525,000 fees to plaintiffs’ counsel in derivative action).
30
See, e.g., Order of Consolidation, In re Compellent Techs., Inc. S’holder Litig., C.A. No 6084-
VCL at 6 (Del. Ch. Jan 10, 2011) (requiring submission of cases in which firms obtained monetary
recovery or other relief solely as a result of representative litigation).
31
See Ct. Ch. R. 23(a)(4).
32
See, e.g., In re Aruba Networks, Inc. Stockholder Litigation, Consol. C. A. No 10765-VCL,
at 73 (Del. Ch. Oct. 9, 2015) (TRANSCRIPT).
M4633-GRIFFITH_t.indd 151 30/10/2018 08:16

Chancery could refuse to find counsel adequate where a firm has sought approval of,
and an award of fees for, a disclosure settlement in a non-Delaware court while failing to
provide that court with relevant authority, including Trulia.33
5.2 Place Greater Emphasis on the Role of Delaware Decisions in non-Delaware Courts
The migration of nuisance settlements outside of Delaware poses a particular risk to

the consistency of Delaware law. The evolutionary nature of Delaware jurisprudence
embraces fine distinctions and eschews brightline rules. For example, decisions of the
Delaware Court of Chancery vary as to the materiality of unlevered free cash flows:
● Disclosures of unlevered free cash flows are important and may well be material
(Maric, Netsmart);34 but
● It is not necessary for a target to disclose information sufficient for a plaintiff to run
its own DCF analysis (Checkfree);35 but
● If the summary of financial data provided to bankers by management has been
disclosed, unlevered free cash flows are not per se material if they were calculated
from that summary data by bankers rather than management (Nguyen);36 and
● Management projections (including unlevered free cash flows) may be of greater
importance (and thus material) in a going-private transaction than in a stock-for-
stock merger, but may be less material where the newly disclosed projections are “all
directionally consistent with the information that was already disclosed.”37
33
One California court has twice refused to preliminarily approve disclosure settlements
where plaintiffs failed to address Walgreen or Trulia. See Order After Hearing, Anderson v. Alexza
Pharms., Case No 16-CV-295357 (Cal. Super. Ct.—Santa Clara Cty. Apr. 3, 2017) (rejecting settle-
ment and noting that preliminary approval initially denied for failure to address relevant authority);
Order after Hearing, Drulias v. 1st Century Bancshares, Inc., Case No 16-CV-294673 (Cal. Super.
Ct.—Santa Clara Cty. Nov. 18, 2016) (rejecting preliminary approval of settlement and finding it
“very troubling” that plaintiffs failed to cite Trulia).
34
Maric Capital Master Fund, Ltd. v. PLATO Learning, Inc., 11 A.3d 1175 (Del. Ch. 2010);
In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d 171 (Del. Ch. 2007).
35
In re Checkfree Corp. S’holders Litig., 2007 WL 3262188 (Del. Ch. Nov. 1, 2007) (rejecting
claim that failure to include cash flow projections constituted material omission because “[a]
disclosure that does not include all financial data needed to make an independent determination of
fair value is not . . . per se misleading or omitting a material fact. The fact that the financial advisors
may have considered certain non-disclosed information does not alter this analysis,” quoting In re
Gen. Motors (Hughes) S’holder Litig., C.A. No 20269, 2005 WL 1089021, at *16 (Del. Ch. May 4,
2005), aff’d, 897 A.2d 162 (Del. 2006)).
36
See Nguyen v. Barrett, 2016 WL 5404095, at *4 (Del. Ch. Sept. 28, 2016) (“Plaintiff acknowl-
edged that our case law indicates that banker-derived financial projections need not be disclosed”);
see also Nguyen v. Barrett, 2015 WL 5882709, at *4 (Del. Ch. Oct. 8, 2015), aff’d 2015 WL 5924668
(Del. Oct. 9, 2015) (“Our case law provides that, where the bankers derive unlevered, after-tax free
cash flows rather than relying on management projections, the inputs on which they rely are not per
se subject to disclosure”); 2016 WL 5404095, at *4 (“With respect to the argument that all inputs
provided by management on which the financial advisor relied in its DCF valuation must, as a matter
of law, be disclosed to stockholders, I found such a per se rule inconsistent with our case law”).
37
See In re Baker Hughes Inc. S’holders Litig., Consol. C.A. No 10390-CB at 70-71 (Del. Ch.
Nov. 30, 2016).
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In any given proxy statement, the question of the materiality of unlevered free cash flows
is, thus, a multifaceted analysis. The Court of Chancery’s caseload ensures that Delaware
judges recognize that, in spite of strong language in Maric and Netsmart, unlevered free
cash flow disclosures are not per se material.38 But judges in other jurisdictions may not,
and litigants may safely wager that those judges will not be familiar with the full line of
Delaware jurisprudence on unlevered free cash flow disclosures. Moreover, the lack of
adversarial process at settlement suggests that complicating factors in this analysis will
not be mentioned at all if left out of the plaintiffs’ brief in support of settlement. And
this indeed is what we found. Maric and Netsmart were cited in the vast majority of the
settlement briefs in our dataset, and plaintiffs’ assertions regarding the meaning of those
cases was rarely questioned.39 Non-Delaware judges will be further hindered by the fact
that much of the more detailed authority resides in transcript opinions that are not avail-
able in Lexis or Westlaw.
Given the complexity of the legal analysis and the lack of adversarial guidance, it
would be remarkable if judges in other jurisdictions did not reach different conclusions
as to the materiality of different classes of disclosure. But a multiplicity of authority
weakens Delaware law in two ways. First, the predictability of Delaware disclosure law is
diminished if a corporation cannot predict whether a given disclosure is necessary until
a lawsuit is filed in a given jurisdiction. Second, class plaintiffs can be expected to cite as
persuasive authority whichever jurisdiction provides rules most favorable to settlement—
and that may not be Delaware.
On the other hand, so long as class plaintiffs bring nuisance suits outside of Delaware,
there are limited means by which the Court of Chancery can contain the damage caused
by inconsistent interpretation of Delaware law. As an initial step, Delaware courts could
consider making transcript opinions available in a searchable online format, so that non-
Delaware judges may access this authority. However, this solution may not be sufficient.
Non-Delaware jurists lack the Court of Chancery’s incentives to maintain a consistent
body of Delaware law. It may be that the migration of litigation out of Delaware forces a
tradeoff, wherein the Court of Chancery must choose between brightline rules that may
be readily applied by nonspecialist judges, or a complex and finegrained legal regime that
is inconsistently applied outside the First State.
6. CONCLUSION
This chapter has examined the sorting of merger claims in the wake of Trulia. In par-
ticular, we have tested the claim that “white hat” firms always litigate in Delaware, while
38
See Maric Capital Master Fund, Ltd. v. PLATO Learning, Inc., 11 A.3d 1175 at 1178 (Del.
Ch. 2010) (“management’s best estimate of the future cash flow of a corporation that is proposed
to be sold in a cash merger is clearly material information”); see also In re Netsmart Techs., Inc.
S’holders Litig., 924 A.2d 171 at 203 (Del. Ch. 2007) (“The conclusion that this omission [of the
company’s expected future cash flows] is material should not be surprising. Once a board broaches
a topic in its disclosures, a duty attaches to provide information that is “materially complete and
unbiased by the omission of material facts”).
39
Many of the exceptions in our dataset involved cases with well-represented objectors.
M4633-GRIFFITH_t.indd 153 30/10/2018 08:16

“black hat” firms always settle, and now settle outside Delaware in the wake of Trulia.
While we have found evidence that “black hat” firms are increasingly avoiding Delaware,
we have also found evidence that at least some firms with a reputation for wearing “white
hats” in fact wear hats of a different shade—gray—outside of Delaware. Moreover, these
firms tend to bring disclosure settlements at least as often, and in some cases dramatically
more often, outside of Delaware. The presence of six- or seven-figure fees for nuisance suit
settlements, in other words, tempts “white hat” firms as well as “black hats.”
Our results suggest the sorting mechanism for good and bad claims is not working as
expected. Even good firms sometimes file and settle nuisance claims. If this is so, can we
really trust these firms to sort good claims from bad? Furthermore, what can Delaware do
to encourage plaintiffs’ lawyers to pursue good claims, but only good claims?
In addition to demonstrating the problem, this chapter has suggested several possible
solutions. Courts could ask hard questions of plaintiffs’ counsel in awarding the lead
plaintiff role. They could ask similarly hard questions at settlement and when reviewing
adequacy of representation. In addition to greater scrutiny, Delaware could consider
reforming its practices with regard to transcript opinions to make them more easily acces-
sible to non-Delaware jurists, perhaps by creating an online searchable database.
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10. Forum shopping in the bargain aisle:
Wal-Mart and the role of adequacy of
representation in shareholder litigation
Lawrence A. Hamermesh and Jacob J. Fedechko*
In determining whether a shareholder class or derivative action is barred by res judicata,1

on one hand, or collateral estoppel,2 on the other, courts may be called upon to evaluate
whether the representation of the interests of the class or the corporation in the prior
litigation was adequate. Doctrinal standards guiding that evaluation are loose and
relatively undeveloped. With the rise of multiforum shareholder class and derivative
litigation, however, there has been increased occasion for judicial review of adequacy of
representation. This chapter reviews the applicable existing doctrine and proposes refine-
ments to that doctrine that may better vindicate the competing policy concerns associated
with judicial evaluation of adequacy of representation: namely, that courts must apply
doctrines of repose robustly enough to minimize or avoid unproductive relitigation of
claims but, on the other hand, must avoid claim preclusion where it would unfairly deprive
the corporation or its stockholders of the opportunity to litigate meritorious claims.
This chapter first explores the reasons for requiring adequate representation, and how
multiforum litigation compels the courts to apply that requirement meaningfully. It then
considers the current doctrinal framework and uses the decision of the Delaware Court of
Chancery in In re Wal-Mart Delaware Derivative Litigation to illustrate how the doctrine
has been applied.3 The chapter then sets forth an alternative approach to the current
interpretation of the Restatement framework.4 Specifically, the chapter proposes a totality
of the circumstances approach that requires consideration of several “badges of inad-
equacy.” The chapter also suggests how the Restatement framework can be interpreted
to accommodate consideration of such “badges of inadequacy,” and thereby more fully
implement the policies mentioned above.
* We would like to acknowledge the contributions of Hon. J. Travis Laster, Sean Griffith, and
other participants in the Corporate & Securities Litigation Workshop in Chicago. Inaccuracies,
oversimplifications, and other shortcomings of this chapter, however, are the exclusive responsibil-
ity of the authors.
1
Also known as “claim preclusion.”
2
Also known as “issue preclusion.”
3
2016 WL 2908344 (Del. Ch. May 13, 2016) (“Wal-Mart I”).
4
See Restatement (Second) Judgments §§ 41–42.
156
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Forum shopping in the bargain aisle 157
1.
THE REQUIREMENT OF ADEQUATE REPRESENTATION5
Shareholder class actions and derivative litigation can provide substantial private and public
benefits. Ideally, class actions enable shareholders to obtain relief for breaches of duties
owed to them where such relief would be impracticable for shareholders to pursue indi-
vidually.6 Supplementing regulatory schemes, derivative litigation provides a mechanism
for private enforcement of corporate management responsibilities to the corporation.7 By
providing incentives to plaintiffs’ lawyers in the form of fee awards in successful cases, both
class actions and derivative litigation enable widely dispersed groups of stockholders to hold
management accountable for breaches of duty that isolated stockholders acting individually
might not be able to challenge.8 And representative shareholder litigation serves the further
purpose of conserving judicial and litigant resources by allowing for the adjudication of
claims common to many shareholders in a single case, rather than in piecemeal fashion.9
These litigation mechanisms do not work efficiently, however, if stockholders could
bring the same claims successively; to work efficiently, adjudication of a suit by a stock-
holder to vindicate the rights of other stockholders or the corporation must have preclu-
sive effect. By some doctrine of repose—collateral estoppel or res judicata—shareholders
who are not parties in litigation brought on their behalf must be prevented from bringing
the same claims that were resolved on their behalf in the original suit.10
For those doctrines of repose to be applied fairly, however, there must be some assurance
that the original shareholder plaintiff has done a reasonably effective job of prosecuting
5
In this chapter, we discuss concurrently two distinct contexts—dismissal on motion and
settlement—in which the issue of preclusion implicates the question of the adequacy of counsel in
the original litigation. We do, however, recognize that the two contexts implicate different consid-
erations and should not necessarily be treated identically.
6
See, e.g., Blank and Zacks 2005, p.11 (“Class actions also enable claims that may be economi-
cally and socially insignificant as individual claims, but that are far more significant as a whole,
to be heard”); Kraakman et al. 1994, p.1733 (“Shareholder suits are the primary mechanism for
enforcing the fiduciary duties of corporate managers”).
7
See, e.g., Davis 2008, p.411 (discussing the derivative suit’s historical role as the “chief regula-
tor of corporate management” and “the most important procedure the law has yet developed to
police the internal affairs of corporations” (citations omitted)).
8
See, e.g., Bird v. Lida, Inc., 681 A.2d 399, 403 (Del. Ch. 1996) (“[I]t is likely that in a public
corporation there will be less shareholder monitoring expenditures than would be optimum
from the point of the shareholders as a collectivity. One way the corporation law deals with this
conundrum is through the derivative lawsuit and the recognized practice of awarding to successful
shareholder champions and their attorney’s [sic] risk-adjusted reimbursement payments (i.e.,
contingency based attorneys fees). The derivative suit offers to risk-accepting shareholders and
lawyers a method and incentives to pursue monitoring activities that are wealth increasing for the
collectivity (the corporation or the body of its shareholders)” (citation omitted)).
9
See, e.g., King v. VeriFone Holdings, Inc., 12 A.3d 1140, 1150 (Del. 2011) (“We agree with
the Vice Chancellor that it is wasteful of the court’s and the litigants’ resources to have a regime
that could require a corporation to litigate repeatedly the issue of demand futility”).
10
See King v. VeriFone Holdings, Inc., 994 A.2d 354, 362 (Del. Ch. 2010) (“King I”) (discuss-
ing how res judicata prevents inefficiencies), rev’d on other grounds, 12 A.3d 354 (Del. 2011) (“King
II”); Ficken v. Golden, 696 F. Supp. 2d 21, 31-32 (D.D.C. 2010) (discussing the benefits of res
judicata and collateral estoppel); see also Clopton 2015, pp.1387–1428 (discussing preclusion in the
context of transnational class actions).
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the claims that absent shareholders are to be precluded from pursuing. Otherwise, absent
class members or stockholders who may have been much better representatives, or who
may have been able to achieve better results by bringing claims on their own, may be
precluded from bringing those claims. This possibility has led some courts—notably the
Delaware Court of Chancery—to call attention to a “specter of unfairness” as a result of
adjudications against “feckless fast filers”—that is, shareholder plaintiffs whose litigation
efforts are substandard and result in dismissals or settlements that fail to achieve the
benefits that the claims being precluded might otherwise warrant.11
Not surprisingly, then, courts have insisted in one way or another that a class or
derivative plaintiff must “fairly” or “adequately” represent non-party class members
or shareholders who would be bound by the disposition of the original case. Since the
1800s, long before the Federal Rules of Civil Procedure were adopted, and when rules of
equity guided the courts in this area of the law, the federal courts required that the named
plaintiff fairly and adequately represent others who shared in the interests at stake.12
Eventually, this adequacy-of-representation requirement evolved from an equitable rule
into an element of due process,13 and it is now codified in Federal Rules of Civil Procedure
Rules 23 and 23.1 and in many of their state law counterparts.14 Thus, in order for anyone
to benefit from representative litigation, the class or derivative plaintiff must prosecute
the common claims “vigorously.”15 So when the representative shareholder plaintiff’s
litigation efforts are inadequate, a final adjudication in a case will not have preclusive
effect, and multiple lawsuits over the same claims may follow.
11
See, e.g., Asbestos Workers Local 42 Pension Fund v. Baamann, 2015 WL 2455469, at *18
n.147 (Del. Ch. May 21, 2015) (revised May 22, 2015) (“A specter of unfairness appears, however,
in the derivative context, where a derivative plaintiff with a viable claim may be estopped from
proceeding based on the inadequate efforts of a fellow stockholder in privity, a feckless fast filer”),
aff’d, 132 A.3d 749 (Del. 2016) (Table).
12
Supreme Tribe of Ben Hur v. Cauble, 255 U.S. 356, 367 (1921) (holding that decree bound
unnamed class members in part because “[t]he parties bringing the suit truly represented the
interested class”); Smith v. Swormstedt, 57 U.S. 288, 303 (1853) (“In all cases where exceptions to
the general rule are allowed, and a few are permitted to sue and defend on behalf of the many, by
representation, care must be taken that persons are brought on the record fairly representing the
interest or right involved, so that it may be fully and honestly tried”).
13
See, e.g., Wright et al. 2016, § 4455; Taylor v. Sturgell, 553 U.S. 880, 897 (2008) (“[O]ur hold-
ing that the . . . application of res judicata to nonparties violated due process turned on the lack of
either special procedures to protect the nonparties’ interests or an understanding by the concerned
parties that the first suit was brought in a representative capacity. [This Court] thus established
that representation is ‘adequate’ for purposes of nonparty preclusion only if (at a minimum) one
of these two circumstances is present”); Hansberry v. Lee, 311 U.S. 32, 42 (1940) (“[T]his Court is
justified in saying that there has been a failure of due process only in those cases where it cannot
be said that the procedure adopted, fairly insures the protection of the interests of absent parties
who are to be bound by it”).
14
See, e.g., Del. Ch. Ct. R. 23, 23.1, 24. Notably, the Delaware Court of Chancery’s counter-
part to Federal Rule 23 lacks a separate provision that addresses the adequacy of class counsel
specifically.
15
See, e.g., Arduini v. Hart, 774 F.3d 622, 635 (9th Cir. 2014) (“Indeed, we have noted that an
‘adequate [shareholder] representative must have the capacity to vigorously and conscientiously
prosecute a derivative suit and be free from economic interests that are antagonistic to the interests
of the class.’” (citation omitted)).
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It is well known that the effectiveness of representation in shareholder class and

derivative litigation rarely depends at all on the nature or efforts of the named plaintiff
shareholder or shareholders; whether representation in such litigation is effective depends
almost entirely on the ability and efforts of plaintiffs’ counsel.16 Therefore, this chapter
focuses on the role of counsel in the adequacy-of-representation analysis.17 We explore
what it means for an attorney to adequately represent a class or corporation, and the
mechanisms available to the courts to evaluate such adequacy.
2.
FORUM SHOPPING IN THE BARGAIN AISLE: A “RACE TO
THE BOTTOM” PROBLEM
The phenomenon of parallel shareholder class and derivative litigation in multiple
forums has sharply highlighted the issue of adequate representation as a condition to
precluding duplicative litigation of similar claims.18 The common scenario is that an
event occurs—such as the announcement of a merger or acquisition, or the reporting of
a corporate catastrophe—and plaintiffs’ attorneys file complaints in multiple jurisdictions
alleging class, derivative, or hybrid claims,19 despite good reasons why such litigation
should be concentrated in the state in which the subject corporation is incorporated.20
This phenomenon creates a classic “race to the bottom” problem:
[R]ational judges, defendants, and plaintiffs’ counsel have incentives to engage in behaviors that
result in deadweight costs: unnecessarily expediting litigation, accepting inadequate settlements
and awarding inappropriate attorneys’ fees, prematurely filing derivative suits that unnecessarily
engender dismissal motion practice, and inadequately supervising selection of class representa-
tives and lead counsel.21
It has been suggested that multiforum shareholder litigation is at least in part a response
to rulings by the Delaware Court of Chancery that took a tougher stance on approving
fees for settled or mooted disclosure claims.22 Regardless of the motivation, however,
16
See Strine et al. 2013, p.9 (“The choice of forum in shareholder representative actions is
driven almost entirely by tactical considerations of plaintiffs’ counsel”); Rubenstein 2001, p.408
(“In fact, as critics have noted for decades, class counsel is conventionally considered the real party
in interest in securities class actions; because plaintiffs are thought to have scant damage claims,
the attorney’s fee far exceeds any interest of the class members. Opportunities for class counsel to
compromise the class’s interests are obvious and abundant. Though these particular concerns have
long been the subject of scholarly criticism, they rarely led courts to deny certification in securities
classes”); see also In re Revlon, Inc. S’holders Litig., 990 A.2d 940, 959 (Del. Ch. 2010).
17
Professor Cox has also alluded to adequacy issues involving counsel (Cox 2017/2018).
18
See, e.g., Wal-Mart I, 2016 WL 2908344, at *18–23 (Del. Ch. May 13, 2016); Asbestos Workers
Local 42 Pension Fund v. Baamann, 2015 WL 2455469, at *18 n.147 (Del. Ch. May 21, 2015) (revised
May 22, 2015), aff’d, 132 A.3d 749 (Del. 2016) (Table); La. Mun. Police Emps.’ Ret. Sys. v. Pyott, 46
A.3d 313, 335-51 (Del. Ch. 2012) (“Pyott I”), rev’d, 74 A.3d 612 (Del. 2013) (“Pyott II”).
19
Myers 2014, pp.483–84; Strine et al. 2013, pp.8–23; Micheletti & Parker 2012, pp.6–14.
20
Strine et al. 2013, p.61 (recommending a presumption that representative shareholder litiga-
tion should proceed in the state of incorporation).
21
Ibid at 54.
22
See Micheletti & Parker 2012, pp.8–9 (citing In re Cox Commc’ns, Inc. S’holder Litig., 879
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a pernicious aspect of multiforum litigation is the temptation it creates for a race to

settlement in which the first plaintiffs’ attorney to obtain a preclusive settlement “wins”
because it is he or she who will receive a fee award to the exclusion of all the other attor-
neys in the parallel cases. Related to the race to settlement is the race to the courthouse
generally, which is commonly thought to be the result of courts conferring lead counsel
status on attorneys who file their complaints first.23 Defendants also have an incentive to
cheer on that race, to the extent that it gives priority to a weaker complaint or promotes
an early and relatively inexpensive settlement, or both. This incentive has even manifested
in defendants waiving exclusive forum selection bylaws in order to secure a preclusive
settlement or judgment that is less costly than one which may occur in a case brought by
more effective counsel.24 Whether through dismissal or settlement, defendants benefit if
similar claims are subsequently precluded.
Thus, the incentive to file quickly and settle quickly—forum shopping in the bargain
aisle—inevitably raises the concern that plaintiffs’ counsel may inadequately represent
the stockholders or corporation, and that similar claims in other forums should not be
precluded.25
A.2d 604 (Del. Ch. 2005)). Others have discussed more recently whether this trend will intensify
post-Trulia (Griffith & Rickey 2017/2018).
23
See Pyott I, 46 A.3d 313, 337–38 nn.18–19 (Del. Ch. 2012) (quoting Elliot J. Weiss & John
S. Beckerman, Let the Money Do the Monitoring: How Institutional Investors Can Reduce Agency
Costs in Securities Class Actions, 104 Yale L.J. 2053, 2062 (1995); Welch, Edward P. et al. Mergers
& Acquisitions Deal Litigation Under Delaware Corporation Law § 2.01[B][3][a], at 2–16 to 17), rev’d
on other grounds, 74 A.3d 612 (Del. 2013); King I, 994 A.2d 354, 355, 357–58 (Del. Ch. 2010), rev’d
on other grounds, 12 A.3d 1140 (Del. 2011).
24
See Lipton 2016 (“[D]efendants have the freedom to ignore a forum selection bylaw if their
interests are served by dealing with a weaker set of plaintiffs in a foreign forum”); Frankel 2015. But
see In re CytRx Corp. S’holder Derivative Litig., C.A. No. 14-6414-GHK-PJW, at 6–9 (C.D. Cal.
Aug. 17, 2016) (scrutinizing parties’ motives for pursuing settlement in California in contravention
of forum selection bylaw that identifies the Delaware Court of Chancery as the exclusive forum).
25
The Delaware courts have, with increasing urgency, called attention to this problem. See e.g.,
in chronological order, Biondi v. Scrushy, 820 A.2d 1148, 1159 (Del. Ch. 2003) (“The mere fact that
a lawyer filed first for a representative client is scant evidence of his adequacy and may, in fact, sup-
port the contrary inference”); W. Coast Mgmt. & Capital, LLC v. Carrier Access Corp., 914 A.2d
636, 643 n.22 (Del. Ch. 2006) (“[I]f [a] second plaintiff makes substantially different allegations
of demand futility based on additional information [obtained from a Section 220 demand], issue
preclusion, from both a logic and fairness standpoint, would not apply”); King I, 994 A.2d 354,
357 (Del. Ch. 2010) (a derivative plaintiff waives its inspection rights if it files a complaint before
seeking books and records); Pyott I, 46 A.3d 313, 336–51 (Del. Ch. 2012) (detailing the fast filer
problem and applying a fast filer presumption of inadequacy); South v. Baker, 62 A.3d 1, 20-26
(Del. Ch. 2012) (describing and applying a “rebuttable” fast filer presumption of inadequacy).
Suggesting a presumption against fast-filing plaintiffs’ attorneys’ being adequate to serve as lead
counsel, the court observed: “When a derivative plaintiff files a damages action hastily in the
wake of a public announcement, there is no basis for expediting the case to further the interests
of the corporation and its stockholders, and, when the derivative plaintiff forewent a books and
records investigation and a period of deep reflection on the publicly available documents and the
law, should not the presumption be that the plaintiff is not fit to serve as the lead fiduciary for the
corporation and its stockholders? What rational argument is there that it advances the legitimate
interests of investors to give a leg up to the first to get to court in a situation when being first to
court is likely to compromise the ability of the filing plaintiff to sustain his derivative complaint?”
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3. WHEN IS COUNSEL INADEQUATE?
In light of that concern, it has become important for courts to evaluate whether to give
preclusive effect to a settlement or dismissal in a multiforum litigation situation. In making
that evaluation, the courts have been called upon to balance two competing policies noted
earlier: minimizing or avoiding unproductive relitigation of claims, and avoiding claim
preclusion where it would unfairly deprive the corporation or its stockholders of the
opportunity to litigate meritorious claims.26
As illustrated in In re Wal-Mart (discussed below), the currently prevailing interpretation
of the Restatement framework imposes a demanding test for establishing that counsel in the
original suit was inadequate. That test may be too demanding—especially in derivative suits,
in which pleading requirements are particularly strict,27 and special procedures to protect
absentees are lacking at the pleading stage.28 A redefined doctrine—or a more flexible
application of existing doctrine—could limit the pathologies of multiforum shareholder
litigation that threaten to unfairly prevent stockholders from asserting meritorious claims.
3.1 Sources of Law
Due process forms the foundation for the analysis, and state law provides the framework.
It is essential as a matter of federal constitutional law that absent parties “are in fact
adequately represented by parties who are present.”29 In determining whether an absent
party is “in fact” adequately represented, the US Supreme Court has thus far required
that:
at a minimum: (1) The interests of the nonparty and her representative are aligned; and (2) either
the party understood herself to be acting in a representative capacity or the original court took
care to protect the interests of the nonparty. In addition, adequate representation sometimes
requires (3) notice of the original suit to the persons alleged to have been represented.30
Aside from this guidance, each state is left to formulate its own approach to determin-
ing whether representation in the first suit was sufficiently adequate to bind the absent
King I, 994 A.2d at 364 n.34. The Supreme Court reversed the Court of Chancery, but nevertheless
agreed that the fast filing approach is harmful to both the judiciary and litigants, King II, 12 A.3d
1140, 1150–51 (Del. 2011), and suggested some less stringent approaches: denying a fast filing
plaintiff “lead plaintiff ” status; “dismiss[ing] the complaint with prejudice and without leave to
amend as to the named plaintiff ”; or allowing the plaintiff to amend its complaint one time only if
it pays the defendants’ fees associated with filing the motion to dismiss. Ibid at 1151–52.
26
See Barkan v. Amsted Indus., Inc., 567 A.2d 1279, 1283 (Del. 1989) (“The Court of
Chancery plays a special role when asked to approve the settlement of a class or derivative action.
It must balance the policy preference for settlement against the need to insure that the interests of
the class have been fairly represented”).
27
Fed. R. Civ. P. 23.1(b) (requiring that demand futility be alleged with “particularity”); Del.
Ch. R. 23.1(a) (same).
28
Fed. R. Civ. P. 23.1(c) (requiring court approval for settlement, voluntary dismissal, and
compromise); Del. Ch. R. 23.1(c) (similar).
29
Hansberry v. Lee, 311 U.S. 32, 42–43 (1940).
30
Taylor v. Sturgell, 553 U.S. 880, 900–01 (2008) (internal citations omitted).
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parties. The Restatement (Second) of Judgments has largely won the day as the favored
framework for addressing preclusion in successive shareholder suits.31
3.2 Current Doctrinal Standards
To date, there has been a general consensus that any determination of adequate represen-
tation involves a fact-intensive analysis.32 In light of that fact-specific approach to evaluat-
ing adequacy of representation, it is perhaps not surprising that doctrinal parameters are
relatively loose and undeveloped.
Under the Restatement test that several jurisdictions, including Delaware, have
regularly used to determine whether to give preclusive effect to a prior judgment,33 “[a]
person is not bound by a judgment for or against a party who purports to represent him
if: . . . [t]he representative failed to prosecute or defend the action with due diligence and
reasonable prudence, and the opposing party was on notice of facts making that failure
apparent.”34 Despite the use of negligence-standard phraseology (“due diligence and
reasonable prudence”) in the first part of the test,35 Comment f explains that “[t]actical
mistakes or negligence on the part of the representative are not as such sufficient to
render the judgment vulnerable.”36 The Comment goes on to identify two basic scenarios
in which representation is inadequate: (1) counsel’s interests were antagonistic to those
of the class (for example, where there was collusion between class counsel and the class
adversary); and (2) counsel was grossly negligent in prosecuting the claim. This has
been applied in a bifurcated manner, where courts analyze alleged conflicts of interest
and then separately analyze whether counsel was grossly negligent.37 Comment f also
makes more than one reference to inadequate representation involving the defendants’
31
§§ 41–42.
32
Ibid § 42(1)(e) cmt. (f); see also Matsushita Elec. Indus. Co., Ltd. v. Epstein, 516 U.S. 367,
397–98 (1996) (discussing Prezant v. De Angelis, 636 A.2d 915 (Del. 1994)); South v. Baker, 62
A.3d 1, 7, 20–26 (Del. Ch. 2012) (quoting Wolfe, Jr, Donald J. and Pittenger, Michael A. (2012)
Corporate and Commercial Practice in the Delaware Court of Chancery § 9.02[b][1], at 9–31 to 32;
Bakerman v. Sidney Frank Importing Co., 2006 WL 3927242, at *11 (Del. Ch. Oct. 10, 2006),
reprinted in 32 Del. J. Corp. L. 551 (2007)).
33
See, e.g., Pyott II, 74 A.3d 612, 618 & n.21 (Del. 2013) (citing Restatement (Second)
Judgments); Wal-Mart I, 2016 WL 2908344, at *18–20 & nn.99–100 (Del. Ch. May 13, 2016)
(relying on the Restatement (Second) Judgments and citing cases from courts in other jurisdictions
that have done the same).
34
Restatement (Second) Judgments § 42(1).
35
As drafted, the Restatement’s rule appears to be unduly (and perhaps unintentionally)
restrictive. It appears to require, as a basis for a finding that a prior judgment is not preclusive due
to inadequacy of representation, that the adverse party was on notice of facts making apparent
the failure of counsel to act with due diligence and reasonable prudence. Thus, plaintiffs’ counsel
could be entirely disloyal and intentionally undermine the interests of absent shareholders, but
as long as that circumstance is not apparent to the opposing parties, a subsequent challenge to
adequacy of representation must fail. Although defendants’ awareness of improper motivations
or inadequate conduct on the part of plaintiffs’ counsel is surely important in the analysis, as dis-
cussed below, it may be inappropriate as an absolute requirement to a finding of representational
inadequacy.
36
Restatement (Second) Judgments § 42(1) cmt. f.
37
See Wal-Mart I, 2016 WL 2908344, at *18–22.
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being on notice of the inadequacy.38 The focus on the defendants’ awareness of the
inadequacy sets the Restatement framework apart from the approach developed in the
federal courts.39
As a practical matter, however, under both the Restatement framework and federal
standards, courts will not find that counsel was inadequate for purposes of avoiding
doctrines of repose unless the facts show that counsel had a direct conflict of interest or
was grossly negligent.40 In other words, inadequacy must be obvious. As observed in one
treatise, “the trend in the case law has been to sustain challenges to the representative only
where a clear-cut conflict or other confidence-undermining problem exists and to reject
challenges around the edges.”41 For example, recent decisions from the Court of Chancery,
with notable exceptions, suggest that attorneys are generally entitled to deference when
they decide to file suit without first seeking to exercise statutory inspection rights as a basis
for strengthening their complaint.42 Like the duty of care in corporate law, which requires
directors to become informed of all material information reasonably available and which
is breached when they are grossly negligent, there appears to be an accountability gap.
This area of the law parallels the duty of care in another way, in that some courts avoid
hindsight bias by refraining from “second-guessing [counsel’s] decision-making based on
information that was unavailable to them at the time” the challenged decision occurred.43
Thus, under the current legal regime counsel may fall well short of prosecuting a claim
38
Restatement (Second) Judgments § 42(1) cmt. f (“[A] fiduciary does not bind those for whom
he acts as against third parties who are aware of the fiduciary’s failure to fulfill his responsibility. As
applied to litigation, this principle implies that a judgment is not binding on the represented person
where it is the product of collusion between the representative and the opposing party, or where,
to the knowledge of the opposing party, the representative seeks to further his own interest at the
expense of the represented person. Where the representative’s management of the litigation is so
grossly deficient as to be apparent to the opposing party, it likewise creates no justifiable reliance
interest in the adjudication on the part of the opposing party”).
39
One of the more popular standards in the federal courts provides that “the primary criterion
for determining whether the class representative had adequately represented his class for purposes
of res judicata is whether the representative, through qualified counsel, vigorously and tenaciously
protected the interests of the class. A court must view the representative’s conduct of the entire
litigation with this criterion as its guidepost.” Pelt v. Utah, 539 F.3d 1271, 1285 (10th Cir. 2008)
(quoting Gonzales v. Cassidy, 474 F.2d 67, 75 (5th Cir. 1973)); see also Arduini v. Hart, 774 F.3d
622, 635 (9th Cir. 2014) (“[A]n adequate shareholder representative must have the capacity to
vigorously and conscientiously prosecute a derivative suit and be free from economic interests that
are antagonistic to the interests of the class” (internal quotations omitted)).
40
See, e.g., Wal-Mart I, 2016 WL 2908344, at *18–22 (Del. Ch. May 13, 2016); Pelt, 539 F.3d at
1286–89; In re Sonus Networks, Inc. S’holder Derivative Litig., 499 F.3d 47, 64–66 (1st Cir. 2007).
But see Johnson v. Shreveport Garment Co., 422 F. Supp. 526, 534–36 (W.D. La. 1976) (demanding
that class counsel perform at a higher standard than that expected of counsel who represents a
single party).
41
McLaughlin on Class Actions vol. 1 § 4:29 (12th ed.) (discussing named plaintiffs and class
counsel).
42
Wal-Mart I, 2016 WL 22908344, at *21–22 (Del. Ch. May 13, 2016) (expressing a reluctance
to “second-guess[]” counsel’s decision-making); Laborers’ Dist. Council Constr. Indus. Pension
Fund v. Bensoussan, 2016 WL 3407708, at *11–12 (Del. Ch. June 14, 2016). But see Krasner v.
Third Avenue Tr., C.A. No. 12113-VCL (Del. Ch. July 28, 2016) (Order); Pyott I, 46 A.3d 313 (Del.
Ch. 2012).
43
Wal-Mart I, 2016 WL 2908344, at *22.
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vigorously—or even competently—and a court may nevertheless find that representation

was adequate for purposes of applying doctrines of repose.
The courts have also been sensitive to whether the original proceeding was adversarial
or collusive in nature.44 This issue appears most often in the context of preclusive settle-
ments, where the interests of class counsel and the class adversary may become aligned,
as opposed to contested judgments. Of course, collusion remains an issue outside of the
settlement context.45 One example of such collusion is when defendants waive a forum
selection bylaw so as to favor a weaker complaint filed in a foreign forum and plaintiffs’
counsel in that forum fights off any attempts by interveners for a stay pending production
and review of corporate books and records.46
The courts’ treatment of the stockholder derivative litigation in Arkansas and Delaware
involving Wal-Mart illustrates the application of these principles.47 That litigation was
triggered when the New York Times released an exposé, supported by hundreds of internal
documents, on April 21, 2012 alleging that Wal-Mart had covered up a bribery scheme
involving government officials in Mexico,48 thus violating US and Mexican law.49 Several
lawsuits were filed in Arkansas and Delaware, some as quickly as four days after the
Times exposé was released.50 While the Delaware plaintiffs vigorously pursued litigation
for years in an effort to inspect corporate records to bolster a derivative complaint,
the Arkansas plaintiffs pushed ahead without ever making a demand for inspection of
relevant corporate records.51 Then, the consolidated Arkansas action was dismissed for
failure to plead demand futility, enabling the defendants to invoke collateral estoppel as
a basis for dismissing the Delaware litigation.52
The Court of Chancery, applying Arkansas law, held that collateral estoppel applied
and that the Delaware plaintiffs failed to carry their burden of showing that the Arkansas
attorneys were inadequate, because they failed to show that the attorneys’ interests were
“directly opposed” to Wal-Mart’s or that their efforts were grossly negligent.53 Thus,
because the Delaware plaintiffs could not establish inadequacy under either the loyalty
or care prongs of the Restatement’s framework, their challenge failed.54 On appeal, the
Delaware Supreme Court agreed,55 adding that “the Delaware Plaintiffs should have
coordinated, intervened, or participated in some fashion in the Arkansas proceedings.”56
44
See, e.g., In re Trulia, Inc. S’holder Litig., 129 A.3d 884, 887, 893 (Del. Ch. 2016); Radcliffe
v. Experian Info. Solutions, Inc., 715 F.3d 1157, 1168 (9th Cir. 2013).
45
See supra note 24; see also Krasner v. Third Avenue Tr., C.A. No. 12113-VCL (Del. Ch. July
28, 2016) (Order).
46
See supra note 24.
47
Wal-Mart I, 2016 WL 2908344, at *17-23; In re Wal-Mart Stores, Inc. S’holder Derivative
Litig., 2015 WL 1470184 (W.D. Ark. Mar. 31, 2015) (Order).
48
Barstow, 2012.
49
Wal-Mart I, 2016 WL 2908344, at *1.
50
Ibid at *7.
51
Ibid at *5–7.
52
Ibid at *7.
53
Ibid at *19, *19–23.
54
Ibid at *23.
55
Cal. State Teachers’ Ret. Sys. v. Alvarez, 2017 WL 239364, at *3–5 (Del. Jan. 18, 2017) (“Wal-
Mart II”), remanding Wal-Mart I, 2016 WL 2908344 (Del. Ch. May 13, 2016).
56
Ibid at *4. The Court found support in New York case law providing “an exception to claim
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The Supreme Court remanded the case for the Court of Chancery to determine whether
applying issue preclusion would violate federal due process requirements, and it reserved
final judgment until after the lower court’s decision on remand.
In light of the unique circumstances involved in Wal-Mart, we agree with the courts’
determination, under the current Restatement framework, that the Arkansas attorneys
were not inadequate representatives. First, although the plaintiffs should have exercised
their inspection rights, much of the information that was critical to making a demand
futility argument was publicly available through the Times’ reporting, and the failure
to pursue statutory inspection rights did not clearly disable the plaintiffs from present-
ing an effective complaint.57 And as the Supreme Court noted, “we cannot say that
the Arkansas Plaintiffs, who made a tactical decision to base their complaint on the
documents referenced in the New York Times article, coupled with their desire for a
jury trial (which is unavailable in the Court of Chancery), and perhaps other strategic
considerations, were ‘grossly deficient’ in their representation.”58 Notably, this was not
a case where the defendants favored the weaker complaint so as to secure a preclusive
judgment; the defendants sought to stay the Arkansas litigation so that the litigation
could proceed in Delaware, where plaintiffs were pursuing efforts to exercise statutory
inspection rights.59
Although the Court of Chancery reached a proper conclusion under the current
doctrine, the outcome may have been different had the court applied the alternative
framework discussed presently. First, this was a derivative case and preclusion was based
on an early stage order dismissing the Arkansas complaint for failure to plead demand
futility, and there were no special procedures to protect the absent shareholders. Second,
the fact that the Arkansas plaintiffs failed to make a demand to inspect books and records
is significant evidence of inadequacy, especially because the plaintiffs were asserting a
Caremark claim and the directors’ awareness of the misconduct was not clear from the
public record. The third (and related) factor that favors a finding of inadequacy is that
the Arkansas plaintiffs resisted the defendants’ motion to stay, despite the recognition that
the plaintiffs in the Delaware suit were attempting an action the Arkansas plaintiffs had
bypassed, namely seeking to bolster their claims through exercise of statutory inspection
rights. Although a rational judge may have found that the Arkansas plaintiffs’ counsel was
inadequate under this alternative framework, it would have also been rational to find that
the representation was adequate because of the thoroughness of the Times’ reporting and
the Delaware plaintiffs’ failure to make any effort to intervene in the Arkansas litigation.
The adequacy issue is indeed a close call. But the Restatement framework may not have
given the court the latitude to sufficiently weigh the issue. That limitation demonstrates
why a refined framework is desirable.
preclusion in derivative actions where a stockholder seeks to intervene in the prior action to protect
its interests but is denied leave to participate.” Ibid at *4 n.23 (citing Parkoff v. Gen. Tel. & Elecs.
Corp., 425 N.E.2d 820, 824 (N.Y. 1981)). Thus, if the Delaware plaintiffs had tried to intervene
but were frustrated from doing so, the Court might well have sided with them on appeal. See ibid
(quoting Parkoff, 425 N.E.2d at 824; Dana v. Morgan, 232 F. 85, 89 (2d. Cir. 1916)).
57
Wal-Mart I, 2016 WL 2908344, at *1.
58
Wal-Mart II, 2017 WL 239364, at *5.
59
Wal-Mart I, 2016 WL 2908344, at *6.
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4. A REFINED DOCTRINAL FRAMEWORK FOR

EVALUATING ADEQUACY OF REPRESENTATION
4.1 Reconsidering a Rebuttable “Fast-Filer Presumption”
As mentioned previously, the predominant framework used for evaluating the adequacy
of counsel ex post may be more forgiving than is appropriate.60 By requiring the defend-
ants to be aware of a direct conflict of interest or grossly deficient representation, the
existing doctrine gives courts relatively little leverage to police the fast-filer problem. The
most significant attempt thus far to modify applicable doctrine to address that problem
was the fast-filer presumption of inadequacy developed over the course of several Court
of Chancery decisions beginning with Biondi and culminating in Pyott I.61 It was a natural
response to the threat posed by substandard pleadings to claims held by corporations and
groups of stockholders, and it may have functioned well in limiting undesirable practices.
The Delaware Supreme Court characterized the presumption as “irrebuttable,” however,
and rejected it on that basis.62 Continuing to reject an irrebuttable fast-filer presumption
is appropriate because it does not fully account for the highly fact-specific and nuanced
nature of inquiries into adequacy of representation. For example, strict application of
the presumption would have rendered counsel in Wal-Mart inadequate as a matter of
course despite the fact that substantial information supporting arguments for demand
futility was publicly available. The courts should be given greater latitude and discretion
to evaluate this issue, not less.
Notably, however, the presumption that the Court of Chancery announced in Pyott I
was not necessarily irrebuttable, and courts in future cases could reconsider adopting
a fast-filer presumption of inadequacy that operates as a conventional presumption—
namely, by dictating a finding of inadequacy only if the parties seeking preclusion based
on a prior judgment fail to produce evidence of adequacy.63
The Delaware Supreme Court’s ruling in Pyott II, however, makes the prospect that
the courts will adopt an ordinary presumption of inadequacy uncertain at best. We
believe, rather, that the courts are more likely to be open to a new approach that follows
previously accepted principles underlying this area of the law—in particular, a “totality
of the circumstances” approach, which is less sweeping than the fast-filer presumption
but allows for more scrutiny than the Restatement approach.
4.2 The “Totality of Circumstances” Test Needs Elaboration
A test that enables the courts to examine the totality of the circumstances has the virtue
of acknowledging that a direct conflict of interest or grossly deficient prosecution are not
60
See supra note 35.
61
See supra note 25.
62
Pyott II, 74 A.3d 612, 618 (Del. 2013).
63
See Fed. R. Evid. 301 (“In a civil case, unless a federal statute or these rules provide other-
wise, the party against whom a presumption is directed has the burden of producing evidence to
rebut the presumption”); see also South v. Baker, 62 A.3d 1, 22–23 (Del. Ch. 2012) (describing a
rebuttable presumption of disloyalty to be applied against fast filers).
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the only possible grounds for finding that counsel was inadequate. Requiring one or the
other of these circumstances as a basis for a finding of inadequate representation does
not account for the reality that a range of human emotions may pull a fiduciary from the
“path of propriety,” including greed, revenge, shame, or pride.64 Moreover, at least where
preclusion arising from a settlement is concerned, there is (to borrow from other cor-
porate doctrine) an “omnipresent specter”65 that counsel’s interest in an early fee award
might compromise counsel’s motivation to act in the long-term best interests of absent
shareholders. And if an improper motive causes counsel to make poor (although not
grossly negligent) litigation decisions that contribute materially to a case being dismissed
or settled too cheaply, then there may be a basis for finding that the absent parties in
interest were deprived of their entitlement to adequate representation, either as a matter
of state law or perhaps as a matter of due process.66
A rote adoption of a “totality of the circumstances test,” however, is not particularly
helpful in guiding the courts’ evaluation of adequacy of representation. Merely reiterat-
ing that amorphous test would most likely continue to produce the same results as the
current analytical framework, without enhancing the courts’ ability to determine when
to give preclusive effect to a prior judgment in shareholder litigation. Accordingly, the
following subsection examines a variety of procedural and substantive factors—or badges
of inadequacy67—that the courts might consider to determine if a prior settlement or
judgment deserves preclusive effect.
4.3 Proposed Doctrinal Refinements and Factors for Evaluating Adequacy of

Representation
Courts evaluating adequacy of representation for the purposes of determining the

preclusive effect of a prior judgment in shareholder litigation should take account of
the defendants’ reliance interest in the prior judgment, along with other considerations.
The factors identified next might inform that account. In general, however, defendants’
reliance interest in a prior judgment in representative shareholder litigation should be
viewed as less significant than in other forms of litigation where the plaintiff (the princi-
pal) has a closer relationship with and control over the attorney (the fiduciary agent), and
agency problems are therefore likely to be less pronounced.68
64
Chen v. Howard-Anderson, 87 A.3d 648, 684 (Del. Ch. 2014) (quoting In re RJR Nabisco,
Inc. S’holders Litig., 1989 WL 7036, at *15 (Del. Ch. Jan. 31, 1989)).
65
Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985).
66
The bar that absent shareholders must reach in claiming that counsel was inadequate as a
matter of due process should perhaps be lower in derivative cases at the demand futility stage than
in other contexts because of the attenuated relationship between shareholders. See In re EZCORP
Inc. Consulting Agreement Derivative Litig., 130 A.3d 934, 947–49 (Del. Ch. 2016) (relying on
Smith v. Bayer Corp., 564 U.S. 299 (2011)).
67
Cf. 37 Am. Jur. 2d Fraudulent Conveyances & Transfers § 12 (Westlaw database updated
Summer 2016) (“Certain circumstances relating to defrauding creditors are characterized as
‘badges of fraud’ because they are circumstances tending to excite suspicion as to the conveyance,
which, standing unexplained, may warrant an inference of fraud”).
68
Cf. Regan 1999, pp.61–83 (discussing the differences in “expectations arising from a greements
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4.3.1 Care in prosecuting the original litigation

Existing doctrine already encourages the courts to examine the degree of care brought
to bear in prosecuting the original litigation. That examination is appropriate; indeed,
depending on other circumstances, it may not be appropriate to insist that a lack of
care rise to the level of gross negligence before finding that representation in the original
litigation was inadequate.69 It may be helpful, however, to identify in a more granular way
how a lack of adequate care might be identified, as follows.
4.3.1.1 Quality of the pleadings In determining if counsel in the original suit exercised
adequate care, the court might consider the degree to which the complaint in the subse-
quent suit differs from the complaint in the previous suit. This is especially relevant in
a derivative case subject to a heightened pleading standard that requires particularized
facts. If there are appreciable differences between the two complaints regarding the
factual allegations (that is, materially stronger allegations that could have been made in
the original complaint), then this factor weighs against preclusion. But if the subsequent
complaint sets forth essentially the same facts that were considered insufficient in the
original proceeding, then the subsequent court may be able to infer that preclusion is
appropriate.70 Similarly, if the pleadings and other submissions in the original proceed-
ing exhibit sloppiness, then this factor may weigh against preclusion in varying degrees,
depending on how egregious and material the errors were.71
4.3.1.2 Absence of meaningful discovery efforts The presence or absence of mean-

ingful discovery efforts indicates whether counsel adequately represented the class or
corporation.72 This includes both presuit investigations, such as the employment of
statutory inspection rights, and postsuit discovery through interrogatories, demands for
production, and depositions. The failure to use the “tools at hand” (that is, statutory
negotiated by representatives” in various fiduciary relationships, including trustee/beneficiary and

agent/principal relationships).
69
See supra note 66.
70
See Laborers’ Dist. Council Constr. Indus. Pension Fund v. Bensoussan, 2016 WL 3407708,
at *12 (Del. Ch. June 14, 2016) (discussing plaintiffs’ claims that unsuccessful counsel in the prior
litigation was inadequate, in part because they plagiarized in their complaint, and observing that
the factual allegations raised in the subsequent complaint were essentially the same).
71
This factor is not intended to replace other established exceptions to res judicata and collat-
eral estoppel recognizing that new facts that create new issues negate the preclusive effect of a prior
judgment. See, e.g., 50 C.J.S. Judgments § 1061, at 423 (2009) (discussing “new facts” and suggesting
that new facts will preclude collateral estoppel if they “alter the legal rights or relations of the
litigants”); see also In re Duke Energy Corp. Derivative Litig., 2016 WL 4543788, at *11–13 (Del.
Ch. Aug. 31, 2016) (giving prior dismissal preclusive effect under collateral estoppel to overlapping
issues involving waste, but declining to do so as to bad faith claims not litigated or dismissed in the
prior dismissal).
72
See, e.g., In re Revlon, Inc. S’holders Litig., 990 A.2d 940, 945 (Del. Ch. 2010) (finding that
counsel was inadequate, in part, because they “did not even bother to serve discovery”); Johnson
v. Shreveport Garment Co., 422 F. Supp. 526, 535 (W.D. La. 1976) (“[C]lass counsel owes a greater
duty to absent clients than to those who are present. Counsel must undertake substantial discovery
to preserve testimony in favor of the class, to rebut possible claims by the parties adverse to the
class, and to impeach opposing witnesses”).
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inspection rights) before filing suit may be an indication that counsel was inadequate. And
in a case (such as a case asserting Caremark oversight claims) in which only damages are
sought, there is rarely ever a need for haste in filing a derivative complaint, and a failure
to pursue inspection rights to bolster the complaint is particularly forceful evidence that
counsel was inadequate. In cases involving a preclusive settlement, the fact that counsel
failed to make basic discovery demands (and amend the complaint if necessary, depend-
ing on what was uncovered in discovery) before entering into a settlement is something
that should weigh against preclusion.
4.3.1.3 Failure to seek appellate review The fact that counsel failed to seek appellate
review of an assertedly preclusive judgment may indicate that representation was less than
adequate. There may be legitimate reasons for not taking an appeal, but if the subsequent
court cannot conceive of any downside associated with doing so, then this factor would
weigh against preclusion. Moreover, this factor should be accorded greater weight where
counsel may not have appealed because it “st[ood] to earn a substantial fee immediately
by not appealing, [and had to] wait for payment and expend additional effort” to pursue
an appeal.73
4.3.2 Other considerations in evaluating adequacy of representation

Indicia of lack of care are not the only bases or “badges” for evaluating adequacy of
representation. Other considerations might include the following.
4.3.2.1 Timing and investment The importance of issue or claim preclusion ought
to increase as the amount invested in the judgment increases, so that a judgment after
discovery and trial ought to be given preclusive effect much more readily than where a
defendant invests relatively little in securing a judgment, as on a motion to dismiss or
through a settlement early in the proceedings.74 In contrast, if the complaint was filed and
the case resolved (by settlement or dismissal) in an unusually rapid manner, a court could
conclude that defendants’ claim of reliance on preclusion is less persuasive. The Delaware
courts have all but acknowledged as much in the context of M&A litigation,75 and federal
courts have done the same.76
73
Macey & Miller 1991, p.43.
74
See Pelt v. Utah, 539 F.3d 1271, 1286 (10th Cir. 2008) (noting that res judicata was appropri-
ate in an earlier case in part because “the fact that the prior litigation had gone on for seven years
was evidence in itself that it was a hard fought contest”). Another way to look at this is to ask
how many procedural “screens” the original litigation passed through before it was dismissed (Cox
2017/2018).
75
See, e.g., In re Trulia, Inc. S’holder Litig., 129 A.3d 884, 887, 898 (Del. Ch. 2016) (declining
to approve disclosure settlement where defendants were to receive a broad release of claims and
plaintiffs’ counsel was to receive a fee, but the stockholders would not receive any material benefit,
and recognizing “‘the risk of buy off’ of plaintiffs’ counsel”); In re Revlon, Inc. S’holders Litig., 990
A.2d 940, 945, 956 (Del. Ch. 2010) (discussing “the Cox Communications Kabuki dance” where fast
filing plaintiffs file an inadequate complaint and defendants intentionally keep it alive to support
a preclusive settlement).
76
See, e.g., In re Walgreen Co. S’holder Litig., 832 F.3d 718, 721 (7th Cir. 2016) (“[A]lmost all
[disclosure strike] suits are designed to end—and very quickly too—in a settlement in which class
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4.3.2.2 The existence of a meaningful check on adequacy of representation in the

original litigation Assertedly preclusive judgments arise through a variety of pro-
cedures. Some of those procedures offer built-in checks and assurances of adequate
representation. For example, where lead counsel is appointed through a competitive
evaluation process, a court in subsequent litigation ought to be more inclined to afford
preclusive effect to the judgment in the original litigation than where the lead counsel
appointment is uncontested or not given significant judicial attention. Similarly, the
court in subsequent class action litigation should consider the extent to which the court
in the original litigation evaluated class certification and the adequacy of the class
representative (and class counsel). And where the judgment is entered in connection
with a settlement, the court in the subsequent litigation should take into account the
significance of any opportunity to object to the settlement and question the adequacy
of representation.77 In contrast, a dismissal arising solely upon defendants’ motion
seems less likely to provide an opportunity for a contemporaneous check on adequacy
of representation, and the court in the subsequent litigation should have greater room
to inquire into that subject.
A further check on adequacy of representation is the opportunity to intervene as a
plaintiff. If that option is available but not exercised, a court in subsequent litigation
may be less inclined to find the original representation inadequate.78 If the court, the
other plaintiffs, or the defendants frustrate these efforts, then this factor weighs against
preclusion.
4.3.2.3 Choice of forum If defendants could have invoked an exclusive forum provision
to dismiss the original litigation but chose to waive the provision, a court in subsequent
litigation could infer, absent a showing of justification, that defendants’ departure from
the forum choice provision was intended to achieve a litigation advantage at the expense
of the class or the corporation.79 In certain cases, courts could expand this factor and find
that not having a forum selection bylaw is equivalent to waiving one.80
counsel receive fees and the shareholders receive additional disclosures concerning the proposed
transaction. The disclosures may be largely or even entirely worthless to the shareholders, in which
event even a modest award of attorneys’ fees ($370,000 in this case) is excessive and the settlement
should therefore be disapproved by the district judge”).
77
Forsythe v. ESC Fund Mgmt. Co. (U.S.), Inc., 2012 WL 1655538 (Del. Ch. May 9, 2012)
(granting objectors an opportunity to “bond” the settlement and take over the case to pursue
a larger recovery). Conversely, there may be evidence that absentee shareholders were satisfied
with the original representatives, such as an “anti-objection” letter indicating that representatives
were adequate. See Letter from Mark F. Turk to Delaware Court of Chancery, Chen v. Howard-
Anderson, C.A. No. 5878-VCL (Del. Ch. Aug. 8, 2016).
78
See Wal-Mart II, 2017 WL 239364, at *4 (Del. Jan. 18, 2017), remanding on other grounds
Wal-Mart I, 2016 WL 2908344 (Del. Ch. May 13, 2016).
79
See sources cited in note 24, supra.
80
Sophisticated corporate boards and their advisors know how to, and do, create forum selec-
tion bylaws easily, and not doing so may be akin to deciding not to invoke such a provision that is
already in place. It is possible that directors who fail to create such a bylaw are motivated by the
possibility of obtaining cheap settlements and broad releases in jurisdictions outside Delaware.
See Griffith 2017 (discussing this issue and how every Delaware corporation should be regarded as
having a “shadow” exclusive forum bylaw).
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4.3.2.4 Benefits conferred through settlement Courts asked to give preclusive effect
to a prior judgment in a settlement of shareholder litigation should review the terms of
the settlement to compare the benefits conferred on the class or corporation with the
benefits conferred on counsel, and to assess the benefits conferred on defendants. The
fact that original counsel received a large fee for achieving a relatively modest benefit is
an indication that counsel inadequately represented the class or corporation. Conversely,
if the fee awarded is proportionate to the benefits conferred on those being represented,
then this would weigh in favor of preclusion, so long as the claims released in the settle-
ment were reasonably related to the claims presented.81 Similarly, a court in subsequent
litigation should examine the scope of any release given in settlement of the original
litigation: the more comprehensive the release and the less tailored it was to the claims
actually presented, the greater the reason to infer awareness on the defendant side that
plaintiffs’ counsel in the original litigation did not adequately represent the interests of
absent shareholders.82
5. INTERPRETING THE RESTATEMENT
To the extent that a court must apply the Restatement framework in a particular case,
it may interpret that framework in a way that incorporates aspects of the alternative
framework set forth in this chapter.
In derivative cases asserting Caremark claims where the only remedy sought is damages
and there is therefore little or no time pressure (indeed, the harm complained of may
have not even occurred at the time suit is filed), the failure to make a presuit demand for
books and records should be considered gross negligence unless substantially all of the
information that could have been obtained through the exercise of statutory inspection
rights was obtained through some other method. This is consistent with Comment f, as
it takes into account a variety of case-specific facts (such as nature of the claim, timing,
discovery efforts), including the defendants’ reliance interests, and it avoids due process
issues when they are at their most palpable.83
As to the defendants’ reliance interests specifically, the reviewing court may interpret
the Restatement in a way that allows it to give greater weight to how and what stage the
81
Settlement Hearing Transcript, Acevedo v. Aeroflex Holding Corp., C.A. No. 7930-VCL,
at 63 (Del. Ch. July 8, 2015); see also Friedlander 2016, p.910 (“So long as it is commonplace for
stockholder plaintiff counsel to recommend the exchange of a global release for supplemental dis-
closures, regardless of whether the sale process was pristine or problematic, stockholder litigation
loses its deterrent effect. Transactional lawyers in negotiated acquisitions have less clout over their
clients and other deal participants to police the integrity of fiduciary decision-making”).
82
See In re Trulia, Inc. S’holder Litig., 129 A.3d 884, 898 (Del. Ch. 2016) (“[P]ractitioners
should expect that disclosure settlements are likely to be met with continued disfavor in the future
unless . . . the subject matter of the proposed release is narrowly circumscribed”); In re Revlon,
Inc. S’holders Litig., 990 A.2d 940, 945, 956 (Del. Ch. 2010) (finding that counsel who negotiated
“a broad, transaction-wide release” was inadequate); see also Hesse v. Sprint Corp., 598 F.3d 581,
589–92 (9th Cir. 2010) (holding on collateral review that overbroad release in consumer class action
was not preclusive).
83
See supra note 66.
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case was settled or dismissed. So if defendants secure a quick dismissal or cheap settle-
ment by waiving an exclusive forum bylaw, the court may draw an inference of either
collusion or awareness of grossly deficient prosecution if the record, viewed as whole,
warrants such an inference.84 In such a situation, the court is taking into account the
timing and investment, the existence of meaningful checks, the choice of forum, and the
benefits conferred on the class or corporation.
6. CONCLUSION
As a result of “feckless fast filers,” whose substandard litigation strategies are encour-
aged in multiforum litigation, stockholders and corporations face a real threat of having
legitimate claims precluded by cheap settlements and dismissals. To combat this threat,
they are increasingly arguing that counsel in the original forum provided inadequate rep-
resentation. Although courts have been open to these challenges, there has yet to emerge
a doctrine that allows them to effectively police the fast-filer problem. We propose that
the courts adopt a “totality of the circumstances” approach that is more flexible than a
fast-filer presumption and allows for more scrutiny than the current Restatement frame-
work. Moreover, by considering several specific “badges of inadequacy,” the courts have
concrete guideposts to aid in working through adequacy challenges that arise. But if a
court must apply the Restatement, the court may interpret it in a manner that incorporates
aspects of the alternative framework set forth above.
7. ADDENDUM
Since this chapter was written, the Delaware Court of Chancery issued a second opinion85
and the Delaware Supreme Court issued its final decision.86 On remand, the Court of
Chancery recommended that the Delaware Supreme Court adopt a new approach for
analyzing collateral estoppel arguments in derivative litigation. The Delaware Supreme
Court rejected that recommendation and affirmed the Court of Chancery’s original
decision.
After the plaintiffs appealed the first decision addressing preclusion (the one which this
chapter examines), the Delaware Supreme Court remanded the case back to the Court of
Chancery for it to answer this question:
84
For collusion see Restatement (Second) Judgments § 42(e) cmt. f (providing that preclusion
is not proper when the representative “seeks to further his own interest at the expense of the repre-
sented person”). Of course, the fact that defendants have successfully argued that the case should
be dismissed at the pleading stage is not, in and of itself, a sufficient basis for inferring inadequate
representation. The party arguing that the prior representation was inadequate must point to
facts in the record demonstrating that counsel’s shortcomings or improper motivations materially
contributed to dismissal at the pleading stage.
85
In re Wal-Mart Stores, Inc. Del. Derivative Litig., 167 A.3d 513 (Del. Ch. 2017) (“Wal-Mart
III”).
86
Cal. State Teachers’ Ret. Sys. v. Alvarez, 179 A.3d 824 (Del. Jan. 25, 2018) (“Wal-Mart IV”).
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In a situation where dismissal by the federal court in Arkansas of a stockholder plaintiff’s

derivative action for failure to plead demand futility is held by the Delaware Court of Chancery
to preclude subsequent stockholders from pursuing derivative litigation, have the subsequent
stockholders’ Due Process rights been violated? See Smith v. Bayer Corp., 564 U.S. 299 (2011).87
The motivation for the Supreme Court’s question was an earlier Court of Chancery
Decision, In re EZCORP. In that decision, the court ruled on three separate bases that
an order dismissing a derivative complaint for failure to allege demand futility could not
preclude later derivative suits over the same claims—one of those bases was due process.88
The EZCORP court relied on Smith v. Bayer Corp., 564 U.S. 299 (2011), and analogized
orders dismissing derivative complaints under Rule 23.1 to orders refusing to certify a class
under Rule 23.89 In both situations, stockholders seek to represent others but are denied the
opportunity to do so. Thus, any such preliminary dismissal will not bind absent stockhold-
ers because “the very ruling that [the defendant] argues ought to be given preclusive effect is
the decision that a class could not be properly certified” or that a derivative plaintiff lacked
standing.90 Contrary arguments face a paradox—that is, the preclusive order denied a
stockholder the opportunity to represent the class or corporation, but absentees are bound
because that stockholder represented the class or corporation.
The Court of Chancery, in its most recent opinion, recommended that the Supreme
Court adopt the rule in EZCORP, which provides that federal due process “prevents a
judgment from binding the corporation or other stockholders in a derivative action until
the action has survived a Rule 23.1 motion to dismiss, or the board of directors has given
the plaintiff authority to proceed by declining to oppose the suit.”91 The Chancellor
provided three reasons for his recommendation: “(1) the similarities between class actions
and derivative actions, (2) some of the realities of derivative litigation, and (3) public policy
considerations.”92 In essence, the court reasoned that a “purported derivative action”
that does not survive a Rule 23.1 dismissal “is no more a representative action than the
proposed class action in Bayer that was denied certification”93 and that the approach in
EZCORP will better curb the ill effects of the fast-filer problem than the current system
of reviewing for grossly negligent representation after the fact.94 If the Delaware Supreme
Court adopted the EZCORP rule, stare decisis would have taken the place of claim or issue
preclusion when deciding whether to dismiss derivative complaints filed after an initial dis-
missal for failure to allege demand futility or wrongful refusal.95 In other words, a dismissal
pursuant to a Rule 23.1 motion would have persuasive as opposed to preclusive effect.
After receiving the Court of Chancery’s recommendation, the Delaware Supreme
87
Wal-Mart II, 2017 WL 239364, at *8 (Del. Jan. 18, 2017).
88
In re EZCORP Inc. Consulting Agreement Derivative Litig., 130 A.3d 934, 942–49 (Del. Ch.
2016). The other two bases were Court of Chancery Rule 15(aaa) and Delaware substantive law.
Ibid at 942–46.
89
Ibid at 947–49.
90
See Bayer, 564 U.S. at 314.
91
Id. at 948.
92
Wal-Mart III, 167 A.3d 513, 525 (Del. Ch. 2017).
93
Ibid at *12.
94
Ibid at *13.
95
See Bayer, 564 U.S. at 317; Taylor v. Sturgell, 553 U.S. 880, 903–04 (2008).
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Court issued its final decision rejecting the recommendation and affirming the Court of
Chancery’s original decision. Like the Court of Chancery, the Supreme Court applied
Arkansas and federal common law in analyzing whether issue preclusion was appropri-
ate.96 After concluding that the Arkansas judgment had satisfied the core elements for
issue preclusion, the Court addressed the adequacy of representation requirement “as
part of the federal Due Process overlay”97 and noted, “the evaluation of the adequacy
of the prior representation becomes the primary protection for the Due Process rights of
subsequent derivative plaintiffs.”98 The Court applied the same Restatement framework
as the Court of Chancery in its original decision and ultimately concluded that “the
Arkansas Plaintiffs were adequate representatives.”99 Importantly, as to the care prong
of the Restatement analysis, the Court held that “the Arkansas Plaintiffs’ decision to
forgo a Section 220 demand in this instance does not rise to the level of constitutional
inadequacy”100 but noted that it may have been “a closer call if the Arkansas Plaintiffs had
not obtained any documents, particularly since the complaints were focused on state-law
Caremark claims.”101
BIBLIOGRAPHY
Barstow, David (2012) “Vast Mexico Bribery Case Hushed Up by Wal-Mart After Top-Level Struggle,”
New York Times, available at www.nytimes.com/2012/04/22/business/at-wal-mart-in-mexico-a-bribe-inquiry-
silenced.html?pagewanted=all&_r=0.
Blank, Joshua D. and Zacks, Eric A. (2005) “Dismissing the Class: A Practical Approach to the Class Action
Restriction on the Legal Services Corporation,” Penn State Law Review vol. 110 pp.1–39.
Clopton, Zachary D. (2015) “Transnational Class Actions in the Shadow of Preclusion,” Indiana Law Journal
vol. 90 pp. 1387–1428.
Cox, James D., “Addressing the ‘Baseless’ Shareholder Suit: Mechanisms and Consequences,” in The Elgar
Handbook for Representative Shareholder Litigation, Jessica Erickson et al. eds (2018).
Davis, Kenneth B. Jr (2008) “The Forgotten Derivative Suit,” Vanderbilt Law Review vol. 61 pp.387–451.
Frankel, Alison (2015) “How Corporations Can Game Their Own Forum Selection Clauses,” Reuters, available
at http://blogs.reuters.com/alison-frankel/2015/11/17/how-corporations-can-game-their-own-forum-selection-
clauses/.
Friedlander, Joel Edan (2016) “How Rural/Metro Exposed the Systemic Problem of Disclosure Settlements,”
Delaware Journal of Corporate Law vol. 40 pp.887–919.
Griffith, Sean J. (2017) “Private Ordering Post-Trulia: Why No Pay Provisions Can Fix the Deal Tax and Forum
Selection Provisions Can’t,” in The Corporate Contract in Changing Times (Steven Davidoff Solomon &
Randall S. Thomas eds)
Griffith, Sean and Rickey, Anthony (2018) “Troubling Patterns in Merger Litigation Post-Trulia and How Delaware
Courts Can Correct Them,” in The Elgar Handbook for Representative Shareholder Litigation, Jessica
Erickson et al eds.
96
Wal-Mart IV, 179 A.3d 824, 841–42, 850 (Del. Jan. 25, 2018).
97
Ibid. at 849.
98
Ibid.
99
Ibid. at 852–55.
100
Ibid. at 854 (emphasis in original).
101
Ibid. at 853 (emphasis in original). The Court also noted “the equities may not favor the
Delaware Plaintiffs here” because they failed to “coordinate with the Arkansas Plaintiffs” or
“express their concerns to the Arkansas court.” Ibid. at 832 n.29. As of the completion of this
chapter, the Delaware plaintiffs filed a petition for a writ of certiorari with the U.S. Supreme Court,
on which no action had been taken.
M4633-GRIFFITH_t.indd 174 30/10/2018 08:16

Kraakman, Reinier et al. (1994) “When Are Shareholder Suits in Shareholder Interests?” Georgetown Law
Journal vol. 82 pp.1733–75.
Lipton, Ann (2016) “Delaware’s Vulnerability,” Business Law Prof Blog, available at http://lawprofessors.
typepad.com/business_law/2016/05/delawares-vulnerability.html.
Macey, Jonathan R. and Miller, Geoffrey P. (1991) “The Plaintiffs’ Attorney’s Role in Class Action and
Derivative Litigation: Economic Analysis and Recommendations for Reform,” University of Chicago Law
Review vol. 58 pp. 1–118.
McLaughlin on Class Actions vol. 1 § 4:29.
Micheletti, Edward B. and Parker, Jenness E. (2012) “Multi-Jurisdictional Litigation: Who Caused This
Problem, and Can It Be Fixed?” Delaware Journal of Corporate Law vol. 37 pp.1–47.
Myers, Minor (2014) “Fixing Multi-Forum Shareholder Litigation,” University of Illinois Law Review vol.
2014 pp.467–551.
Regan, Paul L. (1999) “Great Expectations? A Contract Law Analysis for Preclusive Corporate Lock-Ups,”
Cardozo Law Review vol. 21 pp.1–119.
Rubenstein, William B. (2001) “A Transactional Model of Adjudication,” Georgetown Law Journal vol. 89
pp.371–438.
Strine, Leo E. Jr et al. (2013) “Putting Stockholders First, Not the First-Filed Complaint,” Business Lawyer
vol. 69 pp. 1–78.
Charles Alan Wright et al., Federal Practice & Procedure vol. 18A § 4455 (2d ed.) (Westlaw database updated
Apr. 2016).
M4633-GRIFFITH_t.indd 175 30/10/2018 08:16

11. Limiting litigation through corporate governance
documents
Ann M. Lipton*
1. INTRODUCTION
For almost as long as it has existed, shareholder litigation (namely, claims brought by
shareholders against corporate managers, under either state or federal law) has been
viewed as vexatious and potentially frivolous, to a degree that surpasses the annoyances
posed by other kinds of lawsuits.1 The chief complaint is that such lawsuits are lawyer-
driven—in the sense that attorneys identify the cases and control the litigation, aided
by nominal plaintiffs with little real stake in the dispute—alleging misconduct based
on nothing more than a stock price drop (or, more recently, the announcement of a
merger). In response, courts and legislators have erected various barriers to shareholder
claims, developing both substantive and procedural law to facilitate quick dismissals and
minimize discovery burdens in the early stages of a case.2
Though these efforts have made it far easier to dismiss claims outright, complaints con-
tinue that too many frivolous cases are filed, and that even litigating the motions to dismiss
can be expensive and burdensome for defendants. As a result, there has been a surge of inter-
est in “private ordering” solutions that would bar the courthouse door at the outset, either by
deterring lawsuits in the first instance, or by allowing dismissals without any time-consuming
inquiry into the merits of the claim. These come in the form of amendments to the corpora-
tion’s governing documents—its charter or its bylaws—to place procedural preconditions
on shareholders’ ability to bring litigation. The most popular type of provision has been the
forum selection clause, limiting lawsuits to the courts of a particular jurisdiction (Romano
& Sanga 2015); other provisions that have been imposed include arbitration requirements,3
* Thanks so much to Jim Cox, Onnig Dombalagian, Jessica Erickson, Sean Griffith, Thomas
E. Rutledge and the participants in the Fourth Annual Corporate & Securities Litigation
Workshop.
1
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975); Cohen v. Beneficial Indus.
Loan Corp., 337 U.S. 541 (1949).
2
See, e.g., The Private Securities Litigation Reform Act of 1995, Pub. L. 104–67, 109 Stat.
737 (imposing substantive and procedural requirements on plaintiffs bringing federal securities
claims); In re Revlon, Inc. S’holders Litig., 990 A.2d 940, 960 (Del. Ch. 2010) (“The ability of
defendants to challenge the legal sufficiency of representative actions on the pleadings, whether
for compliance with Rule 23.1 or by invoking the protections of the business judgment rule, helps
limit the degree to which entrepreneurial plaintiffs can litigate on a volume basis”); Del. Code
Ann. tit. 8, § 102(b)(7) (2016) (permitting corporations to eliminate directors’ monetary liability
for gross negligence).
3
Corvex Mgmt. LP v. CommonWealth REIT, No 24-C-13-001111, 2013 WL 1915769 (Cir. Ct.
Balt. City May 8, 2013).
176
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Limiting litigation 177
fee shifting to require that losing plaintiffs pay defendants’ attorneys’ fees,4 and minimum
stake requirements.5
The policy rationale behind these proposals is that frivolous shareholder litigation dam-
ages the very class of persons it purports to protect; that is, it increases costs to corporations
and thus indirectly to shareholders themselves (Winship 2016). As a result, privately adopted
litigation limits benefit shareholders and will be valued in the marketplace. Moreover, the
market itself can serve as a corrective mechanism, so that litigation-limiting provisions
adopted in defiance of shareholders’ preferences will result in a devaluation of the stock,
thus facilitating management’s ouster (Henderson & Pritchard 2014; Weitzel 2013).
Legally, the enforceability of litigation limits rests on the metaphor of a corporation
as a contract among shareholders, or between shareholders and the corporation (Geis
2016). Ordinary contracts for similar limitations on litigation are enforced by courts even
when the substantive right underlying the claim cannot be waived;6 thus, proponents of
litigation limits in corporate governance documents argue that corporate contracts should
receive the same treatment (Grundfest & Savelle 2013).7
In this chapter, I recount the history of proposals for litigation limits and the current
state of the law. I then discuss some of the doctrinal and policy questions that have been
raised regarding the wisdom of different types of litigation limits and the propriety of
private ordering in this context. In particular, I explore how corporate managers’ struc-
tural and informational advantages may make litigation limits easy to abuse; moreover,
litigation itself serves public purposes that may be more appropriately subject to public
control.
2. HISTORY
The call for privately ordered litigation limits came about gradually, in response to a
variety of pressures.
Originally, critics of abusive state law derivative litigation proposed that arbitration
clauses be inserted into corporate charters (for example, Shell 1989). It was argued that
arbitration would be faster and cheaper than judicial resolution, thus curbing some of the
potential for misuse. The charter was deemed to be the appropriate location for such provi-
sions, because charter amendments (unlike bylaws) would require shareholder consent to
adopt, and shareholders could be placed on notice of the provision in their stock certificates.
As the Supreme Court demonstrated increasing willingness to enforce arbitration
clauses in a variety of contexts,8 proposals expanded to cover claims under the federal
4
ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014).
5
Rothenberg v. Goldstein, No 9:15-cv-80505-KLR (S.D. Fla. filed Apr. 20, 2015) (challeng-
ing a bylaw that required the written consent of at least 3 per cent of shares before derivative or
representative litigation could be filed).
6
The Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972); Shearson/Am. Express v. McMahon,
482 U.S. 220 (1987).
7
Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 957 (Del. Ch. 2013).
8
See Doctor’s Assocs., Inc. v. Casarotto, 517 U.S. 681 (1996); Buckeye Check Cashing, Inc.
v. Cardegna, 546 U.S. 440 (2006); Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20 (1991).
M4633-GRIFFITH_t.indd 177 30/10/2018 08:16

securities laws. Proponents continued to advocate either that such provisions be approved
by shareholders,9 or that they be included in the corporation’s governing documents at
the initial public offering stage so that any public shareholder would be on notice prior
to purchase (Schneider 1990). These proposals did not gain traction, however, due to
doubts about their legality. The SEC took the position that arbitration clauses constituted
an impermissible waiver of substantive federal rights (Schneider 1990; Weiss et al 2012),
and there was no indication whether states would recognize these provisions as binding
on shareholders.
Beginning in 2002, a new problem arose: multijurisdictional litigation (Winship 2016).
Several years earlier, Congress had imposed onerous procedural limitations on federal
securities claims.10 Shortly thereafter, the dominant plaintiffs’ securities firm split in
two, and one of the surviving halves collapsed in a kickback scandal. Suddenly, newer
and smaller plaintiffs’ firms were competing for cases, and they increasingly did so by
challenging mergers as unfair to target shareholders (Coffee 2012). Brought as class
actions under state law, they were not subject to the daunting procedural hurdles of
either state law derivative litigation or federal securities litigation. By 2014, between 85
percent and 95 percent of all mergers in excess of $100 million were attacked as unfair
(Griffith & Rickey, Chapter 9 of this volume) and, as plaintiffs’ firms jockeyed for
control of litigation, frequently multiple challenges to the same merger were lodged in
different jurisdictions around the country (Cosenza 2016). This litigation, it was argued,
exponentially increased the burden on defendant corporations (Grundfest & Savelle
2013), while encouraging competing plaintiffs’ attorneys to cheaply sell out the class.11
Moreover, the jurisdictional competition meant that more corporate governance claims
were being resolved outside of Delaware, the state long recognized as expert in the field
of corporate law.
In In re Revlon, Inc. Shareholders Litigation,12 Vice Chancellor Laster suggested that
the problem could be solved with charter provisions limiting intraentity claims—claims
governed by the internal affairs doctrine13—to a single forum. Immediately, forum
selection provisions began to proliferate, usually added to charters at the pre-IPO stage,
or taking the form of manager-adopted bylaws in companies that were already publicly
traded (Romano & Sanga 2015). Thus, the provisions were mostly adopted in a manner
that avoided the need for public shareholder approval.
The legality of these provisions was finally tested in the Delaware case of Boilermakers
Local 154 Retirement Fund v. Chevron Corporation.14 There, director-enacted bylaws
required that all intracorporate disputes be litigated in a Delaware forum.15 Stockholders
9
See Comm. On Capital Mkts., Interim Report 72, 74–84 (2006), http://capmktsreg.
org/app/uploads/2014/08/Committees-November-2006-Interim-Report.pdf; Scott & Silverman
2013.
10
The Private Securities Litigation Reform Act of 1995, Pub. L. 104-67, 109 Stat. 737; The
Securities Litigation Uniform Standards Act of 1998, Pub. L. 105-353, 112 Stat. 3227.
11
In re Revlon, Inc. Shareholders Litigation, 990 A.2d 940, 945.
12
990 A.2d 940, 960 (Del. Ch. 2010).
13
Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 952 & n.78, 960 n.129
(Del. Ch. 2013).
14
73 A.3d 934 (Del. Ch. 2013).
15
Ibid at 942.
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claimed that the bylaws exceeded directors’ powers under the Delaware Code and could
not bind shareholders who had not explicitly agreed to them.
Then-Chancellor Strine rejected the stockholders’ claims and upheld the bylaws as
facially valid. First, Strine reasoned that because the bylaws only concerned internal
affairs claims, they represented a reasonable regulation of stockholders’ rights, and
thus fell within directors’ statutory authority.16 Strine also rejected the argument that
stockholders had not assented to the bylaws and thus could not be contractually bound,
holding that by purchasing stock in Delaware corporations, stockholders “assent[] to
a contractual framework . . . that explicitly recognizes that stockholders will be bound
by bylaws adopted unilaterally by their boards.”17 Strine recognized that there might be
situations where application of a forum selection bylaw would be unfair or inequitable,
but held that this fact alone would not justify invalidating the bylaw on its face. Rather,
directors would be expected to waive the bylaw in good faith when it would work an injus-
tice and, if they did not, a court could refuse to enforce the bylaw as either unreasonable
contractually, or as an improper exercise of directors’ fiduciary responsibilities.18
Shortly after Boilermakers, the Delaware Supreme Court decided ATP Tour, Inc. v.
Deutscher Tennis Bund, involving a certified question from a federal district court.19 The
issue was the legitimacy of a management-enacted bylaw of a nonstock corporation that
required the plaintiff to pay the defendants’ attorneys’ fees and expenses for any claim
where the plaintiff did not “obtain a judgment on the merits that substantially achieve[d],
in substance and amount, the full remedy sought.”20 The bylaw had two unusual features:
first, it purported to apply to any claims brought against other members or the corpora-
tion itself, regardless of the subject matter—indeed, the reason for certification was
concern over the bylaw’s application to antitrust claims21—and second, it purported to
bind not only members, but also third parties who provided “substantial assistance” to
members.22
The Delaware Supreme Court upheld the bylaw en banc. Elaborating on Boilermakers,
the court held that even though corporate directors are authorized to adopt litigation-
limiting bylaws, they are still prohibited from either passing such a bylaw in the first
instance, or invoking it in a particular case, for an “improper purpose” in violation of their
fiduciary duties.23 The mere fact that the directors intended to deter litigation, however,
would not be considered improper.24 Strikingly, not only did the court ignore that the
bylaw applied to nonmembers, but it also appeared confused as to its scope. Specifically,
the court upheld feeshifting for intracorporate claims,25 even though the ATP bylaw
extended much farther.26
16
Ibid at 950–51.
17
Ibid at 956.
18
Ibid at 958.
19
91 A.3d 554 (Del. 2014).
20
Ibid at 556.
21
Deutscher Tennis Bund v. ATP Tour, Inc., 480 F. App’x 124 (3d Cir. 2012).
22
ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 556 (Del. 2014).
23
Ibid at 559–60.
24
Ibid at 560.
25
Ibid at 557.
26
Justice Ridgely, a member of the Delaware Supreme Court at the time of ATP, later
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Following ATP, corporations flocked to adopt their own versions of feeshifting bylaws
(Sjostrom 2015), while commenters advocated for their use for securities claims as well
as state law governance litigation (Bainbridge 2014). Meanwhile, in a series of related
cases, courts in Massachusetts and Maryland upheld an arbitration bylaw adopted by a
Real Estate Investment Trust organized under Maryland law.27 A Florida corporation’s
bylaw imposing a 3 percent ownership requirement on any shareholder seeking to bring
derivative or representative claims was challenged as a violation of the directors’ fiduciary
duties, though the lawsuit was eventually dropped.28 A Delaware corporation adopted,
and then discarded, a bylaw that limited plaintiffs’ ability to recover fees and expenses in
stockholder lawsuits.29
The final act in the drama occurred in August 2015, when the Delaware legislature
amended the Delaware General Corporate Law to address litigation limits. New statutory
provisions explicitly permitted forum selection clauses to be inserted either into the bylaws
or the charter,30 but overruled ATP by prohibiting the inclusion of feeshifting provisions.31
The amendments also prohibited any forum selection provisions that would bar access to
Delaware courts32—thus barring the exclusive selection of either a non-Delaware forum
(as at least one company successfully accomplished in the wake of Boilermakers33) or an
arbitral forum. However, the amendments only addressed “internal corporate claims,”
leading to speculation that they did not extend to limits on other types of claims, like
federal securities litigation (Bainbridge 2016; Coffee 2015).34
In 2017, several companies went public with forum selection provisions in their charters
that purported to govern claims brought under the federal Securities Act of 1933.35 As this
elivered an address affirming that ATP’s holding was confined to internal affairs claims.
d
See Henry duPont Ridgely, Justice, The Supreme Court of Del., Keynote Address at the
Southern Methodist University Dedman School of Law Corporate Counsel Symposium:
The Emerging Role of Bylaws in Corporate Governance (31 Oct. 2014) (transcript available
at www.delawarelitigation.com/files/2014/11/The_Emerging_Role_of_Bylaws_in_Corporate_
Governance-copy.pdf).
27
Del. Cnty. Emps. Ret. Fund v. Portnoy, 2014 WL 1271528 (D. Mass. Mar. 26, 2014); Katz v.
CommonWealth REIT, No 24-C-13-001299 (Cir. Ct. Balt. City Aug. 31, 2015); Corvex Mgmt. LP
v. CommonWealth REIT, 2013 WL 1915769 (Cir. Ct. Balt. City May 8, 2013).
28
Order, Rothenberg v. Goldstein, No 9:15-cv-80505-KLR (S.D. Fla. filed Sept. 10, 2015).
Unusually, the directors sought and obtained shareholders’ ‘advisory’ approval of the bylaw after
its adoption. See Complaint ¶12, Rothenberg v. Goldstein, No 9:15-cv-80505-KLR (S.D. Fla. filed
Apr. 20, 2015).
29
Sydelle Guardino v. StemCells, Inc., et al., C.A. No 12266, compl. (Del. Ch. Apr. 27, 2016).
30
Del. Code Ann. tit. 8, § 115 (2016).
31
Del. Code Ann. tit. 8, §§ 102(f), 109(b) (2016).
32
Del. Code Ann. tit. 8, § 115 (2016). The Model Business Corporation Act (MBCA) was
subsequently amended to include similar forum selection provisions. See MBCA § 2.08 (2016).
Kentucky, interestingly, granted corporations the right to mandate a Kentucky forum, but only in
the articles of incorporation. See KRS §§ 271B.7-400(7); 271B.1-400(1) (2016).
33
City of Providence v. First Citizens Bancshares, Inc., 99 A.3d 229 (Del. Ch. 2014).
34
Moving in the opposite direction, Oklahoma—home to few public corporations—amended
its corporate code to require that the losing party pay the prevailing party’s attorneys’ fees in all
derivative actions. See 18 Okl. St. § 1126 (2016).
35
See Blue Apron Holdings, Registration Statement (June 28, 2017), https://www.sec.gov/
Archives/edgar/data/1701114/000104746917004287/a2232570zs-1a.htm; Stitch Fix, Inc., Registration
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publication goes to press, a lawsuit is pending in Delaware Chancery seeking a declaratory

judgment that articles of incorporation cannot extend to govern the conduct of federal
claims.36 A decision is not expected until late 2018 or early 2019.
In sum, proposals to limit shareholder litigation through private ordering have mutated
over time. Initially rooted firmly in shareholder approval, they were later deemed to be an
inherent aspect of management power to which shareholders implicitly assented merely
by virtue of their investment. Though they were once limited to arbitration of derivative
claims (or at least claims governed by the internal affairs doctrine), eventually proponents
sought to expand them to cover different types of claims, and to impose a variety of
procedural limitations.
3. CONTINUING DOCTRINAL AND POLICY QUESTIONS
3.1 Should Litigation Limits Be Considered Matters of Corporate Internal Affairs?
One fundamental question raised by litigation limits is the extent to which they may be
deemed to concern corporate internal affairs, such that the law of the state of incorpora-
tion determines their enforceability—and, relatedly, how broadly such provisions may
extend.
The internal affairs of a corporation are the rules regarding the balance of power
between investors, officers, and directors (DeMott 1985; Ribstein & O’Hara 2008).
Corporate internal affairs are governed by the law of the chartering state, regardless
of where the corporation conducts business or where the investor resides. Boilermakers
concluded that forum selection bylaws concern corporate internal affairs when they apply
to claims governed by the internal affairs doctrine because such lawsuits go to the heart
of the relationship between stockholders and managers. As the court put it:
bylaws would be [improperly] regulating external matters if the board adopted a bylaw that
purported to bind a plaintiff, even a stockholder plaintiff, who sought to bring a tort claim
against the company based on a personal injury she suffered that occurred on the company’s
premises or a contract claim based on a commercial contract with the corporation.37
This conclusion is not without weaknesses. Litigation limits concern the civil procedural
rules that are used to maintain an action, whereas the internal affairs doctrine has been
traditionally understood to concern the substance of the claim itself (Brown 2015).
Moreover, in ordinary contracts, the enforceability of forum selection clauses is first
tested not by reference to the law that governs the contract as a whole, but by reference to
the law of the court in which the claim is brought, in part to allow the selected jurisdic-
tion to maintain control over its docket (Clermont 2015). But looking first to local law,
Statement (Nov. 6, 2017), https://www.sec.gov/Archives/edgar/data/1576942/000119312517333497/

d400510ds1a.htm; Roku, Inc., Registration Statement (Sept. 18, 2017), https://www.sec.gov/Archives/
edgar/data/1428439/000119312517286740/d403225ds1a.htm.
36
See Matthew Sciabacucchi v. Matthew B. Salzberg, Docket No. 2017-0931-JTL (Del. Ch.
Filed Jan. 5, 2018).
37
73 A.3d at 951–52.
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rather than the law of the chartering state, is the opposite of how the internal affairs
doctrine operates. As a result, some courts have expressed outright confusion as to what
Boilermakers intended;38 others have looked first to their own doctrine on the subject, not
Delaware’s (informed, naturally, by Delaware’s approval of such provisions), to determine
enforceability.39
That said, the scope of the internal affairs doctrine has always been malleable (DeMott
1985), and ultimately it appears that at least as regards forum selection, courts outside
of Delaware are eager to follow Delaware’s lead.40 Thus, if forum selection was once
theoretically outside the scope of internal affairs, the law has now changed—or at least,
due to near-uniform agreement on considerations governing the enforceability of such
provisions, the issue has become moot. It remains to be seen, however, whether courts
will be as eager to enforce more onerous litigation limits.41 For example, a state could
determine that its interest in protecting residents who invest in foreign corporations is
stronger than the interest of the chartering state in allowing managers to unilaterally
adopt liability-insulating provisions.42
Yet Boilermakers’ rationale for treating forum selection bylaws as matters of internal
affairs raises the related question whether litigation limits can apply to underlying claims
that are not governed by the internal affairs doctrine, such as federal securities claims.
Even if corporate governance documents are viewed as contractual, American law
has long distinguished between the contract that forms the corporation and allocates
power between its managers and shareholders—which is governed by the internal affairs
doctrine—and the contract that governs the transfer of a security between buyer and
seller, which is not (Lipton 2016). Securities claims concern the latter rather than the
former. Indeed, if corporate governance documents address the rights of stockholders
as stockholders, almost all securities claims concern the rights of investors before they
become stockholders, at the point of entry into the corporate polity. Litigation limitations
contained in the corporate governance contract may not extend to claims that do not arise
out of it.
There is good reason for the division. Federal securities law, like other kinds of external
regulation, rests on its own set of public policies and priorities. By contrast, states—not
the federal government—set the ground rules regarding what powers directors may
38
Roberts v. TriQuint Semiconductor, Inc., 364 P.3d 328, 335 (Or. 2015).
39
In re CytRx Corp. Stockholder Derivative Litig., 2015 WL 9871275 (C.D. Cal. Oct. 30,
2015); North v. McNamara, 47 F. Supp. 3d 635 (S.D. Ohio 2014).
40
In re CytRx Corp. Stockholder Derivative Litig., 2015 WL 9871275 (C.D. Cal. Oct. 30,
2015); North v. McNamara, 47 F. Supp. 3d 635 (S.D. Ohio 2014); Butorin v. Blount, 106 F. Supp.
3d 833 (S.D. Tex. 2015).
41
So far, forum selection has been the most heavily litigated issue; arbitration provisions have
apparently only been tested in the context of a single company, though the dispute generated
three different court opinions. Del. Cnty. Emps. Ret. Fund v. Portnoy, No 13-10405-DJC, 2014
WL 1271528 (D. Mass. Mar. 26, 2014); Katz v. CommonWealth REIT, No 24-C-13-001299 (Cir.
Ct. Balt. City Aug. 31, 2015); Corvex Mgmt. LP v. CommonWealth REIT, No 24-C-13-001111,
2013 WL 1915769 (Cir. Ct. Balt. City May 8, 2013). All three opinions assumed that the law of the
organizing state applied.
42
Ordinarily, contract validity is determined by reference to the law of the state with the great-
est interest in the dispute. Restatement (Second) Conflict of Laws §188 (1988).
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exercise to limit litigation (whether the limitation must appear in the charter, whether
shareholders must vote, and so forth). State officials are not positioned to make the
appropriate policy determinations when the matter involves a federal, rather than state,
regulatory scheme. Indeed, some litigation limits, like feeshifting, may undermine federal
policy and be preempted on that ground alone.43 Boilermakers recognized as much,
anchoring directors’ legal authority to limit litigation in the fact that the affected claims
were governed by the internal affairs doctrine.44
3.2 Are Litigation Limits an Appropriate Subject for Private Ordering?
Leaving aside the issue of scope, questions continue to arise as to whether corpora-
tions should be able to individually select the rules that will govern litigation by their
shareholders. Usually, these limits are unilaterally imposed by corporate directors, and
directors have flexibility as corporate fiduciaries to invoke them, or not, in a particular
case. Because directors may be inherently conflicted in such a decision—and certainly
are operating from a position of informational advantage—litigation limits may be
particularly susceptible to abuse.45
Forum selection, for example, represents the most mild of litigation limits, in that it
preserves shareholders’ access to the courts and imposes no procedural hurdles beyond
those imposed by the forum. Yet it may not be the panacea for multijurisdictional
litigation that its proponents expect. Though multijurisdictional litigation has been
characterized as a scourge that benefits plaintiffs’ attorneys at the expense of defendants
(Grundfest & Savelle 2013), one study found that experienced defense counsel are adept
at exploiting multijurisdictional litigation to conduct reverse auctions among plaintiffs’
counsel, resulting in cheap settlements (Krishnan et al 2017). Delaware courts have long
recognized that when derivative actions are filed in multiple jurisdictions, defendants
may encourage the weakest plaintiffs to move forward on the fastest schedule so as to
win a quick dismissal that collaterally estops stronger plaintiffs.46 Forum selection provi-
sions are another weapon in directors’ arsenal; directors can choose to adopt them—or
43
For example, to the extent that fee-shifting is meant to deter litigation, it may conflict with
the complex set of rules Congress has already enacted to balance deterrence of frivolous federal
securities litigation against the benefits of meritorious claims (Sjostrom 2015; Coffee 2014).
44
Boilermakers, 73 A.3d at 950–52.
45
In the simplest scenario, directors may be aware whether their internal documents contain
incriminating or exculpatory evidence. Based on that information, they may choose to invoke
an arbitration bylaw that limits discovery, or to waive the bylaw so that their innocence may be
proclaimed in a public judicial forum.
46
La. Mun. Police Emples. Ret. Sys. v. Pyott, 46 A.3d 313, 347 (Del. Ch. 2012), rev’d, Pyott
v. Louisiana Mun. Police Employees’ Ret. Sys., 74 A.3d 612 (Del. 2013); Avi Wagner v. Third
Avenue Management, LLC, et al. and Third Avenue Trust, C.A. No 12184-VCL, transcript
(Del. Ch. May 20, 2016; filed June 14, 2016) (“The defendants want to get out of litigation, and
the best way to do it is to fight the weak plaintiff . . . [T]hey have the plaintiff they want and
the allegations they want . . . This whole system of multi-forum litigation . . . creates a lot of
systemic dysfunction. It’s certainly true that things should be resolved in one forum and at one
time, but it doesn’t follow from that . . . that they should necessarily be followed under a system
that incentivizes the filing of a fast complaint by a weak plaintiff so that defendants have the
high ground”).
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not—even on the eve of expected litigation,47 and then can selectively enforce them to pick
their preferred plaintiff. Indeed, there is already evidence that some corporate directors
have made precisely this attempt.48
The more onerous burdens imposed by arbitration and feeshifting raise even larger
concerns.
Arbitration allows the parties to choose the procedural rules they will employ, including
the selection of arbitrators who may be affiliated with the litigants, the curtailment of
discovery, and prohibitions on class actions (Lipton 2016). Because plaintiffs have little
information about the claim without access to discovery, and often rely on the economies
of scale of class litigation, the flexibility of arbitration can tilt the playing field in favor
of defendants to the point of barring meritorious claims.
Feeshifting is perhaps the most draconian of the proposed litigation limitations.
Most stockholder litigation is representative; therefore, the nominal plaintiff expects to
personally recover only a small fraction of the benefit obtained on behalf of the class.
If the plaintiff is responsible for the full amount of the defendant’s costs, the risks may
be too great to make litigation economical, particularly if—in line with the text of the
ATP bylaw—plaintiffs must pay defendants’ fees even when they are partially successful.
Feeshifting also creates perverse incentives: the more meritorious the claim, the longer the
litigation continues, and the higher the plaintiff’s potential costs. Thus, feeshifting is likely
to deter the strongest cases (Coffee 2014).49
47
See note 52, infra. Given the ease with which such bylaws can be adopted, Sean Griffith
argues that all companies should be viewed as having a forum selection option, which they may
exercise to manipulate multijurisdictional litigation to their advantage. He believes defendants ex
ante would prefer to minimize litigation but, ex post, have incentives to settle with weak plaintiffs.
His solution is for defendants to adopt “no pay” provisions that would preclude the corporation
from paying attorneys’ fees for shareholder litigation. Then, lawsuits for nonmonetary relief would
be discouraged, while lawsuits for damages could continue with fees to be obtained from any
recovery (Griffith 2017). Yet Griffith assumes that corporations want to deter litigation in the first
place—an assumption called into question if corporations use the prospect of multiforum litiga-
tion to negotiate lower premium deals in the expectation that they can settle on the cheap and avoid
more aggressive challenges (Krishnan et al. 2017).
48
In Steven A. Kriegsman, et al. and CytRx Corp., C.A. No 11800-VCMR, tr. ruling (Del.
Ch. May 2, 2016), a Delaware court stayed a Delaware action in favor of a California action,
notwithstanding the existence of a bylaw that specified Delaware as the exclusive forum for deriva-
tive litigation. The California court eventually refused to approve a settlement and recommended
that the parties continue their litigation in Delaware. The court explained, “we are skeptical of the
Parties’ motivation for attempting to settle here . . . We cannot ignore the possibility that the cur-
rent Motion may be an attempt to shop for a more hospitable forum in which to settle the dispute.”
In re CytRx Corp. Stockholder Derivative Litigation, C.A. No 14-6414-GHK-PJW, order (C.D.
Cal. 17 Aug. 2016). In another case, a Nevada corporation adopted a Utah forum selection bylaw,
but then moved to stay a case filed in Utah in favor of a case filed in Nevada, raising suspicions that
the company was selectively enforcing its bylaw in order to litigate against its preferred plaintiffs.
See Alison Frankel, How corporations can game their own forum selection clauses, Reuters, http://
blogs.reuters.com/alison-frankel/2015/11/17/how-corporations-can-game-their-own-forum-selec
tion-clauses/ (Nov. 17, 2015).
49
Albert Choi argues that properly drafted fee-shifting provisions may discourage frivolous
direct litigation while providing greater incentive for attorneys to bring direct claims that have a
high likelihood of success but relatively low damages (Choi 2016). Professor Choi recommends that
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The standard rejoinder is that shareholders may vote out directors who adopt litigation
limits of which they disapprove, or enact their own counterbylaws, exactly as Chancellor
Strine described. Moreover, if shareholders discount the share prices of companies that
have adopted disfavored limits on litigation, that fact alone will compensate investors for
the risk and subject the errant directors to the market for corporate control. And because
today’s equities are mostly owned by sophisticated institutions who have sufficient stakes
to attend to governance matters,50 there is less concern that rational apathy, or collective
action problems, will prevent shareholders from taking action.
Yet the question remains whether shareholders, acting from a position of informational
disadvantage, can determine how litigation limits should be priced. They know little about
how these limits may encourage future misbehavior by shielding directors, and they do
not know which conditions will prompt directors to invoke—or not invoke—a limitation
in response to particular circumstances. Thus, any pricing impact may simply “reflect the
range of uncertainty as to the likely amount of managerial misappropriation of corporate
returns to which shareholders are legally entitled” (Coffee 1988).51 And because directors
can enact litigation limits at any time,52 the market must discount all shares for the pos-
sibility that a new litigation limit will be adopted in the future (Klausner 2013).
3.3 Is Contract and Consent the Correct Frame for Examining Litigation Limits?
Thus, the larger question looms as to whether these provisions should be viewed through
the lens of contract and consent in the first place.
Within the corporate structure, shareholders and directors are not on an equal footing.
Shareholder power is sharply limited, not merely by the practicalities of coordinating
among potentially dispersed investors, but by legal ground rules that vest directors with
broad discretion to take action on behalf of the corporation as they see fit. The justifica-
tion for this power differential is that shareholders do not have either the skill or the
incentives to make decisions on the corporation’s behalf; instead, directors are expected
to protect shareholders’ interests (Lipton 2016).
Boilermakers recognized as much, locating shareholders’ consent not in their accept-
ance (even tacit) of a particular bylaw, but in their buyin to the overall corporate structure,
which includes directors’ managerial power. Courts have rejected challenges to bylaws
that were adopted and invoked under conditions that did not give shareholders a mean-
ingful chance to counter via exercise of their own governance powers,53 thus implicitly
the matter be left to private ordering, but with more muscular judicial review, so that ATP-style
fee-shifting—where unsuccessful plaintiffs, but not defendants, pay fees—can be invalidated.
50
Vipal Monga & David Benoit, Companies Forgot About Mom-and-Pop Investors . . . Until
Now, Wall St. J., July 19, 2016.
51
Moreover, if the company’s shares do not trade efficiently, there can be no assumption that
information regarding charter and bylaw provisions will be incorporated into its stock price in the
first place (Cox 2015).
52
See Butorin v. Blount, 106 F. Supp. 3d 833 (S.D. Tex. 2015); City of Providence v. First
Citizens Bancshares, Inc., 99 A.3d 229 (Del. Ch. 2014); Groen v. Safeway Inc., 2014 WL 3405752
(Cal. Super. Ct. May 14, 2014).
53
See, e.g., Roberts v. TriQuint Semiconductor, Inc., 364 P.3d 328 (Or. 2015); see also City of
Providence v. First Citizens Bancshares, Inc., 99 A.3d 229 (Del. Ch. 2014).
M4633-GRIFFITH_t.indd 185 30/10/2018 08:16

recognizing that stockholders’ “consent” to bylaws is not rooted in their hypothetical

power of repeal.54 The legal framework does not treat shareholders as autonomous agents
bargaining opposite directors to protect their interests, as in contract; instead, it treats
directors as trustees for shareholders, legally obligated to act not in their own interests,
but as fiduciaries for the corporation (Lipton 2016).
Both Boilermakers and ATP reiterated this point, stressing that litigation limits are
tested not merely for contractual validity, but also for compliance with directors’ fiduci-
ary duties, both at the time of adoption and at the time of invocation. Thus, the legal
obligations of directors—not merely the market, or shareholders’ consent—are a critical
pillar to protect against abuse. But those obligations must be enforced by courts, and to
date, we have little information as to how much appetite courts actually have for delving
into managerial motivations in a context so laden with structural conflict, especially given
ATP’s puzzling pronouncement that deterrence of litigation (even, apparently, nonfrivo-
lous litigation) is a proper managerial purpose. Many courts outside of Delaware have
ignored fiduciary considerations entirely, treating litigation limits as a simple contractual
term, indistinguishable from a term that might be found in a contract by two opposing
parties independently pursuing their own interests.55
For this reason, theorists have argued that litigation limits at the very least require a
higher form of shareholder consent than simply the consent attendant upon participation
in the corporate structure. For example, James Cox distinguishes between the power of
directors to manage the company from a business perspective, and the power of direc-
tors to alter the balance of power between shareholders and managers (Cox 2015). The
latter, he argues, must be subject to more exacting judicial scrutiny, and should require
shareholder approval.56 Verity Winship, recognizing that certain managerial duties are
unwaivable (the duty of loyalty, compliance with federal securities laws), argues that the
more onerous the burden on litigation—that is, the closer it comes to waiver—the more
robust the consent required (Winship 2016).57
Other scholars tie investor consent to their reasonable expectations in light of estab-
lished corporate practice (Hamermesh 2014; DeMott 2015). The difficulty with this
reasoning, however, is its circularity: if investor consent is rooted in existing law, then
54
Even if shareholders were to repeal a forum selection bylaw, in many states, the directors
would have the power to simply reinstate it. See, e.g., Christina Rexrode & Dan Fitzpatrick,
Investors Push Back At BofA’s Reversal, Wall St. J., Oct. 31, 2014, at C1.
55
Del. Cnty. Emps. Ret. Fund v. Portnoy, WL 1271528 (D. Mass. Mar. 26, 2014); Katz v.
CommonWealth REIT, No 24-C-13-001299 (Cir. Ct. Balt. City Aug. 31, 2015); Corvex Mgmt.
LP v. CommonWealth REIT, 2013 WL 1915769 (Cir. Ct. Balt. City May 8, 2013); Hemg Inc. v.
Aspen Univ., 2013 WL 5958388, at *1 (N.Y. Sup. Ct. Nov. 4, 2013); In re: CytRx Corp. Stockholder
Derivative Litig., 2015 WL 9871275 (C.D. Cal. Oct. 30, 2015).
56
See also Brown (2015) (arguing that until Boilermakers, Delaware statutory law required that
limits on shareholder power be placed in the charter, not the bylaws, where shareholder notice or
consent would be required). Even the shareholder approval requirement for charter amendments
may not be fully capable of protecting investors because of managers’ greater informational
advantage (Bebchuk 1989).
57
Winship additionally argues that litigation limits should follow the scope of permissible
waivers; thus, because only monetary claims for care violations are waivable, and such waivers must
be included in the charter, litigation limitations that approach waivers of the duty of care should
have similar constraints.
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it waxes and wanes as that law changes. Even a wrongly decided case—as Lawrence
Hamermesh argues of ATP—changes investor expectations for the future.
3.4 Are Shareholder Rights Public or Private Law?
The debate over the validity of shareholders’ consent may obscure the larger policy ques-
tion, namely, whether the relationship between shareholders and a corporation is in fact
properly characterized as private law.
The fiduciary duties imposed by states on corporate managers are a form of govern-
ment regulation (Ribstein 2010). The purpose of that regulation is to protect investors,
reduce agency costs, and ultimately encourage investment, with the resulting economic
benefits shared across society. If reduced enforcement of those duties weakens fidelity to
them, the public benefit is similarly reduced (Cox 2015).
Litigation itself has a particularly public character. When it comes to corporate govern-
ance, the law is developed overwhelmingly through common law rulemaking, rather than
through statutory enactments or even regulatory enforcement (Griffith & Steele 2005);
thus, measures that diminish opportunities for judicial analysis may retard the healthy
development of legal standards for all corporations. Discovery alone has proved a key
tool for giving the public insight into corporate operations, beyond what any mandatory
disclosure could require (Gorga & Halberstam 2014). Even forum selection may have
hidden drawbacks; Delaware already dominates the market for the creation of substantive
corporate law, and the legal system may benefit from allowing other states breathing room
to examine these issues, even if only in the context of applying Delaware rules of decision
(Griffith & Lahav 2013).
Ironically, in amending its corporate law to circumscribe the use of litigation limits,
Delaware itself has implicitly recognized the public character of corporate litigation.
By refusing to allow corporations to voluntarily select a non-Delaware forum, Delaware
ensures that its own courts are available to decide questions of Delaware law; by banning
feeshifting and mandatory arbitration, Delaware eliminates existential threats to its judi-
cial system. It is difficult not to interpret Delaware as utilizing litigation limits to further
its own provincial interests in funneling more litigation into Delaware, thus rendering
somewhat hollow the idea of litigation limits as species of private ordering.
4. CONCLUSION
It remains to be seen whether litigation limits are here to stay, perhaps in ever more crea-
tive permutations, or whether they are simply a passing fad. The more that litigation limits
generate collateral litigation, the more their appeal may sour.
The critical issue moving forward will be to determine the extent to which shareholder
litigation is intended to compensate the individual investors, and the extent to which it is
intended to deter misconduct and benefit the economy as a whole. Viewed as a compensa-
tion mechanism, it may be reasonable for investors to trade their litigation rights to spare
themselves the (indirect) expenses of litigation; if such litigation has broader positive
externalities, however, that determination cannot be made at the investor/corporate
level. If excessive litigation remains a problem despite state and federal attempts to deter
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f rivolous filings, the alternative might be a more robust system of governmental enforce-
ment of shareholder rights, which may allow a more systemic cost–benefit calculation.
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Section B
Judicial Perspectives on Shareholder Litigation
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12. Disclosure settlements in the state courts post-
Trulia: practical considerations
James L. Gale
It has become commonplace for the announcement of any significant merger to be imme-
diately followed with litigation, often involving multiple actions in multiple fora. More
often than not, the transaction involved a Delaware corporation, and as a result, the issues
inherent in such litigation were most often presented to Delaware’s Court of Chancery.
This litigation trend has generated significant attention, controversy, and litigation across
a spectrum of issues. This chapter focuses on the particular issue of judicial approval of
“disclosure settlements,” which are settlements of class action lawsuits where the primary
settlement consideration has typically involved a corporation making supplemental
disclosures in exchange for a broad classwide release, with no further financial benefit to
the shareholder class, but with significant attorneys’ fees paid to class counsel.
Chancellor Andre G. Bouchard’s opinion in In re Trulia, Inc. Stockholder Litigation
received almost immediate landmark status and came as the culmination of an evolv-
ing, substantial body of precedent from the Delaware Court of Chancery addressing
disclosure settlements.1 Trulia acknowledged the consequences of what may have proved
to be a too lenient standard of review of such settlements and announced a heightened
standard for judicial approval that focuses on the respective value of the “give” and “get”
of such settlements, restricting a broad release not commensurate with the limited benefit
obtained, and conditioning an award of any attorneys’ fees on counsel having achieved
supplemental disclosures that are “plainly material.”2
Chancellor Bouchard’s opinion further describes the particular challenge that a
judge faces when assessing whether there is such materiality, where the nature of the
settlement results in corporate defense counsel becoming the plaintiff class counsel’s ally
in securing court approval for the settlement in order to allow the transaction to move
forward, as a result of which the judge no longer enjoys the illuminating benefit of the
adversarial process.3 As discussed more fully presently, Chancellor Bouchard suggested
alternative procedures for judicial review that may allow for the continued benefit of
that adversarial process in reviewing the settlement while the underlying transaction is
allowed to proceed.
Trulia has already been credited with leading to a reduction in the percentage of
corporate transactions being subjected to litigation.4 Such a result would be expected
considering the number of transactions that involve Delaware corporations, many of
1
129 A.3d 884 (Del. Ch. 2016).
2
Ibid at 887, 891, 893, 898, and n.46.
3
See ibid at 893.
4
See Cornerstone (2016) (revealing that the rate of litigation related to mergers and acquisi-
tions has dropped “substantially” following Trulia).
191
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which may now have bylaws that compel litigation involving their transactions to be
brought in the Court of Chancery.5
However, concern has been expressed that Trulia’s impact may be marginalized by
the plaintiffs’ bar bringing suit in other states that will apply less exacting standards and
continue the more accommodating review that disclosure settlements enjoyed in Delaware
prior to Trulia. The concern is that judges in other states will be either ill-equipped,
by experience or training, or simply unwilling to meaningfully implement an exacting
standard based on Trulia. Chancellor Bouchard acknowledged that others have raised this
concern. First noting the role that forum selection clauses may have in mitigating such
concerns, if legitimate, the Chancellor expressed his “hope and trust that our sister courts
will reach the same conclusion if confronted with the issue.”6
The purpose of this chapter is to identify at least some of the practical considerations
that judges of those sister states may undertake, should the prediction that deal litigation
will continue unabated in states outside of Delaware be proved accurate. The author
recognizes, but here takes no side, on the clear debate between the plaintiffs’ bar, which
champions the underlying litigation on behalf of shareholders, and those that character-
ize disclosure settlements as no more than a necessary “deal tax” that serves no salutary
purpose (O’Connell et al 2015). There may be separate considerations to be faced by the
federal judiciary if the focus shifts to litigation under the federal securities laws. If so,
those considerations are outside the scope of this chapter.
While other states certainly have not confronted the same frequency of disclosure
settlements seen by the Chancery Court, there is widespread recognition of similar
underlying policy considerations inherent in class action settlements. The class action
procedure is regularly implemented and can achieve substantial social benefit. Judicial
preference for settlements is entrenched. Naturally, judges may prefer settlement to the
management challenges inherent in class action litigation. There is, at the same time,
widespread judicial recognition that the class action vehicle is subject to abuse, and that,
without judicial restraint, settlements can exact large attorneys’ fees unaccompanied by
meaningful value for the represented class on whose behalf a comprehensive release is
offered (Ratner, 2015). One of the author’s counterparts somewhat famously referred
to such fees as “stinky fees.”7 Prior to Trulia, Vice Chancellor Laster expressed his dis-
pleasure for “junky cases,” in which plaintiff class counsel pursues “easy money.”8 Judge
Richard Posner has recently called such abuses in the context of disclosure settlements a
“racket” that “must end.”9
This combination of factors would appear to have been at play as the decisions by the
Chancery Court only evolved toward Trulia over time, where a series of judicial approvals
5
See ibid at 3.
6
In re Trulia, 129 A.3d at 899.
7
Ward v. Lance, Inc., No 10 CVS 16553, slip op. at 1–2 (N.C. Super. Ct. Feb. 28, 2011) (Tennille,
J.) (describing “stinky fees” as fees that “just smell bad and have no economic justification,” and
noting that “[s]tinky fee suits may actually discourage other legitimate and serious claims, thus
doing further damage to our system”).
8
Transcript at 37, 59, 64, 70, Acevedo v. Aeroflex Holding Corp., No 7930-VCL (Del. Ch. July
8, 2015).
9
In re Walgreen Co. Stockholder Litig., 832 F.3d 718, 724 (7th Cir. 2016).
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Disclosure settlements in the state courts post-Trulia 193
of settlements was believed to have “created a real systemic problem.”10 There may be a
similar evolution in other states, which may now be confronted with class action deal liti-
gation on more than a sporadic basis. In that process, state court judges may be required
to focus on variations between their state’s law and Delaware law, both procedural and
substantive, which may either preclude or caution against a direct adoption and applica-
tion of Trulia or the adoption of the approach for reviewing disclosure settlements that
may now become favored by the Chancery Court.
A foundational consideration is that judges cannot be expected to adopt a procedure
that they believe will make it impossible to settle cases. If judges confronted with class
action litigation conclude that the only practical way to settle the litigation is to allow for a
significant award of attorneys’ fees, there will be a natural resistance to adopting a rule that
prohibits any such fees from being awarded. There are also well-grounded public policy
reasons not to adopt rules that would close the courthouse to legitimate litigation that chal-
lenges certain transactions. Litigation has long been recognized as playing a valuable role
in the overall scheme of corporate governance, providing necessary checks and balances
on the activities of corporate directors.11 And corporations likewise will resist a procedure
that will effectively rob them of the ability to remove a litigation impediment to moving
a transaction forward. Trulia accommodates those competing concerns in its balancing
approach. But where the court’s ability to award attorneys’ fees is limited—for example,
by the absence of the “corporate benefit” doctrine—how is that balance to be achieved?
In predicting how Trulia will be applied in various states, it is significant that the
Delaware courts recognize the corporate benefit doctrine as an exception to the American
Rule prohibiting the award of attorneys’ fees to a successful litigant.12 The corporate
benefit doctrine allows a court to award—and, presumably, parties to contract to pay—
attorneys’ fees to class counsel because of the nonmonetary relief achieved for the class,
unaccompanied by a common monetary fund from which fees can be taken, with the
result that the fees are shifted to the settling corporation.13 The corporate benefit doctrine
is contrasted with a separate exception to the American Rule known as the “common
fund doctrine,” in which a monetary fund is created from which fees may be paid.14 The
common fund exception is widely recognized. The corporate benefit doctrine is not.
10
Transcript of Oral Argument at 65, In re Aruba Networks Stockholder Litig., C.A. No
10765-VCL (Del. Ch. Oct. 9, 2015) (Laster, V.C.). Vice Chancellor Glasscock has made similar
observations. See, e.g., In re Riverbed Tech., Inc. Stockholders Litig., C.A. No 10484-VCG, 2015
WL 5458041 (Del. Ch. Sept. 17, 2015).
11
See Shaner (2014: 327) (describing derivative litigation as “vital to a successful system of
internal corporate governance and management accountability,” and noting that such litigation “is
the most powerful tool available to stockholders in checking management power”).
12
The United States Supreme Court has described the American Rule as the “bedrock prin-
ciple” that courts must consider when awarding attorneys’ fees. Baker Botts L.L.P. v. ASARCO
LLC, 135 S. Ct. 2158, 2164 (2015) (quoting Hardt v. Reliance Standard Life Ins. Co., 560 U.S. 242,
252–53 (2010)). Under the American Rule, each litigant pays his or her own attorneys’ fees, regard-
less of whether the litigant wins or loses, absent a statute or contract that provides otherwise. Ibid.
13
See, e.g., Alaska Elec. Pension Fund v. Brown, 988 A.2d 412, 417 (Del. 2010); Dover
Historical Soc’y, Inc. v. City of Dover Planning Comm’n, 902 A.2d 1084, 1090 (Del. 2006); Cal-
Maine Foods, Inc. v. Pyles, 858 A.2d 927, 929 (Del. 2004).
14
See Boeing Co. v. Van Gemert, 444 U.S. 472, 478 (1980) (noting that the common fund
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Trulia allows for a successful class counsel to obtain an award of attorneys’ fees as long
as counsel can demonstrate that the disclosures had value to the class because they were
material. Chancellor Bouchard expressed a preference for an “optimal” approach of a
“mootness settlement,” whereby the corporation makes supplemental disclosures volun-
tarily without the benefit of a classwide release of all claims; the litigation is dismissed,
but with prejudice only to the named class representative; the transaction is presented
to shareholders for approval; and it moves forward if approved. Class counsel may then
pursue an award of attorneys’ fees either by a negotiated settlement or, if necessary,
through a contested legal proceeding.15 The benefits of such a procedure are obvious.
The class is not required to give a broad release, and the settling corporation maintains
an advocate’s incentive to contain the award of fees to a reasonable amount. But again,
in other states there may be constraints to adopting such an approach.
The majority of states strictly apply the American Rule and have not adopted the cor-
porate benefit doctrine.16 The American Rule is generally considered not only to constrain
the court’s ability to award attorneys’ fees, either as costs or damages, but also to prohibit
parties from agreeing on the payment of such attorneys’ fees as a matter of contract. In
those states that adhere strictly to the American Rule, in the absence of a common fund
from which fees may be paid, an award of attorneys’ fees depends on statutory authority.
Most often in merger litigation, the only statutory authority for an award of fees is the
octrine “rests on the perception that persons who obtain the benefit of a lawsuit without contrib-
d
uting to its costs are unjustly enriched at the successful litigant’s expense”).
15
See In re Trulia, Inc. Stockholder Litig., 129 A.3d 884, 896 (Del. Ch. 2016).
16
See, e.g., Client Follow-Up Co. v. Hynes, 434 N.E.2d 485, 491 (Ill. App. Ct. 1982) (recogniz-
ing the common fund doctrine but reaffirming that, “in the absence of a fund, a plaintiff’s attorney
is not entitled to attorney’s fees merely because he has conferred a benefit upon members of a class”
(quoting Hamer v. Kirk, 356 N.E.2d 524, 528 (Ill. 1976))); Hall v. Hamilton, 667 P.2d 350, 357
(Kan. 1983) (“The common-benefit doctrine is the subject of many varying interpretations based
upon common law and statutory differences between the states. Each jurisdiction has adopted its
own rules for the allowance or refusal to allow attorney fees in partition actions, and we see no
compelling reason to adopt or base our holding here upon the rules adopted elsewhere”); Kindred
v. City of Omaha Emps.’ Ret. Sys., 564 N.W.2d 592, 596 (Neb. 1997) (recognizing a common fund
exception, but not an expansion on the doctrine); Am. Civil Liberties Union of N.M. v. City of
Albuquerque, 992 P.2d 866, 876 (N.M. 1999) (declining to expand an award of attorneys’ fees by
use of the substantial benefit doctrine); Kaufman Malchman & Kirby, P.C. v. Hasbro, Inc., 897
F. Supp. 719, 722 (S.D.N.Y. 1995) (applying Rhode Island law and stating that “Rhode Island
courts have never found such a[] [common benefit] exception to exist”); In re Wachovia S’holders
Litig., 607 S.E.2d 48, 52 (N.C. Ct. App. 2005) (recognizing the common fund doctrine but affirm-
ing that North Carolina does not recognize the incorporation of the common benefit doctrine);
Petow v. Warehime, 996 A.2d 1083, 1088 (P.A. Super. Ct. 2010) (affirming that the court “do[es]
not recognize the common or substantial benefit doctrine as the law in Pennsylvania”); Kanaly v.
South Dakota ex rel. Janklow, 401 N.W.2d 551, 553 (S.D. 1987) (holding that no exception to the
American Rule is permitted, because it is not expressly or specifically provided for by any statute
and is therefore prohibited); Kaniecki v. O’Charley’s Inc., No M2012-02221-COA-R3CV, 2014 WL
575904, at *3–4 (Tenn. Ct. App. Feb. 11, 2014) (applying the American Rule strictly, but recogniz-
ing the common-fund doctrine and declining to apply the substantial benefit doctrine); Robes v.
Town of Hartford, 636 A.2d 342, 350 (Vt. 1993) (“Vermont has not recognized the ‘common fund’
exception, and we see no reason to do so today”); Mkt. St. Sec., Inc. v. Midwest Air Grp., Inc.,
No 07-CV-345, 2009 WL 2985451, at *3 (E.D. Wis. Sept. 15, 2009) (noting that Wisconsin law has
adopted the common fund doctrine but not the common benefit doctrine).
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particular state’s statute regulating shareholder derivative actions, which may allow for
fees to be awarded if the litigation obtains substantial benefit for the corporation.17 In that
event, separate procedural issues arise, some of which are discussed presently.18
With this background in mind, the following factors may arise alone or in combination
when a court outside of Delaware is presented with a request to approve a disclosure-
based class action challenging a merger transaction. The discussion assumes that the
litigation is pending only in a single state and does not address separate considerations
that may be involved where one state court is asked to defer to other pending litigation
involving the same transaction in another state. The procedure for such discretionary
stays is a generally well-settled and common procedure.19
A court’s first inquiry is to determine what law it should apply. There is not always an
obvious choice involving an interplay in a court’s determination on whether it should
honor a contractual choice and whether the issues at hand should be deemed substantive
or procedural. Particular considerations arise where the corporation is incorporated in
Delaware but has its principal place of business in the state being asked to consider the
disclosure settlement. Many Delaware-based corporations have chosen to enact forum
selection bylaws based on the authority of Boilermakers Local 154 Retirement Fund v.
Chevron Corp.20 and City of Providence v. First Citizens BancShares, Inc.21 Trulia may
increase the frequency of such bylaws. To date, most states have honored such bylaws
when confronted with them.22 However, Trulia conceivably could present a counterincen-
tive for a board of directors to waive the protection of such bylaws if the only pathway
toward settlement is to agree to a settlement that might be expected to be rejected by the
Chancery Court but approved by the local state court.
Where a suit involving a Delaware corporation remains outside of Delaware and there
is no contractual choice-of-law provision, the forum court must consider how the internal
affairs doctrine should apply. The internal affairs doctrine calls for application of the law
of the state of incorporation on matters affecting corporate governance.23 A suit that
17
See, e.g., N.C. Gen. Stat. § 55-7-46(1) (2015) (providing that, upon termination of a deriva-
tive proceeding, the court may “[o]rder the corporation to pay the plaintiff’s reasonable expenses,
including attorneys’ fees, incurred in the proceeding if it finds that the proceeding has resulted in a
substantial benefit to the corporation”).
18
This chapter does not address the impact that corporate bylaws could have on derivative
litigation challenging corporate transactions, such as requiring any derivative plaintiff to own or
control a minimum percentage ownership.
19
See N.C. Gen. Stat. § 1-75.12 (2015); see also Paramount RX, Inc. v. Duggan, No 14 CVS
13216, 2015 WL 1421391 (N.C. Super. Ct. Mar. 27, 2015); Justewicz v. Sealy Corp., No 12 CVS
2417, 2012 WL 5959397 (N.C. Super. Ct. Nov. 27, 2012).
20
73 A.3d 934 (Del. Ch. 2013).
21
99 A.3d 229 (Del. Ch. 2014).
22
See, e.g., North v. McNamara, 47 F. Supp. 3d 635 (S.D. Ohio 2014); In re MetroPCS
Commc’ns, Inc., 391 S.W.3d 329 (Tex. Ct. App. 2013). But see, e.g., Roberts v. TriQuint
Semiconductor, Inc., 364 P.3d 328 (Or. 2015) (refusing to enforce bylaw that was adopted following
alleged wrongdoing).
23
See Sagarra Inversiones, S.L. v. Cementos Portland Valderrivas, S.A., 34 A.3d 1074, 1081–82
(Del. 2011) (describing the internal affairs doctrine as “a dominant and overarching choice of law
principle,” and stating that “[a]n important rationale for the doctrine is that, ‘in order to prevent
corporations from being subjected to inconsistent legal standards, the authority to regulate a
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challenges a transaction for breaches of directors’ fiduciary duties would seem to clearly
present an issue of corporate governance.24
The internal affairs doctrine is generally considered to require only that the substantive
law of the incorporating state be applied, with procedural matters to be governed by the
law of the forum state.25 There have been instances—such as, for example, in choosing a
statute of limitations—where courts have elected to treat as a matter of substance an issue
that otherwise is normally considered procedural, because to do otherwise would have an
improper impact on the underlying matter of internal corporate governance.26 Reasoned
arguments can be made on both sides of the issue as to whether the award of attorneys’ fees
in a settlement involving a class challenge to a corporate acquisition is a matter of substance
or procedure. It is not clear whether the award of attorneys’ fees would be determined from
state to state as a matter of substantive or procedural law. A recent ruling from a New Jersey
state court suggests that some courts may elect to treat the Trulia standard as a matter of
substantive law when applied to transactions involving Delaware corporations.27
Where Delaware law is potentially persuasive but not controlling, a court may be
confronted with significant differences between Delaware’s corporate laws and the cor-
porate laws of the forum state. The forum state may apply a different standard of review
for measuring the conduct of the board of directors. Following the Delaware Supreme
Court’s decision in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.,28 the North
Carolina General Assembly enacted legislation providing that a director’s duties do not
change in a change-of-control environment.29 There may likely be significant variations
in the procedural requirements for derivative litigation in the various states. For example,
Delaware law allows for demand futility, whereas North Carolina by statute requires strict
compliance with a statutory demand and waiting period.30 Such a variance can have very
practical significance on a court’s selection of lead counsel or a lead complaint when
confronted with multiple filings in the “race to the courthouse,” which in turn may require
application of a “first to file” rule.31
That choice may prove to be significant in those states that do not allow for the
corporation’s internal affairs should not rest with multiple jurisdictions’” (quoting VantagePoint
Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108, 1112 (Del. 2005))).
24
See, e.g., In re Topps Co. S’holders Litig., 924 A.2d 951, 960 (Del. Ch. 2007) (“[T]he adjudi-
cation of cases involving the fiduciary duties of directors . . . is one of the most important methods
of regulating the internal affairs of corporations”).
25
See ibid.
26
See, e.g., Tong v. Dunn, Nos. 11 CVS 1522, 13 CVS 1318, 2016 WL 3944092, at *4–5 (N.C.
Super. Ct. July 8, 2016).
27
Vergiev v. Aguero, No L-2276-15, Statement of Reasons at 6 (N.J. Super. Ct. June 6, 2016),
http://blogs.reuters.com/alison-frankel/files/2016/08/griffithnewjersey.pdf.
28
506 A.2d 173 (Del. 1986).
29
N.C. Gen. Stat. § 55-8-30(d) (2015) (“The duties of a director weighing a change of control
situation shall not be any different, nor the standard of care any higher, than otherwise provided
in this section”).
30
See ibid § 55-7-42; Allen v. Ferrera, 540 S.E.2d 761, 765 (N.C. Ct. App. 2000). Cf. In re
Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 120 (Del. Ch. 2009) (reciting the legal
standard for demand futility under Delaware law).
31
See, e.g., Biondi v. Scrushy, 820 A.2d 1148, 1154 (Del. Ch. 2003), aff’d sub nom. In re
HealthSouth Corp. S’holders Litig., 847 A.2d 1121 (Del. 2004) (unpublished table decision).
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corporate benefit doctrine, where the ultimate award of attorneys’ fees in connection
with a disclosure-based settlement depends on statutory authorization, and the only
potential authorizing statute is one that allows a court to award attorneys’ fees upon a
finding that the litigation has achieved a substantial corporate benefit. But even there,
difficult potential questions arise regarding whether a disclosure claim is deemed to be
a direct action or a derivative action. Typically, the idea has been that a class complaint
challenging a corporate transaction involves a panoply of claims, including those that
challenge the process or overall fairness of the transaction, in addition to those that focus
on the adequacy of disclosures for which shareholder approval is requested. In the typical
disclosure settlement, only the disclosure claims are addressed in seeking approval of the
settlement, with other claims being abandoned. The question may then arise whether the
claim upon which the adequacy of the settlement is premised is one that allows for an
award of attorneys’ fees as a derivative claim that achieves a benefit for the corporation.
The argument as to whether a disclosure claim is a direct claim, a derivative claim,
or both is not fully settled. For example, North Carolina, like other states, distinguishes
between a direct claim, in which the shareholder seeks to recover for injuries specific to
that shareholder or because of a special duty owed to that shareholder, and a derivative
claim, in which the shareholder seeks recovery only for injuries or damages suffered by
other shareholders in common, such as effect on share price.32 The argument in favor of a
disclosure claim being a direct claim focuses on the fact that the shareholder is being asked
to vote individually to approve corporate action. The argument in favor of a disclosure
claim being a derivative claim is that all shareholders are similarly situated and are being
asked collectively to vote in favor of the transaction. North Carolina’s intermediate
appellate court has suggested that a disclosure claim may be direct,33 but the state’s highest
court has not yet addressed the issue.
A court may ignore such procedural distinctions when motivated by the inherent
preference for settlement, as long as the amount of fees is not so unreasonable as to be
uncomfortable to award or where the substance of the settlement does not appear out of
bounds. Arguably, those were the motivations for Delaware’s early approval process before
any pernicious effect of disclosure settlements became evident. Similar considerations
may be evident in North Carolina’s approach to date in considering disclosure-based
settlements, both before and after Trulia.
North Carolina’s appellate courts historically have been staunch advocates of the
American Rule.34 In one case, a North Carolina trial court was presented with a series
of class actions challenging a bank merger.35 As the litigation progressed, primary
responsibility was assumed by counsel, which had not brought a derivative action.36 Upon
settlement, the trial court elected to grant the predominant share of fees to class counsel
pursuant to the common benefit doctrine, finding that the lead class counsel should be
32
See Barger v. McCoy Hillard & Parks, 488 S.E.2d 215, 220–21 (N.C. 1997).
33
See Ehrenhaus v. Baker, 717 S.E.2d 9, 27 (N.C. Ct. App. 2011).
34
See, e.g., ibid at 32.
35
In re Wachovia S’holders Litig., No 01 CVS 4486, 2003 WL 22996328 (N.C. Super. Ct. Dec.
19, 2003), rev’d, 607 S.E.2d 48 (N.C. Ct. App. 2005).
36
Ibid at *3.
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credited with the benefits of the settlement.37 The trial court granted a lesser share of fees
to counsel who had brought a derivative action but did not assume primary responsibility
for the litigation.38 The North Carolina Court of Appeals rejected the trial court’s use of
the corporate benefit doctrine and chose to adhere to the American Rule.39
Later, without discussing this earlier decision, the North Carolina Court of Appeals
approved the award of fees for the settlement of a class claim without squarely address-
ing the authority upon which the award was based.40 While not addressing that initial
question of authority, the court adopted a test for measuring the amount of fees awarded
that was premised on factors derived from Rule 1.5 of the North Carolina Rules of
Professional Conduct, most often applied in the context of a contingency fee allowing for
the attorney to be paid a percentage of a recovery.41
Thereafter, the North Carolina Business Court was on several occasions requested to
approve disclosure settlements, with class counsel regularly justifying the request by citing
settlements and fee awards approved by the Delaware Chancery Court.42 By and large,
class counsel simply assumed that the settling parties had the right to contract, and that
the court had the right to approve, the award of attorneys’ fees, so long as the standard
of reasonableness adopted earlier by the appellate court was satisfied.
The Business Court approved the settlements based on the assumption that the appel-
late courts had tacitly recognized the court’s authority to do so.43 In a recent subsequent
opinion, North Carolina’s intermediate appellate court held more squarely that parties
can, through a settlement agreement, contract for the award of attorneys’ fees in order
to settle class litigation, but in the process of so deciding did not discuss or seek to
distinguish a long line of North Carolina Supreme Court opinions that prohibit a grant
of attorneys’ fees as either damages or costs, whether by agreement or court order.44 The
North Carolina Supreme Court has not yet addressed the question whether parties can
contract for an award of attorneys’ fees to settle class litigation in the absence of express
statutory authority, or whether, in the context of deal litigation, such authority may be
found based on the statute authorizing derivative actions where the settlement yields no
monetary fund.45
37
Ibid at *13.
38
Ibid at *18–19.
39
In re Wachovia S’holders Litig., 607 S.E.2d at 52–53.
40
Ehrenhaus v. Baker, 717 S.E.2d 9, 34–35 (N.C. Ct. App. 2011).
41
See, e.g., ibid at 33–34 (analyzing the reasonableness of an attorneys’ fee award based on
North Carolina Rule of Professional Conduct 1.5); In re Harris Teeter Merger Litig., No 13 CVS
12579, 2014 WL 4748566, at *9 (N.C. Super. Ct. Sept. 24, 2014).
42
See Corwin v. British Am. Tobacco PLC, No 14 CVS 8130, 2016 WL 635191 (N.C. Super.
Ct. Feb. 17, 2016); In re Pike Corp. S’holder Litig., No 14 CVS 1202, 2015 WL 5918183 (N.C.
Super. Ct. Oct. 8, 2015); Nakatsukasa v. Furiex Pharm., Inc., No 14 CVS 6156, 2015 WL 4069818
(N.C. Super. Ct. July 1, 2015); In re Pokertek Merger Litig., No 14 CVS 10579, 2015 WL 270210
(N.C. Super. Ct. Jan. 22, 2015); In re Harris Teeter, 2014 WL 4748566; In re Progress Energy
S’holder Litig., No 11 CVS 739, 2011 WL 5967183 (N.C. Super. Ct. Nov. 29, 2011).
43
See Ehrenhaus, 717 S.E.2d at 34–35.
44
Ehrenhaus v. Baker, 776 S.E.2d 699, 707 (N.C. Ct. App. 2015).
45
The underlying question of the court’s authority was presented to the North Carolina
Supreme Court on an appeal of the approval of class settlement where the settling corporation
had agreed to an award of attorneys’ fees but did not agree to the amount of fees the trial court
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If the reviewing court is satisfied of its authority to award attorneys’ fees in a disclosure
settlement, it then must confront the difficult task of assessing the materiality of the
disclosure and the comparative value of that disclosure in comparison to the amount of
attorneys’ fees requested. These are related but distinct questions, and neither is particu-
larly within the common experience of a judge who is not regularly involved in litigation
challenging or valuing corporate transactions.
The approach of assessing the reasonableness of fees based on the Rules of Professional
Conduct becomes decidedly more difficult when there is no common fund from which the
fees will be taken, as those factors are more easily applied when measuring an attorney’s
share of a monetary settlement based on a contingency fee agreement. Those factors
include:
(1) the time and labor required, the novelty and difficulty of the questions involved, and
the skill requisite to perform the legal service properly;
(2) the likelihood, if apparent to the client, that the acceptance of the particular employ-
ment will preclude other employment by the lawyer;
(3) the fee customarily charged in the locality for similar legal services;
(4) the amount involved and the results obtained;
(5) the time limitations imposed by the client or by the circumstances;
(6) the nature and length of the professional relationship with the client;
(7) the experience, reputation, and ability of the lawyer or lawyers performing the
services; and
(8) whether the fee is fixed or contingent.46
Those factors guard against an excessive fee when measured by an attorneys’ efforts, but
they do not provide a meaningful, objective standard for measuring whether there is any
significant nonmonetary benefit obtained through a supplemental disclosure.
Those who have been deeply entrenched in the efforts to attack the overall landscape
of disclosure settlements leading up to Trulia may be inclined to argue that Trulia has
now made the test a simple one and that a court should apply a strict standard without
hesitation. The discomfort confronted by a trial judge when attempting to measure the
adequacy of a supplemental disclosure and the potential arrogance of belittling that
discomfort is evident in the recent decision in In re Walgreen Co. Stockholder Litigation.47
There, the district court judge approved a disclosure settlement, including a significant
attorneys’ fee award, but before doing so expressed a concern as to the court’s ability
to assess the materiality of the supplemental disclosures, reaching no comfortable
decision as to whether the disclosures were clearly material.48 Judge Posner had no
such discomfort in criticizing the trial court’s hesitancy and suggesting that a simple
awarded. See In re Pike Corp., 2015 WL 5918183. The case settled while the appeal was pend-
ing, and thus, no appellate decision was issued. See In re Pike Corp., 2015 WL 5918183, appeal
dismissed sub nom. Orban v. Pike Corp., No 32A16 (N.C. Mar. 29, 2016).
46
N.C. R. Prof’l Conduct 1.5; Ehrenhaus, 717 S.E.2d at 33–34.
47
In re Walgreen Co. Stockholder Litig., No 1:14-cv-9786 (N.D. Ill. Nov. 20, 2015), rev’d, 832
F.3d 718 (7th Cir. 2016).
48
See Transcript of Proceedings at 36–37, In re Walgreen Co., No 1:14-cv-9786.
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approach to addressing any such discomfort was available through the expediency of a
court-appointed expert.49
Judge Posner observed that Federal Rule of Evidence 706 would allow the trial court
to appoint an expert to assess the materiality of disclosures.50 He did not comment
further on how such an approach would be implemented where one of the two advocates,
the settling corporation, could not be expected to advocate against the settlement.51
Likewise, most states would grant the trial court similar authority, as most have adopted
evidentiary rules modeled on the federal rules. However, in the typical process, should a
court appoint its own expert, and should such expert’s opinion become the basis of the
court’s decision, generally the expert would be made available for examination by the
litigants, and opposing litigants would participate. But as Chancellor Bouchard pointed
out, that adversarial process is no longer at play when both the class representative and the
corporation promote the settlement.52 But in that circumstance, practical considerations
arise as to how to involve an expert. Does the court assume its own role as an advocate? Is
the court required to tender the equivalent of an expert disclosure or report before making
the expert available for examination? There is also the potentially significant expert cost
that presumably would be borne by the settling corporation.
To date, in many cases, the advocate’s role left aside by the settling corporation has
been assumed by an objecting class member. Professor Sean Griffith has been effective
in opposing disclosure-based settlements.53 But often, an objector’s first notice of the
settlement may be shortly before a fairness hearing is scheduled, and the particular
circumstances of a settlement may demand that the court condition the time required for
full consideration of arguments presented by the objector on a delay in the shareholder
vote to consider the transaction and the many factors that may be involved in such a
balancing determination.
This chapter’s primary focus has been on the component of the disclosure settlement
that provides for the award of attorneys’ fees, and on noting the issues that a non-
Delaware court may encounter due to the absence of a recognized corporate benefit
doctrine. Clearly, there are potential abuses when a settlement offers a release of claims
that is not commensurate with the settlement consideration, and those considerations
may be deserving of a separate article altogether.
The significant point is that Trulia was adopted by the Court of Chancery after many
years of handling deal litigation and developing standards under which disclosure settle-
ments became prevalent. The Court of Chancery, based on the manifest results of its own
procedures, has now elected to retrench. If, as predicted, the substantial volume of deal
litigation now moves away from Delaware courts, to other state courts, those courts may
ultimately follow the path toward a strict standard of review. But, before doing so, they
depend on their own independent experiences, which will require weaving through the
49
In re Walgreen Co., 832 F.3d at 724.
50
Ibid.
51
Ibid.
52
In re Trulia, Inc. Stockholder Litig., 129 A.3d 884, 893 (Del. Ch. 2016).
53
See, e.g., Brief of Sean J. Griffith as Amicus Curiae, In re Trulia, 129 A.3d 884 (C.A.
No 10020-CB); In re Riverbed Tech., Inc. Stockholders Litig., C.A. No 10484-VCG, 2015 WL
5458041, at *2, *6 (Del. Ch. Sept. 17, 2015).
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many issues presented by deal litigation involving high-dollar transactions proceeding at

a fast pace and involving complex and sophisticated financial issues for which most judges
are ill-trained. Until such time as it may be proven that no disclosure-based litigation has
merit, judges will instinctively look for ways to settle such complex litigation. And often,
some assurance of a pathway toward the recovery of attorneys’ fees for class counsel may
be a predicate for any such settlement.
BIBLIOGRAPHY
Cornerstone Research, 2016. “Shareholder Litigation Involving Acquisitions of Public Companies,” available
at www.cornerstone.com.
O’Connell, K. Tyler, Emily V. Burton, & Julia B. Ripple, October 2015. “Reducing the ‘Deal Tax’: Delaware’s
Recent Scrutiny of Nonmonetary Settlements,” Business Law Today.
Ratner, Morris A., 2015. “Class Counsel as Litigation Funders,” Georgetown Journal of Legal Ethics 28:271.
Shaner, Megan W., 2014. “The (Un)Enforcement of Corporate Officers’ Duties,” UC Davis Law Review
48:271–336.
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13. Changing attitudes: the stark results of thirty
years of evolution in Delaware M&A litigation
J. Travis Laster*
More than 30 years ago, during the remarkable “watershed year” of 1985,1 the Delaware
Supreme Court issued four landmark decisions: Van Gorkom,2 Unocal,3 Moran,4 and
Revlon.5 Together, these decisions established a new framework for reviewing third
party mergers and acquisitions.6 Since then, Delaware courts have reviewed third party
M&A scenarios, such as hostile bids and transactions involving a change of control,
using an intermediate standard known as enhanced scrutiny. Under that standard, the
* This chapter revisits themes that I addressed during a speech on November 18, 2015, to the
Society of Corporate Secretaries and Governance Professionals in Wilmington, Delaware.
1
Veasey (1990) (reviewing Block et al. (1989)); accord Veasey (2004) (“The watershed year of
1985, featuring Smith v. Van Gorkom, Unocal, Moran v. Household, and Revlon, was indeed a time
when many of the rules of the road did change in the context of mergers and acquisitions” (cita-
tions omitted)). The four written opinions actually were issued during a 14-month period between
January 1985 and March 1986, making the reference to a single calendar year a form of interpretive
license reminiscent of the long nineteenth century of European historians. Delaware’s long year is
perhaps more temporally grounded because although the Delaware Supreme Court published the
written decision in Revlon on March 13, 1986, outside the calendar year, the high court issued its
injunction ruling orally from the bench on November 1, 1985, within the watershed.
2
Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), overruled on other grounds by Gantler v.
Stephens, 965 A.2d 695 (Del. 2009).
3
Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
4
Moran v. Household Int’l, Inc., 500 A.2d 1346 (Del. 1985).
5
Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173 (Del. 1986).
6
By third party mergers and acquisitions, I mean a transaction negotiated at arm’s length,
or a board’s arm’s length resistance to a hostile bid. I exclude from this term scenarios where the
counterparty is a controlling stockholder, or where a majority of the directors have a traditional
conflict of interest resulting from direct transaction-related benefits. The latter two transactional
categories have long been governed by the entire fairness test, and during the 1980s they continued
to be. See Rosenblatt v. Getty Oil Co., 493 A.2d 929 (Del. 1985); Weinberger v. UOP, Inc., 457
A.2d 701 (Del. 1983). The principal doctrinal development for controlling stockholder transac-
tions took place in the 1990s, when the Delaware Supreme Court held that the threat of inherent
coercion created by the presence of a controlling stockholder meant that the use of a special
committee of independent directors was not sufficient to restore business judgment review. See
Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110 (Del. 1994). Recent Delaware Supreme Court
decisions show evolving attitudes in this area as well. See In re Cornerstone Therapeutics Inc.,
S’holder Litig., 115 A.3d 1173 (Del. 2015) (holding that presence of controller and threat of inher-
ent coercion are insufficient to call into question independence and disinterestedness of a director
for purposes of pleading a claim for breach of fiduciary duty that would overcome exculpation
under Del. Code Ann. tit 8 § 102(b)(7)) (2016); Kahn v. M & F Worldwide Corp., 88 A.3d 635
(Del. 2014) (holding that use of both a special committee and a majority-of-the-minority vote ab
initio are sufficient to negate the threat of inherent coercion and cause the operative standard of
review to be the business judgment rule).
202
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Changing attitudes 203
defendant directors bear the burden of proving that they sought to serve a legitimate
corporate purpose and that their actions fell within a range of reasonableness (Laster
2013b).7
The concept of reasonableness can denote an objective standard that requires an
assessment of what humans generally should do when presented with a particular set of
factual circumstances. But there is no Platonic form of reasonableness, and attitudes and
perceptions necessarily influence the determination. Whenever possible, judges charged
with striving to apply neutral principles of law must draw those attitudes and perceptions
from authoritative legal sources, such as constitutions, statutes, and judicial precedent.
For the Delaware common law of fiduciary obligations, the attitudes and perceptions that
emerge from the Delaware Supreme Court’s opinions and the justices’ scholarly writings
necessarily and substantially influence a trial court’s assessment of what types of conduct
are reasonable.
Over the decades, the Delaware Supreme Court’s attitudes and perceptions of recurring
third party M&A scenarios have evolved significantly, and the pragmatic application of
enhanced scrutiny has evolved with them. Many of the attitudes exhibited in the opinions
from the watershed year and its aftermath no longer hold. More recent Delaware Supreme
Court case law manifests quite different perceptions.
This chapter highlights four of these areas (more could be identified). In doing so, it
does not suggest that the current attitudes burst forth suddenly or out of the blue. Most
of the intervening evolutionary work took place at the Court of Chancery level, and this
chapter does not attempt the daunting (but laudable) task of chronicling the intervening
developments.
Nor does this chapter suggest that the current attitudes are misguided, or that the
process by which they have developed is inappropriate. To the contrary, the evolutionary
process fulfills a promise that the Delaware court made 30 years ago in the landmark
Unocal decision: “[O]ur corporate law is not static. It must grow and develop in response
to, indeed in anticipation of, evolving concepts and needs.”8 Although other factors could
be cited, this chapter points to two predominant influences: (1) the rise of sophisticated
institutional investors who have the ability to influence the direction of the corporations
in which they invest and determine the outcome of M&A events, and (2) the systemwide
failure of stockholder-led M&A litigation to generate meaningful benefits for investors,
setting aside occasional recoveries by a small subset of the bar.
Regardless of the reasons, enhanced scrutiny as applied in the second decade of
the current millennium differs markedly from enhanced scrutiny as applied during the
watershed year and its aftermath. No longer can courts, practitioners, or scholars treat
the old learning as authoritative, simply because the decisions have not been formally
overruled. The law operates not only through the formal standard of review, but more
directly through the manner in which it is applied. For enhanced scrutiny, the mode of
application has become significantly more deferential to sellside boards.
7
See, e.g., Pell v. Kill, 135 A.3d 764, 784–86 (Del. Ch. 2016) (describing parameters of enhanced
scrutiny); Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457–59 (Del. Ch. 2011) (same).
8
Unocal, 493 A.2d at 957.
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1. EARLY ATTITUDES TOWARD RECURRING M&A

SCENARIOS
The Delaware Supreme Court’s decisions during the watershed year of 1985 and for
approximately a decade thereafter, culminating in its opinion in QVC,9 reflected a particu-
lar set of attitudes toward recurring M&A scenarios. One strong message was skepticism
toward management-led, single-bidder processes, combined with encouragement of
board-led, multibidder processes. Skepticism also greeted the deployment of defensive
measures, particularly no-shop clauses, that appeared designed to limit a board’s ability
to generate multibidder processes. When the Delaware Supreme Court deemed a defensive
measure to be questionable, it prioritized the fiduciary responsibilities of the selling
directors over the contract rights of the third party acquirer. The high court’s decisions
during this era did not regard stockholders as capable of protecting their own interests
through voting, leaving the court to fill the gap by enforcing the directors’ fiduciary duties.
The resulting framework led to targeted preliminary injunctions that enjoined the specific
features of the transaction agreements that the high court found problematic.
1.1 Skepticism about Management-Led, Single-Bidder Processes
In its early enhanced scrutiny decisions, the Delaware Supreme Court consistently
displayed skepticism toward management-led, single-bidder transactions while appearing
to favor multibidder scenarios. Looking back on the case law from the era, Chancellor
Allen remarked that “perhaps one of the clearest messages repeatedly affirmed by the
Delaware Supreme Court’s corporate law jurisprudence from 1985 forward is that outside
directors may not blindly rely upon a strong CEO without risk.”10 While serving on the
Court of Chancery, Chief Justice Leo E. Strine, Jr. similarly described the “paradigmatic
context for a good Revlon claim” as one where “a supine board under the sway of an
overweening CEO bent on a certain direction, tilts the sales process for reasons inimical
to the stockholders’ desire for the best price.”11
These judicial preferences burst forth in 1985 with the decisions in Van Gorkom and
Revlon, which bookended the watershed year. Van Gorkom was the first of the four
landmark opinions, and although the Delaware Supreme Court did not expressly apply
enhanced scrutiny (it was not invented until five months later in Unocal), a broad
consensus now exists that Van Gorkom was the Delaware Supreme Court’s initial—albeit
unacknowledged—enhanced scrutiny decision.12 The blunt practical outcome of Van
9
Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34 (Del. 1994).
10
Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1141 (Del. Ch. 1994), aff’d, 663 A.2d
1156 (Del. 1995).
11
In re Toys “R” Us, Inc. S’holder Litig., 877 A.2d 975, 1002 (Del. Ch. 2005).
12
See In re Dollar Thrifty S’holder Litig., 14 A.3d 573, 602 (Del. Ch. 2010) (“Van Gorkom,
after all, was really a Revlon case”) (footnotes omitted); Gagliardi v. TriFoods Int’l, Inc., 683
A.2d 1049, 1051 n.4 (Del. Ch. 1996) (“I count [Van Gorkom] not as a ‘negligence’ or due care case
involving no loyalty issues, but as an early and, as of its date, not yet fully rationalized, ‘Revlon’
or ‘change of control’ case”); see also Allen, Jacobs, and Strine, Jr. (2002: 459 n.39) (“Van Gorkom
. . . must also be viewed as part of the Delaware courts’ effort to grapple with the huge increase in
mergers and acquisition activity in the 1980s and the new problems that posed for judicial review
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Gorkom was to hold independent directors liable for approving a merger that resulted
from a single-bidder process dominated by the CEO. The Delaware Supreme Court
seemed to be sending a clear message: Don’t do what the Van Gorkom directors did.
Revlon, fourteen months later, appeared to make explicit what was implicit in Van
Gorkom, namely that a sellside board was supposed to engage with multiple bidders. In
Revlon, a board of directors initially resisted a hostile bid, but once the bid reached a
certain level it authorized management to explore a management buyout. The Delaware
Supreme Court held that “[t]he Revlon board’s authorization permitting management to
negotiate a merger or buyout with a third party was a recognition that the company was for
sale.”13 Then, in the ringing words that have formed the principal legacy of the decision, the
Delaware Supreme Court stated that “[t]he directors’ role changed from defenders of the
corporate bastion to auctioneers charged with getting the best price for the stockholders at a
sale of the company.”14 The reference to an auction seemed to contemplate multiple bidders.
In Barkan,15 three years later, the Delaware Supreme Court used dictum to weigh in at
length on its preference for multiple-bidder scenarios. Barkan arose in the relatively rare
procedural posture of an objector appealing the approval of a settlement. Two groups of
stockholder plaintiffs had challenged a management buyout in which the board neither
sought out nor received competing bids. The lead plaintiffs filed suit immediately after the
announcement of an earlier transaction that was subsequently abandoned in favor of the
MBO, did not engage in meaningful litigation activity, did not update their complaints
to challenge the MBO, and accepted as the consideration for their settlement a price
bump negotiated independently by a large stockholder. When they sought approval of
the settlement, Chancellor Allen was “frank to say that [he] regard[ed] this as a difficult
motion,”16 and he detailed many concerns about the underlying transaction and how the
plaintiffs had approached their case. But he approved the settlement.
On appeal, the Delaware Supreme Court affirmed, then took the opportunity to express
its own concerns about the deal process. First, the high court addressed whether enhanced
scrutiny would have applied to the plaintiffs’ postclosing claims for breach of fiduciary
duty, had they pressed them at trial:
There is some dispute among the parties as to the meaning of Revlon, as well as its relevance to
the outcome of this case. We believe that the general principles announced in Revlon, in [Unocal],
of director conduct”); Allen (1998: 325) (“In retrospect, [Van Gorkom] can be best rationalized not
as a standard duty of care case, but as the first case in which the Delaware Supreme Court began to
work out its new takeover jurisprudence”); Black and Kraakman (2002: 522) (“Van Gorkom should
be seen not as a business judgment rule case but as a takeover case that was the harbinger of the
then newly emerging Delaware jurisprudence on friendly and hostile takeovers, which included the
almost contemporaneous Unocal and Revlon decisions”); Macey and Miller (1988: 128) (“Trans
Union is not, at bottom, a business judgment case. It is a takeover case”); Bainbridge (2002: 51–52)
(interpreting “the oft-maligned decision in Smith v. Van Gorkom” as addressing a breakdown in
the group decision-making process in which the board “blindly relied on Van Gorkom,” thereby
enabling Van Gorkom to not disclose and the board to not discover “key facts suggesting that the
deal was not as attractive as it seemed on first look”).
13
Revlon Inc. v. MacAndrew & Forbes Hldgs., Inc., 506 A.2d 173, 181 (Del. 1986).
14
Ibid.
15
Barkan v. Amsted Indus., 567 A.2d 1279 (Del. 1989).
16
In re Amsted Indus. Inc. Litig., 1988 WL 92736, at *1 (Del. Ch. Aug. 24, 1988).
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and in [Moran] govern this case and every case in which a fundamental change of corporate
control occurs or is contemplated. However, the basic teaching of these precedents is simply
that the directors must act in accordance with their fundamental duties of care and loyalty. It is
true that a court evaluating the propriety of a change of control or a takeover must be mindful
of “the omnipresent specter that a board may be acting primarily in its own interests, rather
than those of the corporation and its shareholders.” Nevertheless, there is no single blueprint
that a board must follow to fulfill its duties. A stereotypical approach to the sale and acquisition
of corporate control is not to be expected in the face of the evolving techniques and financing
devices employed in today’s corporate environment. Rather, a board’s actions must be evaluated
in light of relevant circumstances to determine if they were undertaken with due diligence and
good faith.17
Today, the “no single blueprint” language is cited ubiquitously in support of an argument
that a board did not have to contact multiple bidders, but the central thrust of this passage
cut in the opposite direction. The Delaware Supreme Court was confirming that enhanced
scrutiny, which at that point carried the connotation of multiple bidders, applied generally
to “every case in which a fundamental change of corporate control occurs or is contem-
plated” and would have provided the operative standard of review for the claims that the
plaintiffs had settled.
Next, the Delaware Supreme Court directly reinforced its preference for multiple bid-
ders, explaining that a single-bidder process, while permissible, should be the exception
rather than the rule:
This Court has found that certain fact patterns demand certain responses from the directors.
Notably, in Revlon, we held that when several suitors are actively bidding for control of a
corporation, the directors may not use defensive tactics that destroy the auction process. When
it becomes clear that the auction will result in a change of corporate control, the board must act
in a neutral manner to encourage the highest possible price for shareholders. However, Revlon
17
Barkan, 567 A.2d at 1286 (quoting Unocal) (citations omitted). Other Delaware Supreme
Court decisions similarly have held that enhanced scrutiny applies to postclosing breach of fiduci-
ary duty claims. See Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 242–44 (Del. 2009) (agreeing with
Court of Chancery that enhanced scrutiny governed postclosing claim that directors acted in bad
faith when approving sale of corporation for cash, but reversing denial of summary judgment on
grounds that plaintiffs had not cited evidence to support their theory of bad faith); McMullin v.
Beran, 765 A.2d 910, 918–20 (Del. 2000) (reversing the Court of Chancery’s dismissal of a claim
that directors had failed to obtain the best value reasonably available in a merger when selling to a
third party in a transaction that allegedly satisfied the controlling stockholder’s need for liquidity
and holding, in the context of a postclosing challenge to a cash sale, that the directors had the
burden to show that they acted reasonably to obtain the best value reasonably available and made a
reasonably informed decision to approve the challenged merger); In re Santa Fe Pac. Corp. S’holder
Litig., 669 A.2d 59, 71 (Del. 1995) (reversing dismissal of post-closing claim that directors had
breached their fiduciary duties by adopting unreasonable defensive measures as part of a third
party arm’s length merger agreement and holding that enhanced scrutiny governed the claim and
that the case therefore “differ[ed] from cases where the presumption of the business judgment
rule attaches ab initio and to survive a Rule 12(b)(6) motion, a plaintiff must allege well-pleaded
facts to overcome the presumption”). These decisions did not address whether a fully informed,
noncoerced stockholder vote (as opposed to the mere fact of closing) would lower the standard
of review. The Delaware Supreme Court has now held that stockholder approval both restores the
business judgment rule and renders it irrebutable. See Singh v. Attenborough, 137 A.3d 151 (Del.
2016); Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015).
M4633-GRIFFITH_t.indd 206 30/10/2018 08:16

does not demand that every change in the control of a Delaware corporation be preceded by a
heated bidding contest. Revlon is merely one of an unbroken line of cases that seek to prevent
the conflicts of interest that arise in the field of mergers and acquisitions by demanding that
directors act with scrupulous concern for fairness to shareholders. When multiple bidders are
competing for control, this concern for fairness forbids directors from using defensive mecha-
nisms to thwart an auction or to favor one bidder over another. When the board is considering
a single offer and has no reliable grounds upon which to judge its adequacy, this concern for
fairness demands a canvas of the market to determine if higher bids may be elicited. When,
however, the directors possess a body of reliable evidence with which to evaluate the fairness
of a transaction, they may approve that transaction without conducting an active survey of
the market. As the Chancellor recognized, the circumstances in which this passive approach is
acceptable are limited. “A decent respect for reality forces one to admit that . . . advice [of an
investment banker] is frequently a pale substitute for the dependable information that a canvas
of the relevant market can provide.”18
Today, the frequently quoted portion of this passage is the line stating that “Revlon does
not demand that every change in the control of a Delaware corporation be preceded by
a heated bidding contest.” The overall sense of the passage, however, seems to convey
a general expectation that directors “conduct[] an active survey of the market.” While
directors could forgo that step and deploy a single-bidder strategy if they had “a body
of reliable evidence with which to evaluate the fairness of a transaction,” the Barkan
decision cautions that “the circumstances in which this passive approach is acceptable
are limited.”19
A reader of the Delaware Supreme Court’s early third party M&A cases thus would get
the message that single-bidder processes should be rare. The high court’s attitude seemed
to be that single-bidder processes carried a risk that management would steer a transac-
tion to a favored bidder, and that without the information gained from contacting other
potential transaction partners, a board could not make a well-informed decision as to
whether to sign off on management’s chosen alternative. The Delaware Supreme Court’s
preference, therefore, was for the board to reach out to multiple transaction partners and
not pursue exclusively single-bidder deals.
1.2 Skepticism about Defensive Measures in Merger Agreements
Hand in hand with the Delaware Supreme Court’s skepticism toward single-bidder processes
came a complementary attitude to defensive measures in merger agreements. Consistent
with its preference for multibidder scenarios, the Delaware Supreme Court condemned the
use of defensive measures that appeared designed to end a sale process, but commended
the use of provisions that appeared designed to elicit additional bids. As a result, the early
Delaware Supreme Court decisions took a particularly negative view of no-shop clauses.
Revlon introduced this concept. As the final step in its resistance to a hostile offer, the
Revlon board approved a management buyout with a financial sponsor (Forstmann). The
unsolicited bidder (Pantry Pride) raised its bid again and announced that it would engage
18
Barkan, 567 A.2d at 1287 (internal citations omitted).
19
Later in the opinion, the Delaware Supreme Court reiterated this perspective in virtually
identical words, stating, “The situations in which a completely passive approach to acquiring
[market] knowledge is appropriate are limited.” Ibid at 1288.
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in fractional bidding to top any further increase by Forstmann. At that point, in return
for an increase of approximately 2 percent in the deal price, the board approved a revised
merger agreement with Forstmann that included an asset lockup, a no-shop provision,
and a termination fee.20 After holding generally that the board breached its fiduciary
duties by prematurely locking up its favored transaction, the Delaware Supreme Court
focused on the defensive measures. Lockups, the high court held, were not “per se illegal
under Delaware law,”21 but the decision distinguished between lockups that “can entice
other bidders to enter a contest for control of the corporation, creating an auction for the
company and maximizing shareholder profit,” and lockups that “end an active auction
and foreclose further bidding.”22 The Delaware Supreme Court disapproved of the asset
lock-up in Revlon because Forstmann “had already been drawn into the contest on a
preferred basis, so the result of the lock-up was not to foster bidding, but to destroy it.”23
The high court used the same analysis for the no-shop clause. It was not “per se illegal,”
but its use was “impermissible under the Unocal standards when a board’s primary
duty becomes that of an auctioneer responsible for selling the company to the highest
bidder.”24 As with the lockup option, the board’s use of the no-shop clause fell short in
Revlon because “[t]he agreement to negotiate only with [Forstmann] ended rather than
intensified the board’s involvement in the bidding contest.”25 The court found it “ironic
that the parties even considered a no-shop agreement when [the board] had dealt prefer-
entially, and almost exclusively, with Forstmann throughout the contest.”26
This left the termination fee, which the Delaware Supreme Court also enjoined. The
fee did not appear invalid on its own, but rather because it was “part of the overall plan
to thwart Pantry Pride’s efforts.”27
In Macmillan, three years later,28 the Delaware Supreme Court deployed the same
doctrinal analysis. The complex factual scenario in Macmillan led to a board confront-
ing competing bids from a financial buyer (KKR) and a strategic bidder (a company
controlled by Robert Maxwell). After management tipped off KKR about the state of the
auction,29 the board entered into an agreement with KKR that included an asset lockup
and a no-shop provision.
In analyzing these provisions, the Delaware Supreme Court reiterated the distinction
between measures designed to draw other parties into the bidding and those designed to
foreclose further bidding:
Although we have held that such agreements are not per se illegal, we recognized that like
measures often foreclose further bidding to the detriment of shareholders, and end active auc-
20
Revlon Inc. v. MacAndrews & Forbes Hldgs., Inc. 506 A.2d 173, 178–79 (Del. 1986) (foot-
notes omitted).
21
Ibid at 183.
22
Ibid.
23
Ibid.
24
Ibid at 184.
25
Ibid.
26
Ibid.
27
Ibid.
28
Mills Acq. Co. v. Macmillan, Inc., 559 A.2d 1261 (Del. 1989).
29
See ibid at 1275; accord ibid at 1285–86.
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tions prematurely. If the grant of an auction-ending provision is appropriate, it must confer a

substantial benefit upon the stockholders in order to withstand exacting scrutiny by the courts.30
The Delaware Supreme Court concluded that the asset lockup in Macmillan “was not
necessary to draw any of the bidders into the contest” and did not result in a materially
better bid from KKR.31 And because the assets involved were the company’s crown jewels,
the court also noted that “at the very least the independent members of the board must
attempt to negotiate alternative bids before granting such a significant concession.”32 This
had not occurred, and the asset lockup was therefore invalid.
Following Revlon, the Macmillan decision subjected the no-shop clause to the same
analysis:
As for the no-shop clause, Revlon teaches that the use of such a device is even more limited than a
lock-up agreement. Absent a material advantage to the stockholders from the terms or structure
of a bid that is contingent on a no-shop clause, a successful bidder imposing such a condition
must be prepared to survive the careful scrutiny which that concession demands.33
Strikingly for a presentday reader, the Delaware Supreme Court regarded the no-shop
clause as more worrisome than the asset lockup.
In the Barkan decision, the Delaware Supreme Court again criticized the use of no-shop
clauses, observing that “[w]e certainly do not condone in all instances the imposition of
the sort of ‘no-shop’ restriction that bound Amsted’s Special Committee.”34 The high
court explained that “[w]here a board has no reasonable basis upon which to judge the
adequacy of a contemplated transaction, a no-shop restriction gives rise to the inference
that the board seeks to forestall competing bids.”35 The directors in Barkan had received
advice that an ESOP-funded management buyout carried tax advantages that meant no
other bidder could pay a higher price, but the Delaware Supreme Court still recommended
eschewing a no-shop clause and contacting other bidders: “Even here, a judicious market
survey might have been desirable, since it would have made it clear beyond question that
the board was acting to protect the shareholder’s interests.”36
Read together, Revlon, Macmillan, and Barkan suggested that Delaware courts would
take a hard look at defensive measures, and particularly those granted as part of a
single-bidder process. That scenario played out five years later in QVC. After the epitome
of a single-bidder process,37 the board of directors of Paramount Communications Inc.
entered into a merger agreement with Viacom Inc. that “contained several provisions
designed to make it more difficult for a potential competing bid to succeed,” including a
no-shop provision, a termination fee, and a stock option lockup.38 Despite these defenses,
30
Ibid at 1284.
31
Ibid at 1286 (“When one compares what KKR received for the lockup, in contrast to its
inconsiderable offer, the invalidity of the agreement becomes patent”).
32
Ibid.
33
Ibid (emphasis added).
34
Barkan v. Amsted Indus., Inc., 567 A.2d 1279, 1288 (Del. 1989).
35
Ibid.
36
Ibid.
37
Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34, 36–39 (Del. 1994).
38
Ibid at 39.
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QVC launched a higher priced, all-cash tender offer for Paramount. “Within hours after
QVC’s tender offer was announced, Viacom entered into discussions with Paramount
concerning a revised transaction.”39 Although the Delaware Supreme Court regarded this
as an “opportunity for a ‘new deal’ with Viacom,”40 the Paramount board approved what
was “essentially the same” merger agreement.41
In the ensuing litigation, the Delaware Supreme Court held that the Paramount direc-
tors’ decision to enter into the original merger agreement with Viacom “was not reason-
able,” because “the Paramount Board clearly gave insufficient attention to the potential
consequences of the defensive measures demanded by Viacom.”42 The problem was that
the stock option lockup and termination fee “clearly made Paramount less attractive
to other bidders,” and the no-shop clause “inhibited the Paramount Board’s ability to
negotiate with other potential bidders, particularly QVC which had already expressed an
interest in Paramount.”43 On the latter issue, the opinion quoted the passage from Barkan
in which the court observed that the grant of a no-shop restriction without an adequate
basis of information “gives rise to the inference that the board seeks to forestall competing
bids.”44 In effect, the defensive measures locked the Paramount board into its single-
bidder strategy, rather than providing an opportunity for the board to explore alternatives
after securing the initial bid.45 The scenario that Barkan anticipated had come to pass.
Particularly after QVC, a reader of the Delaware Supreme Court’s M&A case law
would perceive congruence between the high court’s attitude toward defensive measures
and its attitude toward single-bidder processes. Both should be rare and only deployed
where the board has a reliable basis for believing it has obtained the best transaction
reasonably available. A trial judge attempting to glean the metes and bounds of the range
of reasonableness in similar transactional scenarios would apply the standard with these
attitudes in mind.
1.3 The Primacy of Fiduciary Duties over Contract Rights
In light of the Delaware Supreme Court’s skepticism toward single-bidder processes and
other forms of bidder favoritism, a third approach from the early M&A cases is perhaps
less surprising: When a defensive provision proved problematic, the Delaware Supreme
Court prioritized the fiduciary duties of the sellside directors over the third party contract
rights of the acquirer and deployed a targeted injunction to disable the problematic
feature. Revlon, Macmillan, and QVC each resulted in a targeted preliminary injunction
39
Ibid at 40.
40
Ibid.
41
Ibid.
42
Ibid at 49; accord ibid at 36 (“[T]he conduct of the Paramount Board was not reasonable as
to process or result”).
43
Ibid at 49.
44
Ibid at 49 n.20 (quoting Barkan v. Amsted Indus., Inc., 567 A.2d 1279 1288 (Del. 1989)).
45
The Delaware Supreme Court also criticized the Paramount Board for not taking advantage
of the opportunity that the QVC bid presented to re-negotiate its deal with Viacom and choosing
instead “to cling to its vision of a strategic alliance with Viacom.” QVC, 637 A.2d at 50. The court
found that the directors “remained prisoners of their own misconceptions and missed opportuni-
ties to eliminate the restrictions they had imposed on themselves.” Ibid.
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against specific features of the challenged third party transaction, which thereby allowed
a competitive sale process to unfold. In Revlon and Macmillan, the outcome of the sale
process flipped, with Pantry Pride acquiring Revlon and Maxwell acquiring Macmillan.
In QVC, the outcome remained the same, with Paramount outbidding QVC.
Perhaps the best indication of the Delaware Supreme Court’s early attitude toward third
party contract rights was the absence of any mention of the issue in Revlon or Macmillan.
In Revlon, the merger agreement contained a crown-jewel asset lockup, a no-shop clause,
and a termination fee, and the Court of Chancery enjoined all three defensive measures.46
The Delaware Supreme Court affirmed the targeted injunction without discussing the
acquirer’s contract rights.47
The Delaware Supreme Court went a step further in Macmillan, where the merger agree-
ment included a crown-jewel asset lockup, a no-shop clause, and a provision waiving the
company’s rights plan to allow KKR’s transaction to proceed.48 The Court of Chancery
enjoined the waiver of the rights plan but not the asset lockup and no-shop clause. On
appeal, the Delaware Supreme Court affirmed the injunction against the waiver of the
rights plan but reversed the denial of the injunction against the asset lockup and no-shop
clause, holding that those features were invalid and should be enjoined as well.49 The high
court did not discuss the acquirer’s contract rights.
The issue of the acquirer’s contract rights finally came to the fore in QVC, where the
defensive measures included a no-shop provision, a termination fee, and a stock option
lockup.50 The Court of Chancery enjoined the no-shop provision and the stock option
lockup, but not the termination fee.51 On appeal, the Paramount directors and Viacom
each advanced arguments premised on Viacom’s contract rights. The Paramount direc-
tors contended that once they approved the initial merger agreement with Viacom, “they
were precluded by certain contractual provisions, including the No-Shop Provision, from
negotiating with QVC or seeking alternatives.”52 After the Delaware Supreme Court’s
decision in Van Gorkom, this argument had substantial force,53 but the QVC court brushed
it aside, stating:
46
Revlon Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173, 183–84 (Del. 1986).
47
Ibid at 184–85.
48
Mills Acq. Co. v. Macmillan, Inc., 1988 WL 108332, at *19 (Del. Ch. Oct. 18, 1988), rev’d in
part, 559 A.2d 1261 (Del. 1989).
49
Macmillan, 559 A.2d at 1285–86, 1288.
50
QVC, 637 A.2d at 39.
51
QVC Network, Inc. v. Paramount Commc’ns, Inc., 635 A.2d 1245, 1270-73 (Del. Ch. 1993),
aff’d, 637 A.2d 34 (Del. 1994).
52
QVC, 637 A.2d at 48.
53
See Balotti and Sparks, III (2002: 468–69) (“In Smith v. Van Gorkom, the Delaware Supreme
Court established that Delaware law does not give directors, just because they are fiduciaries, the
right to accept better offers, distribute information to potential new bidders, or change their rec-
ommendation with respect to a merger agreement even if circumstances have changed”) (citation
omitted); Allen (2000: 654) (“One of the holdings of the Delaware Supreme Court in Van Gorkom
was that corporate directors have no fiduciary right (as opposed to power) to breach a contract”)
(citations omitted); Johnston (1998: 778) (“[T]here is . . . no public policy that permits fiduciaries to
terminate an otherwise binding agreement because a better deal has come along, or circumstances
have changed”); Sparks, III (1997: 817) (“[Van Gorkom] makes it clear that under Delaware law
there is no implied fiduciary out or trump card permitting a board to terminate a merger agreement
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Such provisions whether or not they are presumptively valid in the abstract, may not validly
define or limit the directors’ fiduciary duties under Delaware law or prevent the Paramount
directors from carrying out their fiduciary duties under Delaware law. To the extent such provi-
sions are inconsistent with those duties, they are invalid and unenforceable.54
In this passage, the Delaware Supreme Court explicitly prioritized fiduciary duties over
contract rights and made the validity of the latter turn on compliance with the former.
At a later point in the decision, the Delaware Supreme Court addressed Viacom’s argu-
ment that it possessed vested contract rights, including the right to enforce the no-shop
provision and stock option lockup. As to the no-shop clause, the Delaware Supreme
Court rejected Viacom’s contention in language resembling its response to the Paramount
directors:
The No-Shop Provision could not validly define or limit the fiduciary duties of the Paramount
directors. To the extent that a contract, or a provision thereof, purports to require a board to
act or not act in such a fashion as to limit the exercise of its fiduciary duties, it is invalid and
unenforceable. Despite the arguments of Paramount and Viacom to the contrary, the Paramount
directors could not contract away their fiduciary obligations. Since the No-Shop Provision was
invalid, Viacom never had any vested contract rights in the provision.55
Once again, fiduciary duties trumped contract rights, rendering the latter a nullity.
The Delaware Supreme Court also rejected Viacom’s attempt to enforce the stock
option lockup, which arguably presented different issues because it did not directly limit
the board’s ability to act. The Delaware Supreme Court nevertheless held that the stock
option lockup was invalid as well because of its ‘“draconian’ aspects,” and stated that
“[a]ccordingly, Viacom never had any vested contract rights in that Agreement.”56
Importantly, under the QVC court’s analysis, whether or not a third party acquirer had
enforceable contract rights depended on whether the sellside directors complied with their
before it is sent to a stockholder vote”); Johnston & Alexander (1997: 15) (explaining that in Van
Gorkom, “the Delaware Supreme Court held that directors of Delaware corporations may not rely
on their status as fiduciaries as a basis for (1) terminating a merger agreement due to changed
circumstances, including a better offer; or (2) negotiating with other bidders in order to develop a
competing offer”).
54
QVC, 637 A.2d at 48 (citing Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d
173, 184–85 (Del. 1986)). The opinion later reiterated this point, stating that “the No-Shop
Provision could not define or limit [the directors’] fiduciary duties.” Ibid at 50. Elsewhere, however,
in a footnote, the Delaware Supreme Court hedged a bit: “We express no opinion whether certain
aspects of the No-Shop Provision here could be valid in another context. Whether or not it could
validly have operated here at an early stage solely to prevent Paramount from actively ‘shopping’
the company, it could not prevent the Paramount directors from carrying out their fiduciary duties
in considering unsolicited bids or in negotiating for the best value reasonably available to the
stockholders.” Ibid at 49 n.20. This language narrowed QVC’s ruling by suggesting that a no-shop
provision could restrict a board’s conduct under some circumstances, but it oddly implied that the
validity of the provision would not be determined at the time the board approved it, but rather
after the fact based on subsequent events. See Laster (2013a: 822–26) (noting similarities between
this aspect of QVC and language in the Delaware Supreme Court’s much criticized opinion in
Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003)).
55
QVC, 637 A.2d at 51.
56
Ibid.
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fiduciary duties when agreeing to the terms of the contract. The QVC decision did not
require a substantial degree of participation by Viacom in the breach. It was sufficient
that “Viacom, a sophisticated party with experienced legal and financial advisors, knew
of (and in fact demanded) the unreasonable features.”57 Having done so, Viacom “cannot
be now heard to argue that it obtained vested contract rights by negotiating and obtaining
contractual provisions from a board acting in violation of its fiduciary duties.”58 The
stockholders’ interests took precedence, and to enforce provisions that resulted from a
breach of duty would “get the shareholders coming and going.”59 As the QVC court saw
it, “Viacom’s . . . fate must rise or fall, and in this instance fall, with the determination that
the actions of the Paramount Board were invalid.”60 Based on this analysis, the Delaware
Supreme Court both affirmed the injunction ruling and expanded its scope to include the
termination fee.
Particularly after QVC, a reader of the Delaware Supreme Court’s early M&A decisions
would draw the message that the Delaware courts would give little weight to an acquirer’s
contract rights. The court’s approach to defensive measures appeared to resemble the
concept of assumption of risk: If a sophisticated, well-advised bidder agreed to a provi-
sion, it did so recognizing that it would not be able to enforce the provision if it were held
invalid because of a sellside breach of fiduciary duty. Again, a trial court seeking to derive
the parameters of reasonableness from the Delaware Supreme Court’s decisions would
incorporate the assumption-of-risk concept and reject the contract-based rejoinders of
acquirers, particularly in the context of preliminary injunction applications.
1.4 The Role of the Stockholder Vote
A fourth characteristic of the Delaware Supreme Court’s early M&A cases was the lack
of deference to stockholder voting. The Revlon, Macmillan, and QVC decisions did not
discuss the possibility of the stockholders protecting themselves by voting.61 At least two
factors likely contributed to the absence of any mention of the stockholder vote from the
Delaware Supreme Court’s early opinions.
One factor was that, during this period, the Delaware Supreme Court endorsed a
strongly boardcentric model in which the board of directors exercised the corporation’s
power and authority during a third party M&A scenario and did so as fiduciaries for
the corporation and its stockholders. In the seminal Unocal decision that created the
enhanced scrutiny test, the Delaware Supreme Court rejected the theory, popular among
academics of the day, that the board should take a passive role when confronted with
a takeover attempt.62 In Revlon, the Delaware Supreme Court extended the concept of
57
Ibid.
58
Ibid.
59
Ibid (quoting ConAgra, Inc. v. Cargill, Inc., 382 N.W.2d 576, 687–88 (Neb. 1986)).
60
Ibid.
61
In fairness, had the argument been made, it seems likely that the Delaware Supreme Court
would have viewed the asset lockups in Revlon and Macmillan and the stock option lockup in
QVC as sufficiently draconian to generate inequitable coercion and prevent the vote from being
meaningful, but it is noteworthy that the issue is not even mentioned.
62
Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954–55 nn.8 & 10 (Del. 1985) (“It has
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an active board to all M&A scenarios.63 The resulting framework required that “the
directors . . . determine the best interests of the corporation and its stockholders.”64 It
also required that the board act affirmatively “to protect the corporate enterprise, which
includes stockholders, from harm reasonably perceived, irrespective of its source.”65 The
board’s statutory and fiduciary obligations were unyielding and could “not be delegated
to the stockholders.”66
A second factor was the Delaware Supreme Court’s doubts about stockholders’ abil-
ity to make the decisions necessary to determine the outcome of an M&A event. The
enhanced scrutiny decisions of the 1980s depicted investors as “a diffuse, disaggregated
group of retail . . . shareholders who, although educated and intelligent, [were] financially
unsophisticated and lack[ed] the power and motivation to influence corporate governance
or policy” (Jacobs 2012: 20). Stockholders were “unable to act collectively to influence
management or governance policy” (Jacobs 2012: 21)67 so they “need[ed] the courts to
protect them from overreaching boards, majority shareholders, or hostile bidders” (Jacobs
2015: 171). This, of course, was the era when the Delaware Supreme Court endorsed the
ability of a board to respond to the threat of “substantive coercion,” which it defined as
the risk that stockholders might decide takeover outcomes incorrectly because of their
“ignorance or mistaken belief ” about the value of the corporation.68
The Delaware Supreme Court’s unwillingness to view the stockholder vote as a
meaningful check on director action had an important consequence. It meant that litiga-
tion provided the only effective means of enforcing the directors’ fiduciary duties. The
absence of an alternative decisionmaker to whom the court could defer likely reinforced
the Delaware Supreme Court’s strong attitudes toward other aspects of third party M&A
scenarios.
2. CURRENT ATTITUDES TOWARD RECURRING M&A

SCENARIOS
A traveler leaping over the 30 years that followed the decisions in Revlon, Barkan, and
Macmillan, or the approximately 20 years that followed the decision in QVC, would find
that the Delaware Supreme Court’s attitudes have changed. Today’s approach is best
been suggested that a board’s response to a takeover threat should be a passive one. However, that
clearly is not the law of Delaware, and as the proponents of this rule of passivity readily concede,
it has not been adopted either by courts or state legislatures”) (citation omitted).
63
Revlon Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173, 184 n.16 (Del. 1986) (“The
directors’ role remains an active one, changed only in the respect that they are charged with the
duty of selling the company at the highest price attainable for the stockholders’ benefit”).
64
Ibid at 181.
65
Unocal, 493 A.2d at 954.
66
Paramount Commc’ns, Inc. v. Time Inc., 571 A.2d 1140, 1154 (Del. 1989).
67
See Easterbrook and Fischel (1983: 416) (“Shareholders, the argument runs, are merely pas-
sive financial investors who lack the expertise and incentive to become involved in making business
decisions”).
68
Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1385 (Del. 1995); Time Inc., 571 A.2d at
1153 n.17.
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represented by C & J Energy,69 a decision that the Delaware Supreme Court issued in
2014. In contrast to the Delaware Supreme Court’s early decisions, the C ‌& J Energy
opinion: (1) does not display skepticism toward a single-bidder, CEO-driven process; (2)
regards a no-shop provision as routine; (3) limits the circumstances in which courts will
issue targeted injunctions and stresses the contract rights of bidders; and (4) defers to the
stockholder vote as the primary check on deal practice. By citing these contrasts, I am
not suggesting any disagreement with the outcome in C & J Energy. Nor am I implying
that the attitudes embodied in C & J Energy emerged out of thin air. To the contrary, the
C & J Energy decision elevated to the level of Delaware Supreme Court doctrine a series
of attitudes that the Court of Chancery had developed during the intervening years.70 For
present purposes, the point is to show how far we have come, which is best accomplished
by contrasting where we are with where we were.
2.1 The Facts of C & J Energy
The transaction in C & J Energy was a stock-for-stock merger between C & J Energy
Services, Ltd and a subsidiary of Nabors Industries, Ltd. C & J was nominally the
acquirer, and its management team would run the combined entity, but Nabors would
hold a majority equity stake in the surviving company, giving the postclosing entity a
controlling stockholder.71
The C & J–Nabors transaction resulted from a CEO-driven, single-bidder process.
Joshua Comstock, C & J’s founder, chairman, and CEO, spearheaded the discussions.
Talks between the two companies’ CEOs started in January 2014, and although Comstock
discussed the deal with some of C & J’s directors, he did not receive formal board approval
to negotiate until April. Later in the process, he made a revised offer without board
approval. The plaintiffs argued that Comstock acted without authority and misled the
board about key issues. The Delaware Supreme Court found “at least some support for
the plaintiffs’ contention that Comstock at times proceeded on an ‘ask for forgiveness
rather than permission’ basis.”72
Before entering into the merger agreement, C & J did not reach out to other potential
transaction partners. There were indications in the record that some of the subtle conflicts
that permeate M&A scenarios played out in the C & J–Nabors deal. For example, the
Nabors CEO “assured Comstock throughout the process that he would be aggressive
69
C & J Energy Servs., Inc. v. Miami Gen. Empls.’ & Sanitation Empls.’ Ret. Tr., 107 A.3d 1049
(Del. 2014).
70
Evidencing this, of the approximately 60 legal citations in the C & J Energy decision, some
17 are to Delaware Supreme Court precedents, while approximately 43 are to Court of Chancery
precedents, including 20 citations to decisions issued by Chief Justice Strine while serving as a
member of the Court of Chancery. Figuring particularly prominently are his decisions in In re El
Paso S’holders Litig., 41 A.3d 432 (Del. Ch. 2012), In re Netsmart Techs., Inc., 924 A.2d 171 (Del.
Ch. 2007), In re Toys “R” Us, Inc. S’holder Litig., 877 A.2d 975 (Del. Ch. 2005), and In re Pennaco
Energy, Inc., 787 A.2d 691 (Del. Ch. 2001).
71
Nabors was a Bermuda corporation, and its majority ownership was necessary to obtain the
more favorable tax rates offered by that jurisdiction. See C & J Energy, 107 A.3d at 1052.
72
Ibid at 1059.
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in protecting Comstock’s financial interests if a deal was consummated.”73 After the

key terms of the transaction had been negotiated, but before it was formally approved,
Comstock asked for a side letter “affirming that C & J’s management team would run the
surviving entity and endorsing a generous compensation package.”74 When the Nabors
CEO balked, Comstock threatened to not sign or announce the deal. The Nabors CEO
gave in, and the deal was announced as planned.75 There were also indications that C &
J’s financial advisor acted more as a “banker for the deal” than as a banker for C & J. The
banker also financed the deal and received fees in that capacity.76 There were thus reasons
to think that the two principal actors for C & J—its CEO and its banker—were focused
on Nabors and had personal reasons to favor a transaction with that entity, rather than
being broadly open to alternatives.
According to the plaintiffs, the agreed-upon exchange ratio implied that C & J stock-
holders received value in the transaction that was less than C & J’s predeal market price
and below what the company’s financial advisors calculated as its standalone value.77 The
defendants argued that with synergies, the transaction would generate up to a 20 percent
premium over the predeal market price. The final merger agreement included a no-shop
clause and a termination fee equal to 2.25 percent of the deal value. Comstock signed a
voting agreement agreeing to vote his shares in favor of the merger, with a provision that
caused the voting agreement to terminate if the board exercised its right to terminate the
merger agreement.78
2.2 The Court of Chancery Decision
No competing bidder emerged, but stockholder plaintiffs sued to enjoin the C & J–Nabors
transaction. In addition to the factual issues just discussed, the stockholder plaintiffs
argued that the C & J board had not focused sufficiently on the fact that it was selling
control of C & J. They asserted that the board minutes and bankers’ books for the key
meeting at which the board approved the deal treated the transaction as an acquisition,
had no discussion of any exploration of alternatives or a sale process, and did not include
a determination that the deal was the best transaction reasonably available.
Given the factual record, the stockholder plaintiffs argued that it was reasonably prob-
able that the directors could not bear their burden, under the enhanced scrutiny standard,
to show that the transaction was the best transaction reasonably available and that their
actions fell within a range of reasonableness. The board could not make this showing, they
contended, because the directors treated the Nabors deal as an acquisition and had not
73
Ibid at 1064.
74
Ibid.
75
Ibid at 1065.
76
Ibid at 1056–57.
77
See, e.g., Transcript of Oral Argument at 5-6, Miami Gen. Empls & Sanitation Empls. Ret.
Tr. v. C & J Energy Servs., Inc., C.A. No 9980-VCN (Del. Ch. Nov. 24, 2014) (No 116).
78
This simplified recitation of the facts does not capture the full depth or breadth of the par-
ties’ arguments or the Delaware Supreme Court’s factual recitation. It suffices to show, however,
that several of the features which seemed to be hot-button issues for the Delaware Supreme Court
in an earlier era were present in the case.
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done anything to explore alternative transactions. As a remedy, the stockholder plaintiffs

sought a targeted preliminary injunction reminiscent of the cases from the 1980s. As
framed in their opening brief, they argued that “the Court should enjoin the shareholder
vote on the Merger and the enforcement of the deal protection provisions to allow C &
J’s Board to appropriately explore reasonable alternative transactions.”79
The Court of Chancery did not issue a written opinion. At the conclusion of the
preliminary injunction hearing, the Court of Chancery announced its decision from the
bench in an 18-page transcript ruling. In assessing the merger process, the court focused
on what it considered the “major problem” for the process: the fact that the C & J board
did not approach the merger as a sale but instead persisted in viewing it as an acquisition.80
The court found preliminarily that “C & J’s board took no steps to sell or shop the com-
pany” and ruled that “[i]n order to justify not shopping the company or engaging in other
techniques available to sellers, it is generally viewed as imperative that the board have
impeccable knowledge of the value of the company that it is selling.”81 Although the court
did not cite Barkan, and although the court referred to “impeccable knowledge” rather
than “reliable grounds upon which to judge its adequacy,” the court’s analytical approach
recalled Barkan’s discussion about when a single-bidder strategy would be appropriate.
The defendants relied heavily on a 2013 opinion in which the same member of the
Court of Chancery had declined to grant a preliminary injunction.82 The court’s ruling
predominantly consisted of comparing the facts of C & J Energy to the earlier decision,
which the court said “approached the line for what may be considered an adequate sales
process, in a single-bidder effort.”83 The court ultimately concluded that there was “a
likelihood of success on the merits as to a breach of the duty of care . . . that goes to the
absence of an effort to sell.”84
After receiving submissions from the parties on the form of relief, the court entered an
order that went beyond a negative injunction enjoining the no-shop provision. The order
instead directed the company to conduct a sale process:
C & J Energy Services, Inc. (the “Company”), through its directors who have not been designated
to be directors of C & J Energy Services, Ltd., is hereby ordered to solicit alternative proposals to
purchase the Company (or a controlling stake in the Company) that are superior to the Proposed
Transaction, as such term is defined by the Merger Agreement, for a period of 30 days from
November 24, 2014.85
The order further provided that “[t]he solicitation of proposals consistent with this
Order and any subsequent negotiations of any alternative proposal that emerges will
79
Plaintiff’s Opening Brief in Support of Motion for Preliminary Injunction at 51, C & J
Energy Servs., Inc., C.A. No 9980-VCN (No 78).
80
Transcript of Oral Argument at 9, C & J Energy Servs., Inc., C.A. No 9980-VCN (No 116).
81
Ibid at 10–11.
82
In re Plains Expl. & Prod. Co. S’holder Litig., 2013 WL 1909124 (Del. Ch. May 9, 2013).
83
Transcript of Oral Argument at 8, C & J Energy Servs., Inc., C.A. No 9980-VCN (No 116).
84
Ibid at 13.
85
Order Granting Preliminary Injunction ¶ 1, C & J Energy Servs., Inc., C.A. No 9980-VCN
(No 106).
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not constitute a breach of the Merger Agreement in any respect.”86 In substance, this
paragraph likely reached the same result as the Delaware Supreme Court in QVC, where
the high court held that the acquirer had no vested contract rights in a provision that
resulted from a breach of fiduciary duty, but it was framed using the different language
of “not constitut[ing] a breach.”
2.3 The Delaware Supreme Court’s Decision
The Court of Chancery certified its ruling for interlocutory appeal, and the Delaware
Supreme Court accepted the appeal and reversed. Its decision shows how far judicial atti-
tudes have evolved since the early M&A decisions of the 1980s.87 Although the standard
of review—enhanced scrutiny—was the same, it was applied from a different perspective
and with a different attitude.
First, the high court exhibited no concern at all about the management-led, single-
bidder process. The court stated the general rule as follows: “When a board exercises its
judgment in good faith, tests the transaction through a viable passive market check, and
gives its stockholders a fully informed, uncoerced opportunity to vote to accept the deal,
we cannot conclude that the board likely violated its Revlon duties.”88 Later the court
elaborated, explaining that a board may
pursue the transaction it reasonably views as most valuable to stockholders, so long as the trans-
action is subject to an effective market check under circumstances in which any bidder interested
in paying more has a reasonable opportunity to do so. Such a market check does not have to
involve an active solicitation, so long as interested bidders have a fair opportunity to present a
higher-value alternative, and the board has the flexibility to eschew the original transaction and
accept the higher-value deal.89
This language has nothing of the sense of Barkan, where contacting multiple bidders
was the general rule and using a single-bidder strategy an exception. The C & J Energy
approach makes the single-bidder strategy equally viable as a general rule. Although
there remains “no single blueprint that a board must follow to fulfill its duties,”90 C & J
Energy goes a long way toward establishing the single-bidder-plus-reasonable-defensive-
measures strategy as a single blueprint that sellside boards can opt to use.
86
Ibid ¶ 2.
87
In addition to reversing on the merits of the enhanced scrutiny analysis, the Delaware
Supreme Court faulted the Court of Chancery for granting an injunction after determining that
there was a “plausible showing of a likelihood of success on the merits,” rather than the actual
injunction standard, which is a reasonable probability of success on the merits. See Transcript of
Oral Argument at 13, C & J Energy Servs., Inc., C.A. No 9980-VCN (No 116). Personally, I suspect
the use of “plausible” was a slip of the tongue. Vice Chancellor Noble noted at several points that
it was late in the day, and although he technically did not describe the standard accurately, I have no
doubt that after 12 years on the bench (as of 2014), he knew and faithfully applied the appropriate
standard for a preliminary injunction.
88
C & J Energy Servs., Inc. v. Miami Gen. Empls’ & Sanitation Empls. Ret. Tr., 107 A.3d 1049,
1053 (Del. 2014).
89
Ibid at 1067–68.
90
Cf. Barkan, 567 A.2d at 1286.
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Relatedly, the C & J Energy decision signaled a more restrictive view of the degree to
which situationally specific conflicts warrant a hard look at M&A scenarios. In the court’s
words:
It is too often forgotten that Revlon, and later cases like QVC, primarily involved board resist-
ance to a competing bid after the board had agreed to a change of control, which threatened to
impede the emergence of another higher-priced deal. No hint of such a defensive, entrenching
motive emerges from this record.91
The implication appears to be that, absent a competing bidder, a reviewing court does not
need to be as worried about subtle conflicts of interest.
Second, in contrast to the early M&A decisions, the court did not even pause over the
no-shop clause. The Delaware Supreme Court instead wrote that “a potential competing
bidder faced only modest deal protection barriers.”92 The court later observed that “there
were no material barriers that would have prevented a rival bidder from making a superior
offer.”93 Just as poison pills were once exceptional but are now commonplace,94 the once
remarkable no-shop clause has become unremarkable.
Third, the Delaware Supreme Court heavily criticized the mandatory nature of the
preliminary injunction, which it aptly described as “unusual.”95 As framed, the injunc-
tion did “require[] C & J to shop itself in violation of the merger agreement between
C & J and Nabors, which prohibited C & J from soliciting other bids,” and it attempted
to deal with the potential question of breach by declaring that the solicitation would not
constitute a breach.96 The high court correctly observed that a mandatory injunction
91
107 A.3d at 1053.
92
Ibid at 1052.
93
Ibid at 1070; accord ibid (“But in this case, there was no barrier to the emergence of another
bidder and more than adequate time for such a bidder to emerge”).
94
In re Gaylord Container Corp. S’holders Litig., 753 A.2d 462, 481 (Del. Ch. 2000) (“The
Rights Plan, for example, is a garden-variety poison pill. Whether or not Delaware law should have
authorized the utilization of this extraordinary option in the first instance is water under the M &
A bridge. As the Supreme Court has observed, Delaware courts have authorized the adoption of a
poison pill in many cases”).
95
C & J Energy, 107 A.3d at 1051; accord ibid at 1053–54.
96
Ibid at 1053. I attribute the language of the injunction to good lawyering by the C & J
defendants, who submitted the form of order that Vice Chancellor Noble adopted and pressed him
to fix its implementing language rapidly, within a day after his injunction ruling. See Letter to Hon.
John W. Noble from Stephen C. Norman, Esq., Enclosing Proposed Form of Order Regarding
Preliminary Injunction, C & J Energy Servs., Inc., C.A. No 9980-VCN (No 105). By framing the
order in mandatory terms and including the “no breach” provision, the defendants substantially
strengthened their hand on appeal.
Vice Chancellor Noble would have been better served by eschewing the defendants’ form of
order and issuing a traditional prohibitive injunction against the transaction as a whole that would
have remained in place until the parties agreed to waive the no-shop provision. While serving as a
vice chancellor, Chief Justice Strine issued this type of injunction in the Topps case, where his ruling
provided that “[t]he Merger vote will be enjoined until after Topps has granted Upper Deck a
waiver of the Standstill to: (1) make an all shares, non-coercive tender offer of $10.75 cash or more
per share, on conditions as to financing and antitrust no less favorable to Topps than contained
in Upper Deck’s most recent offer; and (2) communicate with Topps about its version of relevant
events.” In re Topps Co. S’holders Litig., 926 A.2d 58, 92–93 (Del. Ch. 2007). The order was framed
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should only issue after trial or on undisputed facts, and the Court of Chancery “did not
rely on undisputed facts showing a reasonable probability that the board had breached its
fiduciary duties when it imposed the mandatory injunction.”97 The trial court’s injunction
in C & J Energy, however, was only semantically different from the traditional, negative,
preliminary injunction in QVC, which enjoined a no-shop clause to the same effect. That
ruling was not based on undisputed facts, and although it was not a mandatory injunction
that required Paramount to explore other bids, it permitted the board to do precisely that.
The Delaware Supreme Court then went further and, in contrast to the early M&A
decisions, emphasized and elevated the importance of the bidder’s contract rights:
Such an injunction cannot strip an innocent third party of his contractual rights while simultane-
ously binding that party to consummate the transaction. To blue-pencil a contract as the Court
of Chancery did here is not an appropriate exercise of equitable authority in a preliminary
injunction order. That is especially true because the Court of Chancery made no finding that
Nabors had aided and abetted any breach of fiduciary duty, and the Court of Chancery could
not even find that it was reasonably likely that such a breach by C & J’s board would be found
after trial.98
Two themes are critical here: the showing necessary to enjoin a provision, and the concept
of “blue-penciling” a contract.
On the showing necessary to enjoin a provision, the C & J Energy court requires
significantly more than was required in QVC. In the earlier case, the Delaware Supreme
Court required only a showing that a sophisticated and well-advised acquirer had sought
and obtained the defensive provision, at which point the bidder’s rights rose or fell with
the validity of the provision from a fiduciary duty standpoint.99 The C & J Energy decision
appears to expect a showing of knowing participation that is distinct from negotiation,
along the lines of conduct that induced the underlying breach.100
as a prohibitive injunction against the transaction as a whole, but it achieved the same practical
result as a targeted mandatory injunction against the use of the standstill agreement to block the
topping bidder’s tender offer. Had Vice Chancellor Noble drafted his order similarly, it likely would
not have changed the result on appeal, but it could have muted some of the senior tribunal’s more
pointed criticisms.
97
C & J Energy, 107 A.3d at 1053.
98
Ibid at 1054.
99
QVC Network, Inc. v. Paramount Commc’ns, Inc., 637 A.2d 34, 51 (Del. 1994).
100
See Malpiede v. Townson, 780 A.2d 1075, 1097–98 (Del. 2001): “Knowing participation in
a board’s fiduciary breach requires that the third party act with the knowledge that the conduct
advocated or assisted constitutes such a breach. Under this standard, a bidder’s attempts to reduce
the sale price through arm’s-length negotiations cannot give rise to liability for aiding and abetting,
whereas a bidder may be liable to the target’s stockholders if the bidder attempts to create or
exploit conflicts of interest in the board. Similarly, a bidder may be liable to a target’s stockholders
for aiding and abetting a fiduciary breach by the target’s board where the bidder and the board
conspire in or agree to the fiduciary breach” (citations omitted). See also, e.g., In re Del Monte
Foods Co. Shareholders Litig., 25 A.3d 813, 841 (Del. Ch. 2011) (granting targeted, prohibitory
injunction where acquirer “knew of and knowingly participated in the breach of duty”); In re
Transkaryotic Therapies, Inc., 954 A.2d 346, 373 n.118 (Del. Ch. 2008) (denying summary judg-
ment on aiding and abetting claim where there was evidence that acquirer offered a director an
inducement for his vote); Goodwin v. Live Entm’t, Inc., 1999 WL 64265, at *28 (Del. Ch. Jan. 25,
1999) (recognizing possibility that third party could be liable as aider and abetter if the third party
M4633-GRIFFITH_t.indd 220 30/10/2018 08:16

Relatedly, the C & J Energy decision’s reference to “blue-penciling” casts doubt on

the continuing viability of the type of targeted preliminary injunction that was issued in
Revlon, Macmillan, and QVC. The language of C & J suggests that a preliminary injunc-
tion has become an all-or-nothing proposition: either the entire deal should be enjoined
or no injunction should issue. Later in its decision, the Delaware Supreme Court returned
to this point:
Preliminary injunctions are powerful tools, and their bluntness can be disconcerting to plaintiffs,
defendants, and trial judges. But the traditional use of a preliminary injunction in the Court
of Chancery is to preserve the status quo—for example, to enjoin a corporate transaction until
there is a full trial if the court believes there is a reasonable probability a fiduciary breach has
occurred—not to divest third parties of their contractual rights. Even after a trial, a judicial
decision holding a party to its contractual obligations while stripping it of bargained-for benefits
should only be undertaken on the basis that the party ordered to perform was fairly required to
do so, because it had, for example, aided and abetted a breach of fiduciary duty. To blue-pencil
an agreement to excise a provision beneficial to a third party like Nabors on the basis of a
provisional record and then declare that the third party could not regard the excision as a basis
for relieving it of its own contractual duties involves an exercise of judicial power inconsistent
with the standards that govern the award of mandatory injunctions under Delaware law.101
Consistent with Court of Chancery decisions authored by Chief Justice Strine while a
member of the trial court, this passage reflects the perspective that a preliminary injunc-
tion should address the transaction as a whole.102 Under this approach, the targeted
preliminary injunctions in Revlon, Macmillan, and QVC would not have been issued.
Finally, and in contrast to stockholders’ earlier view, the C & J Energy decision
explained that stockholders can protect themselves by voting down a suboptimal deal. As
a result, Delaware courts should defer in the first instance to the stockholder vote rather
than granting injunctive relief:
That [the balancing of hardships counsels against an injunction] is especially the case when the
stockholders subject to irreparable harm are, as here, capable of addressing that harm themselves
by the simple act of casting a “no” vote. In a situation like this one, where no rival bidder has
emerged to complain that it was not given a fair opportunity to bid, and where there is no reason
to believe that stockholders are not adequately informed or will be coerced into accepting the
transaction if they do not find it favorable, the Court of Chancery should be reluctant to take
the decision out of their hands.103
In short, empowered institutional investors can best look out for their own interests,
and when stockholders can protect themselves through voting, trial courts should not
interfere.
“purposely induced the breach of the duty of care”), aff’d, 741 A.2d 16 (Del. 1999); Zirn v. VLI
Corp., 1989 WL 79963, at *6 (Del. Ch. July 17, 1989) (finding that complaint stated a claim for
aiding and abetting where complaint supported inference that acquirer took advantage of conflict
faced by directors and used it to secure benefits).
101
C & J Energy, 107 A.3d at 1072 (citations omitted).
102
See In Re El Paso S’holders Litig., 41 A.3d 432, 449–51 (Del. Ch. 2012); In re Netsmart
Techs., Inc., 924 A.2d 171, 209 (Del. Ch. 2007); In re Toys “R” Us, Inc. S’holder Litig., 877 A.2d
975, 1021 (Del. Ch. 2005).
103
C & J Energy, 107 A.3d at 1072–73 (citations omitted).
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3. POSSIBLE REASONS FOR THE CHANGING ATTITUDES

AND PERCEPTIONS
To reiterate, the attitudes and perspectives embodied in C & J Energy did not burst forth
unheralded. They are consistent with decisional developments in the Court of Chancery
over the past 15 years or so. The significant contribution of C & J Energy was to elevate
the Chancery approach to Supreme Court doctrine. It is impossible to identify with any
degree of precession the reasons why judicial attitudes have evolved so significantly, but
there are several likely candidates.104
In my view, the predominant contributor has been the rise of sophisticated stockhold-
ers with the ability to influence the direction of corporate governance and the outcome
of M&A events (Armour et al 2011; Kahan and Rock 2010).105 Both Chief Justice Leo
E. Strine, Jr and retired Justice Jack B. Jacobs have written about the need for the law to
adapt to a world in which institutional investors play a significant role (see, e.g., Jacobs
2011, 2012; Strine Jr 2010). In 2000, writing while a member of the Court of Chancery,
Chief Justice Strine systematically dismantled the concept of substantive coercion and the
premise of the disempowered stockholder.106 During his years as a Vice Chancellor, Chief
Justice Strine regularly deferred to the stockholder vote, as did other members of the
court.107 He also argued for elevating the role of the stockholder vote in other areas, such
as when combined with committee approval as a means of achieving business judgment
review for a controller squeezeout.108
Recognizing that stockholders are empowered and capable of making their own decisions
104
During the later stages of drafting this chapter, I came across work which identifies similar
themes on a broader scale. See Solomon and Thomas (2016). I agree with their excellent analysis.
105
See, e.g., Armour et al. (2011) (describing influence of institutional investors on M&A
regimes); Kahan & Rock (2010) (documenting rise of institutional investor ownership and influ-
ence). See generally Bd. of Governors of the Fed. Res. Sys., Flow Of Funds Accounts Of The
United States: Annual Flows and Outstandings 1985–1994, at 82 tbl.L.213 (2004), available‌
www.federalreserve.gov/Releases/z1/20040115/annuals/a1985-1994.pdf.
106
Chesapeake Corp. v. Shore, 771 A.2d 293, 324–29 (Del. Ch. 2000).
107
See, e.g., In re El Paso Corp. S’holder Litig., 41 A.3d 432, 434-35 (Del. Ch. 2012) (“Although
the pursuit of a monetary damages award may not be likely to promise full relief, the record does
not instill in me the confidence to deny, by grant of an injunction, El Paso’s stockholders from
accepting a transaction that they may find desirable in current market conditions, despite the
disturbing behavior that led to its final terms”); In re Dollar Thrifty S’holder Litig., 14 A.3d 573,
618 (Del. Ch. 2010) (ruling that the balance of harms tilted against injunction because stockholders
could decide for themselves to vote a deal down and take the chance of receiving an action-
able higher bid); In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d 171, 208 (Del. Ch. 2007);
(“[W]hen [the] court is asked to enjoin a transaction and another higher-priced alternative is not
immediately available, it has been appropriately modest about playing games with other people’s
[(i.e., the stockholders’)] money”); In re Pennaco Energy, Inc. S’holders Litig., 787 A.2d 691, 715
(Del. Ch. 2001) (“After all, even when a sufficient merits showing is made by a plaintiff, this court is
justifiably reluctant to enjoin a premium-generating transaction when no other option is available,
except insofar as is necessary for the disclosure of additional information to permit stockholders to
make an informed decision whether to tender”).
108
In re MFW Shareholders Litig., 67 A.3d 496, 524–36 (Del. Ch. 2013, aff’d sub nom. Kahn v.
M & F Worldwide Corp., 88 A.3d 635 (Del. 2014); In re Cox Commc’ns, Inc. S’holders Litig., 879
A.2d 604, 642–48 (Del. Ch. 2005).
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changes the role of the judiciary. When stockholders cannot protect themselves, litigation
becomes the principal check on fiduciary behavior. But when stockholders can protect
themselves, they do not need judges. Only when the voting process itself is undermined does
a role for the judge remain. Otherwise, property owners can best make their own decisions
about the fate of their property.
In C & J Energy, the existence of empowered stockholders able to decide whether to
accept the Nabors deal directly explains the Delaware Supreme Court’s message that trial
courts defer to the stockholder vote for purposes of the balancing of the hardships under
the preliminary injunction standard. But it also has a second-order effect on the degree of
intrusiveness of the court’s review. If the court system appears to be the only viable check
on fiduciary opportunism, then the litigation framework has to include components that
permit meaningful review of a board’s decision, and the court has to take a hard look at
the directors’ conduct. The innovative standard of enhanced scrutiny accomplished this
through its range-of-reasonableness test and the shifting of the burden of proof to the
defendant directors. When warranted, a court need not defer automatically to the decisions
of even disinterested and independent directors, precisely because they could be under-
mined by the situationally specific conflicts of interest inherent in the settings that trigger
enhanced scrutiny.109 The court instead evaluates the reasonableness of the directors’
actions for evidence of conscious or subconscious pretext.110 But if stockholders can be
trusted to make the ultimate decision on a transaction, then the court system can step back.
In my view, this effect can be seen in C & J Energy, where the court discounts the CEO’s
self-interested bargaining over the terms of his employment, minimizes the banker’s dual
role as sellside advisor and financier for the deal, and repeatedly stresses the independence
of the directors, despite their relative lack of involvement in a management-led process.
Again, my point is not to suggest that the C & J Energy decision was decided incorrectly,
but simply to contrast its tone with the Delaware Supreme Court’s early M&A decisions,
which took a harder, even moralistic stance toward conflicts of interest (Rock 1997).
A more removed approach to examining sellside directors’ actions is also, in my view,
a product of a second major factor: the generalized failure of stockholder-led M&A
litigation. In the aggregate, stockholder-led M&A litigation did not establish a track
record suggesting that it was contributing to the public good, rather than operating as
a means of rent extraction for plaintiffs’ lawyers. In the early landmark M&A cases, the
primary litigant was a disadvantaged bidder, with stockholder plaintiffs at most occupy-
ing a secondary role.111 The bidder’s presence provided a powerful driver for meaningful
109
See, e.g., Dollar Thrifty, 14 A.3d at 598 (“[W]here heightened scrutiny applies, the predicate
question of what the board’s true motivation was comes into play. The court must take a nuanced
and realistic look at the possibility that personal interests short of pure self-dealing have influenced
the board to block a bid [Unocal] or to steer a deal to one bidder rather than another [Revlon]”).
110
See ibid (“Through [enhanced scrutiny], the court seeks to assure itself that the board acted
reasonably, in the sense of taking a logical and reasoned approach for the purpose of advancing a
proper objective, and to thereby smoke out mere pretextual justifications for improperly motivated
decisions”).
111
See Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1366 (Del. 1995); Paramount
Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34, 36 (Del. 1994); Mills Acq. Co. v. Macmillan,
Inc., 559 A.2d 1261, 1264 (Del. 1989); Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d
173, 179 (Del. 1986); Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 949 (Del. 1985).
M4633-GRIFFITH_t.indd 223 30/10/2018 08:16

litigation. The bidder retained highly qualified counsel, paid on an hourly basis, who had
every reason to match the lawyers representing the defendants in terms of thoroughness
and effort. The bidder’s presence also changed the remedial dynamic because the bidder’s
alternative transaction provided a concrete alternative that put real economic value behind
its arguments.
The litigation framework that the bidder-driven cases generated, however, was designed
to be sensitive to the possibility of disloyalty under ambiguous circumstances. It therefore
adopted proplaintiff features like the reasonableness standard and the placing of the
burden of proof on the defendants. Specialized plaintiffs’ firms soon realized that they
did not need a competing bidder to invoke these principles. They could file suit and argue
that the defensive measures in a merger agreement had deterred other bidders from emerg-
ing. At that point, the very litigation features that made enhanced scrutiny meaningful
unfortunately made it easy for plaintiffs to state claims and difficult for the defendants to
dispose of weak cases. The Delaware Supreme Court effectively endorsed the bringing of
weak cases when it declined to dismiss a postclosing challenge to defensive measures in a
third party merger agreement, stating “This case may very well illustrate the difficulty of
expeditiously dispensing with claims seeking enhanced judicial scrutiny at the pleading
stage where the complaint is not completely conclusory.”112
Slowly at first, and then at an accelerating pace, the volume of stockholder-led M&A
litigation increased (Cain and Davidoff 2015: 475–6). During the first decade of the
twenty-first century, it became an epidemic, with challenges to more than 90 percent of all
takeovers in excess of $100 million (Cornerstone 2015). This in itself was an obvious sign
of a misaligned incentives, as it could not have been true that 90 percent of all takeovers
had deep fiduciary flaws.
More tellingly, the avalanche of lawsuits produced comparably minimal value for stock-
holders. The vast majority of cases were resolved through disclosure-only settlements, in
which the defendants agreed to make supplemental disclosures to stockholders in advance
of the vote on the merger, and the merger parties and their directors, officers, affiliates,
and advisors received a court-approved global release of known and unknown claims.
As compensation for providing the ostensible benefits conferred by these settlements, the
plaintiffs’ attorneys received an award of attorneys’ fees, which for many years clustered
in the mid- to high six figures (Cain and Davidoff 2015; Fisch et al 2015; Friedlander
2016). The disclosure-only settlement’s attractiveness to both defendants’ and plaintiffs’
lawyers channeled virtually all M&A cases toward the same nonsubstantive result. While
some plaintiffs’ firms engaged in meaningful litigation activity and achieved monetary
recoveries for investors, they were comparatively rare.113 The ubiquity of stockholder
litigation coupled with the routine generation of disclosure-only settlements amounted
to a systemic failure.
The degradation of the M&A litigation environment demanded a retooling of stand-
ards that would reduce the ability of the plaintiffs’ bar to bring litigation and extract
112
In re Santa Fe Pacific Corp. S’holder Litig., 669 A.2d 59, 72 (Del. 1995).
113
See Friedlander (2016: 904) (describing a two-tiered plaintiffs bar in which “[o]ne tier of law
firms pursued disclosure settlements as a business model” while “[a]nother tier of law firms never
presented disclosure settlements to the Court of Chancery, and instead brought Revlon cases with
the objective of seeking a significant monetary recovery or significant non-monetary relief ”).
M4633-GRIFFITH_t.indd 224 30/10/2018 08:16

settlements. At the same time, voting by sophisticated stockholders had emerged as an

alternative, market-based means of protecting against fiduciary overreaching. The natural
course was to weaken the availability of the litigation option, recognizing that because
of how stockholder plaintiffs had been managing that mechanism, little would be lost.
To the contrary, and paradoxically, weakening the incentive for stockholder plaintiffs to
file suit on every deal and seek a disclosure-only settlement might be expected to have the
real-world effect of increasing oversight. Without the (relatively) cheap deal insurance of
a disclosure-only settlement, transaction counsel could again do their jobs by arguing
against egregious norm violations that might draw a meaningful lawsuit. A step back in
terms of scrutiny becomes a step forward in terms of integrity.
The generalized failure of the stockholder-led M&A litigation model also suggests a
reason for the Delaware Supreme Court’s current skepticism toward targeted injunctions
and the prioritization of the contract rights of the acquirer. In general, over time, courts
have become more comfortable with defensive measures as they have gained greater
familiarity with them. No-shop clauses in particular have become virtually omnipresent,
making it difficult to maintain the extreme stance exhibited in Revlon and Macmillan.
Moreover, in litigation, bidders have argued effectively—and usually accurately—that they
were outsiders to the sellside board’s process, who were simply bargaining at arm’s length,
and who therefore should not be prejudiced by a potential sellside breach. Defendants also
have argued, again with some truth, that granting a degree of deal certainty to a bidder
could inure to target stockholders in the form of a higher price. Indeed, scholarly work
has demonstrated that some degree of protection for the initial bidder helps to induce
the first bid and can create value for stockholders (Coates IV and Subramanian 2000;
Restrepo and Subramanian 2016). In short, the inclusion of some degree of defensive
measures became expected and accepted. Recent Court of Chancery decisions call them
“standard merger terms.”114
These trends explain why the courts have shown greater deference toward the use
of defensive measures, but they do not explain why a reviewing court cannot enjoin a
particularly extreme provision—as opposed to the transaction as a whole—if warranted
on the facts of a given case. Granting this type of relief has not only the pedigree of
Revlon, Macmillan, and QVC, but also support in the doctrine of severability, which
114
See, e.g., In re Answers Corp. Shareholders Litig., 2011 WL 1366780, at *4 n.47 (Del. Ch.
Apr. 11, 2011) (describing “a termination fee plus expense reimbursement of 4.4% of the Proposed
Transaction’s equity value, a no solicitation clause, a ‘no-talk’ provision limiting the Board’s ability
to discuss an alternative transaction with an unsolicited bidder, a matching rights provision, and a
force-the-vote requirement” as “standard merger terms”); In re Atheros Commc’ns, Inc. S’holder
Litig., 2011 WL 864928, at *7 n.61 (Del. Ch. Mar. 4, 2011) (characterizing a no-solicitation provi-
sion, a matching right, and a termination fee as “standard merger terms”); In re 3Com S’holders
Litig., 2009 WL 5173804, at *7 (Del. Ch. Dec. 18, 2009) (describing “the no solicitation provision,
the matching rights provision, and the termination fee” as “standard merger terms”); In re Novell,
Inc. S’holder Litig., 2013 WL 322560, at *10 (Del. Ch. Jan. 3, 2013) (describing “the no solicitation
provision, the matching rights provision, and the termination fee” as “customary” and “routine
terms”); In re Ness Techs., Inc., 2011 WL 3444573, at *2 (Del. Ch. Aug. 3, 2011) (describing a “‘no
shop’ provision”, a ‘no talk’ provision, a termination fee amounting to 2.72% of the sale price, and
a fiduciary out that requires the Board to determine that a higher bid is a ‘superior offer’ before it
can engage in negotiations” as “relatively mundane deal protections”).
M4633-GRIFFITH_t.indd 225 30/10/2018 08:16

enables a court to invalidate a portion of a contract or statute and enforce the remainder
(Movsesian 1995).115 Merger agreements often contain severability clauses that expressly
incorporate this doctrine as a matter of contract. Permitting targeted injunctions also
comports with the general remedial principle that if a court can grant a broad form
of relief, it also can grant a lesser and narrower form of relief that otherwise would be
encompassed by the broad relief.
Here again, the systemic failure of stockholder-led M&A litigation provides an expla-
nation, because a judicial willingness to entertain targeted injunctions easily could open
the door to a new form of litigation abuse. If, for example, stockholder plaintiffs could
obtain targeted relief enjoining aggressive deal protection measures, in the absence of a
competing bid, then plaintiffs’ firms would have an incentive to continue challenging deals
in an effort to obtain that type of relief. This would have two effects. First, the Delaware
courts would be forced to rule on multiple iterations and combinations of defensive meas-
ures, determining which were overly restrictive given the extent of the board’s knowledge
at the time it entered into the transaction and which were not. Some might argue that over
time, clear patterns would develop, and the resulting decisions would generate a public
good. Others would argue, with considerable force, that this would involve the Delaware
judiciary substituting its views about the level of deal protection that was appropriate
in the context of a particular negotiation for those of directors. Second, the threat of a
targeted injunction would create settlement pressure, enabling the M&A plaintiffs’ bar
to transition quickly from disclosure-only settlements to deal-tweak settlements, such
as moderate reductions in the size of a termination fee. The Delaware Supreme Court’s
preference for all-or-nothing injunctions can thus be seen as part of its response to the
litigation epidemic.116
One certainly can posit other factors that potentially contributed to the substantial
evolution in the Delaware Supreme Court’s attitude toward recurring M&A scenarios,
including changes in the composition of the Delaware Supreme Court and in the broader
legal environment in which Delaware operates (Davidoff 2012; Roe 2003). In this
author’s view, however, the rise of the institutional investor and the generalized failure
of stockholder-led M&A litigation explain the bulk of the attitudinal shift. Powerful
stockholders do not need judges to make their decisions for them, and when the litigation
that would generate those decisions seems to be doing little good, it only makes sense to
recalibrate the system.
115
Restatement (Second) of Contracts § 183, cmt. a (1981) (discussing concept of “divis-
ibility” or “severability”).
116
The Delaware Supreme Court’s current treatment of a merger as an integrated whole
rather than a series of severable events is also reflected in its recent analysis of the effect of a fully
informed stockholder vote on the standard of review applicable to a third party M&A situation.
See, e.g., Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) (holding that a fully
informed stockholder vote restores the business judgment rule as the standard of review, with a
claim for waste as the only remaining challenge). In effect, the stockholder approval that is required
by statute to effect a merger is now also treated as stockholder approval of each step in the process
that led to the merger. Stockholder approval of the merger is also treated as stockholder approval
of each contractual provision in the merger agreement, including defensive measures that may tend
to foreclose or discourage competitive bidding. For both the injunction and the vote, the merger is
a package deal.
M4633-GRIFFITH_t.indd 226 30/10/2018 08:16

4. CONCLUSION
The Delaware Supreme Court’s attitudes toward recurring aspects of third party M&A
litigation have changed markedly over three decades. In contrast to the skepticism of the
1980s, the Delaware Supreme Court has now signaled: (1) presumptive validity of a single-
bidder process combined with a passive market check; (2) presumptive deference to the
stockholder vote absent a competing bid; and (3) prioritization of the bidder’s contract
rights and hostility toward targeted injunctions. Each of these steps is a deregulatory
move that makes it less likely that a Delaware court will issue an injunction in a deal case.
For lawyers and law professors, that might be an unwelcome change. But for anyone who
believes that markets should decide the outcome of M&A events rather than courts, it is
a positive development.
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14. Appraisal rights in complete tender offers in
Israel: a look into Israeli case law
Ruth Ronnen
Appraisal decisions require courts to estimate the value of companies, a task that is
difficult for judges and finance professionals alike. In order to determine the value of a
company, one has to foresee its future, and as the Jewish saying goes: “since the destruc-
tion of the Temple, prophecy has been taken from prophets and given to fools.” As most
of us are not prophets (and hopefully not fools), it is an almost impossible task to foresee
the future cash flow of a company.
However, alongside the use of experts to estimate the “objective” value of an asset—
whether it is a company, its shares, or any other asset—there is another common method
that estimators use: looking at market prices. When, for example, a real estate appraiser
estimates the value of land or of an apartment, one of the basic tools they use is checking
the prices of similar assets and deriving the “right” price of the assessed asset from the
comparison. The assumption behind this method is simple—the best way to know the value
of an asset is to check what “real” people in “real” transactions are willing to pay for it.
In this chapter, I would like to briefly discuss these two methods, and their application
to appraisal rights. I would like to discuss whether and how courts make use of informa-
tion derived from the “market” in order to estimate the value of companies, and how
courts use expert opinions.
1. GOING PRIVATE UNDER ISRAELI LAW
Under Israeli law, appraisal is available only for “going private” tender offers.
Section 336 of the Companies Law deals with a controlling shareholder’s purchase of
minority shares in a public company in order to “go private.”1 According to this section,
a person shall not purchase more than 90 percent of the shares in a public company, other
than by way of a “complete tender offer” (or “full tender offer”)—a tender offer of all
of the shares.
Section 337 then states that “[w]here a complete tender offer is accepted by the offerees
in such a way that the rate of holding of the offerees who did not accept the offer is less
than five percent of the issued share capital . . . all of the shares that the offeror sought to
purchase shall be transferred to it.”
This section assures minority shareholders that even if they do not accept the offer and
most other shareholders do, they will not be left as a tiny minority shareholder (of less
than 5 percent) in a company held by one majority shareholder. It also enables the buyer,
1
Companies Law, 5759–1999.
229
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the majority shareholder, to buy all of the shares and avoid the “holdout problem,” in
which offerees demand an extortionate price to sell their shares knowing that the control-
ler needs them to complete the deal.
To protect minority shareholders who are forced to sell under the terms just described,
Section 338 offers them “appraisal rights.” According to Section 338, “The court may, on
the application of any offeree in a complete tender offer accepted as aforesaid in section
337(a), rule that the consideration for the shares was less than their fair value, and that
the fair value should be paid as determined by the court.”
If a petition for an appraisal prevails in court, the purchaser must add to the original
price of the tender offer the difference between the offer price and the “fair price,” with
no way out from the deal. The purchaser therefore faces serious legal exposure, and a very
rare judicial intervention in one of the most substantial deal terms: its price.
Petitions for appraisal in Israel are in most cases motions to certify class actions on
behalf of the class of all of the offerees (usually all of the minority shareholders). To
prevail on a class certification motion, the plaintiff must show that the final price was not
“fair.” This is usually done by an expert opinion stating that the fair value of the shares
was higher than the final price.
According to Section 338 (as quoted above), “any offeree”—including consenting
shareholders, not just dissenting shareholders—has an appraisal right. However, the
Companies Law was amended in 2011 and, as of today, the offeror may state in the offer-
ing documents that a shareholder that accepted the offer will not be eligible for appraisal
rights. That eliminates appraisal rights for such shareholders and excludes them from the
plaintiffs’ class. Most offerors use that right in their offers.
2. ESTIMATING “FAIR VALUE”
The core difficulty with appraisal claims is the complexity of estimating the value of a
company, as noted above. Multiple methods are used to determine the fair price of the
shares (or in assessing the fair value of the company). Some of these include asset-based
methods and discounted cash flow, among many others.
Moreover, it is common knowledge that appraisal is not an exact science: every calcula-
tion based on approximate data will produce approximate results.2 The estimations often
rely on the expected future of the company, and the prospects of it being successful.
When using the DCF method, it is necessary to estimate the future cash flow of the
company. To do that, it is necessary to foresee future macroeconomic conditions, the
competition that the company may face, the demand for the company’s products or
services, and so on. Obviously, trying to foresee all of these elements and their effect on the
company’s future is nigh on impossible. As a result of these difficulties, expert opinions
as to what the “fair value” of the company is can vary and the differences between them
can reach billions of shekels.
2
LCA 779/06 Kital Holdings & Int’l Dev. Ltd. v. Maman (Aug. 28, 2012).
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Appraisal rights in complete tender offers in Israel 231
3. OBJECTIVE “ANCHORS” IN DETERMINING FAIR VALUE
Due to these difficulties and the necessity of dealing with the question of “fair value,”
courts are trying to find some objective and reliable anchors on which to rely in determin-
ing “fair value.” Such anchors may be, if they become part of the case law, factors that the
offeror can rely on as well, in order to mitigate the risk of a court’s retroactive intervention
in the deal’s price.
Some of these possible “anchors” include:
● market price;
● the consent of most minority shareholders to the offer;
● a prior deal, with a “large” minority shareholder;
● a sophisticated shareholder’s consent to the offer. Such shareholder may be:
● An institutional investor (either an investor that negotiated the price with the
buyer or one that did not do so; an investor that held a substantial portion of
shares that was large enough to “veto” the proposal or an investor with a por-
tion that has no veto power);
● A private investor that holds a large portion of the shares (that may have negoti-
ated the price with the buyer or held a portion of shares that was large enough
to “veto” the proposal);
● negotiating the price through an independent committee.
We will now discuss these methods in further detail.
3.1 Market Price
According to the efficient capital market hypothesis, the market price reflects the fair
price. The market price aggregates the various valuations of the market participants as
reflected in trading. Despite that fact, the market price is not considered an anchor for
the courts in Israel in fair value claims. According to the majority opinion of the Israeli
Supreme Court in the Kital case,3 the market price of the shares bought in a complete
tender offer is irrelevant when deciding the fair value of the shares. The main reason for
that holding is that most public companies traded on the Tel Aviv stock market suffer
from illiquidity. Therefore, their market price does not necessarily reflect the value of the
company, and it can be easily influenced by the majority shareholder.
According to Delaware law, on the other hand, “[i]f there is an established market for
shares of a corporation the market value of such shares must be taken into consideration
in an appraisal of their intrinsic value” (though market value is not the sole element that
would be considered).4
Could the market price be relevant in Israel for companies with highly liquid securities?
3
Ibid.
4
Application of Del. Racing Ass’n, 213 A.2d 203, 211 (Del. 1965).
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In the Atzmon ruling, the court discussed that issue.5 In that case the offerors argued that
the shares were widely traded on the stock exchange and therefore their market value
should be an indication of their fair value. In the Kital case,6 Judge Danziger referred
again to the Delaware case law in this context, and mentioned that even in Delaware the
market price will not be relevant in cashout mergers.
In the Atzmon ruling,7 as well as the Kital ruling,8 the court mentions that Delaware
case law treats controlled companies differently. In such cases, share value evaluation will
not be made according to market price, since that price does not reflect their full internal
value. That is the usual situation in Israel when the controlling shareholder wishes to
purchase the shares of minority shareholders.
As this is the case for most companies in Israel, the court’s conclusion was that market
price is not relevant under Israeli law. This is so even when the share is included in one of
the leading stock exchange indexes. This fact is insufficient in forming an indication that
market price reflects company value, and that the consideration offered by the offeror is
fair. In this context, the controlling shareholder usually enjoys access to inside informa-
tion not reflected in the price and foreknowledge of the cashout tender offer’s timing,
informational advantages that may make the use of market price subject to manipulation.
3.2 Consent of Most of the Minority
Consent of most of the minority shareholders to the tender offer could be considered
a relevant factor in estimating the value of the company. However, the Israeli Supreme
Court rejected the notion that the consent of most of the minority of the shareholders—
the consent of the majority of the offerees—is in itself a relevant factor when estimating
the fair value of the shares. The Supreme Court ruled in the Kital decision that if most
of the minority’s consent was to be considered an indication of fair price, it would have
made the Companies Law’s appraisal right almost useless.9 This is due to the fact that most
of the minority of the offerees accepted the offered price in all appraisal cases. Otherwise,
the buyout would not have been completed and there would be no reason to seek the
court’s assistance. Similar notions were expressed by the court in the Atzmon case,10 where
it was determined that
majority consent to the tender offer does not form . . . an indication of fair value . . . share value
issue is decided only according to its essential value appraisal. The instruction determining the
appraisal remedy pre-supposes that most of the offerees consented to the price offered in the
tender offer . . . and still provides the minority shareholders refuge in the form of approaching
the court to examine whether share value according to the tender offer was fair.
This ruling was problematic before the amendment of the Companies Law, when all
shareholders, including those that accepted the majority’s offer, could apply for appraisal
5
CA 10406/06 Atzmon v. Bank Hapoalim Ltd. (Dec. 28, 2009).
6
Kital, supra note 2.
7
Atzmon, supra note 5.
8
9
Ibid.
10
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rights. When this was the law, it was reasonable for every shareholder to agree to the offer
(disregarding its price), and then go to court and apply for the fair value. The court could
only raise the price, so there was no risk involved.11 If there is no relevance to the minority
shareholders’ agreement to the offer, why “ask” the shareholders whether they agree to sell
their shares at the offered price in the first place? Why not go immediately to court, and
ask the court to evaluate and set the fair price?
However, today, the shareholder’s decision to tender or not is more crucial because only
dissenting shareholders can apply for appraisal rights. Despite that, as I mentioned, the
law in Israel does not give any weight to this decision, disregarding also the size of the
majority that accepted the offer.
3.3 Possible Manipulation of the Share Price
In the Atzmon decision,12 the court addressed the issue of possible share price manipula-
tion. It also addressed the situation where it was proven that the offeree shareholders
were not given all the relevant information necessary to assess the offer’s fairness. An
offer accepted in this situation may also raise issues as to whether it was binding under
“regular” contract law.
The share price manipulation issue is meaningful in the Israeli market, in which
most companies are dominated by one controlling shareholder who holds the major-
ity of shares and only the minority shares trade on the stock exchange. Beyond the
informational asymmetry between majority and minority shareholders, the controlling
shareholder could use other manipulations to influence share value.
One such method is harming the shares’ tradability. This issue arose in the Pinros deci-
sion.13 In that case, shares of a controlled company were transferred to the “preservation
list” on the stock exchange. The stock exchange adds companies to this list when their
public holding rate is small. When a company is included in the preservation list, its shares
are no longer traded on the stock exchange in the “continuous trading stage.” A company
that is included in the preservation list for two consecutive years is dropped from the stock
exchange altogether. The transfer of shares to the preservation list harms them in two ways:
it harms their tradability (since they do not continuously trade); and it creates concerns
that the company will be dropped from the exchange if it fails to return to the main list
within two years. (After one year, it becomes more difficult to return the main trading list.)
In the Pinros case,14 the controlling shareholder issued a tender offer. The offer accept-
ance date was the date on which the shares were supposed to start trading on the preserva-
tion list for the second year, raising the concern that the company would be dropped from
the stock exchange within a year. The petitioner argued that the controlling shareholders
did not act to remove the company from the preservation list—although they could have
done so—to enable them to purchase the minority shares under the tender offer for a
11
Companies Law, 5759–1999, § 338(a).
12
13
Class Action (TA) 7477-10-11 Goldstein v. Pinros Holdings Ltd. (Mar. 18, 2013); Class
Action (TA) 7477-10-11 Goldstein v. Pinros Holdings Ltd. (Feb. 24, 2016) (hereinafter Pinros 2016)
[a decision of the undersigned].
14
Ibid.
M4633-GRIFFITH_t.indd 233 30/10/2018 08:16

lower price. The petitioner therefore claimed the tender offer (which was accepted by 78
percent of minority shareholders) was an “extortionate transaction.”
The court accepted the petitioner’s arguments. A class action against the controlling
shareholders was approved and the plaintiffs ultimately prevailed as a result of the
determination that:
The fact that company shares were transferred to preservation list trading, could not only
not harm the controlling shareholders, but rather benefit them. This is so in case the control-
ling shareholders wish to make a tender offer and purchase all of the shares of the minority
shareholders. In that case, the controlling shareholders will prefer the share price to be as low
as possible. However, the fact that the shares are not traded in the main list, and the concern
that their trading could be discontinued altogether, is not a concern relevant to the controlling
shareholders in this case – since they wish to turn the company into a private company anyway,
and do not intend to sell their holdings in it.
Due to the possibility of the controlling shareholder manipulating share price by pre-
venting the removal of shares from the preservation list to harm their price, the consent
of minority shareholders did not indicate price fairness, and the court was required to
examine the fair value of the shares and compare it with the tender offer price.
3.4 A Prior Deal with a Large Minority Shareholder
Under Israeli law, a price that resulted from an arm’s-length negotiation between two
independent and sophisticated parties is considered a credible proxy to the fair market
value of the shares. A deal price where the bulk of the company’s shares were sold within
the relevant period is therefore a relevant and reliable factor to be considered by the court
when estimating the fair value of the company. The rationale for this is that in private
law, courts rarely interfere with the parties’ agreed sale price of an asset. The very basic
presumption of the law is the freedom of the parties to set the terms of their contract as
they wish. Therefore it is not surprising, in my opinion, that in Atzmon,15 then in Kital,16
the Supreme Court was willing to rely on the sale price of a block of shares as a relevant
factor in determining the fair value of the shares of the same company.
In Atzmon,17 the court addressed several factors to be considered when examining a
transaction in which shares were voluntarily sold outside the stock exchange. In that
context, the court first addressed the number of shares sold in that transaction, on the
theory that the larger the block of shares, the more likely it was that the seller would not
have agreed to sell for less than their true value. When dealing with the sale of company
control, the share price also includes a control premium. Thus, a tender offer price that is
no less than the price at which control was also sold is a very strong indication of a fair
price.
Another matter the court addressed is the time period from the previous transaction up
to the tender offer. Naturally, the longer the time gap, the lesser the impact of the previ-
ous transaction, and vice versa. In the case of a lengthy period, the offeror in the tender
15
16
17
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offer will have to prove that, since the previous transaction, no significant changes have
occurred in company value. The court mentioned a period of six months as one beyond
which the significant indication of price fairness weakens.
The above leads to the conclusion that where, a short while prior to the tender offer,
a significant transaction was made outside the stock exchange, under which a minority
shareholder sold a block of shares to the controlling shareholder, the price determined
in that transaction is a significant indication of share price value. If the price offered to
the minority shareholders in the tender offer is not less than that price, this could attest
to this price being a “fair price.”
On the other hand, the Delaware Chancery Court (Judge Laster) recently decided in the
Dell case that a “deal price” will not inevitably equal fair value.18 Such a ruling may shift
the weight back to the courts to evaluate—with little help from objective “anchors”—the
fair value.
3.5 Consent of a Sophisticated Shareholder
Based on similar considerations, the Israeli Supreme Court accepted the proposition that
acceptance of the tender offer by certain shareholders may be used as a relevant factor
indicating the fairness of the offered price. This ruling rests on the presumption that in
certain cases, the price to which the “sophisticated shareholder” agreed was a result of
an arm’s-length negotiation between that shareholder and the buyer before the offer was
made, and can be therefore used as a good proxy for the fair value of the company.
In the Kital decision,19 the Supreme Court ruled that the agreement to the offer by an
institutional investor which the court considered to be “sophisticated,” and which was
aware of all of the relevant facts and reached a decision based on these facts, is a good
indication of the fairness of the price.
Other decisions of the Economic Division of the Tel Aviv district court followed that
line, and ruled that the agreement of a sophisticated shareholder to the complete tender
offer is a good indication to the fairness of the price. However, the court stated that if there
is good evidence that the sophisticated shareholder agreed to the price due to irrelevant
considerations (such as liquidity needs, interfacing connections to the offeror, and so on)
then his agreement would have no relevance to the court’s decision. The burden of proof
in this context is on the plaintiff. It is obviously difficult to track the precise reasons why
the sophisticated shareholder agreed to the offer, and if no evidence to the contrary is
offered, the presumption is that the agreement indicates that the price was fair.
In this context, there are several relevant factors that should be taken into considera-
tion: first, whether the relevant shareholder is an institutional shareholder or a private
shareholder; second, whether the “large” shareholder actually negotiated the offered price
with the buyer; third, whether the consent of that shareholder was crucial to the success
of the deal (in other words, did that shareholder hold an amount of shares providing him
a “veto power” to reject the offer).
18
In re Appraisal of Dell Inc., No. 9322-VCL (Del. Ch. Oct. 17, 2016) (Laster, V.C.).
19
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3.6 Institutional Holders versus Private Holders
Regarding the first factor, the question is whether there is a difference between a private
shareholder, who holds his own shares, and an institutional shareholder in this context?
One answer, given by the Tel Aviv District Court in the Ulitzky decision,20 is that
institutional shareholders are more trustworthy than private shareholders because of
the responsibility given to them by the state—the responsibility to invest other people’s
money.
But one might also think that the best way to determine fair value is by checking
the decision of someone who made a decision that will affect him personally, rather
than someone whose decision will affect other people. If this is the case, than a private
shareholder will be a “better candidate” to look after (as was mentioned in the Pinros
decision21).
The Kital ruling was criticized in the academic literature for this reason.22 The authors
of “Following the Kital Ruling: The Burden of Proof in a Complete Tender Offer”23 state
that institutional entities suffer from conflicts of interest between the investors whose
money is being invested and the management of the institutional entity. The managers of
the institutional investor could be influenced by conflicts of interest stemming from their
business activity beyond the management of investors’ funds. In addition, they could be
driven by liquidity considerations and the wish to present short-term profits. If this is the
case, then the consent of institutional shareholders should rarely be a factor that courts
consider in estimating fair value.
3.7 Actual Negotiations with the Sophisticated Offeree
As for the second factor, the question is whether it is necessary to show that the sophisti-
cated shareholder actually negotiated the price with the buyer before the complete tender
offer was made, in order to use his consent as an indicator of fair value.
The idea behind the Supreme Court’s ruling seems to be that the large sophisticated
shareholder’s agreement reflects a thorough analysis of the share price. The sophisticated
holder has the tools to assess fairness, and it is usually worthwhile for them to invest in
checking into the value of the shares, since his portion of the shares is relatively large and
so a price difference has a larger effect on him. Therefore, his agreement has more weight
than the agreement of a “regular,” small shareholder (whose agreement would have no
effect at all, as mentioned previously).
There are cases in which evidence exists of real negotiations between the offeror and
the sophisticated offeree before the tender offer was made, regarding the price to be
offered within the tender offer, to which the sophisticated offeree will consent. However,
the sophisticated offeree presumption does not require, as a necessary precondition to
its application, actual negotiations between the “sophisticated offeree” and the offeror.
20
Class Action (TA) 36604-02-10 Magen v. Ulitzky Mining (1990) Ltd. (Dec. 21, 2015).
21
Pinros 2016, supra note 13.
22
23
Hadas Aharoni-Barak & Assaf Hamdani, Following the Kital Ruling: The Burden of Proof
in a Complete Tender Offer, Ta’agidim, Nov. 2012, at 17.
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Actual negotiations will cause Israeli courts to give greater weight to the sophisticated
offeree’s consent to the tender offer, since they resemble a transaction under market terms.
That is in contrast to the situation in which the sophisticated offeree consented to the
tender offer as is, without prior negotiations (a “take it or leave it” offer), in which case
consent is less significant.
However, the consent of a sophisticated offeree with whom no negotiations were held
can be meaningful too. Mainly, this applies to a sophisticated offeree whose consent
could determine the fate of the tender offer. This was the situation in the Kaniel
case24—in which the selling company held a position in which, without its consent, the
tender offer could not have been accepted—and in the Matam case.25 When a certain
shareholder is aware that, without their consent, the tender offer could not go through,
it could be assumed that their consent is meaningful as an indication of offer price
fairness.
In other words, when there is one offeree who will determine whether the offer will be
accepted or rejected, the tender offer could be deemed as pointed at them. The offer can
be viewed as being made under hypothetical negotiations between the offeror and the
offeree. Had there been no other offerees, negotiations would have naturally been held
between the offeror and that offeree alone, who would have decided whether to accept or
reject it. The fact that there are other offerees usually need not impact the legal outcome,
and, as mentioned, the rules applied here should be similar to those applied when, prior
to the offer, a transaction was made with a significant minority shareholder outside the
stock exchange.
In the Malachi case,26 it was determined that no negotiations were held with the
sophisticated offerees. However, their consent was a relevant factor since it was proven
that the offeror tried to assess their “desires.” This conclusion was based on the fact that
the initial price offer was later increased by the offeror—probably to ensure the consent
of the sophisticated offerees.
3.8 Consent of Several Sophisticated Offerees versus Consent of One Offeree
Another issue in the Malachi case dealt with the fact that in that case,27 several sophisti-
cated offerees consented to the tender offer. The question is whether such consent carries
greater or lesser weight than that of one offeree.
In that context, several issues should be taken into consideration. First, as mentioned
previously, the consent of the majority of the “regular” nonsophisticated offerees does
not in itself indicate price fairness (as determined in Kital,28 as well as in Atzmon29). The
significant consent is, as mentioned, only that of “sophisticated” offerees, that is, those
regarding whom it could be assumed—contrary to what could be assumed regarding
24
CC (TA) 1209/03 Shkolnik v. Kaniel Beverages Packages Ltd. (May. 8, 2007) [a decision of
the undersigned].
25
Class Action (TA) 20457-03-11 Safra v. M.T.M. Indus. & Craft Bldgs. Ltd. (June 9, 2014).
26
CC (TA) 9714-07-15 Elad High Plateau Acquisition Inc. v. Malachi (Dec. 8, 2015).
27
Ibid.
28
29
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“regular” offerees—that they possess the tools to examine the tender offer and the price
offered in it, and would refuse the offer should they believe the price is unfair.
Another issue is whether, for the purpose of defining an offeree as “sophisticated,”
they should hold a large block of shares. In the Kital case,30 the court emphasized the
amount of shares held by the “sophisticated” offeree as one of the indications classifying
the offeree as sophisticated. Indeed, holding a large amount of shares is relevant not to
sophistication in itself, but to the offeree’s motivation to make extensive inquiries concern-
ing the price offered in the tender offer, and its comparison with the “fair” price of the
share. In the case of a shareholder that holds a larger block of shares, it is more likely
that it would benefit them to invest resources in making inquiries about the company to
evaluate its price.
It should further be taken into consideration that the investment interest of the selling
shareholder depends on their total investment in the company, and the size of that invest-
ment relative to its overall portfolio. An offeree whose holdings in the company form a
significant part of their investment portfolio differs from one whose holdings in the com-
pany are a marginal, insignificant part of their overall portfolio. Therefore, to determine
what weight to give to the consent of the sophisticated investor, the investor’s decision to
tender should be assessed in light of their overall investment status. The consent of one
offeree with a significant holding in the company that is also significant to their portfolio
carries more value than the consent of several “small” sophisticated offerees.
On the other hand, there are considerations showing that there is significant value in
the consent of several “sophisticated” offerees, even if they are not large shareholders.
As mentioned, the distinction made by the court between sophisticated offerees and
nonsophisticated ones relates first and foremost to the issue of their tools in assessing the
tender offer. If there are several offerees with tools enabling them to examine the offer
in an informed manner and make an informed decision regarding it, then the consent
of several offerees carries greater value than that of only one offeree. It also reduces the
risk of a mistake by one offeree, and the concern of consent stemming from irrelevant
considerations (such as liquidity needs etc.).
Regarding the consent of nonsignificant sophisticated offerees, the implication of the
amendment to the Companies Law should be noted too, by virtue of which a shareholder
who consented to a tender offer is no longer permitted to file a fair value claim or be
considered as part of the class in such a class action claim. In light of that amendment, it
seems that the consent of a sophisticated offeree should be given additional weight. Such
an offeree refusing a tender offer takes into consideration the possibility that, despite their
objection, the tender offer will be accepted (assuming that their vote is not required for
the offer to be accepted).
In that case, the offeree is entitled to request an appraisal remedy (personally or on
behalf of a class) claiming the difference between offer value and fair value. However, the
option of petitioning for an appraisal remedy is not available to a sophisticated offeree
who accepted the tender offer. The fact that only those refusing a tender offer could enjoy
an appraisal remedy (under a motion filed by them or by another offeree) could increase
a nonsignificant sophisticated offeree’s motivation to refuse an offer. Thus, their consent
30
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to an offer carries considerable weight and attests to the assumption that they considered
the offer’s price to be fair.
3.9 Negotiating the Price through an Independent Committee
Another option that has not yet been explored in Israel is negotiating the price of the
tender offer with an independent committee. This option was offered in an article by
Hamdani and Barak’s previously cited article following a Delaware court ruling in CNX.
According to this option, the majority shareholder will negotiate the offer price with an
independent committee that will represent the minority shareholders. Such a committee
should be given full authority. If the court is convinced that the committee was independ-
ent, and that it did actually have full negotiation authority, the price that is reached and
agreed upon by the committee may very well be considered by the court as an indication
for the fair value, at least in the same way as a prior deal would have been considered by
it. If such a possibility will be accepted by courts in Israel, it could be a helpful tool for
majority shareholders making a complete tender offer that want to mitigate the risk of
future litigation and interference of the court with the deal’s price.
Another interesting option is for the court to select one of the parties’ expert opinions
and evaluate the value of the shares according to it. If the parties are aware of this in
advance, than the evaluations made by their experts are expected to be more “reasonable”
and closer to each other.
3.10 Should “Fair Value” Represent the Value of the Company or of the Purchased
Shares?
In those cases where the court has no external “anchors” of the kind discussed above
(consent of a sophisticated offeree or a previous transaction outside the stock exchange),
the court is required to perform an appraisal to determine whether the tender offer price
was fair. Examination of that question requires assessment of a preliminary question:
should the court appraise the shares purchased under the tender offer, or should it evalu-
ate the company value as a whole, as a going concern (and derive share value according
to their relative share in the company)?
One of the questions in this context is whether share liquidity should be considered as
a relevant factor when estimating the value of those shares. Obviously, the fact that the
share marketability of a certain company is low impacts its stock exchange value, that
is, impacts share price in a transaction between a willing seller and willing buyer in the
stock exchange. Therefore, the difference between these approaches could be significant.
Thus, should the court be required to appraise the value of purchased shares, it could
lead to lower appraisal values—both because these are minority shares lacking a control
premium, and because there may be little or no market for these shares. However, if
company value is to be calculated as a whole, neither the lack of a control premium nor
the illiquidity of the shares will detrimentally affect their value.
According to Delaware case law, in appraisal cases the court should determine the
value of the company itself as a going concern. The relative share of the shareholder
is irrelevant, except with regard to the determination of their share in overall company
value. This determination was aimed at preventing unfair profit for the majority
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shareholders purchasing the shares of minority holders, a result the court deemed
undesirable.31
For that matter, the Delaware court distinguished between the value appraisal of shares
held by the company itself (and forming a part of company assets to be appraised)—in
which case low share marketability carries weight in the appraisal—and the appraisal of
minority shares purchased in the tender offer. Then, as mentioned, the appraisal is not
of the specific shares but rather appraisal of company value as a going concern, when
minority share value is derived from that value according to the relative share of the
minority in the company.
In the Kital case,32 the Supreme Court determined that in motions for an appraisal
remedy, the court has to consider the difference between a transaction under which
the minority shareholders wish to voluntarily “detach” themselves from the company
(for example, due to a change in its activity fields) and a transaction in which those
shareholders are forced to sell their shares to the majority shareholders. In that matter, the
court also referred to the “main position amongst scholars in the U.S. and the Delaware
court ruling,” stating that no discount should be made due to minority shares under an
appraisal remedy.
That leads to the conclusion that no reduction is to be made in the value of minority
shares purchased which lack a control premium. This conclusion also impacts the ques-
tion of a possible price discount due to lack of marketability. Should such discount be
made, the result will be that the controlling shareholder purchasing the minority shares
will pay the minority shareholders a price for their shares that is lower than their relative
share in the company, when that value is calculated according to the DCF method. In
other words, the majority could purchase part of the company for less than its value.
The result is that the controlling shareholder will be getting the value difference due to
nonmarketability (purchasing the minority shares for a price lower than that reflecting
their relative share in the company). Should the law enable the controlling shareholders to
purchase minority shareholders’ shares for a price lower than that reflecting their relative
share in the company, the controlling shareholders will always obtain a high profit from
purchasing the minority in companies with low share marketability. Such profit actually
reflects a “control premium” of the controlling shareholders, which minority shareholders
are deprived of.
Another reason for the conclusion that minority share value should not be discounted
due to low marketability is the fact that, as mentioned above, shares’ marketability could
often be controlled by the controlling shareholder. Controlling shareholders are usually
less affected by reductions in share marketability, since controlling shareholders usually
do not wish to market their shares on the stock exchange. They usually trade small quanti-
ties. When the controlling shareholder wishes to sell company control, they usually do that
in a transaction outside the stock exchange.
Should the controlling shareholder be allowed to purchase the minority shares for a
discounted price reflecting their nonmarketability (or limited marketability), their incen-
tive would be to ensure reduce share marketability. Minority shareholders will be affected
31
Cavalier Oil Corp. v. Harnett, 564 A.2d 1137, 1145 (Del. 1989).
32
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by that both before the tender offer (when they will struggle to “rid themselves” of their
shares) and under the tender offer—when their shares’ “fair” price will be deemed lower.
Therefore, low share marketability should be disregarded in the appraisal of their fair
value.
4. CONCLUSION
The Israeli case-law regarding appraisal decisions is still in the making.

This chapter did not deal with several other questions that arise as far as appraisal
decisions are concerned: What should be the method of evaluating the fair value? Is DCF
always the best method? Moreover, since courts may have to rely on expert opinions, what
is expected of the experts? Can their fee be contingent? If not, it may be very difficult for
the minority shareholder to finance such an opinion. Finally, how should courts examine
the expert opinions and determine the fair value of the shares, in those cases where there
is no alternative “anchor” to do so?
However, Israeli case-law did address in several cases the question of whether the
price paid for the minority’s shares was their “fair price.” In doing so, the courts were
aware of the difficulty in relying on expert testimony, and considered other alternatives.
In some rulings, courts relied on sophisticated shareholders’ agreement to the offered
price as a possible indication to the price’s fairness. These rulings may effect controlling
shareholders that plan to make a tender offer, and may give additional power to those
minority shareholders that can be considered “sophisticated.” Courts have to be aware of
that and make sure that this additional power is not used coercively.
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Section C
Appraisal Actions
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15. Recent developments in stockholder appraisal
Charles R. Korsmo and Minor Myers* 33
This chapter provides an overview of stockholder appraisal activity, including data from
2015, together with an evaluation of recent legal developments, both judicial and legisla-
tive. The year 2015 was a record one for stockholder appraisal in terms of the number of
mergers challenged and the dollar amounts involved. The evidence shows, however, that
appraisal remains relatively rare and continues to be focused on deals with abnormally
low merger premia and sales processes marked by conflicts of interest. Developments
in the Delaware legislature and Court of Chancery suggest a growing acceptance of the
recent blossoming of appraisal arbitrage as an investment strategy, coupled with sensible
prophylactic measures against potential abuses of the appraisal remedy.
1. INTRODUCTION
In the past five years, the appraisal remedy has gone from being an arcane and little-
known feature of stock ownership to a routine feature of the Delaware Court of Chancery
docket and a topic of heated debate. This change has largely been driven by the emergence
of so-called appraisal arbitrage, where sophisticated funds pursue appraisal litigation as
part of a deliberate investment strategy, often buying stakes in merger targets after a deal
has already been announced.
Critics of appraisal arbitrage have described it as an “abuse” of the appraisal remedy
and have suggested that it could deter beneficial mergers. We have previously argued that
the evidence suggests appraisal arbitrage can serve a useful governance function, deter-
ring managerial opportunism in a way that redounds to the benefit of all stockholders
and, ultimately, to the benefit of issuers of public equity. In this chapter, we present and
evaluate recent activity in appraisal litigation, and we find the evidence continues to
support our contention that appraisal provides useful deterrence effects against abusive
transactions.
Recent years have also seen significant legal developments. These include the first
amendments to the Delaware code in response to the increase in appraisal arbitrage, as
well as the largest batch yet of judicial opinions in the new era. Both the legislative and
judicial responses to the growth of appraisal litigation have been measured, reflecting
cautious acceptance of appraisal arbitrage as a useful tool in deterring opportunistic
* Thanks to participants in the 2016 Corporate and Securities Litigation Workshop. The
authors are the principals of Stermax Partners, which provides compensated advice on stockholder
appraisal and manages appraisal-related investments, and have economic interests in the outcome
of appraisal proceedings. They received no compensation for the preparation of this chapter, and
none of the views expressed here were developed directly out of their advisory work, although, of
course, general experience serves as helpful background.
243
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transactions, while attempting to put a damper on potentially destructive practices. These

efforts paralleled a significant judicial crackdown on frivolous fiduciary duty class actions
challenging mergers, which may reflect a judicial desire to steer merger challenges into
appraisal, where they are less likely to be distorted by the agency problems that plague
class actions (Korsmo & Myers 2014).
This chapter focuses on Delaware law and proceeds in three parts. First, we offer a short
introduction to the appraisal remedy itself. Second, we provide an overview of the empiri-
cal data on modern appraisal litigation—including the rise of appraisal arbitrage—with a
focus on recent data from 2015. Third, we describe and evaluate recent judicial opinions
and legislative actions regarding appraisal, both of which reflect an increasing acceptance
of appraisal arbitrage as part of the constellation of Delaware corporate governance
tools, together with a desire to head off potential abuses.
2. THE APPRAISAL REMEDY
The appraisal remedy in Delaware provides minority stockholders a right to dissent from
a merger transaction, forgo the consideration they would otherwise receive, and seek a
judicial determination of the “fair value” of their stock in the Court of Chancery. This
section outlines the operation of Delaware’s appraisal statute.
Appraisal is a longstanding feature of corporate law, and has been available in its
modern form for a century (Thompson 1995). While a definitive statement of the “origi-
nal intent” of appraisal is elusive, the standard account ties the emergence of the remedy
to other contemporary changes in corporate law and patterns of stock ownership. Earlier
corporate codes had, by analogy to partnership law, insisted that stockholders consent
unanimously to mergers and other extraordinary transactions (Carney 1980). With the
rise of very large corporations and increasingly dispersed ownership of stock traded
via public markets, this unanimity requirement generated difficult holdout problems.
As a result, in the decades around the turn of the century, states began amending their
corporate codes to eliminate the requirement of unanimous shareholder consent to
fundamental transactions. This change, however, left minority shareholders vulnerable
to majority stockholder opportunism or otherwise exploitative mergers. Thus, state
corporate codes began to offer appraisal as a replacement protection. In an appraisal
proceeding, the terms on which minority stockholders exit their investment are set by a
judge rather than by a board of directors (Geis 2011).
Section 262 of the Delaware General Corporation Law (DGCL) governs the remedy,
and only a merger transaction triggers stockholders’ appraisal rights in Delaware. For
public companies, the form of merger consideration affects appraisal eligibility. Only
when stockholders are required to accept cash or unmarketable securities is appraisal
available. Notably, when the merger consideration is entirely publicly traded stock, stock-
holders have no appraisal rights. Elsewhere we have criticized this so-called market-out
exception to appraisal eligibility because the form of merger consideration is irrelevant to
the question that matters to stockholders: the adequacy of the consideration (Korsmo &
Myers 2016A; Goetz 2010).
Appraisal statutes require minority stockholders to jump through a number of
procedural hoops in order to preserve and assert their appraisal rights. In Delaware, for
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Recent developments in stockholder appraisal 245
example, a dissenting stockholder must not vote in favor of the merger and must make a
written demand to the company in advance of any stockholder vote informing the com-
pany of the intent to seek appraisal and the number of shares held. After making demand,
the dissenter may, within 60 days of the effective date of the merger, unilaterally withdraw
his dissent and accept the merger consideration. Meanwhile, appraisal rights are forfeited
if no petition is filed in the Court of Chancery within 120 days of the merger’s closing.
The sole merits issue in an appraisal proceeding is the fair value of the dissenting stock-
holder’s shares. In Delaware, fair value is calculated as of the effective date of the merger,
and will include any applicable control premium but exclude any synergies or other value
gained in anticipation of the merger. The court is not constrained to use any particular
valuation technique, but is empowered to rely on any technique generally considered
acceptable within the financial community. Both parties bear the burden of proof on
the question of fair value, and the court must make its own independent determination
of value. Trial involves extensive testimony by competing expert witnesses. The merger
price itself is not formally presumed to constitute fair value, though in practice the court
often affords substantial weight to a merger price that emerges from a competitive sales
process. The trial award entitles the dissenting stockholders to cash equal to the judicially
determined fair value, together with interest. The DGCL awards interest at the legal rate,
which in Delaware is 5 percent above the Federal Reserve discount rate. As discussed more
fully below, Delaware recently amended its appraisal statute to allow companies to avoid
the accrual of interest by prepaying petitioners.
The structure of the appraisal remedy and the timeline of a typical merger transaction
make it possible to invest in appraisal litigation in a way that is seldom feasible for other
forms of stockholder litigation. Investing in a company with an intent to pursue appraisal
has come to be known as “appraisal arbitrage.” After a merger transaction has been publicly
announced, outside investors can consider whether the transaction undervalues the target
stock. If they believe the Court of Chancery would be likely to find a substantially higher
“fair value,” they simply need to establish a position and dissent before the stockholder vote.
For two-step transactions under 251(h) and other mergers effected without a shareholder
vote, an investor can establish a position and dissent right up until the closing date.
Appraisal actions differ in several important ways from the more familiar fiduciary duty
class action. Most fundamentally, an appraisal petition is an individual action. While mul-
tiple petitions may be consolidated into a single proceeding, any stockholder who wishes
to dissent must affirmatively meet the procedural requirements in the DGCL. Unlike an
optout class action, a stockholder seeking appraisal does so only on his own behalf, and
not on behalf of any other stockholders. While a fiduciary duty plaintiff can spread the
costs of litigation across a large class, an appraisal petitioner generally must have a large
enough stake to justify the costs. Furthermore, an appraisal petitioner—unlike a member
of a fiduciary duty class—must forgo the merger consideration and bear the risk that fair
value will be found to be less than the merger price. Together, these costs and risks force
an appraisal petitioner to consider carefully the strength of his claim prior to bringing a
suit. By contrast, an entrepreneurial plaintiffs’ attorney pursuing a fiduciary duty class
action can generally find a small stockholder to serve as lead plaintiff. Unsurprisingly,
these structural differences between appraisal actions and fiduciary duty class actions
manifest in strikingly different patterns of litigation, which we have explored elsewhere
(Korsmo & Myers 2014).
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3. MODERN APPRAISAL ACTIVITY
Until approximately 2010, appraisal litigation was relatively rare in the public company
context. When it occurred, it tended to represent a last-ditch maneuver by a disgruntled
long-term stockholder unhappy with a merger. Since 2011, however, the landscape has
changed substantially, and appraisal has become a potent governance tool. The modern
period has been characterized by a substantial increase in the number of challenged
transactions, as well as in the number of dollars at stake. It has also seen a change in the
identity of the typical appraisal petitioner, with specialized repeat players now filing the
bulk of the claims and holding the vast majority of the money at stake. In this section, we
sketch these changes, with a focus on 2015.
In sum, 2015 saw a rebound following a period of reduced appraisal activity in 2014.
This rebound mirrored a surge in the merger market as a whole, which reached an all-time
record dollar volume in 2015. This rebound in appraisal activity was accompanied by a
sharp and widely noted decrease in the frequency of fiduciary duty challenges to merger
transactions, though such challenges still substantially outnumber appraisal petitions (see
Griffith and Rickey, Chapter 9, this volume).
Our data focuses on appraisal petitions challenging public company mergers filed in the
Delaware Court of Chancery. We exclude any natural persons who file their petitions pro
se, as these are of little economic significance. Our analysis and presentation focuses on
the effective date of the merger, rather than the date when the merger is announced or the
date when the first petition is filed. The effective date is generally more meaningful and
forms a single point of reference, whereas petitions challenging a single transaction may
be filed in different years. The effective date also better captures the appraisal petitioner’s
timing, given that the investment must be made prior to that time.
From 2004 through the end of 2015, approximately 200 appraisal petitions involving
publicly traded stock were filed in Delaware by counseled petitioners. 2015 reflected a new
high, with a total of 52 counseled petitions filed, surpassing the previous high-water mark
of 37 in 2013. Figure 15.1 shows the number of petitions filed per year.
The number of filed petitions—a number frequently trumpeted by journalists—is not
always particularly meaningful. For one thing, the number of petitions may naturally
60
50
40
Petitions filed
30
20
10
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Figure 15.1 Counseled appraisal petitions per year, 2004–2015
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fluctuate along with underlying activity in the merger market. The year 2014 showed a
dramatic decline in the number of appraisal petitions, but this decline largely tracked a
drop in overall merger activity in 2014, a year which saw the fewest appraisal-eligible deals
of any year in our sample.
In addition, the raw number of filings may both understate and overstate the actual
level of appraisal activity. It understates appraisal activity because it counts only petitions
actually filed in court, so any disputes that are settled before the filing of a petition are
unobservable. Undoubtedly, some particularly strong claims are settled in this fashion. As
a result, actual filings may somewhat undercount the actual number of appraisal disputes.
Numbers of petitions may also overstate the level of appraisal activity. Multiple petitions
are often filed challenging the same merger and are ultimately consolidated into a single pro-
ceeding. It makes little difference whether multiple dissenters each file separate petitions and
are then consolidated, rather than simply joining together in a single petition at the outset.
The PetSmart merger, for example, saw seven petitions filed—some involving multiple
individual dissenters—with six petitions brought by parties represented by the same lawyer.
More meaningful than the raw number of petitions filed is the percentage of appraisal-
eligible deals where at least one dissenter files a petition. This is shown in Figure 15.2.
Through 2010, appraisal activity was generally around 5 percent of eligible transactions.
This figure began to rise in 2011, peaking at 17 percent in 2013 before falling slightly to
13 percent in 2014. In 2015, the figure was 14.5 percent. These figures represent more
of a continuation than a marked change from the pattern of the past several years. This
leveling off may indicate that the recent period of growth has plateaued, and appraisal
activity has reached a new equilibrium in the vicinity of 15–20 percent.
The value at stake in appraisal proceedings in 2015 also rebounded from 2014, hitting a
record $2.75 billion, again tracking an increase in the total value of merger transactions,
which hit a record in 2015 (see Figure 15.3). Again, this value represented only a very
small percentage (0.12 percent) of the aggregate value of appraisal-eligible deals dissented,
as compared to an average of 0.35 percent since the level of appraisal activity began to
increase in 2011 through the end of 2014. The value in appraisal in 2015 was highly con-
centrated on three mergers in particular, involving Safeway, AOL, and PetSmart. These
cases represent three out of only four transactions where more than 5 percent of shares
20%
15%
Percentage
10%
5%
0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Figure 15.2
Appraisal petitions as a percentage of appraisal-eligible transactions,
2004–2015
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2,800
2,400
Millions of 2015 dollars
2,000
1,600
1,200
800
400
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Figure 15.3 Value of dissenting shares in Delaware appraisal, 2004–2015 (in millions of

constant 2015 dollars)
sought appraisal, the other being a much smaller company where the bulk of the dissenting
shares were held by a long-term stockholder and first-time appraisal petitioner. Together,
Safeway, AOL, and PetSmart accounted for more than $1.8 billion—approximately 65
percent—of the value at stake in appraisal. In the PetSmart case alone, nearly at least $890
million in stock sought appraisal, the largest single case yet. Even excluding these three
large cases, however, the value seeking appraisal in 2015 was greater than $500 million, an
amount that had been exceeded only in two other years in our data.
As has been the case every year since 2011, the majority of value at stake in appraisal
in 2015 came from repeat petitioners. The dominance of specialist appraisal arbitrageurs,
however, was not as great in 2015 as it has been in recent years. Several large institutional
investors—including the hedge fund Third Point and Stichting APG (a Dutch pension
fund)—resorted to appraisal in 2015. Altogether, petitions from first-time or nonspecialist
petitioners totaled approximately $1 billion, easily a record. This shift may reflect greater
awareness and acceptance of appraisal, both as part of an overall investment strategy and
as a tool for institutional shareholders.
Appraisal does, however, carry significant risk even for sophisticated nonspecialists, as
evidenced by the experience of T. Rowe Price—a large mutual fund—in the recent Dell
appraisal case. Vice Chancellor Laster found that, due to a series of administrative mis-
takes too technical and tedious to relate here, T. Rowe Price had failed to comply with the
requirements of Section 262. He thus excluded T. Rowe Price from the eventual recovery,
costing it approximately $200 million. This embarrassing episode ultimately resulted in
T. Rowe Price’s investment manager reimbursing its investors the lost $200 million. It
remains to be seen whether this example—which took place in 2016—chills nonspecialist
participation in appraisal going forward.
While not directly related to appraisal, it is worth remarking on an important parallel
development. From 2010 through 2014, fiduciary duty class actions challenging merger
transactions were well-nigh ubiquitous. Well over 90 percent of deals larger than $100 mil-
lion faced at least one class action, with large deals often facing a blizzard of class action
filings in multiple jurisdictions (Cain & Davidoff Solomon 2014). There was a sharp drop
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in the frequency with which mergers were challenged by fiduciary duty class actions in
2015 (Griffith and Rickey, Chapter 9, this volume). This drop followed a series of judicial
opinions scrutinizing and rejecting settlement agreements providing substantial fees for
plaintiffs’ attorneys but little or no value for stockholders.
4. LEGAL DEVELOPMENTS IN APPRAISAL
The past year has seen the first real legal response to the rise of appraisal arbitrage.
This response has two components, and arguably a third. First, the Delaware legislature
amended the appraisal statute in response to concerns—well-founded or not—about
potentially abusive tactics by appraisal petitioners. Second, the Court of Chancery gener-
ated the first significant batch of merits opinions for cases filed in the new era. Finally,
while not appraisal-related on the surface, the recent judicial crackdown on disclosure-
only settlements in fiduciary duty class actions has a variety of implications for appraisal.
The appraisal amendments emerged from an unlikely place. The initial suggestion to
amend the appraisal statute grew out of public anger over feeshifting bylaws. Soon after
the Delaware Supreme Court had seemingly endorsed feeshifting bylaws, the Corporation
Law Council of the Delaware state bar leapt into action, proposing an amendment that
would prohibit such bylaws. In the face of significant controversy, the Delaware legisla-
ture did not act on the Council’s proposed amendment but instead passed a resolution
that invited the Council to further analyze the topic. In a surprising nonsequitur, the
resolution also requested that the Council delve into “the operation and administration
of the statutes and court rules governing the exercise of appraisal rights; and the rate of
interest on any fair value determination in an appraisal.”
After examining the appraisal statute, the Council released two appraisal-related
DGCL amendments in March 2015.
To guard against small claims brought for nuisance value, the first amendment
introduced a de minimis rule: Only where the dissenting group held more than $1 million
worth of stock or 1 percent of shares was appraisal available. The second amendment was
driven by concerns that appraisal arbitrageurs might park money in appraisal in order to
take advantage of Delaware’s purportedly “above-market” interest right. The Council’s
proposal would give the company the unilateral right to pay over some amount, and doing
so would stop the running of interest on amounts so paid.
The 2015 Council proposal was especially notable in that it declined to propose any of
the more radical proposals proffered by detractors of appraisal. The most common such
proposal would restrict appraisal eligibility to those stockholders who held on the record
date for voting on the merger. Instead, the Council emphasized the possible governance
benefits of an active appraisal market. Disappointed with the incrementalism of the
Council, a handful of M&A law firms based of New York City wrote to the Council
insisting on more aggressive reforms.
The proposed amendments were not enacted by the legislature in 2015—a highly
unusual occurrence. News reports at the time suggested that the Dole Food Company
was a major instigator of this push for radical changes to the statute. Dole, of course,
happened to be the defendant in one of the larger appraisal cases in Delaware at the time.
Following an August 2015 court opinion finding that Dole’s managers had engaged in a
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pervasive scheme of fraud and award of damages to public stockholders, Dole appears
to have fallen silent on the issue.
In 2016, the Council again recommended the same two amendments. In the absence of
Dole’s lobbying efforts, the amendments were ultimately enacted in the summer of 2016.
The amendments are, on balance, positive developments. While evidence of nuisance
claims had previously been lacking, in 2015 we did for the first time observe small-value
claims (<$250k) brought by repeat litigants. This reform would have had a substantial
impact on appraisal activity in 2015. More than 20 percent of appraisal petitions would
have been disallowed, and the transactions facing an appraisal petition would have fallen
by 35 percent.
The de minimis requirement is a sensible prophylactic against potential nuisance suits
and has little downside as a matter of public policy. If a transaction does not trouble
holders of more than 1 percent or $1 million in stock, it makes little sense to force defend-
ants to defend a proceeding, or to expend judicial resources in the process. Indeed, there
is little reason to limit this approach to appraisal. A de minimis requirement could be
equally helpful in avoiding nuisance derivative litigation, securities litigation, and merger
class actions.
As we have suggested elsewhere, the prepayment option—borrowed from the MBCA—
could be improved (Korsmo & Myers 2016B). As enacted, it enables the respondent to
engage in strategic behavior, adjusting the timing of any prepayment for tactical reasons,
and declining to prepay at all where the company’s cost of borrowing exceeds the statutory
interest rate. Nonetheless, the amendment is, on balance, an improvement, removing the
statutory interest rate as an independently attractive feature of seeking appraisal.
More important than their direct impact on appraisal practice, however, is the fact that
the new amendments represent incremental reforms rather than a radical reshaping of the
appraisal remedy. The amendments reflect an appreciation of appraisal as an important
governance tool and of appraisal arbitrage as vital in ensuring the effective use of that
tool. Rather than simply seeking to curtail appraisal or appraisal arbitrage, the amend-
ments appear designed to ensure that appraisal activity will continue to be focused on the
transactions most in need of judicial scrutiny.
These legislative developments have been paralleled by the first large batch of Court of
Chancery opinions involving cases brought in the new era of appraisal arbitrage. The first
half of 2015 saw three major opinions in quick succession finding the fair price either equal
to the merger consideration (In re Appraisal of Ancestry.com, Inc. and Merlin Partners,
LP v. AutoInfo, Inc.) or slightly below the merger consideration (LongPath v. Ramtron).
These results came despite the formal precedent holding that a negotiated merger price
is not presumptively evidence of fair value. All three cases had been brought by specialist
appraisal arbitrage funds who, after legal expenses, may have experienced negative returns.
This series of cases led some commentators to speculate that the Court of Chancery was
inclined to take a dim view of appraisal arbitrage and sought to discourage it.
Subsequent opinions, however, have been more mixed. While the Court again deferred
to the merger price in BMC Software, petitioners were awarded more than the deal price—
sometimes substantially more—in a number of cases, including ones involving Dole
Foods, Dell, DFC Global, and Energy Services Group. The common thread in all of these
cases was that the petitioners were able to successfully call into question the integrity and
robustness of the sales process leading to the deal price. Indeed, both the Dole Foods case
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and the Energy Services case involved hybrid fiduciary duty/appraisal actions. In the Dole
case, Vice Chancellor Laster found that the CEO and his trusted lieutenant committed a
pervasive scheme of fraud to drive down the cost of a management buyout. Similarly, the
Energy Services valuation was accompanied by Chancellor Bouchard finding a culpable
breach of duty in a management buyout scenario.
Even in the DFC Global and Dell cases—where parallel fiduciary duty claims were
abandoned postclose—Chancellor Bouchard and Vice Chancellor Laster, respectively,
devoted significant energy to determining whether the deal price itself was a reliable
measure of fair value. The decision to depart from the merger price came only after find-
ing that it was not reliable. In both cases, this finding was due to two factors: (1) obstacles
to a true auction and failings in the shop process itself, and (2) the fact that the ultimate
buyers were private equity firms. Both judges noted that in deciding what to pay for a
target company, private equity firms typically discount the company’s future earnings at
a target rate of return that often exceeds the target’s cost of capital. As a result, the most
a private equity buyer is willing to pay may be dramatically less than what the company
is worth on an ongoing, standalone basis.
Some commentators have questioned the reasoning behind the second factor, finding
it anomalous that the fair value of a company could be higher than any actual party is
willing to pay for it. We find these criticisms lacking and think the Court of Chancery’s
approach is sensible. Fair value certainly should not be equated with “the most a willing
buyer will pay.” Such a definition would exclude the very real possibility that a company’s
value could be maximized by remaining independent and maintaining a capital structure
where equity is held by dispersed, diversified stockholders. The Dell case, in particular,
seems to us one in which it was quite plausible that the company’s equity was worth more
when held by a shareholder base of diversified investors than when held by a concentrated
ownership group.
In 2015, many Delaware observers predicted that appraisal arbitrage would continue to
play a beneficial role and be a viable investment strategy, but that the proposed amend-
ments then before the legislature and the pending cases then before the Court of Chancery
would result in a finetuning of incentives for arbitrageurs, requiring them to only bring
serious cases. Subsequent developments have vindicated these predictions. The recent
amendments will limit the availability of appraisal only to investors willing to dedicate
significant resources. It will no longer even be theoretically attractive for an investor to
park money in appraisal simply to avail itself of a “high” interest rate. The recent case law
makes clear that petitioners will only profit if they can reliably demonstrate both that the
sales process was imperfect and that fair value was higher than the merger price.
The increasing legal acceptance of appraisal can be juxtaposed against—and perhaps
helps explain—the simultaneous judicial crackdown on frivolous fiduciary duty class
actions challenging mergers. Over the past decade, fiduciary challenges to merger
transactions had become nearly ubiquitous. From 2010 to 2014, more than 90 percent of
deals larger than $100 million were subject to at least one class action (Cain & Davidoff
Solomon 2014). In 2014, this frenzy of litigation reached a peak, with nearly 95 percent
of transactions of all sizes attracting at least one class action lawsuit (Cain & Davidoff
Solomon 2015). Fiduciary duty class actions had been attractive to plaintiffs’ attorneys
primarily due to the ease with which they could secure a settlement that provided
essentially meaningless “relief ” to the stockholders—typically additional disclosures of
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debatable significance—together with substantial attorneys’ fees (Korsmo & Myers 2014).
Roughly 80 percent of merger class actions ended with such “disclosure-only” settlements,
and these settlements were historically subjected to fairly cursory scrutiny when submitted
to the Court of Chancery for approval (Fisch, Griffith, & Davidoff Solomon 2015).
In 2015, the landscape of merger class actions changed dramatically, and the develop-
ments are chronicled expertly in other chapters of this volume (Griffith & Rickey 2018).
Following these judicial shots across the bow, the percentage of deals challenged in
Delaware dropped to only 21 percent in the last three months of 2015.
Indeed, while the Court of Chancery has not explicitly drawn a connection, it seems
possible that the willingness to put the brakes on merger class actions was driven, at least
in part, by the emergence of appraisal as a viable alternative for checking managerial
opportunism and deterring abusive transactions. In a world where fiduciary duty class
actions were the only form of judicial supervision, disclosure-only settlements were
perhaps a small price to pay to provide an incentive for plaintiffs’ attorneys to scrutinize
merger transactions. In a world where appraisal arbitrageurs are increasingly identifying
and targeting the most suspect transactions, frivolous class actions need no longer be tol-
erated. To the extent that the emergence and increasing acceptance of appraisal arbitrage
has helped to put an end to the plague of meritless fiduciary duty class actions, even deal
advisers can find reason for gratitude.
5. CONCLUSION
Recent developments in appraisal suggest the emergence of what may be equilibrium

conditions in both appraisal activity and appraisal policy. This equilibrium, of course,
could be a mirage: litigation patterns will change and policy upheavals are sure to come.
But there are grounds for confidence that appraisal will continue to play a modest but
beneficial role in deterring opportunistic transactions at the margin.
BIBLIOGRAPHY
Cain, Matthew D. & Steven Davidoff Solomon (2015). “A Great Game: The Dynamics of State Competition
and Litigation,” Iowa Law Review, 100: 465–500.
Carney, W. (1980). “Fundamental Corporate Changes, Minority Shareholders, and Business Purposes,”
American Bar Foundation Research Journal, 5: 69.
Fisch, J., Griffith, S., & Solomon, S. (2015). “Confronting the Peppercorn Settlement in Merger Litigation: An
Empirical Analysis and a Proposal for Reform,” Texas Law Review, 98: 557.
Geis, George (2011). “An Appraisal Puzzle,” Northwestern Law Review, 105: 1635–77.
Gilson, Ronald J. & Jeffrey N. Gordon (2003). “Controlling Controlling Shareholders,” University of
Pennsylvania Law Review, 152: 785–843.
Goetz, Jeff (2010). “A Dissent Dampened by Timing: How the Stock Market Exception Systematically Deprives
Public Shareholders of Fair Value,” Fordham Journal of Corporate & Financial Law, 15: 772–806.
Griffith, Sean & Rickey, Anthony (2018). “Who Collects the Deal Tax, Where, and What Delaware Can Do
about It,” Research Handbook on Representative Shareholder Litigation (Sean Griffith, Jessica Erickson,
Verity Winship & David Webber, eds, Edward Elgar Publishing).
Korsmo, Charles R. & Minor Myers (2014). “The Structure of Stockholder Litigation: When Do the Merits
Matter?” Ohio State Law Journal, 75: 829–901.
Korsmo, Charles R. & Minor Myers (2015). “Appraisal Arbitrage and the Future of Public Company M&A,”
Washington University Law Review, 92: 1551–1613.
M4633-GRIFFITH_t.indd 252 30/10/2018 08:16

Korsmo, Charles R. & Minor Myers (2016). “Reforming Modern Appraisal Litigation,” Delaware Journal of
Corporation Law, 41: 249–343.
Korsmo, Charles R. & Minor Myers (2017). “Interest in Appraisal,” Journal of Corporation Law, 42: 109–46.
Morphy, James C. (2008). “Doing Away with Appraisal in Public Deals,” Delaware Lawyer, 26–30.
Thompson, Robert (1995). “Exit, Liquidity, and Majority Rule: Appraisal’s Role in Corporate Law,” Georgetown
Law Journal, 84: 1–60.
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16. Appraisal as representative litigation
Minor Myers*
1. INTRODUCTION
This chapter examines the ways in which appraisal rights proceedings are a form of
representative litigation. The outcome of an appraisal proceeding binds all dissenting
stockholders, not just those who have filed a petition in court, and in that sense the
proceeding operates as aggregate litigation and consequently raises numerous procedural
issues.
It is easy to overlook the representative nature of appraisal because the remedy other-
wise differs in important ways from the standard forms of stockholder suit, particularly in
the formation of the class (Gilson & Gordon 2003; Aronstam, Balotti, & Rehbock 2003).
Stockholder derivative suits and merger class actions proceed on behalf of all stockhold-
ers. Absent class members may not even know of the existence of the suit. Appraisal, by
contrast, is available only to those stockholders who affirmatively meet a set of require-
ments that are straightforward but have long been characterized as an obstacle to the
exercise of appraisal rights (Fried & Ganor 2006). As Gilson & Gordon have observed,
“the Delaware corporate statute does not authorize a class appraisal procedure” (Gilson
& Gordon 2003).
This basic procedural distinction has attracted academic and judicial attention (Letsou
1998).1 It also marks an important contrast between the appraisal remedy and other forms
of stockholder suits. But those who file and pursue an appraisal petition in court neces-
sarily represent other dissenting stockholders—large and small—who do not bother to
file a petition. This generates legal questions about control of claims, sharing of expenses,
settlement rights, and notice obligations to other dissenters that are familiar but distinct
from the class action context.
This chapter outlines the ways in which the appraisal statute explicitly contemplates
and supports collective action by the dissenting group. The policy ambition is to induce
those in control of the appraisal proceeding to invest the optimal amount in prosecuting
* Thanks to T. Brad Davey, Charles Korsmo, and participants in the 2016 Corporate and
Securities Litigation Workshop. The author is a principal of Stermax Partners, which provides
compensated advice on stockholder appraisal and manages appraisal-related investments, and has
economic interests in the outcome of appraisal proceedings. The author received no compensation
for the preparation of this chapter, and none of the views expressed here were developed directly
out of his advisory work, although of course general experience serves as helpful background.
1
E.g., Berger v. Pubco Corp., 976 A.2d 132, 143 (Del. 2009) (“[I]t is self evident which alterna-
tive is optimal. As between an opt in requirement that would potentially burden shareholders
desiring to seek an appraisal recovery but would impose no burden on the corporation, and an opt
out requirement that would impose a lesser burden on the shareholders but again no burden on
the corporation, the latter alternative is superior and is the remedy that the trial court should have
ordered”).
254
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Appraisal as representative litigation 255
the case given the size of the dissenting group, regardless of the size of only the petitioner’s
holdings (Silver & Miller 2010). The statutory framework encourages petitioning stock-
holders to make decisions in reliance on classwide relief and in expectation of recovering
expenses pro rata from the dissenting group. Similarly, the Court has interpreted the
appraisal statute in a way that promotes its underlying remedial goals by constraining
opportunistic behavior. The equitable rules fashioned by the Court parallel many of those
found in the Rule 23 context.2
With the recent growth in appraisal activity, disputes among dissenting stockholders
may become more common and more consequential. One predictable source of ten-
sion that remains unresolved is between the atomized settlement rules in an appraisal
proceeding—no dissenter can be forced to accept a settlement—and the necessarily
centralized management of the proceeding itself. The petitioner may invest in the case
based on the size of the dissenting group at time 1 only to have some portion of that group
settle and possibly avoid sharing expenses at time 2. A sensible solution to this problem is
for the Court to key the petitioner’s ability to recover from other dissenters to the extent
to which those dissenters profited directly from the petitioner’s investments.
This chapter analyzes the dynamics of an appraisal claim through its life cycle, from the
initial decision to dissent to the sharing of expenses following a trial judgment.
2. MITIGATING THE RISKS OF OPTING IN
Stockholders suffer from a potential disability when electing appraisal rights: each
will have no idea who else may be dissenting. For a large holder, that may not matter
because the benefits of pursuing the claim can be worth the cost of legal fees and
expenses. But for a small holder, the costs of pursuing the proceeding may overwhelm
any benefits from even a wildly successful result at trial. For this reason, appraisal is
sometimes derided as a remedy that fails small holders (Cox, Hazen, & O’Neal 1997).
This is not an issue in the standard class action because class members do not need to
join the class in the first place and also do not need to finance the prosecution of the
claim. The representative party and its lawyer are empowered to act on behalf of the
class, and the class members may not even know about the claims until some level of
classwide notice is required.
Delaware’s appraisal statute lays out a procedure that even a small holder can rely on
to make an informed decision about appraisal. Each dissenter has the right to demand
of the surviving corporation two crucial pieces of information: the total number of dis-
senting shares and the aggregate number of holders of dissenting shares.3 This allows the
dissenter to determine the best terms on which to proceed. The dissenter could, of course,
2
Mannix v. PlasmaNet, Inc., No CV 10502-CB, 2015 WL 4455032, at *5 (Del. Ch. July 21,
2015) (“For this type of settlement, the analogy between the appraisal proceeding and the class
action holds true”).
3
DGCL § 262(e) (“Within 120 days after the effective date of the merger . . . any stockholder
. . . shall be entitled to receive from the corporation surviving the merger or resulting from the
consolidation a statement setting forth the aggregate number of shares not voted in favor of the
merger or consolidation and with respect to which demands for appraisal have been received
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discover that the number of dissenting shares is large and concentrated in the hands of a
few holders. For a dissenter concerned that the costs of prosecuting the appraisal claim are
too large to justify pursuing the claim, the postclosing informational rights provide some
insight into whether other dissenters will be there to help shoulder the burden.
The stockholder who initially dissents may instead discover following the closing that
no others are around to help share the costs. This dissenter has a statutory escape hatch.
For 60 days following the closing of the transaction, the dissenting stockholder retains
the right to change course and walk away from the merger consideration.4 This right
mitigates the principal risk that would prevent stockholders from dissenting for reasons
having nothing to do with the merits of the claim.
3. THE FIDUCIARY NATURE OF FILING A PETITION
The statutory right to abandon the appraisal claim and walk away with the merger
consideration disappears when the stockholder files an appraisal petition in court. After
filing, the dissenter earns greater informational rights from the company. Shortly after a
stockholder files a petition for appraisal, the company must file a list of the names and
addresses of all dissenting stockholders.5 The verified list allows a lone petitioner to iden-
tify others with a similar stake in the outcome of the case. Dissenters can develop a shared
strategy or perhaps reach an agreement about sharing expenses. Any stockholder appear-
ing on the company’s verified list is entitled to participate in the appraisal proceeding,6
though in practice that right to participate is limited.
A stockholder who elects to file an appraisal petition takes on obligations to other
members of the dissenting group, if any exist. As the Supreme Court has explained, an
appraisal proceeding is “in the nature of a class suit.”7 This means that a stockholder who
files a petition for appraisal undertakes “a version of a class action, in which all members
and the aggregate number of holders of such shares”). The company has ten days to deliver the
information. Ibid.
4
DGCL 262(e) (“[A]t any time within 60 days after the effective date of the merger or consoli-
dation, any stockholder who has not commenced an appraisal proceeding or joined that proceeding
as a named party shall have the right to withdraw such stockholder’s demand for appraisal and to
accept the terms offered upon the merger or consolidation”).
5
DGCL 262 (f) (requiring that the surviving company “shall . . . file in the office of the Register
in Chancery in which the petition was filed a duly verified list containing the names and addresses
of all stockholders who have demanded payment for their shares and with whom agreements as to
the value of their shares have not been reached by the surviving or resulting corporation”).
6
DGCL 262(h) (“Any stockholder whose name appears on the list filed by the surviving
or resulting corporation pursuant to subsection (f) of this section and who has submitted such
stockholder’s certificates of stock to the Register in Chancery, if such is required, may participate
fully in all proceedings until it is finally determined that such stockholder is not entitled to appraisal
rights under this section”).
7
Southern Prod. Co. v. Sabath, 32 Del. Ch. 497, 508, 87 A.2d 128, 134 (1952). See also In re
Appraisal of Dell Inc., C.A. No 9322-VCL (consol.), transcript (Del. Ch. June 27, 2016; filed July
12, 2016) at 7 (“[A]ppraisal is in the nature of a class action. It’s not a class action. It’s in the nature
of a class action”).
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of the class enjoy the fruits of the class representative’s labor.”8 Dissenting stockholders
who do not petition for appraisal can rely on those who do to determine the fair value of
their stock. For this reason, appraisal proceedings, though not Rule 23 class actions, are
a “special classification of class lawsuit” in which a representative proceeds on behalf of
a larger group.9
3.1 Who Controls the Proceeding and Who Bears the Costs?
Regardless of the number of dissenting shares or even the number of stockholders

filing petitions for appraisal, the statute contemplates only one proceeding determining
the value of the shares.10 If multiple stockholders petition the Court of Chancery for
appraisal, those filings are consolidated into one proceeding under the Delaware rules.11
Consolidation of multiple suits is especially appropriate in the appraisal context,
because the petitioners have not filed separate suits so much as separately initiated a
single statutory inquiry. As the Supreme Court has recognized, “in a section 262 appraisal
action, the only litigable issue is the determination of the value of the appraisal petition-
ers’ shares on the date of the merger, the only party defendant is the surviving corporation
and the only relief available is a judgment against the surviving corporation for the fair
value of the dissenters shares.”12 Thus, there will only be one judicial determination of the
fair value of the stock for all dissenters.13 Indeed, when four appraisal petitions involving
Jarden Corp. each appeared to be proceeding to trial, the Court wrote to counsel in all
actions and invited them to submit a consolidation order or explain why one was not
appropriate.14
The appraisal statute, unlike Rule 23, does not contemplate the selection of a “repre-
sentative party” to lead the litigation. Under Section 262(h), each dissenter has a “right
to participate fully in all proceedings.”15 Questions of control are unavoidable, however.
With one proceeding, there will be only one slate of expert testimony, one trial strategy,
and one theory of the case. No Delaware court has addressed the rules governing alloca-
tion of control in an appraisal case, and leadership disputes rarely come before the court
in appraisal proceedings because, as in other types of stockholder litigation,16 the practice
8
2015).
9
Lutz v. A. L. Garber Co., 357 A.2d 746, 750 (Del. Ch. 1976).
10
DGCL 262(b).
11
Del. Ct. Ch. R. 42(a)) (allowing consolidation of “actions involving a common question of
law or fact”); Cahall v. Lofland, 108 A. 752, 754 (1920) (“Chancery . . . discourages the splitting up
of a cause into several suits where it can be confined in one suit without serious injury to the rights
of the parties involved, or undue annoyance to them in enforcing or defending them”).
12
Cede & Co. v. Technicolor, Inc., 542 A.2d 1182, 1187 (1988).
13
Raynor v. LTV Aerospace Corp., 317 A.2d 43, 46 (Del. Ch. 1974) (noting that the statute
contemplates “a single procedure in which all the dissenting stockholders who have perfected their
right to appraisal will participate”).
14
Letter to counsel, In re Appraisal of Jarden Corp., CA 12456, Sept. 14, 2016.
15
DGCL 262(h).
16
Silverstein v. Warner Commc’ns Inc., 1991 WL 12835, at *2 (Del. Ch. Feb. 5, 1991) (Allen,
C.) (“[I]n most complex corporate or securities litigation in this jurisdiction, class counsel agree
upon appropriate roles and the court is not drawn into such disputes”).
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appears to be negotiation among counsel for various petitioners on an order that will
allocate control over the consolidated claims (Erickson 2015).
The terms of the consolidation order sometimes vest control over the case in one
party.17 Under these agreements, the Court does not appoint a lead petitioner but does
appoint lead counsel, who is empowered to prosecute the appraisal action on behalf of
the dissenting group and to address all issues common to the dissenting group.18 The lead
counsel in an appraisal case has fiduciary obligations along the lines of those that apply
to class counsel in the Rule 23 context.19
In practice, this lead counsel appears to be the counsel of choice for the largest petitioner.
In the Dell case, for example, the aspiring lead counsel pressed its case based on the size
of its clients’ holdings and the number of petitioners it represented.20 This differs from the
class action context, where Delaware law considers a broader range of factors in leadership
disputes, focusing as much on the lawyers who may take on the lead counsel role as on the
litigants themselves.21 Indeed, Delaware has explicitly declined to place excessive weight on
the holdings of potential class representatives in the class action context.22
The parties sometimes provide consolidation orders that preserve each petitioner’s
ability to participate in the litigation. For example, in two recent proceedings—involving
Safeway and ISN Software—there was no lead counsel appointed.23 This may appeal to
petitioners because clients with substantial amounts of money on the line may prefer
not to cede complete responsibility over the case to another petitioner’s lawyer. In the
appraisal of Jarden Corp., for example, two separate groups of petitioners that both held
large blocks of stock and together held all of the dissenting stock agreed to a consolida-
tion order that allowed both sets of counsel to participate fully in the proceeding.24
The respondent company objected and asked the court to order appointment of a lead
17
Consolidation Order, In re Appraisal of PetSmart, 10782-VCS, April 30, 2015. Consolidation
Order, In re Appraisal of Dell, 9322-VCL, April 10, 2014 (appointing a lead counsel but making no
mention of a lead petitioner).
18
See Consolidation Order, In re Appraisal of Dell, 9322-VCL, April 10, 2014 (appointing a
lead counsel but making no mention of a lead petitioner); In re Appraisal of Dell, Inc., C.A. No
9322-VCL, memo. op., Oct. 17, 2016, at 6 (“This provision required that G&E act as lead counsel
wherever an issue arose that was common to the entire appraisal class”).
19
Rulings of the Court from Telephonic Status Conference, Dell Appraisal, 9322-VCL, April
10, 2014, at 10 (“Part of being lead counsel is that you act as a fiduciary for the class. That’s true in
the appraisal context as well”).
20
Memorandum in Support of Petitioners’ Joint Motion for Consolidation and for Designation
of Lead Counsel, April 7, 2014, at 12 (“Specifically, the selection of G&E as Lead Counsel in the
Consolidated Action is appropriate. As counsel to petitioners in ten of the thirteen above-captioned
actions, G&E represents clients who hold more than 82.5% of all shares demanding appraisal”).
21
In re Del Monte Foods Co. S’holders Litig., No CIVA6027-VCL, 2010 WL 5550677, at *6
(Del. Ch. Dec. 31, 2010) (“The Hirt factors contemplate a more nuanced and case-specific test in
which the Court examines both the proposed lead counsel and the proposed named plaintiff ”).
22
See Wiehl v. Eon Labs, 2005 WL 696764, at *3 (Del.Ch. Mar. 22, 2005) (“If every difference
in economic stakes were given great weight, the court could simply add up the number of shares
and select the law firm with the largest absolute representation. This is not Delaware law”).
23
Consolidation Order, In re Appraisal of Safeway, 10719-VCL, April 21, 2015; Order of
Consolidation, In re ISN Software Corp. Appraisal Litig., 8388-VCG, July 29, 2013.
24
Letter to Hon. Joseph Slights from Joel Friedlander, In re Appraisal of Jarden, 12456-VCS,
at 2 (Sept. 28, 2016).
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counsel, arguing that the “respondent in an appraisal action must be able to rely upon
agreements and representations made by lead counsel for petitioners, without fear that
other counsel for petitioners will disagree or assert disparate positions in the litigation.”25
The Court allowed the petitioners to proceed with their leadership structure, but left the
door open that the respondent could renew its request if it could present “documented
instances where Petitioners’ counsel have failed to litigate this consolidated litigation in a
coordinated and efficient manner.”26
3.2 Settlement: The Statutory Framework
The appraisal statute address settlement in a limited but important way. It requires that
the Court approve a settlement with any stockholder, and that approval “may be condi-
tioned upon such terms as the Court deems just.”27 This settlement review is limited,28
but it constitutes a constraint on parties’ freedom to settle an appraisal claim as any other
private law dispute: they must obtain court approval.29 This mirrors the requirements of
a procedural class action, where Rule 23(e) allows dismissal or compromise only with the
approval of the court.30
3.2.1 Settlement disputes

Settlement of appraisal claims is an especially fertile area for disputes. No dissenting stock-
holder can be forced to settle its claim unwillingly.31 This marks an important distinction
between appraisal proceedings and other types of aggregate litigation. In a class claim where
the representative proposes to settle, a class member can either opt out of the settlement
25
Letter to Hon. Joseph Slights from Joel Friedlander, In re Appraisal of Jarden, 12456-VCS,
at 4–5 (Sept. 28, 2016) (providing argument on behalf of respondent).
26
Modifications to Order, Consolidation Order, In re Appraisal of Jarden, 12456-VCS, at 2, at
6, Oct. 3, 2016.
27
DGCL 262(k).
28
Matter of ENSTAR Corp., 604 A.2d 404, 414 (Del. 1992) (“Similarly, the provision in the
appraisal statute which gives the Court of Chancery authority to impose ‘just terms’ as a condition
of its approval of a statutory appraisal proceeding, does not give it authority to reform a settlement
agreement that was premised upon a unilateral mistake”).
29
Ibid (“[T]he parties to a statutory appraisal action cannot voluntarily settle such a proceed-
ing without the approval of the Court of Chancery”).
30
Rule 23(e) of the Court of Chancery (“Subject to the provisions of Rule 15(aaa), a class
action shall not be dismissed or compromised without the approval of the Court, and notice
by mail, publication or otherwise of the proposed dismissal or compromise shall be given to
all members of the class in such manner as the Court directs”); FRCP 23(e) (allowing for the
settlement of a certified class claim “only with the court’s approval”); C. Wright, A. Miller &
Mary Kay Kane, Federal Practice & Procedure, Civ. § 1797 (3d ed.) (“The purpose of subdivision
(e) is to protect the nonparty class members from unjust or unfair settlements affecting their
rights when the representatives become fainthearted before the action is adjudicated or are able
to secure satisfaction of their individual claims by a compromise, abandoning the claims of the
absent class members”).
31
Nelson v. Frank E. Best, Inc., No CIV.A. 16329, 2001 WL 34054611, at *2 (Del. Ch. Jan. 12,
2001) (“In a statutory appraisal, each person who demands an appraisal has the individual right
to agree to accept or reject a settlement offer. Moreover, no one petitioner can require any other
petitioner to also settle his or her claim”).
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(where available) or object to the settlement (Eisenberg & Miller 2004). By contrast, there
are no mechanisms in an appraisal proceeding that would compel a dissenting stockholder
to accept a settlement offer. Interesting dynamics arise when the settlement does not include
all dissenters. It is the settlement context in which the aggregate nature of the appraisal
proceeding has the most purchase.32 As Chancellor Allen noted, “it is a part of the respon-
sibility of a court administering a class action to assure, within the law, that a party to a
class action does not act inappropriately to destroy the practical utility of the class action
device.”33 The Court has followed a similar path in reviewing appraisal settlements.
3.2.2 Settlements with petitioners

The most troubling circumstance is a settlement with a petitioner that does not include
other dissenting stockholders. The risk is that the company seeks to settle with only the
petitioner at a premium in hopes of frustrating the prosecution of the suit.
The Court of Chancery confronted this problem in Raynor v. LTV Aerospace Corp.34
The four petitioners in Raynor had reached a settlement with the company in which they
agreed to dismiss their claims in exchange for the original merger consideration.35 The
120-day period in which other dissenting stockholders could file a petition had already
expired, and thus the company argued that the “failure of each of those dissenting stock-
holders to actually file their own appraisal suits completely deprives them ‘of any further
remedy afforded by the General Corporation Law.’”36 The court rejected the argument
that only those dissenters who had filed petitions were part of the proceeding, reasoning
that “those other dissenting stockholders had a right to rely on the language of § 262 and
believe that their stock would be valued in the appraisal proceeding.”37 The petitioner may
perform the administrative task of filing the petition but does not have the power to stop
it against the wishes of other dissenters.38
To combat the risk of buyoff, the Court in Raynor held that any settlement with
the petitioners must be made available to other dissenting stockholders.39 The Court’s
approach guards against the risk that the company can “defeat the rights of those other
32
Lutz v. A. L. Garber Co., 357 A.2d 746, 749 (Del. Ch. 1976) (“I therefore conclude that
both the statute and case law require an appraisal proceeding to be treated as a class action for the
purpose of dismissal or compromise”).
33
In re Winchell’s Donut Houses, L.P. Sec. Litig., No CIV.A. 9478, 1988 WL 135503, at *1
(Del. Ch. Dec. 12, 1988).
34
317 A.2d 43, 47 (Del. Ch. 1974).
35
Raynor v. LTV Aerospace Corp., 317 A.2d 43, 45 (Del. Ch. 1974).
36
Ibid at 45.
37
Ibid at 47.
38
Lichtman v. Recognition Equip., Inc., Del. Ch., 295 A.2d 771, 772 (1972) (“The appraisal
petition, which may be filed either by the stockholder or the surviving corporation, is simply the
means provided for enforcing the stockholder’s right to have his shares evaluated or the corpora-
tion’s correlative right to obtain his shares upon payment thereof ”).
39
Raynor v. LTV Aerospace Corp., 317 A.2d 43, 47 (Del. Ch. 1974) (“[A]s provided by § 262(d),
a hearing shall be noticed and held after which the Court shall determine those stockholders who
have become entitled to the valuation of and payment for their shares. Thereafter, these dissenting
stockholders shall be entitled to participate equally with the plaintiffs in any settlement of this
consolidated appraisal action”).
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dissenting stockholders by settling at a premium with the present plaintiffs.”40 This

approach is consistent with the practice in Rule 23 class actions, where “Rules 23 and 23.1
are intended to guard against surreptitious buy-outs of representative plaintiffs, leaving
other class members without recourse.”41
In appraisal, other dissenters are entitled to receive notice of the pendency of a settle-
ment to ensure that they have the opportunity to participate.42 Where a petitioner settles
and another dissenter declines to participate, that dissenter may intervene in the case and
step into the role of petitioner.43
3.2.3 Settlements with nonpetitioners

A settlement with dissenting stockholders but not the petitioner presents a slightly dif-
ferent issue. The principal concern with a petitioner settlement is that the party actively
prosecuting could be bought off at a premium, leaving the other dissenters in the lurch.44
Settlements with nonpetitioners do not raise this risk. The Court of Chancery recently
addressed this situation in Mannix v. PlasmaNet, Inc.45 The company had reached a
settlement with a group of dissenters in which they would receive equity in the surviving
company.46 Because the equity securities were not registered with the SEC, the settling dis-
senters had to attest that they were “accredited investors” under the federal securities laws.
The company made the same offer to the petitioner and other nonappearing dissenters
who could attest to being accredited investors. The petitioner challenged the settlements,
arguing that a company could not settle with any dissenter unless the offer is available
to all dissenters, and because some dissenters were perhaps not accredited investors the
company could not include such a condition.47
The Court allowed the settlement, noting that the specter of a buyoff was not present.48
The settlement at issue would “have no legal effect on Petitioner’s standing in this pro-
ceeding or on the ability of other former PlasmaNet stockholders who have demanded
40
Ibid at 47.
41
Wied v. Valhi, Inc., 466 A.2d 9, 15 (Del. 1983); Hutchison v. Bernhard, 43 Del. Ch. 139, 141,
220 A.2d 782, 784 (1965) (“I say this because to allow a dismissal in this situation without court
control would make possible one of the very abuses sought to be controlled by the notice require-
ment of the rule, i.e., the buy-off of an objector without regard to the rights of the stockholders
generally”).
42
Lutz v. A. L. Garber Co., 357 A.2d 746, 751–52 (Del. Ch. 1976)
43
Edgerly v. Hechinger, 1998 WL 671241, at *4 (Del. Ch. Aug 27, 1998) (noting that if petition-
ers settle, then the remaining claimants are “given notice . . . and an opportunity to intervene” to
continue the proceeding).
44
Alabama By-Prod. Corp. v. Shearson Lehman Bros., 657 A.2d 254, 260–61 (Del. 1995)
(“The court approval requirement ensures that a shareholder does not settle out of the class suit
at a premium, thereby abandoning the prosecution of the action to the detriment of other class
members”).
45
2015).
46
Ibid at *2.
47
Ibid at *2.
48
Ibid at *5 (“[T]he concerns regarding the settlement of representative litigation, discussed in
Alabama By–Products and Activision and applied in Raynor, do not apply here, where the surviving
corporation seeks to settle the appraisal demands of non-appearing dissenters.”).
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appraisal to continue to rely on Petitioner to litigate this proceeding.”49 Moreover, there

was no evidence that the settlement was designed to coerce other dissenters. Thus, the
Court rejected the proposition that it could approve a settlement with a dissenter only if
the “petitioner and all other non-appearing dissenters also are offered—and are able to
accept—a settlement on the same terms.”50
The Court again found persuasive support in the Rule 23 context, where a defendant
generally may settle claims with class members despite the pendency of a class action.51
The Court noted that “[i]f a defendant in a putative class action is readily permitted under
the law to settle a class claim with non-representative class members, then it logically
follows that the surviving corporation after a merger may seek to settle the appraisal
demands of individual non-appearing dissenters.”52
The petitioner raised an important and separate argument against the settlement: If
dissenters were permitted to settle, that would undermine the economics of the appraisal
proceeding by shrinking the group across which the petitioner could spread his expenses.53
The court rejected this argument, noting that the petitioner had voluntarily assumed
the risk that the proceeding might be limited to the petitioner’s own shares. The court
explicitly considered the possibility that the petitioner relied on the existence of other
stockholders in pursuing the claim, but noted that nothing in the statute justified that
reliance. In the Court’s words, “no provision of the appraisal statute prevents those
non-appearing dissenters from seeking to settle their appraisal demands.”54 To conclude
otherwise would give the petitioner a veto right over the settlement decisions of other
dissenters, a right not contemplated by the statute.55
3.2.4 The problem of sharing costs

The disputes surrounding settlement and control are often driven by concerns over
the costs and expenses associated with the appraisal proceeding. Dissenters generally
bear their own expenses, and the fee shifting common in class actions is uncommon in
appraisal. Though appraisal draws on the common fund principles of Rule 23 litigation,
the cost allocation in appraisal has a fundamental dissimilarity with the class action in that
the basic incentive structure is different. In the class action, the representative party and
its counsel have no incentive to pursue the claim absent some fee award. The fee award is
crucial to the operation of the liability system. By contrast, in appraisal, the stockholder
is making a decision to dissent after taking into account the costs of the proceeding. This
is especially true in the era of repeat, specialized appraisal petitioners. A stockholder does
49
Ibid at *5.
50
Ibid at *5.
51
In re Winchell’s Donut Houses, L.P. Sec. Litig., No CIV.A. 9478, 1988 WL 135503, at *1
(Del. Ch. Dec. 12, 1988) (“[I]t seems well settled that before a class action is certified, it will ordi-
narily not be deemed to be inappropriate for a defendant to seek to settle individual claims, even
though a class claim has been asserted”).
52
2015) (citing Winchell’s Donut Houses).
53
Ibid at *2.
54
Ibid at *5.
55
Ibid at *5: adopting petitioner’s argument “effectively would give the Petitioner a settlement
hold-up right not envisioned by” the statute).
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not seek appraisal in hopes of conferring some benefit on absent stockholders, although
that may necessarily happen. For this reason, a background rule in appraisal proceedings
is that the petitioner “should bear the burden of paying its own expert witnesses and
attorneys, unless some equitable exception applies.”56
Matters are different when the question is whether the petitioner may recover costs and
expenses from other dissenters. The statute addresses the expense allocation in Section
262(j): “Upon application of a stockholder, the Court may order all or a portion of the
expenses incurred by any stockholder in connection with the appraisal proceeding, includ-
ing, without limitation, reasonable attorney’s fees and the fees and expenses of experts,
to be charged pro rata against the value of all the shares entitled to an appraisal.”57 A
petitioner who invests in pursuing the case necessarily does so on behalf of all dissenters
because any stockholder who complies with the statute is entitled to receive the valuation
that results from the appraisal proceeding.58 The dissenters who appear on the verified list
do not need to hire an attorney or engage an expert, so long as some petitioner out there
has already shouldered that burden.59 Section 262(j) allows that petitioner to spread the
costs of the litigation effort across the group that benefits from it.
This was not always so. Under earlier statutory language,60 the Court of Chancery
concluded that a petitioner could not force other dissenting stockholders—even those
who directly benefited from the trial award—to share the costs of the proceeding.61 The
Court of Chancery lamented “the seeming unfairness of the results permitted by the
language of the statute in its present form,”62 and the current statutory language was
added by amendment in 1976.63
The petitioners can agree to bear their own costs and memorialize that agreement in
the consolidation order. In two recent large cases, for example, the petitioners agreed on a
56
M.G. Bancorporation, Inc. v. Le Beau, 737 A.2d 513, 527 (Del. 1999). In re Radiology
Associates, Inc. Litig., 611 A.2d 485, 501 (Del. Ch. 1991) (“[A]s with any appraisal proceeding,
plaintiff should bear the costs of his own expert”).
57
DGCL 262 (j).
58
Levin v. Midland-Ross Corp., 41 Del. Ch. 352, 353, 194 A.2d 853, 854 (1963) (“Other parts
of Sec. 262 make it clear that any stockholder who complies with the provisions of the merger
statute shall ‘. . . become entitled to the valuation of any payment for their shares’”).
59
Ibid (“[Dissenting stockholders] are not, of course, required to engage the services of an
attorney or of an expert to represent their interests in the statutory proceedings designed to arrive
at a proper valuation of their securities. This being so, such dissenting stockholders are, in my
opinion, entitled to receive the full amount allowed them in an appraisal proceeding subject only to
the taxing of such costs as are permitted by statute”).
60
See former Section 262 (h), quoted in Levin v. Midland-Ross Corp., 41 Del. Ch. 352, 353, 194
A.2d 853, 854 (1963) (“The cost of any such appraisal, including a reasonable fee to and the reason-
able expenses of the appraiser, but exclusive of fees of counsel or of experts retained by any party,
may on application of any party in interest be determined by the Court and taxed upon the parties
to such appraisal or any of them as appears to be equitable, except that the cost of giving the notice
by publication and by registered mail hereinabove provided for shall be paid by the corporation”).
61
Levin v. Midland-Ross Corp., 41 Del. Ch. 352, 355, 194 A.2d 853, 854–55 (1963) (“I see no
alternative but to deny petitioners’ request that those stockholders found to be entitled to valuation
and payment for their shares who are not represented by counsel . . . be ordered proportionately to
share the counsel and expert witness fees incurred by those stockholders who are represented.”).
62
Ibid at 854.
63
60 Del. Laws, Chapter 371 (128th General Assembly), formerly H.B. 916.
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consolidation order that provided for petitioners’ counsel to be compensated only pursu-
ant to their agreements with their respective clients.64 This effectively constitutes a waiver
of each petitioner of its right under 262(j) to seek costs and expenses from other parties.
For obvious reasons, this sort of agreement seems to arise when petitioners’ counsel have
agreed to work together on the case.
When the Court appoints a lead counsel, however, the orders expressly preserve the
ability of lead counsel to tax fees and expenses.65 Under the current statutory language,
dissenters are not entitled to avoid sharing in the costs of the prosecution simply by
retaining their own counsel. In the Dell case, one petitioner proposed a consolidation
order that would make each petitioner responsible only for the fees of its own counsel.66
The Court rejected this idea out of hand, noting that the statute expressly contemplated
that all dissenters would share in the costs: “The fees and expenses at the end under 262(j)
can be taxed against the entire appraisal class pro rata because that’s what’s fair. It’s a
classic application of common-fund principles across the entire class. So that’s not going
to happen in terms of the we-only-want-to-pay-our-guys rule. And that’s just, you know,
too bad for whoever thought that was a nifty little trick, to the extent anyone did.”67
In awarding fees, the Court has reasoned from the class action context. The petitioner
may recover fees and expenses under 262(j) only when that petition generates a benefit
for other dissenters, making the appraisal standards “identical to those in other types of
shareholder benefit litigation.”68 A critical difference between the two contexts, however,
is that while non-pecuniary benefits may suffice in class actions, in appraisal “the only
benefit . . . is a measurable monetary benefit.”69 The Court has discretion in the award of
a fee under Delaware’s Sugarland factors,70 but the principal variable in that analysis is the
value of the benefit achieved.71 In appraisal, that benefit is generally susceptible of easy
64
Safeway Consolidation Order, CA 10719-VCL, Granted April 21, 2015 (“At the conclusion
of the Consolidated Action, all counsel of record for petitioners shall be compensated pursuant
to the agreements with their respective clients, whether such resolution is by settlement or Court-
determination of the value of petitioners’ Safeway Inc. stock after trial”); In re Appraisal of Jarden
Corp., 12456-VCS, Granted October 3, 2016 (“At the conclusion of the Consolidated Action, all
counsel of record for the petitioners shall be compensated pursuant to the agreements with their
respective clients, whether such resolution is by settlement or Court-determination of the value of
petitioners’ Jarden stock after trial”).
65
E.g., Consolidation Order, In re Appraisal of PetSmart, 10782-VCS, April 30, 2015 (“As
contemplated by 8 Del. C. § 262(j), at an appropriate stage of the proceeding, [lead counsel] may
seek to have its fees and expenses charged pro rata”).
66
See Proposed order, Exhibit B to Response to Petitioners’ Joint Motion for Consolidation
and Designation of Lead Counsel, filed April 9, 2014, at 6 (“Each petitioner shall be solely respon-
sible for the fees payable to each such petitioner’s counsel and G&E’s current clients shall be solely
responsible for the fees payable to G&E, which includes the fees payable to G&E as lead counsel”).
67
Rulings of the Court from Telephonic Status Conference, Dell Appraisal, 9322-VCL, April
10, 2014, at 8.
68
Matter of Appraisal of Shell Oil Co., No CIV. A. 8080, 1992 WL 321250, at *3 (Del. Ch.
Oct. 30, 1992).
69
Ibid at *4.
70
Sugarland Industries, Inc. v. Thomas, 420 A.2d 142 (Del. 1980).
71
Matter of Appraisal of Shell Oil Co., No CIV. A. 8080, 1992 WL 321250, at *4 (Del. Ch.
Oct. 30, 1992) (“The primary factor to be considered in the discretionary award of attorney fees,
however, is the value of the benefit achieved through the litigation”).
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measurement. In the Shell Oil appraisal, for example, the court awarded 25 percent of the
benefit achieved for other dissenters to the petitioner for attorneys’ fees and expenses.72
3.3 Recovering Fees and Expenses from Settling Plaintiffs
Although the current system is durable, there are some predictable points of friction
where disputes are likely to occur. The first involves a situation where a petitioner seeks to
recover fees against a dissenting stockholder who settles before trial. The second involves
the question of what limits there ought to be on the fees and expenses a petitioner can
charge against other dissenters.
There is a straightforward way in which dissenters may freeride on the efforts of peti-
tioners. When a petitioning stockholder pushes forward with litigation, the petitioner may
incur fees and expenses in reliance on sharing those costs with nonappearing dissenters.
Together the 262(e) rights, the verified list, and the 262(k) cost recovery provision create a
system that affirmatively encourages petitioners to incur the optimal amount of expenses
given the size of the dissenting group, not given the size of the petitioner’s holdings. But
the Mannix case shows that this approach carries some risk for the petitioner. If a dis-
senter settles after the petitioner has already incurred significant expense on behalf of the
dissenting group, the dissenter would be capturing what appears to be a form of unjust
enrichment. Although this sort of freeriding has raised the Court’s ire before,73 there is
language in Mannix suggesting that the petitioner explicitly assumes the risk that the class
may shrink and the petitioner may find itself bearing all of the expenses.74
The Court, however, did not reach the question in Mannix of whether the petitioner
may recover costs from a dissenter who settles.75 The statutory language is certainly broad
enough to accommodate such a request.76 In the class action context, the Court has
awarded fees to class counsel when their efforts conferred monetary benefits on settling
class members who settled their claims individually.77 But under 262(j) costs may only be
charged to those “entitled to an appraisal,” and in Mannix the company took the posi-
tion that those who had settled were no longer so entitled.78 Moreover, some cases have
72
Ibid at *7.
73
Levin v. Midland-Ross Corp., 41 Del. Ch. 352, 354, 194 A.2d 853, 854 (1963) (“Obviously,
there is an element of inequity in having dissident stockholders ‘go along for the ride’, as it were,
while other stockholders incur the expense of engaging the services of counsel or of an expert
or both often with results, as here, beneficial to all dissenting stockholders”) (result under earlier
statutory language).
74
2015) (“Petitioner and his counsel thus voluntarily accepted the risk that this appraisal proceeding
might be limited to 1,700 PlasmaNet shares”).
75
Ibid at *6 (Del. Ch. July 21, 2015) (“Finally, Petitioner’s assertion that ‘[a]ny dissenting
stockholders who ultimately decide to settle should also be aware that they may be responsible for
Petitioner’s attorneys’ fees and expenses on a pro rata basis’ under 8 Del. C. § 262(j)—a position the
Company contests—involves a legal question that is not ripe for review”).
76
DGCL 262(j) (allowing the Court to order “expenses incurred by any stockholder in con-
nection with the appraisal proceeding . . . to be charged pro rata” against all shares entitled to an
appraisal).
77
Smith, Katzenstein & Jenkins LLP v. Fid. Mgmt. & Research Co. (Del. Ch. Apr. 29, 2014).
78
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s uggested that only an award at trial above the merger price entitles a petitioner to recover
from other dissenters under 262(j).79
A sensible approach here is to look for a causal connection between the efforts of
lead counsel and the settlement reached by the dissenters. Whether the petitioner can
recover from the settlers depends on whether the petitioner has conferred any benefit on
them.80 One natural factor would thus be the timing of the settlement. At one extreme, a
settlement that follows trial would obviously be struck in the shadow of the petitioner’s
trial efforts and expenses. At the other extreme, a settlement reached by a dissenter while
the petitioner is still engaged in the early stages of document discovery would likely owe
nothing to the petitioner’s efforts. During the pendency of the case, the petitioner will
often be solely in possession of the fruits of discovery and expert reports. If there have
been no communications between the dissenter and the petitioner conveying the fruits
of discovery, there should be a presumption that the efforts of the petitioner have not
contributed to any settlement reached by another dissenter. Once the petitioner begins
filing pretrial briefs and reports, matters may be different, as the dissenter at that point
can directly capture the benefit of the petitioner’s efforts.
Another factor that may bear on whether the petitioner conferred any benefit on the
dissenter is whether the dissenter retained separate counsel. If the settling dissenter hired
its own lawyer or incurred separate expenses, the court might presume that the petitioner
did not confer any benefit on the dissenter because the settlement would most naturally
be the result of the efforts of the dissenter’s counsel, not the petitioner’s counsel. Such a
presumption might work as a notional set-off. Section 262(j) entitles recovery of fees and
expenses incurred by “any stockholder,” not just the petitioner. In the early stages of the
proceeding, the settling dissenter could just as easily be entitled to recover its expenses
from the petitioner as the petitioner from the settling dissenter.
A related issue concerns who is in the dissenting group. Under the statute, costs may
only be charged to those “entitled to an appraisal,” and in Mannix the company took
the position that those who had settled were no longer so entitled. That “entitled to an
appraisal” language references a hearing under 262(g) where the Court determines, in a
sense, who has successfully opted into the class. The statute contemplates that the hearing
will occur at the outset of the proceeding, and it has the effect of certifying the class of
dissenters. One problem is that the hearing can happen late in the proceeding—even after
trial—with hairy results.
In Dell, for example, the determination that T. Rowe Price and other entities holding
the lion’s share of dissenting stock were not entitled to an appraisal did not come until
2015) (The Company argues that, after giving effect to the settlements, the shares formerly owned
by the Non–Appearing Dissenters will no longer be “entitled to appraisal” and thus cannot be
subject to a pro rata charge of Petitioner’s attorneys’ fees and expenses under 8 Del. C. § 262(j).).
79
In re Appraisal of Dell, Inc., C.A. No 9322-VCL, mem. op., (Del. Ch. Oct. 17, 2016) (“Under
Section 262(j), this means that the appraisal proceeding must generate a fair value determination
that exceeds the merger price. If an appraisal petitioner does not obtain a fair value determination
that exceeds the merger price, then Section 262(j) does not ‘authorize any pro rata assessment of
attorneys fees among the appraisal class’”) (citing In re Appraisal of Shell Oil Co., 1992 WL 321250
(Del. Ch. Oct. 30, 1992).
80
See In re Appraisal of Shell Oil Co., 1992 WL 321250 (Del. Ch. Oct. 30, 1992).
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after trial. The result was a fee request from the Dell lead counsel that attempted to charge
the expenses and fees incurred in contemplation of a large amount of stock against the
smaller group of stock that actually remained after the trial. And it was that same lead
counsel that had deliberately pushed the eligibility hearing off until after the merits trial.
The Court of Chancery had allowed the lead counsel in Dell to tax its full expenses across
the remaining group of dissenting stockholders, over their objection.81 The members of
the dissenting group were broadly held to the same terms that lead counsel had negotiated
with its largest client.82 On appeal, the Supreme Court reversed this expense allocation,
emphasizing that the remaining dissenters should not be forced to bear the full expense
load.83
The increase in appraisal activity in recent years should, at the margins, make courts less
concerned about the incentive effects of settlements. Given the emergence of funds that
specialize in the exercise of appraisal rights, the plight of the small holder is not as large a
concern as before. And those who do pursue appraisal do so in full contemplation of the
expenses involved, so while the expense allocation will have marginal effects on dissenting
behavior it is unlikely to impact the use of the remedy in a substantial way.
4. CONCLUSION
This chapter chronicles the underappreciated but important ways in which appraisal
proceedings are representative in nature. On top of the bare statutory framework in
Delaware, the Court of Chancery has fashioned sensible equitable principles that ensure
the effectiveness of the system. The system generally ensures that dissenters can rely on
the efforts of petitioners, and petitioners can proceed in confidence that the expenses
they incur will be shared by all those who benefit from them. There are still windows for
opportunism, however, and these will require continuing efforts from the Court to ensure
the effectiveness of the remedy.
BIBLIOGRAPHY
Aronstam, B., Balotti, R., & Rehbock, T., Delaware’s Going-Private Dilemma: Fostering Protections for Minority
Shareholders in the Wake of Siliconix and Unocal Exploration, 58 Business Lawyer 519 (2003), 547.
Cox, J., Hazen, R., & O’Neal, F. Hodge, Corporations (1997), sec 22.18.
Eisenberg, T. & Miller, G., The Role of Opt-Outs and Objectors in Class Action Litigation: Theoretical and
Empirical Issues, 57 Vanderbilt Law Review 1529 (2004).
Erickson, J., The Market for Leadership in Corporate Litigation, 2015 University of Illinois Law Review
1479 (2015).
81
In re Appraisal of Dell Inc., C.A. 9322-VCL, Oct. 17, 2016, at 2.
82
Ibid at 28–30.
83
Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd, 177 A.3d 1, 46–47 (Del. 2017)
(“Although the Court of Chancery need not award expenses against T. Rowe, it must make a
reasoned and sizable reduction in those awarded against the shares entitled to appraisal to account
for the fair share T. Rowe should have borne, but that Lead Counsel chose not to seek from it. To
the extent Lead Counsel wished to cut T. Rowe a break, it should not have done so against the other
petitioners to whom it owed a fiduciary duty as Lead Counsel.”).
M4633-GRIFFITH_t.indd 267 30/10/2018 08:16

Fried, J. & Ganor, M., Agency Costs of Venture Capitalist Control in Startups, 81 New York University Law
Review 967 (2006).
Gilson, R. & Gordon, J. Controlling Controlling Shareholders, 152 University of Pennsylvania Law Review
785 (2003).
Letsou, Peter V., The Role of Appraisal in Corporate Law, 39 Boston College Law Review 1121 (1998), 1156.
Silver, C. & Miller, G., The Quasi-Class Action Method of Managing Multi-District Litigations: Problems and a
Proposal, 63 Vanderbilt Law Review 107 (2010), 143–9.
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PART IV
LITIGANTS AND LAW FIRMS
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Section A
Plaintiffs and Law Firms
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17. Lead plaintiffs and their lawyers: mission
accomplished, or more to be done?
Stephen J. Choi and A.C. Pritchard*
1. INTRODUCTION
More than 20 years ago, Congress adopted the Private Securities Litigation Reform Act
(PSLRA)1 in response to widespread claims of frivolous securities fraud litigation. The
PSLRA contains a variety of provisions designed to limit litigation and to reduce the
settlement value of nonmeritorious or nuisance claims. These provisions include a height-
ened pleading requirement,2 safe harbor from liability for forward-looking statements,3 a
requirement that plaintiffs prove loss causation,4 a mandatory discovery stay pending a
motion to dismiss,5 and the replacement of joint and several liability with proportionate
liability for collateral defendants.6 There is evidence that these reforms strengthened
the connection between the merits and the outcomes in securities fraud class actions
(Johnson, Nelson, & Pritchard, 2007).7 It is still the case, however, that a substantial
percentage of claims—more than half—are dismissed or settled for nuisance value.
A second—and ostensibly independent—goal of the PSLRA was to “empower inves-
tors so that they, not their lawyers, control securities litigation.”8 Congress believed that
individual investors who served as class representatives prior to the enactment of the
PSLRA were largely figureheads dominated by class action lawyers. As one prominent
(now disbarred and a felon) plaintiffs’ attorney famously said, “I have the greatest
practice of law in the world . . . I have no clients” (Barrett, 1993). Because class action
lawyers typically had a much greater interest in the class recovery than the named class
representatives, plaintiffs may have lacked the incentive to monitor class counsel (Coffee,
1986). To remedy that imbalance, the PSLRA created a presumption that courts should
appoint as lead plaintiff the class member seeking appointment with the largest financial
* We would like to thank Sean Griffith and other participants at the Fourth Annual Workshop
for Corporate & Securities Litigation for helpful comments on an earlier draft of this chapter.
Pritchard acknowledges the generous support of the William W. Cook Endowment of the
University of Michigan.
1
Pub. L. No. 104067, 109 Stat. 737 (1995) (codified at 15 U.S.C. §§ 77a et seq.).
2
See Section 21D(b)(2), Exchange Act.
3
See Section 27A, Securities Act; Section 21E, Exchange Act.
4
See Section 21D(b)(4), Exchange Act.
5
See Section 27(b), Securities Act; Section 21D(b)(3)(B), Exchange Act.
6
See Section 21D(f), Exchange Act. Outside directors also enjoy proportionate liability under
Section 11 of the Securities Act. See Section 11(f)(2), Securities Act.
7
But see Choi (2007) (providing evidence that the reforms reduced the incidence of certain
types of meritorious claims).
8
S. Rep. No. 104-98 (1995); see also H.R. Conf. Rep. No. 104-369, at 32 (1995).
271
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interest in the relief sought.9 The provision vests the lead plaintiff with authority to select
and retain class counsel.
Large shareholders, the theory went, would have more of an incentive to oversee
lawyers who represent the class. Congress hoped that institutional shareholders serving
as lead plaintiffs would negotiate with class counsel over attorneys’ fees, ensuring that
a larger share of the recovery would accrue to the class members. In addition, an active
shareholder monitor would discourage class action counsel from settling good cases on
the cheap.
We now have more than 20 years of experience of litigation since PSLRA was
adopted—enough time to assess the statute’s effects, tallying up what has been accom-
plished and highlighting where further reforms might be needed. In substantial measure,
the PSLRA’s lead plaintiff provision has succeeded. After a slow beginning, institutional
investors have stepped forward to serve as lead plaintiffs in a substantial number of
cases. As we discuss below, there is evidence that institutional investors are more likely to
volunteer as lead plaintiffs in the strongest cases, and that they may play a role in ensur-
ing greater recovery for investors in those cases. In addition, institutional investors seem
to have reduced the share of recovery that goes to pay lawyers post-PSLRA. In sum, the
PSLRA has changed the game for securities class action lawyers, who now compete for
the favor of institutional investors in order to be selected as counsel.
There is also evidence, however, that that competition has not been driven exclusively
by price and quality of representation. The larger institutional investors that have
most frequently agreed to serve as lead plaintiffs in securities class actions have been
government-sponsored pension funds. Many of these funds are managed directly by
politicians, such as state comptrollers, who must campaign to retain their current posi-
tions, or may have designs on higher offices. Alternatively, these funds are managed by
political appointees, who typically owe their position to the state’s governor. The political
influence over these funds raises the question whether law firms are making campaign
contributions to politicians to enhance their chances of being selected to represent the
funds. The available evidence raises suspicion that at least some class action law firms are
buying lead counsel status with campaign contributions; that is, lawyers are paying to
play. Not surprisingly, government officials receiving campaign contributions appear to
be less vigorous overseers of class action counsel.
In this chapter, we assess what we know about lead plaintiffs and their lawyers and
what reforms might enhance the role played by lead plaintiffs in securities class actions.
In section 2, we provide background on the lead plaintiff provision and how it operates.
In section 3, we survey the existing literature on the effects of the lead plaintiff provision.
In section 4, we build off that understanding to explore potential reforms relating to lead
plaintiffs and their lawyers. In particular, we suggest specific reforms that might promote
additional transparency and competition on price, rather than buying political favor.
More provocatively, we suggest additional requirements for lead plaintiffs to further
enhance the screening role played by the PSLRA.
9
Private Securities Litigation Reform Act of 1995 § 101(a), 15 U.S.C. § 77z-1(a)(3)(B) (2006).
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Lead plaintiffs and their lawyers 273
2. BACKGROUND AND PURPOSES OF THE PSLRA
The PSLRA was Congress’s response to widespread calls for reform of securities fraud
litigation. The statute was enacted following an extensive lobbying campaign by account-
ing firms, corporate leaders and members of the securities industry, who complained that
plaintiffs’ lawyers were filing excessive and frivolous cookie-cutter complaints, often on
the basis of no more than a sudden drop in stock price, in an effort to coerce nuisance
settlements. Critics described meritless lawsuits as “blackmail,” forcing “innocent” firms
to settle rather than endure the high costs of vindicating themselves through litigation
(Saparoff, 1996).
Congress’ perception that securities fraud class actions were “lawyer-driven litigation”
was a separate, although related, concern.10 Congress heard testimony that lawyers
maintained rosters of professional plaintiffs, willing to file suit at the lawyer’s request.
Class representatives seemed to have little involvement in litigation decisions, and even
less control. Perhaps most important, lawsuits’ outcomes appeared to favor the interests
of class counsel over the class itself—generally resulting in substantial fee awards, but
often providing limited compensation to class members.11
One of the abuses of securities class actions that Congress attempted to address in
enacting the PSLRA was “the manipulation by class action lawyers of the clients whom
they purportedly represent.”12 Congress found a potential solution to that problem in a
proposal by Weiss and Beckerman (1995). Weiss and Beckerman argued that institutional
investors, if placed in the lead plaintiff role, would act as effective monitors of plaintiffs’
attorneys’ actions in securities class action litigation. Acting on their proposal, Congress
adopted the PSLRA’s lead plaintiff provision, which creates a “rebuttable presumption
. . . that the most adequate plaintiff . . . is the person or group of persons that . . . has the
largest financial interest in the relief sought by the class.”13 The PSLRA also stated that
the most adequate plaintiff will “select and retain counsel to represent the class.”14 The
premise of the PSLRA’s lead plaintiff provision is that larger investors, with correspond-
ingly larger stakes in the class recovery, would serve as more effective monitors of class
counsel. By providing effective monitoring, the lead plaintiff would protect the interests
of the absent class members.
Congress worried, however, about the potential for lead plaintiff monitoring to be
undermined by side payments, and with this in mind it included a provision in the PSLRA
prohibiting non pro rata payments to the lead plaintiff.15 Such payments were rumored
to have been an issue in securities class actions prior to the adoption of the PSLRA.
10
The Common Sense Legal Reforms Act, H.R. 10, 104th Con. 1st Sess. § 202 (1995) (provi-
sion entitled “Prevention of Lawyer-Driven Litigation”).
11
See, e.g., H.R. Conf. Rep. No. 104-369, at 36 (1995), reprinted in 1995 U.S.C.C.A.N. 730
(observing that lawyers “often receive a disproportionate share of settlement awards”); Sen. Rep.
No. 104-98 at 9 (complaining that, although investors recover only “pennies on the dollar,” much
of the $1.4 billion paid during 1994 alone went to plaintiffs’ lawyers).
12
See H.R. Rep. No. 369, at 31 (1995), reprinted in 1996 U.S.C.C.A.N. 730, 1103.
13
15 U.S.C. § 78u-4(a)(3)(B)(iii)(I).
14
15 U.S.C. § 78u-4(a)(3)(B)(v).
15
15 U.S.C. § 78u-4(a)(4).
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(Those rumors appear to have been well founded; several former partners of the Milberg
Weiss law firm, now “Milberg,” subsequently went to prison for hiding such payments
from courts overseeing securities class actions. See Selvin, 2008.) Those payments raised
concerns that class representatives would not have an incentive to protect the interests
of absent class members. One measure of lead plaintiff monitoring is attorneys’ fees;
vigilant monitors presumably would negotiate lower fees, which would mean a greater net
recovery for class members. Consistent with this theory, Perino (2008) finds that Milberg
Weiss’s attorneys’ fees were significantly higher for cases in which side payments were
made to lead plaintiffs (as identified in the indictment against the firm) than in those cases
in which payments were not made.
3. EFFECTS OF THE LEAD PLAINTIFF PROVISION
3.1 Who Are the Lead Plaintiffs?
The lead plaintiff provision took time to get rolling. The number of institutions participat-
ing as lead plaintiffs was quite small in the first few years following the adoption of the
PSLRA. In a report on the first year of practice under the PSLRA, the SEC reported that
institutional investors became lead plaintiffs in only 8 of 105 filed cases (SEC, 1997). This
indifference was overcome relatively quickly, however, with institutional investors stepping
forward as lead plaintiffs in substantial numbers of securities fraud class actions. A 2003
study released by Cornerstone Research reported that institutions had served as lead plain-
tiffs in approximately 30 percent of post-PSLRA cases, a figure that Cornerstone described
as a substantial increase from the pre-PSLRA participation rate of 15 percent (Simmons &
Ryan, 2003). A PricewaterhouseCoopers study (2003) reported that institutional investors
represented 51 percent and 42 percent of lead plaintiffs, respectively, in all securities class
actions filed in 2002 and 2003. These institutional investors were producing results: Choi,
Johnson-Skinner, and Pritchard (2011) report that at least one institution was the lead
plaintiff in 58.9 percent of class actions filed from 2002 to mid-2007 that resulted in a set-
tlement. It is fair to say that for more than a decade, institutional investors have dominated
as lead plaintiffs. Their presence is particularly felt in the largest cases, which tend to attract
multiple class members stepping forward seeking to serve as lead plaintiff.
What explains this increase in institutional participation? One factor is greater experi-
ence under the PSLRA. As courts converged in their interpretation of the lead plaintiff
provision and institutions become more experienced with the lead plaintiff role, the
perceived benefits of participation began to outweigh the potential costs in a given case. A
second factor is the evolving judicial preference for a single institutional lead plaintiff over
a large group of individuals. Courts in some early post-PSLRA cases appeared to endorse
the idea that plaintiffs’ lawyers could cobble together large groups of lead plaintiffs and
aggregate their losses (Fisch, 2001). The more plaintiffs a lawyer could attract, the better
her chances of winning the contest to have the largest collective stake in the case. The
rise in institutional lead plaintiffs suggests that courts have become more skeptical of this
practice.
Although the studies show overall increased institutional participation, the increase
does not appear to have been uniform across types of institution. Public pension funds
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appear to have been considerably more active than other institutions. Most notably,
certain types of institutional investors, such as mutual funds, have not participated in
securities fraud litigation in meaningful numbers, despite their substantial holdings.
There are two potential explanations for mutual funds’ failure to participate as lead
plaintiffs. The first is the standard agency problem. Litigation decisions are made by
mutual fund managers, who are evaluated on the basis of fund performance relative to
other funds and market benchmarks. Litigation recoveries do not go to fund managers,
but to fund beneficiaries. Because of the time lag between the fund’s trading and the
resolution of litigation, litigation recoveries may not be fully reflected in performance
figures. At the same time, a mutual fund’s participation as lead plaintiff would draw
public attention to the fact that the fund has been the victim of fraud, perhaps reflecting
adversely on the expertise of the fund’s managers. The second explanation is that a sub-
stantial component of business for the major mutual funds involves managing retirement
accounts for publicly traded issuers. Unlike litigation recoveries, the fees associated with
these services go directly to mutual fund managers. Fund managers might reasonably be
concerned that active litigation participation would hurt their ability to compete for this
business from managers of public companies.
When one examines participation by institutions other than public pension funds, such
as hedge funds, private pension funds, and trusts, the nature and effect of institutional
participation becomes murky. It can be difficult, particularly with some smaller investors,
to determine whether they should be classified as institutions or individuals. Importantly,
these other institutions differ substantially from each other and from the large public
pension fund or mutual fund that Weiss and Beckerman (and Congress) projected as the
prototypical institutional lead plaintiff. These differences may go to the issue of whether
the institutions are capable of responsibly serving as lead plaintiffs. Weiss and Beckerman
assumed, with little discussion, that institutions will be typical and adequate representa-
tives of other class members. Accordingly, Weiss and Beckerman devoted relatively little
attention to exploring the ways in which institutional investors’ interests might diverge
from those of the rest of the class. Similarly, Weiss and Beckerman focused on the
institutional investor as a singular entity, ignoring agency problems among actors within
an institution that might impede its ability to act in the interests of its own beneficiaries
(and other members of the class). This concern manifests itself most acutely in the form
of pay to play. We focus more on this issue presently.
Hedge funds reflect a distinct group of institutional investors that have the potential
to play a meaningful role in securities litigation. Hedge funds are typically sophisticated
investors and, due to their investing strategies, often have substantial stakes in their
portfolio companies. Hedge funds’ ability to hold concentrated interests rather than
a diversified portfolio, coupled with the metrics by which hedge fund performance
is measured, increase the likelihood that hedge fund managers will benefit from a
litigation recovery relative to mutual fund managers. On the other hand, due to the
distinctive trading strategies employed by hedge funds, these are the institutions most
likely to face typicality objections to their taking the lead plaintiff position. Although
hedge funds have participated as lead plaintiffs post-PSLRA, they have not become
dominant players.
Much more common as lead plaintiffs—but less promising—are union pension funds.
Although these funds typically have greater funds under investment than the average
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individual, it is doubtful that their investment sophistication measures up to that of larger

institutions. Moreover, their ability to act as independent monitors of class counsel is
open to serious question, given the recruitment efforts used by plaintiffs’ lawyers to attract
them.
An additional factor that may impair institutional oversight is the structure of institu-
tional participation. Prior to the adoption of the PSLRA, many institutions were part of
what was effectively a group of plaintiffs that also included a number of individual inves-
tors. Courts initially disagreed on whether groups should be appointed as lead plaintiffs
under the PSLRA.16 Despite several decisions criticizing the appointment of unrelated
investors as a lead plaintiff group, courts continue to appoint institutional investors,
particularly smaller institutions as colead plaintiffs together with one or more individual
investors.17 In some post-PSLRA cases, courts have appointed groups of public pension
funds to serve as lead plaintiff.
The potential effectiveness of institutional participation may be reduced when an
institution serves as a member of a mixed lead plaintiff group. Courts and commentators
that have criticized the use of lead plaintiff groups argue that such groups are often
formed by counsel and as a result do not exert the type of control over lawyers that was
the objective of the PSLRA.18 If this is true, institutional participation as part of a group
may not be as effective in monitoring counsel, and such groups will not have a significant
effect on fee awards or fee structures. Moreover, the appointment of a lead plaintiff group
can lead to a fractured position among group members or cause some members to refrain
from active participation.19
3.2 What Is the Effect of Institutional Lead Plaintiffs?
3.2.1 Settlement amounts

We now have considerable evidence that the PSLRA’s lead plaintiff provision has led
to improved monitoring of class counsel in a broad range of cases. Choi, Fisch, and
16
Compare In re Telxon Corp. Sec. Litig., 67 F. Supp. 2d 803, 811–16 (N.D. Ohio 1999) (reject-
ing the argument that a lead plaintiff should consist of a group of unrelated investors) with In re
Cendant Corp. Litig., 264 F.3d 201, 267 (3d Cir. 2001) (holding that “rule of reason” should be
applied to determine whether size and nature of group appointment is appropriate). See also Brief
of the Securities and Exchange Commission as Amicus Curiae in Support of Appellants on the
Issues Specified. In re Cendant Corp. Litig., Nos 00-2769, 00-3653, 264 F.3d 201 (3d Cir.), at 17
n.13 (endorsing concept of lead plaintiff group but arguing that that group should consist of no
more than five members).
17
See, e.g., Tice v. Novastar Fin., Inc., 2004 U.S. Dist. LEXIS 16800, *29 (W.D. Mo. 2004)
(appointing institution and two individuals to “ensure a broader, more diverse representation of
the class”); In re Party City Litigation, 189 F.R.D. 91, 114 (D.N.J. 1999) (appointing individual
and institutional investors as co-lead plaintiffs); In re Oxford Health Plans, Inc. Sec. Litig., 182
F.R.D. 42, 47–49 (S.D.N.Y. 1998) (explicitly endorsing joint appointment of institution and several
individuals on the basis that it would result in “diverse representation”).
18
See, e.g., Telxon, at 811–16 (stating that appointed of unrelated groups would thwart legisla-
tive purpose of greater client control).
19
See, e.g., Kloster v. McColl (In re BankAmerica Corp. Secs. Litig.), 350 F.3d 747 (8th Cir.
2004) (describing inability of lead plaintiff group to agree on whether to approve or object to
proposed settlement and failure of some group members even to take a position).
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Pritchard (2005) report that the presence of public pension funds correlates with high
value settlements. That finding is not surprising, since they also find that institutional
investors are more likely to serve as lead plaintiffs in cases with accounting restatements
or SEC investigations—obvious indicia of merit. Simmons and Ryan (2003) and Cox
and Thomas (2006) also report that institutional lead plaintiffs correlate with increased
settlement amounts. Cox and Thomas (2006) also note, however, that the provable losses
of individual lead plaintiffs are a trivial percentage of the claims filed in the cases in
their sample, calling into question individuals’ incentives to monitor class counsel. Cox,
Thomas, and Bai (2008) similarly report that institutional investor lead plaintiffs, in par-
ticular public pension funds and labor unions, are positively related to larger settlement
amounts even when controlling for a measure of provable losses, market capitalization,
class period length, and the presence of an SEC enforcement action. By contrast, they
also find that very small settlements (less than $3 million) are predominantly found in
cases with individual lead plaintiffs. These studies suggest that institutional investors who
serve as lead plaintiffs may be promoting larger recoveries for shareholder class members,
relative to individual lead plaintiffs.
Cornerstone Research’s latest settlement report offers a more comprehensive com-
parison of the settlements obtained by institutional and individual lead plaintiffs (Bulan,
Ryan, & Simmons, 2015). In 2015, 64 percent of settled cases had an institutional investor
as lead plaintiff. Cornerstone reports a median settlement amount of $18 million for cases
involving public pension funds as lead plaintiff. For other cases with an institutional inves-
tor as lead plaintiff (presumably primarily labor pension funds), the median settlement
value was $6.4 million, which is slightly greater than the overall median of $6.1 million.
For cases with an individual investor as lead plaintiff, the median settlement value was
a paltry $2.7 million, consistent with the finding of Cox, Thomas, and Bai (2008). This
finding suggests that individuals serving as lead plaintiffs are primarily associated with
nuisance-value settlements, and that institutional investors which are not public pension
funds are not much better.
There is obviously a selection effect at work here. Cheng et al (2010) report that suits
brought by institutional investors are less likely to be dismissed, which is fairly direct
evidence that the suits they choose to participate in have greater merit (to the extent that
the identity of lead plaintiff does not in and of itself affect the probability of dismissal).
If public pension funds choose only to participate as lead plaintiff when the litigation
involves large potential damages and a higher probability of recovery, higher settlements
will naturally follow. This selection effect means that there may be a correlation between
public pension funds’ participation and larger settlement amounts, but it does not support
an inference of a direct causal relationship. But selection may be just as important as the
vigor with which these cases are litigated, as we discuss below.
3.2.2 Attorneys’ fees

Choi, Fisch, and Pritchard (2005) also examine the relationship of lead plaintiffs and
attorneys’ fees. They report no significant correlation between fees and public pension
funds post-enactment once they control for the size of the case. Their study looked only at
cases filed from 1991 to 2000, so it antedates the time that institutional investors stepped
forward in large numbers to serve as lead plaintiff. Looking at a later sample period, Choi
(2011) finds significantly lower fee requests—along with greater hours worked—for cases
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with institutional investors serving as lead plaintiffs. He also finds that lead plaintiffs with
smaller provable losses are less likely to negotiate for lower attorneys’ fees.
Perino (2012), after controlling for case quality, finds that cases with public pension
lead plaintiffs have larger recoveries and lower fee requests and fee awards than cases
with other lead plaintiff types. He also finds a spillover effect: fee requests have declined
generally over time, suggesting that lower fees negotiated by institutional investors have
reduced the going rate in cases with individual investors serving as lead plaintiffs as well.
More recently, Baker, Perino, and Silver (2015) find that judges in districts with a high
volume of securities litigation are more likely to cut fees, and fees are generally lower in
high-volume districts. More troubling, they also find that fee reductions are essentially
random. Moreover, they find little evidence that lead plaintiffs are negotiating attorneys’
fee agreements at the outset of the litigation, when their efforts are most likely to be effec-
tive. They conclude that courts are generally setting fees in securities fraud class actions in
the same way they did before the enactment of the PSLRA: ex post, based on the results
of the suit. They also suggest reforms to improve the process, which we discuss presently.
3.3 Pay to Play
It is not all sunshine and roses with respect to public pension funds as lead plaintiffs.
Media reports have highlighted political contributions to officials overseeing public
pension funds who serve as lead counsel to the lead plaintiffs. For example, Fortune
magazine ran a story detailing political contributions received by former New York State
Comptroller Carl McCall from the partners at Bernstein, Litowitz, Berger & Grossman
(BLBG) (Weinberg & Fisher, 2004). McCall received these contributions shortly before
McCall chose BLBG to serve as the New York public pension fund’s counsel in the
WorldCom securities class action, which produced one of the largest settlements ever in a
securities class action—and a correspondingly large fee for BLBG.
McCall was also involved in perhaps the most frequently cited example of pay to play
in securities cases, In re Cendant Corp. Litigation. The district court in Cendant discovered
that two law firms selected as lead counsel contributed nearly $200,000 to McCall, who
was the sole director of the New York public pension fund that was a lead plaintiff in
the case (Dewan, 2002). The district court in Cendant, however, declined to find that pay
to play affected the selection of counsel, and this finding was affirmed by the Court of
Appeals for the Third Circuit.20 The Cendant court’s skepticism that pay to play had an
important influence on counsel selection is typical: a district court in California rebuffed
“speculative” arguments that political contributions created a conflict between the
attorney and the class, noting that “[c]ourts have long been less enamored of securities
litigation pay-to-play arguments than litigants and the press.”21
Johnson-Skinner (2009) provides the first systematic effort to document pay to play. He
presents summary statistics of law firms’ political contributions side by side with pension
funds’ selection of law firms as counsel in securities class actions from 2002 to 2006. He
finds that law firms contribute to the officials of funds that select them as class counsel in
20
In re Cendant Corp. Litig., 264 F.3d 201, 269 (3d Cir. 2002).
21
In re Countrywide Fin. Corp. Sec. Litig., Case No. CV-07-05295 (C.D. Cal. Dec. 9, 2009).
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a substantial number of cases. By contrast, Webber (2010) rejects arguments that pay to
play has a substantial influence on counsel selection based on his finding that the number
of politicians on pension funds’ boards correlates negatively with selection as lead counsel.
Unlike Johnson-Skinner, however, Webber does not examine the influence of campaign
contributions, which would seem to be a more direct measure of the incidence of pay to play.
Choi, Johnson-Skinner, and Pritchard (2011) study the effect of campaign contribu-
tions to lead plaintiffs on the level of attorneys’ fees in securities class actions. They
find that state pension funds generally pay lower attorneys’ fees when they serve as lead
plaintiffs in securities class actions than do individual investors serving in that capacity,
and larger funds negotiate for lower fees. This differential disappears, however, when they
control for campaign contributions made to officials with influence over state pension
funds. This effect is most pronounced for state pension funds that receive the largest cam-
paign contributions and that associate repeatedly as lead plaintiff with a single plaintiffs’
attorney firm. Thus, pay to play appears to increase agency costs borne by shareholders
in securities class actions, undermining one of Congress’s principal goals in adopting
the Private Securities Litigation Reform Act. They do not, however, find any correlation
between campaign contributions and weaker cases. It appears that plaintiffs’ attorneys are
only willing to invest in access to potential lead plaintiffs for cases in which there is likely
to be competition to serve as lead counsel.
Other forms of recruitment of institutional lead plaintiffs have also persisted in the
post-PSLRA era. These recruitment efforts are more difficult to document than campaign
contributions, however, so they are less amenable to statistical analysis. Securities class
action law firms provide “portfolio monitoring” services for institutional investors, alert-
ing their clients to the possibility of legal claims for securities fraud. Not coincidentally,
the law firm providing the monitoring services gets a leg up in the competition to represent
the largest investors, a critical advantage in being appointed as counsel to represent the
class in a securities fraud class action. Plaintiffs’ law firms also sponsor conferences
for pension fund managers, including managers of labor union pension funds; these
conferences—typically held in warm, sunny places—appear to function as recruiting
grounds for potential lead plaintiffs.
4. LEAD PLAINTIFF REFORMS
4.1 Transparency
The evidence previously discussed suggests that the lead plaintiff provision has promoted
greater recovery for shareholders and reined in the percentage of that recovery that goes
to plaintiffs’ lawyers. These results are consistent with Congress’s vision in enacting the
lead plaintiff provision: institutional investors would take control of securities fraud
class actions, aligning such suits more closely with the interests of shareholders generally.
The evidence also suggests, however, that in certain circumstances plaintiffs’ lawyers
have successfully subverted the monitoring that Congress intended by making campaign
contributions to key government officials who have influence over public pension funds.
This section discusses reforms that could address these concerns by bringing increased
transparency to securities litigation.
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4.2 Campaign Contributions
To ensure that Congress’s purposes are not undermined, courts need to take a closer—and
earlier—look at the relationship between lead plaintiffs and their lawyers. Payments to
plaintiffs in class actions other than their pro rata share of the recovery are already pro-
hibited.22 The question is: Are those prohibitions being enforced? To ensure the alignment
of interest between the lead plaintiff and the class that Congress intended is not subverted
by pay to play, courts should take a hard look when a state and local pension fund comes
forward to seek lead plaintiff status. If government officials affiliated with that fund
have received political contributions from the firms representing them, those institutions
should not be presumed to be the vigorous monitors that Congress hoped to attract when
it adopted the lead plaintiff provisions of the PSLRA. Accordingly, courts appointing
lead plaintiffs should inquire whether campaign contributions have been made after a
firm has represented a pension fund in a class action that generated a settlement for the
class. If contributions are being made as quid pro quo for selection as counsel, either
explicitly or, more likely, implicitly, that would seem to violate the PSLRA’s prohibition on
non-pro rata recovery. Disclosure of such contributions at the time that the lead plaintiff
was being selected would allow for disqualification of funds that have received pay to play
at the outset. To ensure that the prohibition is effective, law firms seeking lead counsel
status should be required to commit to not making campaign contributions to officials
connected to state pension funds going forward as well.
4.3 Repeat Plaintiffs
The PSLRA bars shareholders from serving as a lead plaintiff in more than five securities
class actions in any three-year period.23 That limit is easily circumvented, however. To
start, the restriction may be ignored by a court at its discretion.24 In addition, individual
state pension fund officials may control a number of different pension funds. Depending
on the holdings of the particular funds, state officials may be able to skirt the PSLRA’s
limits by relying on different funds in different cases. Tightening these limits on repeat
plaintiffs would curtail the ability of plaintiffs’ attorneys to recruit lead plaintiffs through
political contributions. Institutions seeking lead plaintiff status should be required to
disclose not only their own involvement in prior cases, but also that of affiliated funds.
This limit would require lawyers to justify their litigation decisions to a broader group of
shareholders when soliciting clients to file suits.
4.4 Fee Arrangements
Transparency—and competition—would be further enhanced if investors seeking lead

plaintiff status were required to publicly disclose their fee arrangements with their
22
15 U.S.C. § 78u-4(a)(4).
23
15 U.S.C.A. § 78v-4 (a)(3)(vi).
24
See, e.g., Iron Workers Local No. 25 Pension Fund v. Credit-Based Asset Serv. and
Securitization LLC, 616 F. Supp. 2d 461, 467 (S.D.N.Y. 2009).
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roposed lead counsel. Disclosure of fee agreements at the time that investors were seek-
p
ing to be appointed lead plaintiff would provide tangible evidence—in the form of lower
fees—that a prospective lead plaintiff was interested in promoting the interests of the
investor class members, rather than the lawyers. Moreover, insofar as the PSLRA seeks
to promote competition among lawyers for work in securities class actions, market forces
cannot work effectively unless the market is transparent. Prices will find their own level
only if those prices are available to all participants. Forcing proposed fee agreements out
in the open, and discussing them in judicial opinions appointing lead plaintiffs, will make
prices clear for courts that do not see a high volume of these cases.
Baker, Perino, and Silver (2015) offer a similar proposal, requiring courts to review
fee arrangements at the outset of the litigation, but allowing proposed lead plaintiffs to
submit their fee arrangements under seal to the court for in camera review. They point
out that disclosing fee arrangements would reveal break points in counsel’s compensation
based on percentage of recovery. (Percentages typically decline as recoveries increase.)
They worry that public disclosure would provide a strategic advantage to defendants, who
might propose settlements targeting those break points, knowing that counsel would have
a lesser incentive to pursue a greater recovery.
We believe that Baker, Perino, and Silver’s concerns are overstated. Although lead
counsel has to weigh the risks of pursuing the litigation in hopes of greater recovery, if
the lead plaintiff has negotiated for break points in the fee agreement, they are clearly
sophisticated enough to understand the incentive effects created by those break points.
It is for the lead plaintiff to decide whether to accept or reject any offer of settlement,
and they will make that decision knowing that the court will be reviewing the decision to
accept a settlement. If the court sees an early settlement of a case in the vicinity of a break
point, it will know to ask questions of the lead plaintiff about the decision to settle and
whether it would be in the class’s interest to pursue the litigation further.
If there is a strategic disadvantage to the lead plaintiff in negotiating a settlement from
having disclosed break points in a fee agreement, it could be countered by negotiating for
a higher percentage above certain levels, signaling that counsel is strongly incentivized to
pursue the largest possible recovery. And what stronger signal could a lawyer send about
the strength of her case? If disclosure induced lawyers to negotiate for higher percentages
for larger recoveries, it would have the fortunate collateral effect of targeting deterrence
where it is most needed, that is, the most egregious cases of fraud. Maintaining the current
secrecy around fee agreements gives cover to lawyers charging higher percentages in cases
that are being brought purely for their extortion value, with no real prospect of prevailing
at trial. More transparency would shed light on these speculative cases.
4.5 Standing and Feeshifting
Weiss and Beckerman, in their original proposal that would eventually be adopted by
Congress as the lead plaintiff provision of the PSLRA, endorsed institutional involve-
ment based on the perception that institutional investors held substantial stakes. Those
stakes would offer appropriate incentives for them to monitor litigation decisions, and the
sophistication that would enable them to do so effectively.
The PSLRA as adopted, however, does nothing to screen out investors who have not
suffered substantial losses from serving as lead plaintiff. These “figurehead” plaintiffs are
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precisely the type of plaintiff that Congress hoped to displace with the PSLRA, and yet
they persist in cases for which there is little or no competition for lead plaintiff status.
They have little regard for whether the lawsuits to which they lend their names produce
any benefit to the shareholder members of the class. As discussed previously, individual
investors continue to serve as lead plaintiffs in a substantial portion of securities fraud
class actions, and the results are not encouraging: high fee percentages to lawyers and
minimal recoveries for investors.
Individual investors are not the only figurehead plaintiffs; institutional status can be
a noisy proxy for having a substantial stake in the litigation. Many institutional lead
plaintiffs, such as union and municipal pension funds, are quite small and have relatively
minor stakes. Similarly, many smaller institutions lack any particular sophistication.
These institutions should not be analyzed separately from individual lead plaintiffs with
similar sized stakes. We should not expect these institutions to add distinctive value to
litigation. Supporting this idea, Baker, Perino, and Silver (2015) find that union pension
funds agree to fee levels that are indistinguishable from fees agreed to by individual lead
plaintiffs.
The fact of the matter is that many securities class actions are still brought with no
expectation that the plaintiff would be able to prevail at trial, but rather with the hope
that the company’s D&O insurer will pay a nominal settlement to make the case go away.
These cases do little for either compensation or deterrence. According to Cornerstone
(Bulan, Ryan, & Simmons, 2015), 26 percent of securities fraud class actions settled for
nuisance value—which Cornerstone defines as $2 million—or less. That is an exceptionally
conservative estimate of the cost of defending a securities fraud class action in an era
of electronic discovery. A more realistic estimate of nuisance value would be at least $4
million, at least for cases that get past a motion to dismiss. With the median settlement at
$6.1 million, it is possible that at least half of all securities fraud class actions are either
being dismissed or settled to avoid nuisance costs. And given that Cornerstone reckons its
median settlement number to reflect between 2 and 5 percent of shareholders’ estimated
losses in these cases, it is difficult to argue that these settlements serve any compensatory
purpose. The cost of D&O insurance reflects this “fraud tax,” which has little connection
to the actual incidence of fraud. A portion of the plaintiffs’ bar is able to make a living out
of filing formulaic complaints in the wake of a stock price drop and collecting a modest toll
from the insurance companies. In exchange, these plaintiffs’ attorneys offer the preclusion
of future claims.
These depressing figures suggest that the screening the PSLRA imposes on securities
fraud complaints does not adequately weed out many of the cases that are lacking in
merit. It is implausible that any competent lawyer would settle a securities fraud class
action with any nontrivial prospect of recovery for less than $6 million, even against an
insolvent defendant. (There is always the D&O policy limit to tap.) Many cases are being
settled to avoid the expense of discovery and defense-side attorneys’ fees. These cases
offer little in either compensation or deterrence, that is, they are simply a wealth transfer
to lawyers. If they could be screened from our system of litigation at a reasonable cost,
shareholders of public companies would be unambiguously better off.
How can we get rid of these nuisance suits, short of adopting a pleading standard so
stringent that it excludes substantial numbers of meritorious cases? The experiment with
the lead plaintiff provision lights the path. Congress could amend the PSLRA to require a
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reasonable minimum loss—“skin in the game”—to serve as lead plaintiff.25 The evidence
surveyed above shows that plaintiffs with skin in the game: (1) screen for good cases; (2)
produce better results. Why not harness this expertise to make securities fraud class actions
more efficient at deterring fraud? There is no more direct way of ensuring sufficient incen-
tive to promote the interests of the class as a whole than requiring that the lead plaintiff
have a substantial loss from the alleged fraud. Under this proposal, those incentives would
be tapped to ensure that lead plaintiffs were bringing cases that should be brought.
Picking the appropriate amount of loss for eligibility to serve as lead plaintiff is an
imprecise task, but it seems obvious that the correct number has to be more than $800, the
smallest number reported by Choi (2011). There may be individuals and small institutions
with sufficient losses to encourage them to be an active monitor. It is hard to imagine,
however, that the number required to provide sufficient incentive is zero. Obviously,
imposing a minimum loss requirement would mean that some cases would not be brought.
That is the point. If a plaintiffs’ lawyer cannot persuade even a single shareholder with
more than nominal losses to file suit, why should a court spend valuable judicial time
resolving it? And why should a defendant bear the expense of litigating the action?
The challenge in setting a standing requirement is that there is unlikely to be a clear divid-
ing line between investors with large and small losses in terms of the results that their lawsuits
produce. Choi (2011) reports a median loss among lead plaintiffs in settled cases of $286,000,
but the corresponding figure was $237,000 for cases that did not result in a settlement. Given
that many settlements were for nominal amounts, this finding may overstate the similarity
between the two groups. A more refined distinction would include nominal settlements
among the cases that are not cost justified. Table 17.1 shows the proportion of cases that can
be classified as nuisance suits in the sample relied upon in Choi (2011), broken down by prov-
able losses alleged by the lead plaintiff arranged from bottom decile to top decile of losses.
We define nuisance suits as cases that were dismissed on a motion to dismiss or summary
judgment, or that settled for less than $4 million, a conservative estimate of defense costs.
A robust standing requirement would set the standing cut off at $1 million in prov-
able losses, the range at which the proportion of losing cases drops below half. Clearly
plaintiffs with losses in this range have real incentive to monitor the litigation. Setting the
standing requirement this high, however, would weed out more than 80 percent of the
existing pool of lead plaintiffs, which could impair the deterrent value of securities fraud
class actions. At the opposite extreme, setting the standing requirement at a nominal
level—$10,000 of provable losses—would weed out lead plaintiffs who are overwhelm-
ingly bringing nuisance cases: nearly 85 percent in this sample. It is hard to imagine that
screening these cases would have any significant impact on deterrence. (If anything,
eliminating these cases would mean the remaining pool of filings would carry a stronger
25
Legislation would likely be required to implement the proposal outlined here as the SEC
would be likely to view any attempt by a company to adopt the proposal through a charter amend-
ment as inconsistent with the federal securities laws (Sjostrom, 2015; Coffee, 2015). Fee-shifting
is prohibited by Delaware corporate law, Del. G.C.L. §§102(f), 109(b), but the prohibition likely
does not apply to federal securities claims (Bainbridge, 2016). Imposing liability on lawyers for
fee-shifting, however, would probably require the preemption of state ethics rules. Model Rules
of Professional Conduct, Rule 1.8(e) (forbidding lawyers, with certain exceptions, from providing
“financial assistance to a client in connection with pending or contemplated litigation”).
M4633-GRIFFITH_t.indd 283 30/10/2018 08:16

Table 17.1 Nuisance suits and provable losses
Decile % Nuisance Mean Provable Loss

1 84.8% $9,178
2 57.6% $38,085
3 65.6% $78,386
4 69.7% $128,892
5 68.8% $213,858
6 66.7% $321,409
7 60.6% $474,001
8 62.5% $799,275
9 42.4% $1,655,121
10 53.1% $20,987,050
signal that wrongdoing was being identified, as there would be less dilution.) This would
be a very lenient restriction on shareholder standing.26 Investors with this level of loss
have a sufficient amount at stake to provide at least some assurance that shareholder
members of the class would think that this is a case that should be brought.27
An intermediate alternative would couple a slightly more robust standing r equirement—
perhaps $50,000 or $100,000 of provable losses—with a feeshifting provision for cases
brought by plaintiffs meeting that threshold, but with less than $1,000,000 in provable
losses. For lead plaintiffs with losses in the intermediate range, fees would be imposed on
plaintiffs’ attorneys if their cases were dismissed on a motion to dismiss or summary judg-
ment, and awarded to them if they prevailed on summary judgment or at trial. (It would
serve little purpose to impose the fees directly on these nominal plaintiffs, as many of
them will be judgmentproof, and most of them have little capacity to assess the likelihood
that a case is a meritorious one.) A feeshifting provision for nominal plaintiffs would give
defendants an incentive to vigorously resist these cases if they are lacking in merit, as it
appears that many are, and to settle early in cases with merit. At the same time, a plaintiffs’
attorney who genuinely believes they have a strong case (if not a strong plaintiff) should
not be dissuaded from bringing suit by the risk of a fee award. If they prevail, they get an
additional award of fees. Even if they lose at trial, they would not be on the hook for the
defendant’s fees. Enhancing the lead plaintiff provision in this fashion would harness the
incentives of plaintiffs’ lawyers to screen out the weakest cases.
5. CONCLUSION
The law expects representative plaintiffs to serve a gatekeeping function in entrepreneurial

litigation, yet currently does little to ensure that plaintiffs meet this expectation. If most
26
Obviously, for a standing requirement to have its intended effect, there could not be grouping
of losses among plaintiffs.
27
Shareholders who could not meet this requirement could still be members of the class; they
would just be ineligible to serve as lead plaintiff.
M4633-GRIFFITH_t.indd 284 30/10/2018 08:16

plaintiffs in shareholder suits are nonlawyers with a minimal financial stake in the
litigation, they cannot serve as a line of defense against frivolous lawsuits. Yet, the legal
system anticipates that law firms will have to justify their litigation decisions to independ-
ent shareholders who have agreed to represent the interests of the shareholder class.
Shareholders with little at stake, or who have been bribed to serve as shareholders, have
little incentive to perform this monitoring function. In short, the prevalence of conflicted
plaintiffs means that there is a missing monitor in many shareholder lawsuits, which in
turn may help explain why plaintiffs’ lawyers are able to file so many lawsuits that are
dismissed or settled for nuisance value. Either way, they are imposing a cost on the system,
and ultimately on shareholders, who are its intended beneficiaries.
The legal system must do more to encourage plaintiffs to monitor their lawyers in
securities class actions. Transparency and a minimum loss requirement, coupled with
a feeshifting requirement for lawyers who are only able to recruit nominal plaintiffs,
would go a long way toward promoting more effective monitoring. Shareholder litigation
is uniquely suited for the reforms proposed here because many shareholders have the
financial stake necessary to take an active role in litigation. Too many lawsuits remain in
the hands of plaintiffs’ attorneys, ultimately hurting corporations and their shareholders
when they bring nonmeritorious actions. The reforms proposed here would be an impor-
tant step to ensure lead plaintiffs’ interests are aligned with their fellow shareholders.
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Setting in Securities Class Actions,” 115 Columbia Law Review 1371.
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Shareholder Litigation,” 95 J. of Financial Economics 356.
Choi, Stephen J. 2007. “Do the Merits Matter Less After the Private Securities Litigation Reform Act,” 23 J. of
Law, Economics & Organization 598.
Choi, S. 2011. “Motions for Lead Plaintiff in Securities Class Actions,” 40 J. of Legal Studies 205.
Choi, Stephen J., Jill E. Fisch, & A. C. Pritchard. 2005. “Do Institutions Matter? The Impact of the Lead Plaintiff
Provision of the Private Securities Litigation Reform Act,” 83 Washington University Law Quarterly 869.
Shoi, S., Johnson-Skinner, D., & Pritchard, A., 2011. “The Price of Pay to Play in Securities Class Actions,”
8 J. of Empirical Legal Studies 650.
Coffee, Jr, John C., 1986. “Understanding the Plaintiff’s Attorney: The Implications of Economic Theory for
Private Enforcement of Law Through Class and Derivative Actions,” 86 Columbia Law Review 669.
Coffee, Jr, John C. 2015. “‘Loser Pays’: The Latest Installment in the Battle-Scarred, Cliff-Hanging Survival of
the Rule 10b-5 Class Action,” 68 S.M.U. 689.
Macey, Jonathan R. & Geoffrey P. Miller, 1991. “The Plaintiffs’ Attorney’s Role in Class Action and Derivative
Litigation: Economic Analysis and Recommendations for Reform,” 58 University Chicago Law Review 1.
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File Claims in Securities Class Actions?” 80 Wash. U. L.Q. 855.
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Empirical Analysis of Securities Class Action Settlements,” 61 Vanderbilt L. Rev. 355.
Cox, James D. & Randall S. Thomas with Dana Kiku. 2006. “Does the Plaintiff Matter? An Empirical Analysis
of Lead Plaintiffs in Securities Class Actions,” 106 Columbia Law Review 1587.
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Eisenberg, Theodore & Geoffrey P. Miller. 2004. “Attorney Fees in Class Action Settlements: An Empirical
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Fisch, Jill E. (2001). “Aggregation, Auctions and Other Developments in the Selection of Lead Counsel under
the PSLRA,” 64 Contemp. Probs. 53.
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Records of his Union Allies?” Forbes, Feb. 13, 2006, at 102.
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through December 2003,” Cornerstone Research, available at http:// securities.stanford.edu/.
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M4633-GRIFFITH_t.indd 286 30/10/2018 08:16

18. The mimic-the-market method of regulating
common fund fee awards: a status report on
securities fraud class actions
Charles Silver*
1. INTRODUCTION
In 2006 I predicted that, “in ten years or less,” judges would routinely set fee terms at or
near the start of securities fraud litigation rather than at settlement, as was the historical
practice (Silver 2006). I expected the Private Securities Litigation Reform Act of 1995
(PSLRA)1 to provide the impetus for the change. Then, nine years later, Lynn Baker,
Michael Perino, and I showed that my prediction was wrong (Baker, Perino, & Silver
2015). We examined 431 securities class actions that settled in federal district courts from
2007 through 2012 and found that judges set fees up front in almost none of them. The
exceptions stood out like stars in the night sky, but even so the darkness was overwhelming.
By leaving class counsel’s compensation unsettled throughout the pendency of lawsuits
that take years or even decades to resolve, judges fail to mimic the private market for
legal services. There, lawyers and clients nearly always contract over contingent fee terms
when representations begin. But judges have not rejected the mimic-the-market approach.
They haven’t set fees at the start of litigation because they are almost never asked to. The
empirical study that falsified my prediction also found that motions asking judges to set
fees other than at settlement were made once in a blue moon. Lawyers request fees when
class actions settle, so that is when judges fix their compensation. When judges set fee
guidelines in advance, they typically act on their own.2
Judges have actually shown considerable willingness to take guidance from private
market arrangements when asked to do so. The Seventh Circuit provides the clearest
example. It has repeatedly held that lawyers representing plaintiff classes are to be
compensated at market rates, meaning rates that “willing buyers and willing sellers of
legal services” would have agreed to at the start of litigation.3 District court judges in
* I wish to thank the participants at the Fourth Annual Workshop on Corporate and Securities
Law and, in particular, Travis Laster and David Webber for helpful comments.
1
15 U.S.C.A. § 78u-4.
2
A judge who attended the Corporate and Securities Regulation Workshop reported that he
encountered resistance from lawyers when attempting to establish fee terms ex ante. Lawyers want
to preserve the option of securing injunctive relief, he reported, not to be forced to recover damages
in order to be paid. This seems like a better explanation for the failure to fee terms ex ante in deriva-
tive actions, where settlements requiring corporate governance reforms are more common than in
securities fraud class actions, which normally settle for cash.
3
Silverman v. Motorola Solutions, Inc., 2013 WL 4082893 *1 (7th Cir. 2013). See also In re
Trans Union Corp. Privacy Litigation, 629 F.3d 741, 744 (7th Cir. 2011) (stating, with approval, that
“[t]he special master recognized that his task was to estimate the contingent fee that the class would
287
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other circuits have often embraced this doctrine too.4 Although not required to do this,
the benchmark rates and multifactor approaches employed by their circuits give them
discretion to consider market rates, so they do.
The Third Circuit has also endorsed a market-like approach by requiring judges to give
a presumption of reasonableness to fee agreements negotiated by lead plaintiffs and their
attorneys. The intuition behind this approach is that lead plaintiffs with large financial
stakes can obtain appropriate fee terms—which may be more generous, less generous,
or altogether different from those which judges would apply—by acting as investors’
bargaining agents and are incentivized to bargain aggressively because their own money is
on the line. A better fee deal is expected to put more money in a lead plaintiff’s pocket than
a worse one, so a lead plaintiff has a reason to want the best possible terms. By deferring
to reasonable agreements, judges give private arrangements priority over regulatory solu-
tions to fee-related problems. It is therefore apt to describe the Third Circuit’s approach
as market-based.
The approaches used in the Third and Seventh Circuits can lead judges to different
conclusions, however, because agreements between lead plaintiffs and their attorneys
may contain terms that differ from those that prevail in the market for legal services more
generally. In the larger market, sophisticated clients tend to pay their attorneys 25 to 40
percent of their recoveries in commercial lawsuits with large stakes. In securities fraud
class actions, fee percentages are sometimes lower. In the Enron litigation, for example, the
lead plaintiff negotiated a rising scale of fee percentages according to which lead counsel
would receive 8 percent of the first billion dollars recovered, 9 percent of the second
billion, and 10 percent of any amount north of that. I know of no segment of the private
market for legal services in which sophisticated clients secure similarly favorable terms, so
it is worth asking why the difference exists.
In this chapter, I will examine judges’ attitudes toward the mimic-the-market approach,
which for this purpose I take to include privately negotiated fee agreements between lead
plaintiffs and their attorneys. I believe that, with some noteworthy exceptions, respect
for the market is both widespread and growing. Flanagan, Lieberman, Hoffman & Swaim
v. Ohio Public Employees Retirement System,5 a recent case in which the Second Circuit
took a step toward adopting the Third Circuit’s approach, strengthens this impression.
More generally, judges seem to sense a need for an objective basis for fee awards and to
have negotiated with the class counsel at the outset had negotiations with clients having a real stake
been feasible”); In re Synthroid Mktg Litig., 325 F.3d 974, 975 (7th Cir. 2003) (“Synthroid II”) (“A
court must give counsel the market rate for legal services”); In re Synthroid Mktg. Litig., 264 F.3d
712, 718 (7th Cir. 2001) (“Synthroid I”) (“courts must do their best to award counsel the market
price for legal services, in light of the risk on non-payment and the normal rate of compensation in
the market at the time”); In re Cont’l Ill. Sec. Litig., 962 F.2d 566, 572 (7th Cir. 1992) (the “market
rate” is “as we have been at pains to stress, [what] the lawyer . . . would have gotten in the way of
a fee in an arms’ length negotiation, had one been feasible”); In re AT&T Mobility Wireless Data
Services Sales Tax Litig., 792 F.Supp.2d 1028, 1033 (N.D. Illinois, 2011) (“The Seventh Circuit has
directed district courts to estimate the market price for legal services in calculating an appropriate
attorneys’ fee”).
4
See section 2 of this chapter.
5
Flanagan, Lieberman, Hoffman & Swaim v. Ohio Public Employees Retirement System, 2016
WL 1082007 (2d Cir. 2016).
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The mimic-the-market method 289
recognize that the market for legal services provides one.6 A willingness to defer to private
arrangements can even be found in cases where, for one reason or another, judges take
control of fees into their own hands.
2. SEVENTH CIRCUIT ORIGINS
The belief that judges should take guidance from private arrangements when awarding
fees in class actions and other contexts has appealed to me since the start of my academic
career. I espoused it in the first articles I wrote as a law professor and have stuck with it
ever since (Silver 1991; Silver 1992). The thesis was novel when it appeared. Back then,
no federal circuit court had formally endorsed the mimic-the-market approach, and the
lodestar method, although perhaps mortally wounded, wasn’t yet on life support.
I didn’t have to wait long for my position to gain doctrinal support. Shortly after
my first article on class action fee awards appeared in print, Judge Richard A. Posner
authored an opinion for the Seventh Circuit in In re Continental Illinois Securities
Litigation,7 memorably writing that “it is not the function of judges [awarding fees in class
actions] to determine the equivalent of the medieval just price. It is to determine what the
lawyer would receive if he were selling his services in the market rather than being paid
by court order.” He did not need my help to reach this conclusion; given his well-known
leanings, it would have been remarkable had he reached any other. The important point
is that the Continental Illinois opinion gave the mimic-the-market approach its doctrinal
launch. Thereafter in the Seventh Circuit, “[t]he object in awarding a reasonable attorney’s
fee . . . [would be] to give the lawyer what he would have gotten in the way of a fee in an
arm’s length negotiation, had one been feasible.”
Although no other circuit has formally adopted the Seventh Circuit’s approach,
district court judges across the country have embraced it. In Allapattah Services, Inc.
v. Exxon Corp.,8 an Eleventh Circuit case, Judge Alan Gold wrote that “the more
appropriate measure of a reasonable percentage is the market rate for a contingent fee in
commercial cases.” In the Tenth Circuit, Judges Timothy D. DeGiusti and Sven Holmes
have both awarded fees at market rates in settled cases.9 Judge Melinda Harmon, who
follows Fifth Circuit law, gave it a nod of approval in In re Enron Corp. Sec., Derivative
& ERISA Litig.10
6
The growing group of judges who recognize a need for an objective basis for fee awards
includes (now former) Judge John Gleeson, whose opinion in In re Payment Card Interchange Fee
and Merch. Disc. Antitrust Litig., 991 F. Supp. 2d 437 (E.D.N.Y. 2014), is a model of clarity on this
and many other points.
7
In re Continental Illinois Securities Litigation, 962 F.2d 566, 572 (7th Cir. 1992).
8
Allapattah Services, Inc. v. Exxon Corp., 454 F. Supp. 2d 1185, 1211 (S.D. Fla. 2006).
9
See Chieftain Royalty Co. v. Laredo Petroleum, Inc., 2015 WL 2254606, at *4 (W.D. Okla.
2015) (Judge DeGiusti) (observing that “[t]he market rate for Class Counsel’s legal services also
informs the determination of a reasonable percentage to be awarded from the common fund as
attorneys’ fees”); and Millsap v. McDonnell Douglas Corp., 2003 WL 21277124, at *6 (N.D. Okla.
2003) (Judge Holmes) (stating that the court would consider “the market rate for Class Counsel’s
services”).
10
In re Enron Corp. Sec., Derivative & ERISA Litig., 586 F. Supp. 2d 732 (S.D. Tex. 2008)
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Perhaps the strongest proponent of the mimic-the-market approach outside the

Seventh Circuit is Judge D. Brock Hornby, who sits in Maine. He has applied the mimic-
the-market approach repeatedly and has never been reversed. He set out his reasons for
doing so in Nilsen v. York County, writing that, unless supplemented by information
about market rates, the multifactor approach “offers little predictability,” “would support
equally a fee award of 16%, 20%, 25%, 30%, or 33-1/3%,” “is not a rule of law or even
a principle,” “allows uncabined discretion to the fee-awarding judge,” employs “factors
[that] seem inconsistent with . . . [the goal of] creat[ing] incentives for the lawyer to get
the most recovery for the class by the most efficient manner,” and “consume[s] significant
lawyer and judicial resources.”11 Judge Hornby made a positive case for mimicking the
market as well. His basic points were that the market is the only game in town, and that
judges take account of market rates in subjective and ad hoc ways even when purporting
to use other methodologies.
I believe that in setting a fee, a judge, consciously or unconsciously, necessarily compares what
lawyers typically get paid for equivalent services—that is, the market price. The judge may do that
based on recollections from when that judge was a lawyer, from information generated in other
cases, or from general lawyer/judge gossip, but inevitably the judge takes such information into
account. The Seventh Circuit appropriately makes this measure explicit, rather than a Gestalt
lurking behind the multifactor review.
There is good reason for using a market-oriented approach. If a consumer wanted to deter-
mine a reasonable plumber’s, mechanic’s, or dentist’s fee, the consumer would have to look to the
market. Why should lawyers be different? Perhaps more important, the market is the implicit if
not explicit standard when a jury awards damages that include reasonable medical expenses in
a personal injury case. We do not use a multifactor approach then. We even look at the market
to a degree in lodestar cases, because we purport there to look at market rates for what a lawyer
can charge as an hourly rate.12
These considerations led Judge Hornby to conclude that “the methodology of the
Seventh Circuit [is] most reflective of what a judge does instinctively in setting a fee as
well as most amenable to predictability and an objective external constraint on a judge’s
otherwise uncabined power.”13
It can take courage to mimic the market, because a commitment to applying market
rates can require a judge to award an enormous percentage-based fee in a megafund case.
In Allapattah Services, mentioned above, the court awarded a 31.33 percent fee on a recov-
ery north of $1 billion, being convinced for many reasons that this was the market rate.
In Standard Iron Works v. Arcelormittal et al., which settled for $164 million, the district
court found “that a 33% fee comport[ed] with the prevailing market rate for legal services
(reviewing fee agreement ex post, applying favorable presumption to its terms, and citing Synthroid
I repeatedly).
11
Nilsen v. York County, 400 F.Supp.2d 266, 277–78 (D. Maine 2005). Judge Hornby also
applied the mimic-the-market approach in Scovil v. FedEx Ground Package System, Inc., 2014 WL
1057079 (D. Maine); In re New Motor Vehicles Canadian Export Antitrust Litigation, 842 F.Supp.2d
346 (D. Maine 2012); and Prescott v. Prudential Ins. Co. of America, 2011 WL 6662288 (D. Maine).
12
Nilsen, 400 F.Supp.2d at 278.
13
Nilsen, 400 F.Supp.2d at 279. Judge Hornby persuaded at least one colleague to embrace the
Seventh Circuit’s approach. See In re Cabletron Systems, Inc. Securities Litigation, 239 F.R.D. 30
(D. N.H. 2006) (following Nilsen).
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of similar quality in similar cases.”14 And in Silverman v. Motorola, Inc., the fee award was
27.5 percent of $200 million because the market would have compensated class counsel at
this level, given the risk.15 Numbers like these are bound to scare many judges. Lawyers are
greatly disliked, and judges who award them tens or even hundreds of millions of dollars
in fees aren’t going to win any popularity contests. But applying the market rate means
following the lead of sophisticated clients and ignoring uninformed critics.
The $55 million Motorola fee award was affirmed on appeal in an opinion by Judge
Frank Easterbrook, who has endorsed the mimic-the-market approach in a raft of
decisions.16 Citing an expert report written by this author, Judge Easterbrook found that
the fee percentage was reasonable, despite being high by comparison to awards in other
megafund cases, because lead counsel bore exceptional risks. Judge Easterbrook also
thought it telling that no institutional investor had challenged the fee award, even though
such investors owned 70 percent of the settlement fund and a smaller fee would have
meant more dollars for them. It was hard to find that the trial judge abused her discretion
by awarding a fee with which the investors with the most at stake were content.
But as he often does, Judge Easterbrook littered the Motorola opinion with dicta in
which he described arguments that would have appealed to him, had they been made.
He was particularly concerned that the trial judge applied a flat percentage to the
entire recovery instead of a scale of percentages that declined at higher recovery levels.
After reminding readers that he applied a declining scale in In re Synthroid Marketing
Litigation,17 he explained that declining marginal percentages make sense because of
economies of scale associated with litigation.18 He then added that my expert report “[did]
not identify suits seeking more than $100 million in which solvent clients agree ex ante
to pay their lawyers a flat portion of all recoveries,19 as opposed to a rate that declines as
the recovery increases.”20
These points merit further discussion, partly because they show that Judge Easterbrook
14
Standard Iron Works v. Arcelormittal et al., 2014 WL 7781572, at *1 (N.D. Ill. Oct. 22, 2014).
15
Silverman v. Motorola, Inc., 2012 WL 1597388 (N.D. Ill. May 7, 2012).
16
See Silverman v. Motorola Solutions, Inc., 2013 WL 4082893 at *3 (C.A.7 (Ill.)) (“[E]stablish-
ing a fee structure at the outset of a suit is desirable; unlike auctions, which private markets in legal
services do not use, ex ante fee structures are common and beneficial to clients . . . It is unfortunate
that the district judge originally assigned to this case did not consider the possibility of establishing
a fee schedule when he appointed a lead plaintiff and approved that party’s choice of counsel”).
17
In re Synthroid Marketing Litigation, 325 F.3d 974, 975 (7th Cir. 2003) (Synthroid II).
18
“Many costs of litigation do not depend on the outcome; it is almost as expensive to conduct
discovery in a $100 million case as in a $200 million case. Much of the expense must be devoted
to determining liability, which does not depend on the amount of damages; in securities litigation
damages of ten can be calculated mechanically from movements in stock prices. There may be some
marginal costs of bumping the recovery from $100 million to $200 million, but as a percentage of
the incremental recovery these costs are bound to be low. It is accordingly hard to justify awarding
counsel as much of the second hundred million as of the first. The justification for diminishing
marginal rates applies to $50 million and $500 million cases too, not just to $200 million cases.”
Silverman v. Motorola Solutions, Inc., 2013 WL 4082893 at *3 (C.A.7 (Ill.)).
19
I am not sure why Judge Easterbrook limited his description to “solvent” clients. Class
members are never “solvent” in the sense of being able to pay for litigation by the hour or on some
other guaranteed basis. In the discussions that follow, I ignore clients’ financial condition.
20
Silverman v. Motorola Solutions, Inc., 2013 WL 4082893 at *3 (C.A.7 (Ill.)).
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failed to read my expert report with care and partly because they raise questions about
the sincerity of his commitment to the mimic-the-market approach. Turning to the first
point, my report actually contained several examples of the sort that Judge Easterbrook
said were missing. I mentioned the patent litigation between NTP and Research In
Motion, Ltd. in which NTP paid its lawyers a flat one third of $612.5 million. I also
discussed the ETSI Pipeline Antitrust Litigation, which generated a one-third fee on a
gross recovery of $634.9 million. Finally, I cited Professor David Schwartz’s study of
patent lawsuits, which found that flat fees in the 33.3–40 percent range predominate.21
Although Professor Schwartz did not indicate the damages that were at stake in all of
his cases, what he did say supports an inference that the potential recoveries in many
were large.
Judge Easterbrook could have found examples not discussed in my report by studying
reported opinions. For example, if he had read Judge Hornby’s opinion in In re New
Motor Vehicles Canadian Export Antitrust Litigation,22 he would have known about the
fee agreement used in In re Merry-Go-Round Enterprises, Inc.,23 “where the court con-
cluded that the ‘market price’ for the legal services supported a 40% fee.”24 In Merry-Go-
Round Enterprises, Inc., the bankruptcy trustee wanted to assert claims against Ernst &
Young. He looked for counsel willing to accept a declining scale of fee percentages, found
no takers, and ultimately agreed to pay a law firm a straight 40 percent of the recovery.
Ernst & Young later settled for $185 million, at which point the law firm applied for $71.2
million in fees, 21 times its lodestar. The bankruptcy judge granted the request, writing:
“Viewed at the outset of this representation, with special counsel advancing expenses on
a contingency basis and facing the uncertainties and risks posed by this representation,
the 40% contingent fee was reasonable, necessary, and within a market range.”25 Judge
Easterbrook should have found this logic impeccable.
He may not have, however, which brings me to the second point, namely, the possibility
that Judge Easterbrook’s commitment to the mimic-the-market approach may be less
than sincere. When proclaiming the superiority of declining marginal fee percentages,
Judge Easterbrook was telling market participants how they should regulate lawyers’ fees
instead of taking guidance from what they are actually doing. He offered no evidence
that sophisticated clients use declining marginal percentages with any frequency, and, as
Professor John C. Coffee, Jr once observed, they may not. Professor Coffee was “aware
that ‘declining’ percentage of the recovery fee formulas are used by some public pension
funds” in securities cases, but he “ha[d] never seen such a fee contract used in the antitrust
context; nor, in any context, ha[d he] seen a large corporation negotiate such a contract.”
21
David L. Schwartz, The Rise of Contingent Fee Representation in Patent Litigation, 64
Alabama Law Review 335 (2012).
22
In re New Motor Vehicles Canadian Export Antitrust Litigation, 842 F.Supp.2d 346 (D. Maine
2012).
23
In re Merry-Go-Round Enterprises, Inc., 244 B.R. 327 (D. Md. 2000).
24
In re Merry-Go-Round Enterprises, Inc was also cited in the report I filed in the Motorola
case. It was entry 26 in Table 2, which listed cases with recoveries of $100 million or more and fee
awards of at least 20 percent. I did not discuss the fee agreement used there, however.
25
In re Merry-Go-Round Enterprises, Inc., 244 B.R. 327 at 335.
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In his experience, large corporations “have instead typically used straight percentage of
the recovery formulas” (Coffee 2004).
Sophisticated clients have actually used contingent fee arrangements of many types,
including scales that follow no consistent pattern. Consider the fee arrangement that was
at issue in Tanox, Inc. v. Akin, Gump, Strauss, Hauer & Feld, LLP, et al.,26 also described
in my Motorola report. The sliding scale started out at 25 percent of the first $32 million,
rose to 33.3 percent of the second $28 million, increased again to 40 percent of the next
$140 million, and finally returned to the original 25 percent of any amount over that.
Judge Easterbrook might think the client foolish for having used this scale, but to condemn
without studying the matter would both display hubris and be at odds with the accepted
wisdom of law and economics, which is that contractual arrangements freely negotiated by
sophisticated parties are jointly wealth maximizing. The contingent fee scale was part of an
intricately structured compensation arrangement that also included a promise to pay $100
million if the lawyers secured a permanent injunction, payments out of future royalties
and licensing fees, two fee caps tied to different components of the possible recovery, and
a commitment to pay the lawyers the first $8 million of any settlement. Given the thought
that went into the compensation package, it seems likely that the parties had a good reason
for using the rising-then-falling scale, even if the explanation is not obvious to an outsider.
Professor Coffee identified a plausible explanation for the use of rising scales many
years ago (Coffee 1986). They incentivize lawyers to reject cheap settlements and hold out
for higher dollars that are harder to obtain. “[I]f courts were to ask what fee structure an
informed, sophisticated client would use to compensate his attorney when close monitor-
ing is not feasible,” Coffee wrote,
the most logical answer to this problem of premature settlement would be to base fees on a
graduated, increasing percentage of the recovery formula—one that operates, much like the
Internal Revenue Code, to award the plaintiff’s attorney a marginally greater percentage of each
defined increment of the recovery. While this approach cannot be said to eliminate the inevitable
tension between the interests of plaintiff’s attorneys and their clients in class actions, it can at
least partially counteract the tendency for premature settlements. (Coffee 1986)
If plaintiffs’ attorneys are motivated to maximize their fees, then clients might wisely
choose to compensate them for bearing the added risks and costs that are associated with
larger recoveries. Rising marginal fee percentages make extra rewards available at higher
recovery levels; declining percentages do not.27
Rising scales have appealed to lead plaintiffs in securities fraud class actions, too, and
have been used in cases such as Enron that produced enormous recoveries.28 Recently, the
26
Tanox, Inc. v. Akin, Gump, Strauss, Hauer & Feld, LLP, et al., 105 S.W.3d 244 (Tex. Appls.—
Houston, 2003).
27
In Synthroid I, Judge Easterbrook expressly refrained from “say[ing] that systems with
declining marginal percentages are always best.” In re Synthroid Mktg. Litig., 264 F.3d 712, 721
(7th Cir. 2001). Rising percentages could work better, he observed, in cases where extra work could
benefit the client or some recovery is certain and the disagreement concerns mainly its amount.
28
See, e.g., In re AT & T Corp., 455 F.3d 160, 163 (3d Cir. 2006) (“The 21.25% fee resulted from
a sliding scale formula negotiated between lead counsel and the lead plaintiff New Hampshire
Retirement Systems at the beginning of the case. The formula provided attorneys’ fees would equal
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law firm of Robbins Geller Rudman & Dowd LLP (RGRD) put an ex ante fee agreement
with a rising scale of percentages into the record in the Household International case,
which happens to have been filed in a district court in the Seventh Circuit.29 The agree-
ment entitles the firm to 19 percent of the first $50 million, 22 percent of the next $100
million, and 25 percent of any greater amount. With $1.575 billion on the table—the
eighth largest recovery in the history of securities fraud litigation—RGRD will collect
$389 million if the district court judge honors the negotiated terms.
Given the result obtained and the obstacles overcome, it is hard to argue that the
decision to use a rising scale of percentages was unwise. In Household International, the
settlement came after 14 years of litigation, during which a class was certified for litiga-
tion, the case was tried to a $2.46 billion judgment for the class, the verdict was appealed
and partly invalidated, and preparations for a retrial were well underway. As if these facts
weren’t enough to justify the fee, RGRD also protected the class from the risk that the
defendant would declare bankruptcy during the appeal by requiring the defendant to post
a supersedeas bond. This meant that RGRD would be on the hook for the bond premium,
which exceeded $13 million, if the Seventh Circuit ruled against the class, which it did. I
know of no other case in which lawyers for a plaintiff class took a comparable gamble.
Whether the district judge could, should, or legally must honor the fee agreement between
RGRD and the lead plaintiff is, of course, the question of the moment at this point in the
litigation. Because Seventh Circuit case law requires the judge to mimic the market, the
court will have to decide whether the class would have agreed to the same or similar terms
had direct negotiations between its members and RGRD been possible ex ante. This will
require the court to consider data on the rates that sophisticated clients typically pay, and
it will require judgments regarding the comparability of cases, too.30 Subjectivity can infect
both assessments, but objectivity should improve over time as the market for legal services
receives more study and additional information about it is produced.
3. THIRD CIRCUIT SECURITIES-SPECIFIC VERSION
If Household International were pending in the Third Circuit, the issue would be cast
differently. There, the Cendant opinion holds that ex ante fee agreements between lead
15% of any settlement amount up to $25 million, 20% of any settlement amount between $25
million and $50 million, and 25% of any settlement amount over $50 million”).
29
Lawrence E. Jaffe Pension Plan v. Household International, Inc., Lead Case No 02-C-5893
(N.D. Ill.). I served as an expert witness in this case.
30
The range of evidence could be broader. See Sutton v. Bernard, 504 F.3d 688, 692 (7th Cir.
2007) (observing that a district court judge should use “the following benchmarks to aid in its
determination on remand of what might have occurred ex ante: (1) actual fee agreements; (2) data
from large common fund cases where the parties negotiated the fees privately, and (3) bids and
results from class counsel auction cases for insight into the fee levels attorneys in competition were
willing to accept”). Auctions were subsequently discredited, so only items (1) and (2) remain. See
Silverman v. Motorola Sols., Inc., 739 F.3d 956, 958 (7th Cir. 2013) (observing that “solvent litigants
do not select their own lawyers by holding auctions, because auctions do not work well unless a
standard unit of quality can be defined and its delivery verified. There is no ‘standard quality’ of
legal services, and verification is difficult if not impossible”).
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plaintiffs and their lawyers are presumptively reasonable.31 This furthers the statutory
purpose of the PSLRA by “ensur[ing] that the lead plaintiff, not the court, functions
as the class’s primary agent vis-a-vis its lawyers” and helps “align[] the interests of the
class and its lawyers during the pendency of the litigation.”32 The presumption may be
overridden in two situations. First, there may be “significant and unusual factual and/or
legal developments that could not reasonably have been foreseen at the time of the original
agreement.” Second, there may be “a prima facie showing that the (properly submitted)
retained agreement fee is clearly excessive.”33 The factors that courts have traditionally
consulted when sizing fee awards—the size of the recovery, the complexity and duration
of the litigation, the risk of nonpayment, and so on—identify the criteria that judges must
consider when questioning whether a prima facie case of excessiveness has been made.
Even when reasonableness is challenged, however, Cendant does not allow a judge to
substitute his or her assessment of the reasonable fee for the lead plaintiff’s determination
whenever there is a divergence. Rather, a judge may intercede only when a lead plaintiff’s
ex ante decision to engage counsel on particular terms was demonstrably unreasonable.
When a properly appointed lead plaintiff asks the court to approve its choice of lead counsel
and of a retainer agreement, the question is not whether the court believes that the lead plaintiff
could have made a better choice or gotten a better deal. Such a standard would eviscerate the
[PSLRA’s] underlying assumption that, at least in the typical case, a properly selected lead
plaintiff is likely to do as good or better job than the court at these tasks. Because of this, we
think that the court’s inquiry is appropriately limited to whether the lead plaintiff’s selection and
agreement with counsel are reasonable on their own terms.34
When a lead plaintiff’s retainer agreement provides for a fee that a reasonable party
might have agreed to pay ex ante, Cendant requires a judge to honor it even though the
judge’s personal opinion is that the percentage should have been lower.
Although the Third Circuit’s approach also shows respect for private arrangements, it
is more complicated and confusing than the Seventh Circuit’s approach. In the Seventh
Circuit, a judge need only consider evidence from private market contexts that tends to
show how lawyers are paid in similar cases. (Although Judge Easterbrook also discussed
studies of fee award practices in Motorola, it is obvious that judges’ tendencies shed
light on market rates only coincidentally, when judges mimic the market intentionally
or by accident.) If the fee agreed to by a lead plaintiff falls in the customary range for
large commercial lawsuits, it is reasonable and should be upheld. A judge can make this
assessment at the start of litigation, when a case’s riskiness is palpable, and need give it
only a cursory review later on.
But in the Third Circuit, two assessments are required: one at the time of appointment
when a lead plaintiff’s adequacy is assessed, and a second when a lawsuit settles and
any factual and legal developments that were unforeseeable at the outset are known. In
fact, matters are actually more complicated than this because, when making the required
assessments, a judge must apply the traditional factors and decide whether contracted-for
31
In re Cendant Corp. Litig., 264 F.3d 201, 282–84 (3d Cir. 2001).
32
Ibid.
33
Ibid.
34
In re Cendant Corp. Litig., 264 F.3d 201, 276 (3d Cir. 2001).
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fee terms are plainly excessive. The factors are poorly designed for this task. They include
considerations like “the complexity and duration of the litigation” and “the amount of
time devoted to the case by plaintiffs’ counsel,” which plainly overlap. They give weight
to “awards in similar cases” even though there is little reason to think that judges set
fees optimally. They require judges to consider “the skill and efficiency of the attorneys
involved” even though claimants care more about results than anything else, as evidenced
by the market’s rejection of the lodestar method. Finally, the list provides no metric for
weighting the factors, and “a list of factors without a rule of decision is just a chopped
salad,” as Judge Easterbrook observed in Synthroid I.35 “[A]ny method other than looking
to prevailing market rates assures random and potentially perverse results,” as previously
explained.36
4. OTHER CIRCUITS’ APPROACHES
Obviously, the lack of a decision rule also mars the fee regimes in the many federal
circuits that require judges to apply the traditional factors. The Fifth Circuit provides an
example. It gives trial judges discretion to use the percentage approach or the lodestar
method but requires them to take guidance from the so-called Johnson factors when doing
either.37 Because one of the Johnson factors is “the customary fee for similar work in the
community,” the Fifth Circuit’s approach permits judges to take guidance from private
arrangements. But it does not require them to mimic the market, and other factors leave
them free to do what they please. By allowing judges to use the lodestar method, the Fifth
Circuit also deviates from the market completely. When sophisticated clients hire lawyers
to handle lawsuits on contingency they use the percentage method overwhelmingly.
Examples of private arrangements that use the lodestar method are scarce as hens’ teeth.
I have yet to find one.
The Ninth Circuit’s benchmark approach, although admirably simple, also permits
arbitrary departures from market rates. In re HPL Techs., Inc. Sec. Litig.38 provides an
example. There, Judge Vaughn Walker, who contributed enormously to the jurisprudence
on attorneys’ fees before resigning from the bench, was presented with a request for a 15
percent fee award from a settlement that included $17 million and seven million shares of
the defendant’s stock. Any other judge would have approved the award automatically—
the lead plaintiff supported the fee request; no class members objected; and 15 percent
was well below the market rate (25–40 percent), the Ninth Circuit’s benchmark (25
percent), and fee awards in comparable cases (29 percent, according to one study)—but
not Judge Walker. He evaluated the fee request carefully and concluded that a lodestar
comparison showed it to be too high. The request for 15 percent required a lodestar
multiplier of 3.59. Judge Walker thought this excessive, so he approved only 11 percent.
He offered not a single example in which a client actually hired a lawyer to handle a
35
In re Synthroid Mktg. Litig., 264 F.3d 712, 719 (7th Cir. 2001).
36
Ibid.
37
See Union Asset Mgmt. v. Dell, Inc., 669 F.3d 632, 644 (5th Cir. 2012) (citing Johnson v. Ga.
Highway Express, Inc., 488 F.2d 714, 717, 720 (5th Cir. 1974)).
38
In re HPL Techs., Inc. Sec. Litig., 366 F. Supp. 2d 912 (N.D. Cal. 2005).
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commercial lawsuit on contingency for so small a fee. Nor did he claim to have found
the aforementioned hen’s tooth—a private agreement that used the lodestar method to
fix a lawyer’s contingent fee.
5. REQUIRING LEAD PLAINTIFFS TO ESTABLISH FEE

TERMS UPFRONT
The preceding remarks convey the impression that Judge Walker had no sympathy for
market-based approaches. In fact, he liked both the both the Seventh and Third Circuits’
approaches. He would likely have deferred to the lead plaintiff’s view that a 15 percent
fee was reasonable had it been part of a fee agreement negotiated ex ante, when it was
actually only an opinion expressed in an affidavit drafted ex post. The following passage
sets out his reasoning.
As a matter of first principles, the earlier a fee arrangement is concluded between lead plaintiff
and lead counsel, the more deference the court should pay to that fee agreement. This is because
fee agreements set early in the litigation—ex ante, so to speak—are more likely than ex post fee
agreements to be the product of market forces (that is, competition among counsel proposing
to represent the class). Those same market forces are thought to result in reasonable fee agree-
ments between attorneys and clients in individual (that is, nonclass) cases. The PSLRA’s lead
plaintiff provisions are largely built around an ideal of private ordering and client-driven class
action litigation; it is therefore plausible that the PSLRA implicitly counsels deference to fee
arrangements concluded early in the litigation. There is also Judge Shadur’s wise observation
that it is inappropriate—indeed, downright unfair to class counsel—to take a fee arrived at by a
market-based mechanism (such as by a court-administered auction or by arm’s-length negotia-
tion between lead plaintiff and lead counsel) and subject it to further review by the court; such
a process will often leave class counsel with the worst of both worlds.39
These observations are sound.

It remains to ask why ex ante fee agreements are not put into the record more often.
Sometimes, perhaps often, they are omitted even when they exist. DeValerio v. Olinski,40
the appeal from the fee award in In re IndyMac Mortg.-Backed Sec. Litig.,41 provides a
recent example. There, the plaintiffs were investors who bought mortgage passthrough
certificates. After the housing market collapsed and the certificates lost value, they sued
everyone who helped bring these mortgage-backed securities to market, including the
banks, underwriters, and rating agencies. Eventually, the underwriters and individual
defendants agreed to pay $346 million in settlement, and lead counsel applied for 13 per-
cent of the recovery—$44.89 million—as common fund fees. No class member objected,
but the district court still cut $16 million off the request. Lead counsel then appealed the
ruling, and the Second Circuit appointed Harvard professor William B. Rubenstein to
argue in support of affirmance.
39
In re HPL Techs., Inc. Sec. Litig., 366 F. Supp. 2d 912, 916 (N.D. Cal. 2005) (citing In re
Synthroid Marketing Litigation, 264 F.3d 712, 718–19 (7th Cir. 2001), and In re Comdisco Securities
Litigation, 150 F. Supp. 2d 943, 947-49 (N.D. Ill. 2001)).
40
DeValerio v. Olinski, 2016 WL 7323980, at *2 (2d Cir. Dec. 16, 2016).
41
In re IndyMac Mortg.-Backed Sec. Litig., 94 F. Supp. 3d 517 (S.D.N.Y. 2015).
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On appeal, lead counsel urged the court to follow the Third Circuit. At the start of the
case, the Attorney General of Wyoming had negotiated a contract that supported the fee
request. The appellants argued that, under the PSLRA, the district court judge should
have deferred to its terms. Professor Rubenstein pointed out several problems with this
contention, one of which was that the trial judge couldn’t have considered the retainer
agreement because lead counsel never put it into the record.42 A trial judge can hardly
be said to have erred by failing to respect an agreement he never saw. The Second Circuit
agreed and left the fee award unchanged.
The DeValerio ruling may be of limited importance, however, for while the appeal
was pending the Second Circuit decided another case, Flanagan, Lieberman, Hoffman &
Swaim v. Ohio Public Employees Retirement System, in which it took a large step toward
adopting the Third Circuit’s approach to fee-setting.43 The earlier opinion embraced
Cendant II, holding that a judge had to respect a lead plaintiff’s decision to allow counsel
for a third party to share in a fee award. The Second Circuit also agreed that, under the
PSLRA, “the primary responsibility for compensation shifts from the court to that lead
plaintiff.”44 Given this, it seems likely that, when presented with a case in which a fee
agreement negotiated with a sophisticated named plaintiff ex ante is put into the record,
the Second Circuit will also embrace Cendant I. Going forward, it seems likely that lawyers
who handle securities fraud cases in the Second Circuit will negotiate ex ante fee agree-
ments with their clients, rely on those agreements when applying for fees, and file them
with district courts. All this is as it should be.
However, it remains for the Second Circuit and all others to require claimants to
file ex ante fee agreements when seeking appointment as lead plaintiffs. The PSLRA
states that the winner of the lead plaintiff competition—the so-called most adequate
plaintiff—“shall, subject to the approval of the court, select and retain counsel to
represent the class.”45 Although some judges think otherwise, I cannot see how a lead
plaintiff can satisfy this responsibility without bargaining for reasonable legal fees
upfront.46
I hold this opinion partly because the process of retaining a lawyer normally involves
setting the lawyer’s fee. Colloquial language reflects this. The deposits that lawyers receive
at the start of representations are known as “retainers,” and the contracts that specify
lawyers’ fees are called “retainer agreements.”47 When Congress empowered and obligated
42
Brief in Support of Affirmance, p. 9, DeValerio v. Olinski, 2016 WL 1003231 (C.A.2).
43
Flanagan, Lieberman, Hoffman & Swaim v. Ohio Public Employees Retirement System, 2016
WL 1082007 (2d Cir. Mar. 17, 2016).
44
Ibid at *4 (quoting Cendant II, 404 F.3d at 197).
45
15 U.S.C. §§ 77z-1(a)(3)(B)(v), 78u-4(a)(3)(B)(v) (2012).
46
In In re HPL Techs., Inc. Sec. Litig., 366 F. Supp. 2d 912, 916 (N.D. Cal. 2005), Judge
Walker expressed the contrary view, writing that “[t]he PSLRA says nothing about when retention
must occur; nor, for that matter, does ‘retain[ing] counsel’ necessarily involve concluding a fee
arrangement.”
47
“When a lawyer is ‘retained,’ that means that someone has hired her, and the money paid
to the attorney is known as the retainer. The agreement signed when someone hires an attorney
is called the retainer agreement.” FindLaw.com (2016). See also “Retain,” Definition 1.6, Oxford
Living Dictionaries—English (US) (“Secure the services of (a person, especially an attorney) with
a preliminary payment”).
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lead plaintiffs to retain class counsel, it presumably meant that they should do all of things
normally done by people who employ lawyers, including negotiate fees.
The second reason for my position is that the PSLRA requires judges to replace the
presumptively most adequate plaintiff with another investor when the former “will not
fairly and adequately protect the interests of the class.” To me, the inadequacy of a lead
plaintiff who fails to bargain with counsel over fees upfront seems self-evident. The
benefits of ex ante fee setting are many, and Professor Rubenstein sets out a number of
them in his class action treatise (Rubenstein 2013).
First, ex ante fee negotiations best mimic the private market: clients hire attorneys
and work out their payment system at the outset of the retention, not at its conclusion.
Second, an advantage of mimicking the market is that ex ante discussions of fees set law-
yers’ expectations about their likely reward at the conclusion of the case and enable them
to invest their resources in the litigation with some certainty as to their plausible return.
Third, and relatedly, early fee setting has the potential to set incentives appropriately for
class counsel; for example, counsel may be entitled to an increasing percentage the more
value she obtains for the class, thus incentivizing her to push for the maximum class
recovery. Fourth, courts have noted that they are not institutionally adept at judging fees
ex post and thus ex ante fee-setting may have a comparative institutional advantage. Some
of the problems ex post are technical (such as auditing thousands of fee record entries)
but some are more substantive: the Seventh Circuit has noted that at the conclusion of
the case, “hindsight alters the perception of the suit’s riskiness, and sunk costs make it
impossible for the lawyers to walk away if the fee is too low.” Fifth, some limited empiri-
cal evidence suggests that ex ante fee negotiations reduce fee levels and thus amplify the
class’s recoveries.
By contrast, ex post fee setting “encourages sellouts by giving defendants leverage over
plaintiffs’ attorneys, who must bargain with defendants over fee terms when negotiating
settlements,” and violates the Due Process Clause by creating conflicts between class
members and their representatives, whose opinions on fees naturally diverge when litiga-
tion ends (Silver 2006; Silver 2000).
Can an investor who forsakes the advantages gained by setting fees early adequately
represent a class? I think not, and even those who believe otherwise should see that so
neglectful a lead plaintiff is off to a bad start. Should a judge charged with a fiduciary
responsibility to protect absent investors’ interests ignore such poor performance? Again,
it seems clear that the answer is negative. A lead plaintiff’s failure to file a motion to set
fees upfront should motivate a judge to initiate an adequacy inquiry. By prodding the lead
plaintiff to do better, the court would show that it expects investors who offer themselves
as leaders to fulfill their responsibilities.48
48
Some judges have taken matters in hand, not only obtaining fee agreements when appointing
lead plaintiffs but also inquiring into the means by which proposed fees were set. Craig v. Sears
Roebuck & Co., 253 F. Supp. 2d 1046 (N.D. Ill. 2003), provides an example. There, Judge Elaine
Bucklo ordered the competing lead plaintiff candidates to answer the following questions: (1) What
procedures did the plaintiff follow to identify a reasonable number of counsel with the skill and
ability necessary to represent the class in the pending matter? (2) What procedures did the plaintiff
follow in inviting competent counsel to compete for the right to represent the class? (3) What
procedures did the plaintiff follow to negotiate a fee and expense reimbursement arrangement that
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6. EXPLAINING LOWER CONTINGENT FEES IN SECURITIES

CLASS ACTIONS
An interesting consequence of ex ante bargaining by lead plaintiffs is that it sometimes

produces agreements with fee terms that differ greatly from those that prevail in the larger
market for legal services. In Enron, the rising scale of marginal fee percentages ran from
8 percent to 10 percent, as previously mentioned. Scales (rising and falling) that contain
percentages in the teens and twenties are also common. All of these numbers are low by
comparison to the fees lawyers normally receive when handling large commercial cases
on contingency, which run from 25 percent to 40 percent of the gross recovery. How can
this discrepancy, when it exists, be explained? And what should judges make of it when
awarding fees? Should they abide by the contracts or mimic the market more generally?
It is easier to answer the second question than the first. It is hard to see why a fee award
should ever exceed the amount a lawyer agreed to accept as compensation when undertak-
ing a representation. I endorsed this “ceiling rule” in the second article I published after
becoming a law professor, and I am not about to walk back my commitment now (Silver
1992). The reason is simple. By accepting a fee, a lawyer indicates that the expected pay-
ment provides sufficient compensation for the services the lawyer expects to provide and
the costs the lawyer expects to bear during the engagement.49 This being so, the lawyer
has no claim under the law of restitution or any other body of law to a larger sum, and
no defensible policy supports a larger payment either.
Returning to the first question, although some possible explanations for lower fees in
securities cases can be ruled out from the armchair, so many other candidates remain that
only an empirical study could conclusively identify the ones that matter. Starting with
factors that can be eliminated, I see no reason to think that any property associated with
lead plaintiffs themselves accounts for the difference. It would be surprising to learn that
public pension funds, which tend to obtain the best terms in securities fraud class actions,
either know more about the market for legal services or are better negotiators than the
sophisticated business clients that hire lawyers to handle patent infringement actions or
to press antitrust claims. Both deal with lawyers on a regular basis. Nor is the segment of
the bar that handles securities fraud class actions significantly more competitive than the
promotes the best interests of the class? (4) On what basis can the plaintiff reasonably conclude
that it has canvassed and actively negotiated with a sufficient number of counsel and obtained
the counsel that is likely to obtain the highest net recovery to the class? (5) Did the plaintiff make
inquiries into the full set of relationships between proposed lead counsel and the plaintiff and
other members of the class, and did the plaintiff reasonably conclude either that there are no such
relationships or that they did not adversely affect the exercise of the plaintiff’s or counsel’s fiduciary
obligations to the class?
It does not seem to have been Judge Bucklo’s practice to require this information at the appoint-
ment stage. She asked for it to resolve a dispute between competing lead plaintiff candidates, one
of whom objected to the other’s choice of counsel on a variety of grounds.
49
Lawyers are sometimes wrong about this. Compensation that seems adequate at the outset
may seem insufficient later on, when a lawsuit has taken longer than expected to resolve, has
entailed more work or greater costs, or seems likely to generate a smaller recovery than initially
predicted. In this situation, a lawyer must either accept the original terms, renegotiate the contract
with the client, or withdraw, which may have fee-related consequences of its own.
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patent bar, the antitrust bar, or any other group of plaintiffs’ attorneys. Given the number
of market participants and the lack of barriers to entry, all should feel significant pressure
to moderate their fees. Lastly, the pay-to-play problems that have been said to taint many
securities fraud engagements cannot explain lower fees, either. If political contributions
have any effect, they should drive fees up.
One fact associated with lawyers may matter, however. The prices lawyers demand for
taking cases on contingency reflect their estimates of case strength and damages, as well as
their confidence that their estimates are right. Larger risks and greater uncertainty mean
higher contingent fees. In typical situations, lawyers initially know little about the merits
of claims and also know that clients, who want to obtain legal services without paying
for them, often mislead. Consequently, contingency premiums are large. But in securities
fraud cases, lawyers may know a lot. Often, they monitor institutional clients’ investment
portfolios and bring to the clients’ attention possible frauds of which the clients are una-
ware (Badawi & Webber 2015; Webber 2014). Securities lawyers may also have access to a
good deal of relevant public information, such as securities filings, statements to analysts,
earnings restatements, or investigations by regulators. If lawyers’ estimates of liability and
damages in securities fraud cases are unusually accurate and reliable, their contingency
premiums should be lower than in other lawsuits that are seemingly comparable.
The high state of development of the substantive and procedural laws that govern
securities fraud class actions may also contribute. Securities fraud class actions are the
most common type, accounting for about 40 percent of the cases and 70 percent of the
settlement dollars (Fitzpatrick 2010). Owing to the volume of cases, most important
issues have been litigated repeatedly. Because clarity of law should have the same accuracy
and confidence-boosting effects as clarity of facts on lawyers’ risk estimates, lawyers
competing for business may give clients with securities fraud claims especially good deals.
There may be interaction effects too. Lawyers’ knowledge of the facts and the relative
clarity of the law may combine with the prospect of obtaining repeat business from public
pension funds and the funds’ ability to require lawyers to compete to generate downward
pressure on fees that is unusually strong.
Finally, although it is tempting to add case size to the mix, it is not clear that securities
fraud class actions systematically involve larger recoveries than large commercial cases of
other types. The median securities fraud case that is not dismissed settles for around $6
million (Cornerstone Research 2016). In 2015, over 75 percent of the settlements were for
$20 million or less, while almost half came in at or below $5 million. Recoveries are often
small even when securities class actions are brought in the wake of enormous frauds. Over
many years, the median settlement has covered about 2 percent of investors’ estimated
losses (Cornerstone Research 2016). There have certainly been enormous securities fraud
settlements, and lawyers may discount their fees significantly when bringing strong cases
with sizable damage claims against defendants with deep pockets. But only a handful of
cases are likely to fit this description in a given year.
I have tried to explain lower negotiated fees in securities class actions by discussing
differences between these cases and class actions of other types. But the cause could lie
elsewhere, as Professor Coffee contends. In the expert report quoted above, he suggested:
public pension funds prefer the “declining percentage” formula largely for political reasons,
while private corporations disdain such formula for economic reasons. That is, public pension
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funds are frequently administered by elected political officials who are potentially subject to
media and political criticism for conferring “windfall” fees on their attorneys. Necessarily, the
seek to avoid criticism, and the declining percentage formula seems primarily a defensive strategy
to protect political officials from such criticism. Corroborating this conclusion is the rareness
of its use by private corporations (as Coca-Cola, PepsiCo and Admiral Beverage have implicitly
confirmed in this case [by paying straight percentage fees in the typical range]). (Coffee 2004)
If Coffee is right, managers of public pension funds are doing investors a disservice by
using inferior fee arrangements. They may look good because they seem to be keeping
lawyers’ fees low, but they are actually costing investors money by using formulas that
encourage cheap settlements.
In theory, one could test Professor Coffee’s suggestion by comparing outcomes in
securities fraud cases led by public pension funds that used different compensation
formulas. But the information available at present is too limited to say. Studies have found
that public pension funds get more “bang for the buck” out of lawyers than other lead
plaintiffs—suggesting that Coffee is mistaken—but no existing study has controlled for
the type of fee award formula employed (Perino 2012). It is therefore conceivable that
cases with flat or rising fee percentages are generating the improvements, while those with
falling percentages are watering down the results. It is also possible that the improvements
in agency costs are due to better monitoring by public pension funds rather than the fee
formulas they use. Finally, because many judges feel free to depart from lead plaintiffs’
fee agreements, the effect of fee award formulas on lawyers’ performance may be muted.
Professor Coffee’s hypothesis also raises an interesting analytical question: Why would
plaintiffs’ lawyers agree to work for public pension funds so cheaply, assuming that the
rates the funds agree to pay are in fact below market? Assuming economic rationality,
the answer would seem to be that, despite the use of suboptimal fee structures, plaintiffs’
attorneys can still earn profits by settling cheaply because they control their resource
commitments. This is what they are thought to have done for years under lodestar-based
fee regimes, which are suboptimal too.
Finally, Professor Coffee’s hypothesis forces one to consider the possibility that public
pension funds render themselves inadequate when, by comparison to prevailing market
standards, they set lawyers’ fees too low. Given the constant emphasis in the scholarly
literature and the cases reducing fees and the strong preference expressed in both these
sources and the PSLRA for placing control of class actions in the hands of investors with
large stakes, it will surely seem outlandish to suggest that fees should sometimes be higher
than they are. But if the market knows best, then all significant departures from market
rates should be viewed with suspicion, including bargain-basement terms negotiated by
public pension funds with political agendas.
7. CONCLUSION
A good deal can be said in support of the mimic-the-market approach to fee regulation in
class actions, and for this reason it has gained many adherents over the years. The PSLRA
generated additional support, as courts recognized Congress’ intention to substitute
private regulation by lead plaintiffs with large financial stakes for public regulation by
judges who have neither appropriate incentives nor any particular expertise.
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But the mimic-the-market approach is still a minority doctrine in the federal courts. The
Supreme Court has never considered it. In fact, it has said nothing about common fund
fee regulation in recent years, even though district court judges have been transferring
billions of dollars and the federal circuit courts have been reasonably active. Worse, by
staying on the sidelines it has allowed practices to persist that are at least controversial,
and, in my judgment, utterly unprincipled and unlawful (Silver and Miller 2010).
If history provides any guidance, the mimic-the-market approach will find new sup-
porters in the coming years. But it seems unlikely that judges will require ex ante fee
agreements any time soon, whether in securities fraud cases or class actions of other types:
Despite the benefits that flow from setting fees upfront, there simply isn’t much demand.
Motions for fee awards are filed when class actions end, not when they start, so ex ante
fee setting will occur only if judges take the initiative in numbers. They have not done so
since 2006, when I predicted they would, and nothing important seems to have changed.
BIBLIOGRAPHY
Badawi, Adam B. and David H. Webber (2015), “Does the Quality of the Plaintiffs’ Law Firm Matter in Deal
Litigation?” Journal of Corporation Law, 41, 102–33.
Baker, Lynn A., Michael A. Perino, and Charles Silver (2015), “Is the Price Right? An Empirical Study of
Fee-Setting in Securities Class Actions,” Columbia Law Review, 115, 1371–1451.
Coffee, John C., Jr (1986), “Understanding the Plaintiff’s Attorney: The Implications of Economic Theory for
Private Enforcement of Law through Class and Derivative Actions,” Columbia Law Review, 86, 669–727.
Coffee, John C., Jr (2004), “Declaration of John C. Coffee, Jr.,” submitted in In re High Fructose Corn Syrup
Antitrust Litigation, MDL 1087 (C.D. Ill.).
Cornerstone Research (2016), Securities Class Action Settlements: 2015 Review and Analysis.
FindLaw.com (2016), “What Does It Mean to Have a Lawyer on Retainer?” http://hirealawyer.findlaw.com/
attorney-fees-and-agreements/what-does-it-mean-to-have-a-lawyer-on-retainer.html (visited Sept. 7, 2016).
Fitzpatrick, Brian T. (2010), “An Empirical Study of Class Action Settlements and Their Fee Awards,” Journal
of Empirical Legal Studies 7, 811–46.
Oxford Living Dictionaries—English (US), www.oxforddictionaries.com/us/definition/american_english/retain
(visited April 25, 2017).
Perino, Michael (2012), “Institutional Activism Through Litigation: An Empirical Analysis of Public Pension
Fund Participation in Securities Class Actions,” Journal of Empirical Legal Studies 9, 368–92.
Rubenstein, William B. (2013), Newberg on Class Actions (5th ed.).
Silver, Charles (1991), “A Restitutionary Theory of Attorneys’ Fees in Class Actions,” Cornell Law Review 76,
656–721.
Silver, Charles (1992), “Unloading the Lodestar: Toward a New Fee Award Procedure,” Texas Law Review 70,
865–962.
Silver, Charles (2000), “Due Process and the Lodestar Method: You Can’t Get There From Here,” Tulane Law
Review 74, 1809–45.
Silver, Charles (2006), “Dissent from Recommendation to Set Fees Ex Post,” Review of Litigation 25, 497–500.
Silver, Charles and Geoffrey P. Miller (2010), “The Quasi-Class Action Method of Managing Multi-District
Litigations: Problems and a Proposal,” Vanderbilt Law Review 63, 107–77.
Webber, David H. (2014), “Private Policing of Mergers and Acquisitions: An Empirical Assessment of
Institutional Lead Plaintiffs in Transactional Class and Derivative Actions,” Delaware Journal of Corporate
Law, 38, 907–50.
M4633-GRIFFITH_t.indd 303 30/10/2018 08:16

19. What do we know about law firm quality in M&A
litigation?
Steven Davidoff Solomon and Randall S. Thomas
1. INTRODUCTION
Corporate law academics view law firm quality as largely a black box. We see many
well-known law firms making hundreds of millions of dollars from their work, but we
have not made any deep inquiry into why some firms do better than others. If pressed, we
might say that firm quality is measured, within a competitive market for legal services, by
customers’ willingness to pay the highest rates for the best law firms. So law firm quality
might be measured by the total firm revenue, or by profits per partner.1 Good law firms
are rich law firms under this metric.
But while making a lot of money may be important to a law firm’s partners, its clients
are more concerned about a different, although perhaps related, measure of law firm
quality: outcome.2 Clients believe that firms that achieve good outcomes are good firms,
although in many situations it is difficult to know if a good outcome has occurred.
Outcomes may be murky in many instances. A client may be happy, but perhaps they
could have been happier? Furthermore, outcomes may not be public information in some
cases, and we need to be able to observe outcomes in order to determine if they are good
or not.
In litigation, outcomes are usually clear. Lawyers win, lose, or settle. If a litigation firm
wins a lot of its cases, it develops a reputation among clients for being a high-quality firm,
perhaps because of its experience.3 Firms that settle cases might also argue that they are
successful. Settlements need the client’s approval, which may indicate client satisfaction.
Firms that lose most of the time have a more difficult path to establishing their quality
in their clients’ eyes. Still, they can always claim that they take more difficult cases if they
get big payoffs in the cases that they win or settle. The quality of the lawyer can also
1
The 2016 Am Law 100: Growth Slows for Big Law, The American Lawyer (April 25, 2016),
available at: www.americanlawyer.com/id=1202489912232/The-2016-Am-Law-100-Growth-Slows-
for-Big-Law--?slreturn=20160705095611.
2
For example, investment banks have been found to select legal counsel after evaluating a
firm’s expertise and its individual attorneys (Shenu, 2011). In one study, investment bank and law
firm quality were found to have significant effects on deal outcomes and takeover premiums in
mergers and acquisitions (Krishnan & Masulis, 2013). In a related vein, de Fontenay compares
public companies and private equity firms in their choice of law firms for their financing transac-
tions (de Fontenay, 2016).
3
In a study of tax court cases, Lederman & Hrung (2006) find a strong positive effect of attor-
ney experience on outcomes in tried cases. Haire, Lindquist, & Hartley (1999) find that marginally
higher litigation success rates were achieved in product liability cases in the US Court of Appeals
for parties with more experienced counsel, but that substantially lower success rates occurred for
parties with a lack of experience.
304
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What do we know about law firm quality in M&A litigation? 305
make a difference.4 Nevertheless, for academics seeking to evaluate the success of the law
firms involved in mergers and acquisitions (M&A) litigation determining the outcomes
is paramount.
From a researcher’s perspective, we need to have access to this information to study
law firm quality in corporate litigation. Because court filings are public records, we can
usually find out who won and who lost. But what about settlements? The terms of many
settlements are private information, even in corporate law. For example, settlements in
appraisal actions are private information, even though they are reviewed by the court
that has jurisdiction over the case (Jiang, Li, Mei, and Thomas, 2016). Luckily for us,
in representative litigation, such as class actions, outcomes are both subject to court
approval and public, making it easier to find out the outcome in all of these cases.
In this chapter, we examine the question of how we should measure law firm quality. We
focus on class action litigation as the outcomes from this litigation are both well-defined
and public. We further refine our analysis to more narrowly examine class action litigation
challenging M&A transactions so that we can draw on recent empirical work in the field
that will help us analyze what constitutes law firm quality. From a research perspective,
the explosion of merger litigation in recent years is a good thing, assuring us of a large
number of observations (Badawi and Webber, 2015).
2. THEORETICAL EXPECTATIONS ABOUT LAW FIRM

QUALITY IN CLASS ACTIONS
In M&A litigation, target company shareholders want a plaintiffs’ law firm that will
maximize the deal price either through a judgment or a settlement in the class action.
Nonpecuniary settlements may also contribute indirectly to increase the welfare of target
firm shareholders, although many courts are skeptical of their worth.
For plaintiffs’ law firms in class actions, we must also consider the effect of agency
costs on law firm quality: In situations where the named plaintiff has a tiny stake in
the company, the real party with an interest in the outcome of the case could be the
plaintiffs’ law firm. Weiss and Beckerman theorize that, considering the effect of agency
costs, institutions with the largest stakes are best situated to protect the interests of class
members. If the shareholders are institutions (or other large investors) with a sufficiently
large stake in the target to be able to select class counsel, they will prefer to choose firms
with a strong reputation for success in order to minimize their own monitoring costs with
respect to the actions of the law firm (Weiss and Beckerman, 1995). Successful plaintiffs’
law firms will generally seek out such investors because these investors’ involvement in the
case signals to the court that it is less likely there will be a strike suit. Conversely, if the
named plaintiff is a small investor without a sufficient stake in the company to engage in
monitoring, this may signal a greater likelihood that the plaintiffs’ law firm is the party
4
In a study involving criminal cases, Abrams & Yoon (2007) found that experience of defense
counsel directly and significantly affected outcomes. In their paper, Miller, Keith, & Holmes (2015)
concluded that high quality legal advocacy is an important determining factor in whether asylum
applicants are successful in their attempts to obtain relief, but that low quality representation actu-
ally results in worse outcomes for applicants than if they had preceded pro se.
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that is in charge of the litigation. We would expect a greater likelihood of low law firm
quality when this occurs (Cox, Thomas, and Bai, 2008; Perino, 2012).
Teasing out the relation between these two factors is also difficult. For example, good
law firms may attract big, institutional investors.5 Bad law firms may not attract these
plaintiffs. In either case, determining whether it is institutional investors driving the results
or merely a selection effect can be difficult.
A competing view of the best plaintiffs’ law firms is that the firms that have historically
achieved the best results in the cases where they were lead counsel for the plaintiffs ought
to be selected. In our own work, discussed more fully later in the chapter, we generally
find that the top plaintiffs’ law firms in M&A litigation have different strategies than other
plaintiffs’ law firms. These firms work harder and put more resources into their cases. In
exchange, they get better recoveries for their clients, and for themselves as well. This lends
itself to the conclusion that it is not the plaintiff which matters in this type of litigation,
but the law firm.
A related claim is that plaintiffs’ law firms are concerned about their reputation. Badawi
and Webber (2015, at 373–4) state:
Law firms with strong reputations may avoid filing in weaker cases because filing them may
harm their reputations or because recoveries in these cases are likely to be small. Law firms are
particularly sensitive to reputational effects in Delaware, which is the site of a high percentage
of this litigation. Delaware has a comparatively small bar and just five judges who hear these
cases at the trial level. Those law firms who already have low quality reputations may have less
to lose in this regard.
In other words, top-quality firms only file strong cases because they are afraid that the
Delaware courts will be less likely to rule in their favor in all of their cases if they are
perceived as weak law firms. In this scenario, law firm quality (however measured) is more
important than the quality of the plaintiff.
Turning to the other side of the case, defendants in M&A class actions want to mini-
mize the total cost of the deal consideration, the amount of their own litigation attorneys’
fees (including any agency costs associated with defense counsel fees), the amount (if any)
of any increase in deal price as part of a settlement/judgment, and the amount (if any) of
the court’s award of plaintiffs’ attorneys’ fees. If the acquirer is a one-time participant in
the market for corporate control, they probably will not care what strategy the litigation
defense firm uses to accomplish these goals. They will hire law firms that are successful
in settling the litigation at a reasonable price (when added to the existing deal premium),
or in getting the litigation dismissed (at a reasonable cost) so that the deal can close. A
top litigation defense firm might also be viewed as a firm that is best able to protect the
transaction from any risk of cancellation or delayed closure, even when the deal price is
relatively low compared to other comparable transactions, or if the deal manifests the
indicia of a conflict of interest, such as, a management buyout (MBO). Viewed in this
light, higher law firm fees may be justified in order to accomplish the overall strategic goal.
5
In a different setting, McClane (2015) found that when a lead underwriter and legal counsel
worked together on deals with some frequency, IPO deal outcomes tended to be better in both the
short and long term.
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Acquirers that are frequent repeat players in the acquisition market may have reputa-
tional concerns that lead them to prefer certain strategies in takeover litigation, such as,
never agreeing to settle cases even when it would be cheaper than litigating the case to trial.
For example, in appraisal cases, repeat players in the acquisition market, such as private
equity firms, are less likely to settle these cases because they don’t want to be perceived as
easy marks in future cases (Jiang, Li, Mei, and Thomas, 2016). Protecting an individual
deal by fighting litigation to the bitter end, in other words, may be cost justified if it
leads to fewer M&A suits in the future. This type of consideration may affect the repeat
acquirer’s selection of litigation defense counsel.
3. M&A DEAL LITIGATION OVERVIEW
In order to better understand the role of counsel in M&A litigation, we need first to exam-
ine the litigation process in those cases. In this section, we provide a broad overview of
how deal litigation works in order to facilitate the reader’s understanding of the lawyers’
role on both sides of the case. We begin by discussing the selection of legal counsel and
then examine the litigation process in single jurisdictions versus that used in multiple fora.
3.1 Selecting Litigation Counsel
There are two types of defense attorneys that will be involved in the M&A deal process:
deal counsel and litigation counsel. Deal counsel is selected separately by each party to
a transaction as part of putting the deal together. The acquirer will usually be the one
formulating the bid so their lawyer is likely to be chosen first. The target will generally
be contacted by the bidder after it has formulated the bid, so in terms of time, their deal
counsel will be selected second. In theory, either firm could be considered deal counsel.
An argument could be made in favor of the bidder’s counsel being more important as they
are putting up the money to do the deal. However, given this chapter’s focus on the deal
litigation, and the choice that the target firm makes in selecting defense litigation counsel,
it makes sense to focus on the target firm’s choice of counsel.
Target management is the group that is generally sued in M&A litigation, so their
counsel will have the primary job of defending the suit. However, the money to settle the
case ultimately comes from the bidder or its insurer. Any increase in the deal consideration
to settle the case, or any large attorneys’ fee award, is likely to be subject to the bidders’
approval. This creates a joint decisionmaking process on the defense side of the litigation.
Almost always, in recent years, if two public companies attempt to complete a merger
worth more than $100 million, there will be a lawsuit—often several—that challenge the
deal price’s adequacy, and name the target company and some of its officers and directors
as defendants (Cain and Solomon, 2015). Given the high degree of likelihood of getting
sued on deals, and the expedited process involved in deal litigation, it is very likely that the
defendants have already decided who they will retain as their main law firm to represent
them if they get sued even before they announce the deal. This is typically the same firm
as deal counsel, but not always.
Target management wants deal completion, and hires a top defendant litigation
firm—which tend to be the same as top deal counsel—in harder deals to make sure
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nothing is derailed if they are litigated. Deals that are likely to complete at a lower
takeover premium have been found to be more likely to attract a larger number of M&A
suits and are more difficult to defend against because of their relatively low price. Other
characteristics of more problematic deals could include those where the parties are from
different industries, or which involve friendly deals and deals without go-shop provisions
in the merger agreement.
The selection process for plaintiffs’ counsel is quite different. Whenever there is public
disclosure of a significant M&A transaction, several plaintiffs’ law firms, frequently at
the behest of interested shareholders, will conduct investigations that ultimately lead to
their filing a complaint on behalf of these clients. Which firm garners that role depends
on what the selection process is in the particular jurisdiction.
Generally speaking, when all of the suits are filed in Delaware, then there will be
competition among the potential plaintiffs’ law firms to be selected as lead counsel or
to be one of the several firms selected as co-lead counsel (Erickson, 2015). Typically,
the law firms will sort this out themselves, although in difficult instances the court may
need to determine which firm is ultimately appointed. If the court becomes involved,
then it will usually apply the Delaware lead plaintiff test to determine which firm should
be appointed (Thomas and Thompson, 2012).6 When multiple suits are filed in several
jurisdictions, it is likely that different plaintiffs’ counsel will be appointed in the different
states where the suits are filed.
3.2 The Litigation Process: Single vs Multiple Jurisdictions
Today, due in part to the widespread enactment of forum selection bylaws, many cases
are litigated exclusively in one jurisdiction. These bylaws have the effect of channeling
M&A litigation to a single forum, typically the state court of the corporation’s state of
incorporation, which is frequently Delaware. At the moment, this makes the Delaware
Chancery Court the single most important forum for deciding these cases.7
The analysis of the single jurisdiction model is relatively straightforward, as there is
only one court that hosts all of the litigation. In its simplest form, this means that a law
firm files a complaint, and the one court in which that complaint is filed has the authority
to exercise jurisdiction over an entire local, state, or nationwide class. With a single juris-
diction, the defense counsel must choose whether to seek dismissal or to seek settlement.
Dismissal requires some litigation activity to either force a voluntary dismissal, get the
court to order dismissal, or offer to settle the case.
However, there are still many corporations that do not have these forum selection
bylaws, and there are many deals in the past that were challenged in several jurisdictions
simultaneously with pending litigation outstanding, so multijurisdictional litigation
6
TCW Tech. Ltd. P’ship v. Intermedia Commc’ns, Inc., No 18336, 2000 WL 1654504, at *4
(Del. Ch. Oct. 17, 2000) establishes the factors that Delaware courts traditionally consider when
choosing a lead plaintiff in cases involving shareholder litigation.
7
Due to adverse decisions in the Delaware courts, there has been a shift recently toward filing
suits outside Delaware and in federal court (Cain, Fisch, Solomon, & Thomas, 2018). However,
Delaware remains a prominent place for corporate litigation and the primary place where corporate
law is produced.
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continues to exist. This result stems from the federalist litigation system that we have in
place as well as the choice of law rule that is employed in corporate law.8 Likely venues
included the state of the corporate headquarters, the state of incorporation and federal
courts either sitting in diversity or interpreting Section 14 of the 1934 Exchange Act.
In these cases, the defense counsel get to choose whether or not to dismiss, consolidate,
or settle the case in one jurisdiction or another. In 2016 there was a marked increase in
federal filings as plaintiffs’ attorneys sought to avoid forum selection bylaws (Cain, Fisch,
Solomon and Thomas, 2018).
If the defendants seek to consolidate the litigation into one jurisdiction, they will file
motions to stay discovery in some jurisdictions, seeking to convince one of the courts to
grant the stay. If these motions are granted, then litigation will proceed in a single jurisdic-
tion and usually result in an outcome being determined by settlement or a court decision
in that venue. For example, if expedited discovery is granted, particularly in Delaware,
then its courts will generally become the focus of the litigation activity. As one of the
Delaware Vice-Chancellors states, this could lead to a dismissal of the case:
[C]ases that proceed with expedited discovery and briefing toward a preliminary injunction
hearing often are those that already have survived at least one, albeit not especially rigorous,
substantive challenge. Hence, the motion to expedite mechanism also operates so as to subdivide
shareholder representative cases into at least three general categories: (1) the wholly meritless, for
which plaintiffs’ counsel probably will receive no fee at all; (2) the colorable, for which counsel
may receive some compensation in the form of an ordinary, hourly rate for raising issues that are
readily remedied and that, perhaps with the benefit of discovery, will unearth a more substantive
claim; and (3) the clearly meritorious, for which counsel have every incentive to prosecute zeal-
ously to trial, if necessary. (Parsons and Tyler, 2013, 499–500)9
If the discovery stay motion fails, or is not filed, then defense counsel must decide where to
litigate the case. One key decision point here is the grant or denial of expedited discovery.
If expedited discovery is granted, particularly in Delaware, then that court should become
the focus of the litigation activity. More generally, the court where there is lots of litigation
activity is likely to become the court where the case gets decided. Most cases that are
not voluntarily dismissed by the plaintiffs will settle, although there are some litigated
dismissals.
8
As one of the authors has explained elsewhere, “The potential for multijurisdictional litiga-
tion over a single deal arises because of the existing rules of civil procedure. Shareholders that
wish to challenge the proposed terms of an M&A transaction can sue in either a state or federal
court located in either the target company’s state of incorporation or the location of the company’s
headquarters (assuming the defendants have the necessary presence in the jurisdiction). While the
internal affairs doctrine dictates that the governing law for such a suit is that of the state of incor-
poration, courts outside of that state have long entertained M&A suits where the filing shareholder
has appropriately established jurisdiction by simply applying the incorporating state’s law. Thus,
if two different investors choose to file complaints in two different state courts, perhaps one in
Delaware (a frequent state of incorporation) and another in New York (a frequent headquarters
state), then, while both the Delaware and the New York courts may have jurisdiction to hear the
case, only Delaware law would apply to determine the validity of the investors’ concerns.” (Thomas,
2013). See also Myers, 2014.
9
Hamermesh and Wachter (2017) provide an in-depth analysis of the motion to dismiss and
the motion to expedite.
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Defendants will seek to minimize the cost of settlement. If they have a choice of two
plaintiffs’ law firms, they are likely to settle with the cheapest one. This creates an incentive
for defense counsel to try to play the plaintiffs’ firms off against one another, thereby
creating a reverse auction.
4. WHAT DO WE KNOW EMPIRICALLY?
Given these theoretical predictions, what do we know about whether the actions of
defense and plaintiffs’ law firms conform to them? Unfortunately, as will be discussed in
this section, very little research has been done to date.
4.1 Which Named Plaintiffs and Plaintiffs’ Law Firms Succeed in M&A Litigation?
A close cousin of M&A deal litigation, and one from which courts have occasionally
borrowed doctrinal innovations, is securities fraud class action litigation. The Private
Securities Litigation Reform Act (PSLRA) created a presumption that, in securities fraud
litigation, the plaintiff with the largest financial stake in the company should be the lead
plaintiff in the action. Concerns that plaintiffs’ attorneys lacked sufficient client monitor-
ing in the context of securities litigation acted as one of the catalysts to the passage of the
PSLRA in 1995 (Perino, 2003). Congress’s primary aim in the adoption of the PSLRA
was “to create a series of procedural hurdles that make it more difficult for plaintiffs’
attorneys to bring and maintain nonmeritorious securities fraud class actions” (Perino,
2003, at 914). To achieve this goal, the PSLRA invokes, among other things, strict lead
plaintiff requirements (Perino, 2003).
As a result of the PSLRA, there are a number of studies in the legal and finance litera-
ture on the effectiveness of different types of lead plaintiffs. These studies generally show
that institutional investor lead plaintiffs and labor union lead plaintiffs are associated
with greater recoveries and lower costs for the plaintiff shareholders (Cox, Thomas, and
Bai, 2008; Perino, 2003). These papers provide some support for the need for shareholder
monitoring in class action litigation, and more specifically in M&A deal litigation.
However, as Thompson and Thomas (2004) have shown, M&A cases do not usually have
large shareholders as their named lead plaintiffs.
There is only one empirical paper that directly examines the effectiveness of plaintiffs’
law firms in M&A litigation. Krishnan, Solomon, and Thomas (2016) look at this issue
in depth. Using a handcollected database of M&A litigation from 2003 to 2012, they
construct several different measures of which are the most reputable plaintiffs’ law firms.
After testing these measures, they ultimately conclude that the best measure is the number
of deals in which these firms were lead or co-lead counsel where a court awarded $1 mil-
lion or more in attorneys’ fees and the named plaintiff was not an individual shareholder.
Using this measure, they examine the top five of these firms and find that they have 5–10
percent market share in the M&A litigation market every sample year.
These top five firms behave differently than the group of all other plaintiffs’ law firms
in M&A deal cases. For example, they pursue litigation against a significantly greater
percentage of cases with an indicia of greater conflicts of interest, such as MBOs or
going private transactions. They also bring suit against statistically bigger target firms
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and file actions in multiple forums, beyond just the state of incorporation of the target
company, more frequently than other firms. In other words, they are more likely to engage
in multijurisdictional litigation challenging M&A deals.
Krishnan, Solomon, and Thomas (2016) find that these top firms do better than
other plaintiffs’ firms. For example, they win more motions, they have fewer of their
cases dismissed by the court, and they obtain better settlements. These results hold even
after using an instrumental variables regression analysis to take into account that better
plaintiffs’ firms are more likely to be selected to litigate better cases.
Why do these firms do better than other plaintiffs’ law firms in M&A litigation?
This study finds that the top five firms are more active in their litigation practice. They
file more documents in their cases. They bring more motions against the defendants
when they are in charge of the litigation. They also face fewer motions against them
filed by the defendants, most likely because they are doing a better job in drafting their
complaints and have created a reputation of aggressively resisting attempts to get them
dismissed.
In a related paper that uses a more indirect method to get at law firm quality, Badawi
and Webber (2015) focus on law firm quality in the context of shareholder transactions
as a determinant of stock market reaction to lawsuit filing, and find
evidence of a large and positive market reaction to the filing of suit by a top law firm in an
MBO and to the filing of suit by a top law firm in a controlling shareholder transaction . . . The
positive market reaction to top firms in both MBOs and controlling shareholder transactions
suggests that the pecuniary benefit associated with these firms outweighs the increased risk that
they might jeopardize the deals. (Badawi and Webber, 2015, 382)
Conversely, for lower quality plaintiffs’ law firms, they find “large, negative, and statisti-
cally significant” correlations with market returns (Badawi and Webber, 2015, 385).
Overall, although they document significant stock market reactions depending on firm
quality, they do not offer a strong explanation of their results, claiming that “[t]op firms
may select better cases, or may litigate them better, whereas poor quality firms are less
selective, and may succeed only in delaying the deal without any prospect for a bump in
the price of the target’s shares” (Badawi and Webber, 2015, 390–1).
One important policy implication of the findings of Krishnan, Solomon and Thomas
(2016) and Badawi and Webber (2015) is that courts should take into account the track
record of the plaintiffs’ law firm when they select lead counsel, and not just the size of
the named plaintiffs’ holdings in the target firm. Perhaps anticipating these findings,
the Delaware courts generally consider both the track record of the plaintiffs’ law firm
and the nature of the named plaintiff in making their determination of which firm to
select if there are disputes among plaintiffs’ law firms over who will be lead counsel in
these cases.
4.2 What Do We Know about Defense Litigation Law Firms?
Chief Justice Strine of the Delaware Supreme Court has explained that the quality of
defense-side legal and financial counsel is of utmost importance in the M&A process.
He believes that “hiring the legal advisor early for the independent directors is critical to
addressing both banker retention and conflicts, and reaching sound decisions about the
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approach the board should take to issues such as whether to have a special committee
and who should serve on it” (Strine, 2015, 20). Logic suggests he is correct: employing
high-quality defense counsel in deal litigation should make a difference.
However, surprisingly little has been written about the quality of defense litigation
firms in M&A transactions. In a recent working paper, Krishnan, Solomon, and Thomas
(2016) examine top defense firms in M&A litigation and ask how these firms conduct
cases. They identify top defense litigation counsel based on the number of appearances
in the annual top-ten league tables from 2006 to 2012, where these tables are constructed
on a rolling three-year basis. These firms are more likely to appear defending cases where
the deals involved have lower takeover premiums. Their appearance is also associated with
deals that have higher percentages of cash consideration, in friendly deals, and in transac-
tions where the target and the acquirer are in different industries. Finally, the top defense
litigation law firms are more likely to show up in deals where there is multijurisdictional
M&A litigation.
These top defense counsels appear to be successful in settling M&A litigation quickly
and cheaply, especially when it involves multijurisdictional litigation. This suggests that
they may be running reverse auctions where they are hired in low priced deals to negotiate
separately with several plaintiffs’ law firms to seek out the cheapest possible settlement
of the litigation. While such a litigation strategy may be in the best interests of the target
company’s directors, the likely clients of the defense litigation firms, it may not result in
the best outcome for the target company’s shareholders.
Recent changes in Delaware law may have a negative impact on this strategy in the
future, thereby eroding some of the advantages of top defense litigation counsel. For
example, the widespread introduction of forum selection bylaws at most Delaware
corporations should have the effect of greatly reducing the prevalence of multistate litiga-
tion in M&A transactions, shifting some of this litigation, at least in the short term, to
federal courts. This will concurrently reduce defense firms’ ability to run reverse auctions
and play off plaintiffs’ firms against one another. Second, the Delaware courts’ recent
rejection of disclosure-only settlements in M&A litigation will cut down on defendants’
ability to use one of the cheapest and easiest methods of eliminating an otherwise
strong plaintiffs’ case. While some frivolous settlements will undoubtedly be eliminated,
stronger cases will now require more expensive consideration settlements or amendment
settlements in order to be dismissed. This may curtail top defense firms’ advantages in
obtaining cheap settlements.
4.3 What Are the Gaps in Our Knowledge about Law Firm Quality and Where Should
Research Focus in the Future?
There are a number of gaps in what we know about law firms. For example, legal scholars
need to have data in order to construct accurate pictures of what law firms do and their
quality. We can only observe publicly disclosed information and that leaves us with some
significant holes in our knowledge. On the defense side, for example, we know nothing
about defense law firm fees as they are undisclosed. We know anecdotally that fees
vary across firms, but very little about how much it costs to litigate M&A deals on the
defense side. Conversely, plaintiffs’ fees are well documented in the settlement papers
for these cases. As a result there is a whole literature about plaintiffs’ fee structures and
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the amounts paid to these firms (Fitzpatrick, 2010). In order to further study the effects
of both plaintiffs’ and defense counsel in litigation we need to obtain more data on the
defense side about fees.
Also focusing on the defense side of the equation, we do not know much about why
acquiring or target companies select certain law firms to act as their deal or litigation
counsel. Perhaps the law firm has a longstanding relationship with the client, or the law
firm is a boutique firm that specializes in the particular type of transaction or litigation.
We don’t know why firms will sometimes use one firm for deal counsel, but a second firm
for their litigation counsel. Again, there is no disclosure of these reasons to the company’s
shareholders, even for public companies that have mandatory disclosure obligations
under the federal securities laws. More information on the retention decision is needed,
perhaps through qualitative, empirical work.
Corporate legal scholarship has also focused relatively little on the pathologies that may
be associated with employing law firms on an hourly fee basis in litigation. For example, a
firm that is paid by the hour has incentives to engage in excessive litigation activity, such
as too many depositions or discovery requests, unwarranted motions practice, and related
costly litigation techniques. Defense law firms have incentives to do all of these things in
M&A litigation. However, some law firms, such as Wachtell, Lipton, charge a flat fee for
their services. Comparing law firm results on this basis may yield insight into whether
these costs do indeed affect litigation.
On the plaintiffs’ side, we need to better understand the dynamics of the selection of
lead counsel. Given the potential presence of multiple firms to act as lead counsel, how
is it that cases are allocated among them? Courts do sometimes choose lead plaintiffs but
that is not widely done in M&A cases. We also need to understand better why plaintiffs’
firms (and defense firms) prefer different types of settlements in different types of cases.
In situations where defendants want to settle a case and obtain a release, what leads to
a consideration settlement in one case and a disclosure only settlement in another case?
Jessica Erickson (2015) has done important work in this area examining the bargaining
among plaintiffs’ law firms for leadership decisions in corporate litigation, but more
qualitative, empirical work would help our understanding.
Finally, the research to date in M&A litigation leads to the conclusion that the quality
of the law firm makes a difference in the outcome of the case. This means that strict
adherence to the lead plaintiff rule that has been developed in federal securities class
actions may not be the best rule for M&A deal litigation. In particular, Delaware’s more
flexible rule that permits the chancellors to make their selection in part based on a law
firm’s track record is more likely to result in the selection of a firm that produces a good
result for the class. Research shows that top plaintiffs’ firms do better than other firms,
and do better even against the top defendant firms. This should lead to further research
regarding whether this is true in the context of other plaintiffs’ litigation, particularly
securities litigation.
BIBLIOGRAPHY
Abrams, David S., and Albert H. Yoon. 2007. The Luck of the Draw: Using Random Case Assignment to
Investigate Attorney Ability, University of Chicago Law Review, 74: 1145–77.
M4633-GRIFFITH_t.indd 313 30/10/2018 08:16

Badawi, Adam B., and D.H. Webber. 2015. Does the Quality of the Plaintiffs’ Law Firm Matter in Deal
Litigation?, Journal of Corporation Law, 41: 359–91.
Cain, Matthew, Jill Fisch, Steven Davidoff Solomon, and Randall Thomas. 2018. The Shifting Tides of Merger
Litigation, Vanderbilt Law Review, 71:603-604.
Cain, Matthew, and Steven Davidoff Solomon. 2015. Takeover Litigation in 2015, Working Paper, available at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2715890.
Cox, James D., Randall S. Thomas, and Lynn Bai. 2008. There are Plaintiffs and . . . There Are Plaintiffs: An
Empirical Analysis of Securities Class Action Settlements, Vanderbilt Law Review, 61: 355–86.
de Fontenay, Elisabeth. 2016. Agency Costs in Law-Firm Selection: Are Companies Under-Spending on
Counsel? Capital Markets L.J., 11:486-509.
Erickson, Jessica. 2015. The Market for Leadership in Corporate Litigation, University of Illinois Law Review,
2015: 1479-1528.
Fitzpatrick, Brian T. 2010. An Empirical Study of Class Action Settlements and Their Fee Awards, Journal of
Empirical Legal Studies, 7: 811–46.
Haire, Susan Brodie, Stefanie A. Lindquist, and Roger Hartley. 1999. Attorney Expertise, Litigant Success, and
Judicial Decisionmaking in the U.S. Court of Appeals, Law and Society Review, 33: 667–85.
Hamermesh, Lawrence A., and Michael L. Wachter. 2017. The Importance of Being Dismissive: The Efficiency
Role of Pleading Stage Evaluation in Shareholder Litigation, Journal of Corporation Law, 42:597-652.
Krishnan, C.N.V., and Ronald W. Masulis. 2013. Law Firm Expertise and Merger and Acquisition Outcomes.
Journal of Law & Economics, 56: 189–226.
Krishnan, C.N.V., Steven Davidoff Solomon, and Randall S. Thomas. 2016. Who Are the Top Law Firms?
Assessing the Value of Plaintiffs’ Law Firms in Merger Litigation, American Law and Economics Review 18:
122–54.
Lederman, Leandra, and Warren B. Hrung. 2006. Do Attorneys Do Their Clients Justice? An Empirical Study
of Lawyers’ Effects on Tax Court Litigation Outcomes, Wake Forest Law Review, 41: 1235–95.
McClane, Jeremy R. 2015. The Sum of Its Parts: The Lawyer–Client Relationship in Initial Public Offerings,
Fordham Law Review, 84: 131–99.
Miller, Banks, Linda Camp Keith, and Jennifer S. Holmes. 2015. Leveling the Odds: The Effect of Quality Legal
Representation in Cases of Asymmetrical Capability, Law and Society Review, 49: 209–39.
Myers, Minor. 2014. Fixing Multi-Forum Shareholder Litigation, University of Illinois Law Review, 2014:
467–551.
Parsons, Donald F. and J.S. Tyler. 2013. Docket Dividends: Growth in Shareholder Litigation Leads to
Refinements in Chancery Procedures, Washington and Lee Law Review, 70: 473–525.
Perino, Michael A. 2003. Did the Private Securities Law Reform Act Work? University of Illinois Law Review,
2003: 913–77.
Perino, Michael. 2012. Institutional Activism Through Litigation: An Empirical Assessment of Public Pension
Fund Participation in Securities Class Actions, Journal of Empirical Legal Studies, 9: 363–92.
Shenu, Karl D. 2011. You Had Me at Hello or Let Them Go? Law Firm Selection, Retention and Defection in
the Investment Banking Industry, Journal of Business, Entrepreneurship, and the Law, 4: 385–423.
Strine, Leo E. 2015. Documenting the Deal: How Quality Control and Candor Can Improve Boardroom
Decision-Making and Reduce the Litigation Target Zone, Business Lawyer, 70: 679–706.
The 2016 Am Law 100: Growth Slows for Big Law, The American Lawyer (April 25, 2016), available at: www.
americanlawyer.com/id=1202489912232/The-2016-Am-Law-100-Growth-Slows-for-Big-Law--?slreturn=
20160705095611.
Thomas, Randall S., and Robert B. Thompson. 2012. A Theory of Representative Shareholder Suits and Its
Application to Multijurisdictional Litigation, Northwestern Law Review, 106: 1753–1819.
Thomas, Randall. 2013. What Should We Do About Multi-Jurisdictional Litigation in M&A Deals? Vanderbilt
Law Review, 66: 1925–60.
Thompson, Robert B., and Randall S. Thomas. 2004. The New Look of Shareholder Litigation: Acquisition-
Oriented Class Actions, Vanderbilt Law Review, 57: 133–209.
Wei, Jiang, Li Tao, Mei Danqing, and Thomas Randall. 2016. Appraisal: Shareholder Remedy or Litigation
Arbitrage?, Columbia Business School Research Paper No 16-31, available at: http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2766776 .
Weiss, Elliot J., and J.S. Beckerman. 1995. Let the Money Do the Monitoring: How Institutional Investors Can
Reduce Agency Costs in Securities Class Actions, Yale Law Journal, 104: 2053–2126.
M4633-GRIFFITH_t.indd 314 30/10/2018 08:16

Section B
Officers and Directors
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20. Jurisdiction over directors and officers in Delaware
Eric A. Chiappinelli*
Delaware is well established as the single most influential state in corporate America.1
Its prominence persists, as the Delaware Court of Chancery remains at the center of
stockholder litigation against corporate fiduciaries (Armour et al 2012; Chiappinelli 2014;
Coyle 2012; Griffith & Lahav 2013). The Court of Chancery occupies this position largely
as a result of its unique system for obtaining personal jurisdiction (adjudicatory jurisdic-
tion) over corporate fiduciaries: Del. Code Ann. tit. 10, § 3114 (2015). Section 3114,
the director-implied consent statute, allows Delaware to exercise personal jurisdiction
over corporate fiduciaries because of their service as directors or officers. In addition to
the implied consent statute, Delaware’s general long arm statute (section 3104) permits
jurisdiction over nonresidents who undertake particular actions in Delaware. Finally, the
conspiracy theory of jurisdiction works as a sort of common law amenability scheme.
Currently, Section 3114 is the preeminent method for obtaining jurisdiction over
Delaware’s corporate directors and officers. Recent decisions from the Delaware Supreme
Court and the Court of Chancery have broadened the Delaware courts’ reach, increasing
the number of lawsuits that can be heard in Delaware.
1. HISTORICAL BACKGROUND
Stockholders have historically experienced great difficulty obtaining valid personal

jurisdiction over directors and officers of Delaware corporations (Chiappinelli 2015). The
primary reason for this difficulty is that fiduciaries of Delaware corporations generally
have very little contact with Delaware itself. Starting in the 1920s, the Delaware legislature
and judiciary created and modified the means of obtaining personal jurisdiction over
corporate fiduciaries in order to maintain Delaware’s status as the preeminent state of
incorporation.
The United States Supreme Court first outlined the rules for personal jurisdiction
in 1877, in Pennoyer v. Neff.2 Under Pennoyer, a state could assert jurisdiction over:
* Thanks to the participants in the Fourth Annual Corporate & Securities Litigation Workshop,
sponsored by the University of Illinois College of Law, held in Chicago on September 30 and
October 1, 2016. Thanks also to Ashleigh Hammer.
1
Some of this chapter is derived from a trilogy of articles: Eric A. Chiappinelli, The Myth
of Director Consent: After Shaffer, Beyond Nicastro, 37 Del. J. Corp. L. 783 (2013); Eric A.
Chiappinelli, The Underappreciated Importance of Personal Jurisdiction in Delaware’s Success, 63
DePaul L. Rev. 911 (2014); Eric A. Chiappinelli, How Delaware’s Corporate Law Monopoly Was
Nearly Destroyed, 65 DePaul L. Rev. 1 (2015). Ashleigh Hammer synthesized and epitomized those
articles into the initial draft for part of this chapter and provided additional research assistance.
2
95 U.S. 714 (1877).
316
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Jurisdiction over directors and officers in Delaware 317
(1) any individual personally served with process in the state; (2) any domiciliary, even if
absent from the state; and (3) any individual who consented to jurisdiction in advance or
by appearance in court (Scott 1919). However, the expansion of nationwide businesses
during the post-bellum era rendered these rules very difficult to apply to corporate
fiduciaries of Delaware corporations (Chiappinelli 2015).
This expansion brought about a truly national economy, whereby both people and
corporations became more mobile (Chiappinelli 2015). Businesses were increasingly
incorporating in one state, but were otherwise headquartered and operating in other
states. These corporations came to be known as “tramp corporations” or “pseudo-foreign
corporations” (Latty 1955).3 Obtaining personal jurisdiction over these pseudoforeign
corporations and their directors and officers by in-state personal service proved increas-
ingly difficult under the Pennoyer scheme because fiduciaries no longer lived or worked
in the corporation’s state of incorporation (Chiappinelli 2013). A stockholder plaintiff
suing corporate fiduciaries also had to sue the corporation, which added to the challenge
of finding a jurisdiction in which to sue all defendants.
Corporations were only domiciled in the state of incorporation; therefore, jurisdiction
predicated upon domicile could not be used by other states (Chiappinelli 2015). A cor-
poration could consent to jurisdiction in another state through registering to do business
there; however, in practice, this did not always occur (Scott 1919; Chiappinelli 2015).
Several states conditioned a corporation’s ability to conduct business in a state upon the
corporation’s agreement to register and designate an in-state agent for service of process,
but oftentimes a corporation would not register in a state in which it had dealings either
unintentionally or for strategic reasons, such as to avoid consent to personal jurisdiction
(Chiappinelli 2015). Under these circumstances, a state could not obtain personal jurisdic-
tion over both a corporation and its fiduciaries under Pennoyer.
Eventually, in 1927, the Delaware General Assembly responded to these issues by enact-
ing Del Code Ann. tit. 10, § 366, the “sequestration” statute. The legal theory supporting
sequestration was that, under Pennoyer, a state had dominion over the property within
its borders (Casad 2011). Under Delaware corporate law, all shares of stock in Delaware
corporations were considered to be personal property located within Delaware regardless
of where the certificate or stockholder was located.4 This allowed an out-of-state plaintiff
to seize an out-of-state defendant’s property in Delaware and bring the defendant into
the forum court to adjudicate the dispute even when the property was unrelated to the
underlying dispute (Chiappinelli 2013).5 Sequestration quickly became the primary
method of obtaining personal jurisdiction over Delaware corporate fiduciaries (Wolfe Jr
& Pittenger 2011).6
Another important provision of sequestration was that in order to effectuate the release
of seized property, the defendant had to make a general appearance.7 Thus, the practical
effect of sequestration was that stockholders could seize an out-of-state defendant’s
stock, forcing the defendant to make a general appearance under the threat of a default
3
See also, e.g., Kimball v. Davis, 52 Mo. App. 194, 213 (Mo. Ct. App. 1892).
4
See Del. Code Ann. tit. 8, § 169 (2011).
5
See Shaffer v. Heitner, 433 U.S. 199 n.17 (1977).
6
See Gordon v. Michel, 297 A.2d 420, 421 (Del. Ch. 1972).
7
Shaffer, 433 U.S. at 190–93.
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judgment. Essentially, Delaware’s sequestration process converted unrelated quasi-in-rem

jurisdiction to in personam jurisdiction for corporate fiduciaries.
In the late 1960s and early 1970s, the Supreme Court decided a number of cases known
as “the debtors’ rights cases,” which eroded the constitutional foundation for Delaware’s
sequestration process (Chiappinelli 2013).8 These cases required procedural safeguards
for pre-judgment seizures of property. Delaware’s sequestration statute arguably did not
have adequate safeguards. These deficiencies led to the Supreme Court decision in Shaffer
v. Heitner, which set the stage for the modern Delaware procedures for obtaining personal
jurisdiction.
In Shaffer, Arnold Heitner, a New York resident, filed a stockholder derivative suit
in the Delaware Court of Chancery against 28 officers and directors of The Greyhound
Corporation, a Delaware corporation, for causing the corporation to violate antitrust
laws.9 Under Section 366, Heitner obtained an order of sequestration against the defend-
ants, seizing more than $1.2 million worth of stock.10 The defendants raised several chal-
lenges to personal jurisdiction, but by the time Shaffer reached the US Supreme Court, the
Court and the parties were focused on the constitutionality of the Delaware sequestration
procedure in light of the debtors’ rights cases (Chiappinelli 2013).
Despite this focus, the Court decided the case on a different constitutional theory—
the lack of minimum contacts under International Shoe,11 and its progeny.12 Justice
Marshall, speaking for the Court, held that all methods by which states assert personal
jurisdiction, including unrelated quasi-in-rem (the basis for Delaware’s sequestration),
must be measured by the minimum contacts test set forth in International Shoe.13
Therefore, “[j]urisdiction is valid only if the defendants have certain ‘minimum contacts’
with the forum state such that assertion of jurisdiction ‘does not offend traditional
notions of fair play and substantial justice.’”14 In order to find that a defendant had
minimum contacts, the Shaffer court inquired into whether the defendant has “pur-
posefully availed [him or herself] of the privilege of conducting activities in the forum
state.”15
Under this analysis, the Court held that the presence of the defendants’ property in
Delaware, which was unrelated to the merits of the action, did not constitute sufficient
8
E.g., Mathews v. Eldridge, 424 U.S. 319, 349 (1976) (pre-termination hearing of social secu-
rity disability benefits); North Ga. Finishing, Inc. v. Di-Chem, Inc., 419 U.S. 601, 613–14 (1975)
(pre-hearing garnishment of commercial goods); Calero-Toledo v. Pearson Yacht Leasing Co., 416
U.S. 663, 679–80 (1974) (pre-hearing seizure of property); Mitchell v. W.T. Grant Co., 416 U.S.
600, 618–20 (1974) (pre-hearing sequestration of consumer goods); Fuentes v. Shevin, 407 U.S.
67, 96–97 (1972) (pre-hearing replevin of consumer goods); Bell v. Burson, 402 U.S. 535, 542–43
(1971) (pre-hearing suspension of driver’s license and automobile registration); Goldberg v. Kelly,
397 U.S. 254, 271 (1970) (pre-hearing cessation of AFDC benefits); Sniadach v. Family Fin. Corp.,
395 U.S. 337, 341–42 (1969) (pre-hearing garnishment of wages); Connecticut v. Doehr, 501 U.S. 1,
18 (1991) (pre-hearing seizure of real property).
9
Shaffer v. Heitner, 433 U.S. 186, 189–90 (1977).
10
Ibid at 192 n. 7.
11
International Shoe Co. v. Washington, 326 U.S. 310 (1945).
12
Shaffer, 433 U.S. at 206.
13
Ibid at 212.
14
Ibid at 203 (quoting International Shoe Co. v. Washington, 326 U.S. 310, 316 (1945)).
15
Ibid at 216 (citing Hanson v. Denckla, 357 U.S. 235, 253 (1958)).
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contact with the forum state to permit jurisdiction.16 Additionally, the Court held that
serving as a fiduciary, vel non, is not sufficiently availing to satisfy the minimum contacts
test; rather, it only illustrates that Delaware law should govern the underlying dispute.17
Likewise, Delaware’s interest in overseeing its own corporations was relevant to the choice
of law, not the minimum contacts analysis for the purpose of personal jurisdiction.18 By
rendering sequestration unconstitutional, the Shaffer decision prohibited the only effec-
tive process for exercising personal jurisdiction over directors and officers of Delaware
corporations.
2. DELAWARE’S IMPLIED CONSENT STATUTE: DEL. CODE

ANN. TIT. 10, § 3114
Because no other Delaware statute could reach corporate fiduciaries, the Delaware
General Assembly enacted the current implied consent statute, section 3114, only two
weeks after the US Supreme Court’s decision in Shaffer.19 In relevant part, it reads:
Every nonresident . . . who . . . accepts election or appointment as a director . . . of a corpora-
tion organized under the laws of this State or who . . . serves in such capacity . . . shall, by such
acceptance or by such service, be deemed thereby to have consented to the appointment of the
registered agent of such corporation . . . as an agent upon whom service of process may be made
in all civil actions or proceedings brought in this state, by or on behalf of, or against such corpo-
ration, in which such director . . . is a necessary or proper party, or in any action or proceeding
against such director . . . for violation of a duty in such capacity . . . Such acceptance or service
as such director . . . shall be a signification of the consent of such director . . . that any process
when so served shall be of the same legal force and validity as if served upon such director . . .
within this State and such appointment of the registered agent . . . shall be irrevocable.20
In 2004 the statute was extended to corporate officers, too.21 This extension was primarily
the result of a perception that corporate wrongdoing was more likely to be undertaken
by senior corporate officers who were not directors. Federal legislation in the wake of
the fin de siècle corporate scandals mandated that public companies have a majority of
outside directors, and the perceived wisdom was that boards would, in the future, have
few directors who were also officers (Winship 2013). In such instances, section 3114 would
not permit easy assertion of personal jurisdiction over the defendant officers. Like the
former sequestration procedure, section 3114 is vital to obtaining personal jurisdiction
over nonresident fiduciaries of Delaware corporations (Wolfe Jr & Pittenger 2011).
Although the statute is phrased as based on implied consent, the Delaware courts
have theoretically imposed a two-part test consistent with International Shoe. When a
16
Ibid at 209.
17
See ibid at 216.
18
Ibid.
19
See Act of July 7, 1977, ch. 119, 61 Del. Laws § 1 (codified at Del. Code Ann. tit. 10, § 3114
(2015)).
20
Del. Code Ann. tit. 10, § 3114 (2015).
21
Act of June 30, 2003, ch. 83, § 3, 74 Del. Laws 213, 213 (codified at Del. Code Ann. tit. 10,
§ 3114(b) (2015)).
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efendant challenges personal jurisdiction, “[t]he court must determine that service of
d
process is authorized by the statute and then must determine that the exercise of jurisdic-
tion over the nonresident defendant comports with traditional due process notions of fair
play and substantial justice.”22
Almost immediately after section 3114 was enacted, its constitutionality was
challenged.23 In Armstrong v. Pomerance, the defendant directors, whose only contact
with Delaware was accepting election as directors of a Delaware’s corporation, made
limited appearances to contest personal jurisdiction.24 The Delaware Supreme Court
applied the correct test for personal jurisdiction—whether the defendants’ acceptance
of the director position constituted sufficient contact with Delaware such that exercising
personal jurisdiction over them would not offend traditional notions of fair play and
substantial justice.25 The court recognized that “the defendants’ numerical contacts with
this State [were] minimal, i.e., limited to their acceptance of directorships in a Delaware
corporation,” but nevertheless found that section 3114 was constitutional.26
The court relied on three specific aspects of being a director that met the required mini-
mum contacts threshold: (1) the defendant’s powers as directors were created by Delaware
law; (2) the statute provided “explicit statutory notice” that they could be brought into
Delaware courts; and (3) the defendants agreed to exercise the power to govern the
corporation, including the possibility of being indemnified by or receiving a loan from
the corporation, by accepting the director position.27 Armstrong laid the foundation for
Delaware’s ability to obtain personal jurisdiction over nonresident defendants through
their implied consent by accepting a director position (Chiappinelli 2013). Interestingly,
the court’s decision directly contrasts with Justice Marshall’s opinion in Shaffer that
service as a director of a Delaware corporation does not automatically confer jurisdiction
upon the state; however, section 3114 has been routinely applied and upheld by Delaware
courts (Chiappinelli 2013).
Armstrong did, however, purport to limit the reach of section 3114 in three ways.
First, the director has to be charged with a breach of fiduciary duty or must be a
necessary or proper party in a lawsuit in which the corporation is also a party.28 Shortly
after Armstrong, the Court of Chancery held that a fair reading of Armstrong, and the
jurisprudence of other states that had adopted statutes on which section 3114 was based,
required section 3114 to be limited to actions in which the director was being sued for a
breach of a duty owed to the corporation.29 Second, jurisdiction is only proper in actions
which are “inextricably found up in Delaware law,” and third, Delaware must have a strong
interest in providing a forum for redress.30
22
Ryan v. Gifford, 935 A.2d 258, 264 (Del. Ch. 2007).
23
Armstrong v. Pomerance, 423 A.2d 174 (Del. 1980).
24
Ibid at 175–76.
25
Ibid at 176.
26
Ibid at 176, 179.
27
Ibid at 179–80.
28
Armstrong v. Pomerance, 423 A.2d 174, 176 n.5 (Del. 1980).
29
Hana Ranch v. Lent, 424 A.2d 28, 30–31 (Del. Ch. 1980). But see Hazout v. Tsang Mun Ting,
134 A.3d 274 (Del. 2016), discussed below (overruling Hana Ranch).
30
Armstrong, 423 A.2d at 176 n.5.
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In general, the trend has been for the Delaware courts to expand the reach of sec-
tion 3114, and thus the cases in which nonresident fiduciaries are required to litigate in
Delaware. In some areas, though, the Delaware courts have shown restraint. For example,
personal jurisdiction has been found lacking under section 3114 where the claim sounded
in tort or was based on the federal securities laws, or where the fiduciary was acting on
behalf of the Delaware corporation’s foreign parent corporation (Chiappinelli 2013).
Despite some counterexamples, Delaware has primarily expanded, rather than con-
tracted, the ambit of section 3114. Delaware courts have held that once jurisdiction is
established a plaintiff may add other claims against the fiduciary, even when the claims do
not arise from the same operative facts (Chiappinelli 2013). In these settings, the fiduciary
has at least one claim asserted that fits under section 3114, as narrowly understood. More
potent, though, are Court of Chancery decisions that expand the conception of what it
means for a fiduciary to breach a duty qua fiduciary and thus be subject to section 3114
in the first place. The most egregious of these cases is In re USACafes, L.P. Litigation,31
in which the court held that defendant did not breach his duties to the entity of which
he was a fiduciary. Nonetheless, Chancellor Allen subjected him to personal jurisdiction
under section 3114 because those actions caused the entity to breach duties it owed to
others (Chiappinelli 2013).
The Delaware Supreme Court made a major expansion of section 3114 in early 2016.
Hazout, a resident of Toronto, was an officer and director of Silver Dragon Resources,
Inc., a Toronto-based mining company incorporated in Delaware. Hazout negotiated
with a group of Hong Kong residents for an infusion of $3.4 million to keep Silver
Dragon afloat. One condition of the infusion was that a majority of the board would
resign to allow the new investors to select replacements and control the corporation. The
investors wired the first $1 million of the $3.4 million believing that Hazout and other
directors would soon execute the operative documents; however, a director other than
Hazout refused to sign. Hazout caused Silver Dragon to pay most of the $1 million to
Travellers International, Inc., a corporation (incorporated and headquartered in Canada)
to which it owed money and which Hazout controlled. Some of the never-executed agree-
ments contained choice of law provisions selecting Delaware contract, but not corporate,
law and one contained a choice of forum clause requiring any litigation to be filed in
Delaware. None of the agreements contained a consent to personal jurisdiction clause.32
The Hong Kong investors sued Silver Dragon, Travellers, and Hazout in Delaware
stating claims of unjust enrichment, fraud, and fraudulent transfer in violation of the
Delaware Uniform Fraudulent Transfer Act. Hazout moved to dismiss for lack of per-
sonal jurisdiction, which had been predicated on section 3114.33 The Delaware Supreme
Court overruled Hana Ranch’s blanket prohibition on invoking section 3114 in suits where
the fiduciary was a necessary or proper party but in which the claim did not involve breach
of a duty owed to the fiduciary’s corporation.34 The court held that the statute’s require-
ment that the corporation also be a party shows that Delaware requires a “close nexus”
31
In re USACafes, L.P. Litig., 600 A.2d 43 (Del. Ch. 1991).
32
Hazout v. Tsang Mun Ting, 134 A.3d 274, 277, 280–81 (Del. 2016).
33
Ibid at 277.
34
Ibid at 287–89.
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between the claims against the Delaware corporation and those against the fiduciary who
is a necessary or proper party. Because of that close nexus, it was “reasonable” to find
that a nonresident who becomes a fiduciary of a Delaware corporation has impliedly
consented to be sued in Delaware on such claims.35
The court correctly observed that the minimum contacts test under the Due Process
Clause restricts section 3114’s application.36 The court found that Hazout had the requi-
site minimum contacts in that by becoming a fiduciary of a Delaware entity he availed
himself of “certain duties and protections” under Delaware law, although the court was
reticent about exactly what those are. Further, the court found that Hazout foresaw that
he could be sued in Delaware because he acted in an official capacity in negotiating on
behalf of a Delaware company for a change of control in that company and some of the
agreements contained choice of law or forum selection clauses that selected Delaware.37
Hazout is a breathtaking and constitutionally unsound extension of personal jurisdic-
tion. The court was surely correct in declining to follow the absolute rule of Hana Ranch.38
However, the court’s reliance on implied consent is seriously misplaced. Implied consent
as a basis for personal jurisdiction has been resoundingly rejected by the US Supreme
Court for more than half a century (Chiappinelli 2013). As for the minimum contacts
test, although there is some support for the idea that mere foreseeability that one might
be sued in a forum is sufficient connection for that forum to assert personal jurisdiction,39
the more modern, the more logical, and the better formulation is that a defendant must
have purposefully done something that affiliates him- or herself with the forum in a way
connected to the litigation (Chiappinelli 2013). None of Hazout’s actions, of course, had
anything to do with Delaware. The only connection to Delaware was that the troubled
corporation was incorporated there; the fact that it is a Delaware corporation had noth-
ing to do with its financial troubles. Further, it seems doubtful whether Hazout actually
foresaw or reasonably should have foreseen being sued in Delaware in connection with the
failed financing of a Canadian corporation by Hong Kong investors.
Even before Hazout, section 3114 as interpreted and applied by the Delaware courts
was almost certainly unconstitutional. To the extent that the plain language of the statute
predicates personal jurisdiction on implied consent, it was unconstitutional on the very
day in was enacted. In the ordinary fiduciary duty lawsuit by stockholders against cor-
porate fiduciaries (and not the attenuated facts of a case such as Hazout) the nonresident
fiduciary has frequently never set foot in Delaware and certainly undertook no relevant
action in the state. Antecedent to the acts giving rise to the lawsuit, the fiduciary will not
have taken any actions truly within the state, although the corporation may have made
filings there, perhaps at the fiduciary’s instance. The actions giving rise to the fiduciary
duty lawsuit also have no connection to Delaware. No board action or officer actions
would have taken place within the state. If the “purposefully availing” language is to
35
Ibid at 289–90.
36
Ibid at 291.The court noted that the doctrine of forum non conveniens could also alleviate
some hardships on some defendants. Ibid.
37
Ibid at 292–94.
38
Hana Ranch, 424 A.2d 28 (Del. Ch. 1980).
39
See Asahi Metal Indus. v. Superior Court, 480 U.S. 102, 117, 119 (1987) (Brennan J. concur-
ring); World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286, 297 (1980).
M4633-GRIFFITH_t.indd 322 30/10/2018 08:16

have any integrity it cannot be stretched so far as to bring in such defendants. Finally,
if foreseeability that one might be sued in a particular forum were sufficient, Delaware
could readily expand its reach and put its assertions on surer footing simply by running a
Superbowl ad announcing that anyone watching the ad can expect to be sued in Delaware
(Chiappinelli 2013).40
3. DELAWARE’S LONG ARM STATUTE: DEL. CODE ANN. TIT.

10, § 3104
Delaware understood the importance of having a director-specific amenability statute

when it adopted section 3114 in 1977. Somewhat surprisingly, then, Delaware was rather
behind the curve in adopting a broader amenability statute for nonresidents. It was not
until 1978, a year after Shaffer and the adoption of section 3114, that Delaware adopted
a general long arm statute.41 When it did so, it did what many other states did, in that it
adopted verbatim the Illinois act of 1955,42 which was the basis for the Uniform Interstate
and International Procedure Act.43 That act provides for amenability to service of process
for claims based on so-called single-act occurrences in Delaware (Wolfe Jr & Pittenger
2011).
Section 3104 provides in relevant part:
§ 3104 Personal jurisdiction by acts of nonresidents.

(a) The term “person” in this section includes any natural person. . .
(b) The following acts constitute legal presence within the State. Any person who commits any
of the acts hereinafter enumerated thereby submits to the jurisdiction of the Delaware courts.
(c) As to a cause of action brought by any person arising from any of the acts enumerated
in this section, a court may exercise personal jurisdiction over any nonresident, or a personal
representative, who in person or through an agent:
(1) Transacts any business or performs any character of work or service in the State;
. . .
(3) Causes tortious injury in the State by an act or omission in this State;
. . .
(k) This section does not invalidate any other section of the Code that provides for service of
summons on nonresidents. This section applies only to the extent that the other statutes that
already grant personal jurisdiction over nonresidents do not cover any of the acts enumerated
in this section.44
Section 3104’s current application to officers and directors of Delaware corporations is

essentially theoretical. In part this is because the long arm statute is explicitly a fallback
provision. Subsection (k) provides that section 3104 only applies “to the extent that the
other statutes that already grant personal jurisdiction over nonresidents do not cover
40
On the circularity of the foreseeability argument, see Asahi Metal Indus. Co., Ltd. v.
Superior Court, 702 P.2d 543, 555 n.2 (Cal. 1985) (Lucas J. dissenting) rev’d 480 U.S. 102 (1987).
41
Act of July 11, 1978, ch. 471, 61 Del. Laws 1328 (codified as amended at Del. Code Ann.
tit. 10, § 3104 (2015)).
42
Ill. Rev. Stat. ch. 110, para 17(1) (codified as amended at Ill. Comp. Stat. § 5/2-209).
43
Uniform Interstate and International Procedure Act § 1.03, 13 U.L.A. 361 (1986).
44
Del. Code Ann. tit. 10, § 3104 (2015).
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any of the acts enumerated in this section.”45 If section 3114 were to be invalidated on

constitutional grounds, section 3104 would be the only amenability statute that could pos-
sibly cover officers and directors, although doing so would take a radical reinterpretation
of the long arm statute.
At the most abstract level, Delaware case law holds that because the General Assembly
adopted section 3104 knowing that the language was derived from other states’ statutes, the
courts will assume that that the General Assembly also intended to adopt caselaw interpre-
tations of the statute from those states.46 At least two state courts have held that nonresident
fiduciaries acting entirely outside the forum state can nonetheless be amenable to personal
jurisdiction in the state of incorporation under the equivalent of section 3114(c).47
In general, however, such assertion of personal jurisdiction is rare to the point of
nonexistence. Professors Kahan and Kamar studied personal jurisdiction statutes in the
corporate setting and concluded that “[w]e are unaware of cases upholding the exercise
of jurisdiction over a director of a domestic corporation where the state lacked a specific
statute authorizing such jurisdiction and the director did not have other contacts with
the state” (Chiappinelli 2013; Kahan & Kamar 2002). If section 3114 were invalidated,
Delaware would not have an amenability statute specifically directed at corporate
fiduciaries. Under the overwhelming weight of authority in other states, the question
of nonresident fiduciary amenability under section 3104 would turn, at a minimum, on
whether the nonresident fiduciaries had sufficient connection with Delaware to warrant
personal jurisdiction under the statute.
One major sticking point in applying section 3104 to corporate fiduciaries is the statu-
tory requirement in subsections (c)(1) and (c)(3) that the fiduciaries’ actions giving rise to
jurisdiction occur “in” Delaware.48 Former Chancellor Chandler and Chief Justice Strine
have stated emphatically that this requirement is literal, not metaphysical (Chandler III
& Strine Jr 2003). The courts in Delaware have consistently taken a literal, and relatively
narrow, view of the statutory language. For example, the Delaware courts have held that
a nonresident car dealer who knew that hundreds of cars he sold were going to Delaware
dealers, knowing the cars were going to Delaware, was not engaged in a persistent course
of conduct in Delaware.49 Likewise, an Illinois transfer agent performing transfer services
in New York for hundreds of Delaware corporations was likewise not engaged in a
persistent course of conduct in Delaware.50 This interpretation has continued unbroken
for 30 years, and was reaffirmed in June 2016.51
45
Del. Code Ann. tit. 10, § 3104(k) (2015).
46
Magid v. Marcal Paper Mills, Inc. 517 F.Supp. 1125, 1130 (D. Del. 1981).
47
See, e.g., Costa Brava P’ship III, L.P. v. Telos Corp., 2006 WL 1313985, at *4 (Md. Cir. Ct.
Mar. 30, 2006); Walter v. M. Walter & Co., 446 N.W.2d 507, 509 (Mich. Ct. App. 1989).
48
Subsection (1) renders a non-resident amenable to personal jurisdiction if he or she “[t]rans-
acts any business or performs any character of work or service in the State.” Likewise subsection (3)
reaches a tortfeasor only is that person “[c]auses tortious injury in the State by an act or omission
in this State.” Del. Code Ann. tit. 10, § 3104(c)(1) and (3) (2015) (emphasis added).
49
Finkbiner v. Mullins, 532 A.2d 609, 620 (Del. Super. Ct. 1987).
50
Ohrstrom v. Harris Trust Co. of N.Y., No CIV. A. 15709, 1998 WL 8849, at *4 (Del. Ch. Jan.
8, 1998).
51
Republic Business Credit, LLC v. Metro Design USA, LLC, C.A. No N15C–09–233 JRJ,
2016 WL 3640349, at *8 (Del. Super. Ct. June 29, 2016).
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Under subsection (c)(3), a corporate fiduciary could be amenable to jurisdiction in

Delaware only if both a “tortious injury” and the action causing it occur in Delaware. A
further roadblock to using (c)(3) is that there is significant authority to conclude that a
Delaware director’s or officer’s breach of fiduciary is not a tort for (c)(3) purposes. What
little Delaware case law there is holds that a breach of fiduciary duties is not like an
intentional tort because liability can be established without a showing of damage or of
causation.52 Additionally, Vice Chancellor Laster has written in an extrajudicial context
that a corporate fiduciary’s breach of duties is not a common law tort, as traditionally
conceived (Laster & Morris 2010). Other academics concur (Kahan & Rock 2011).
The harm alleged to have befallen a Delaware corporation in stockholder litigation can
only in the most strained sense be said to have occurred in Delaware. The corporation’s
headquarters are elsewhere and any economic harm to the corporation cannot, in any
real sense, be said to have occurred in Delaware. Nonetheless, some Delaware authorities
purport to find “tortious injury” in Delaware for (c)(3) purposes from alleged corporate
misdoings.53 The Supreme Court of Delaware, however, has strongly suggested that
economic harm to a corporation does not occur in Delaware simply by virtue of the
corporation’s being incorporated there.54
Section 3104 is nonetheless a key provision in stockholder litigation, even though it is
not the source for personal jurisdiction over officers and directors of the subject corpora-
tion. It is used to bring in those people, who may be fiduciaries, who are alleged to have
participated in wrongdoing against the corporation, even though they are not officers or
directors. These people may be, for example, controlling stockholders of the corporation,
or those who control a corporation that controls the subject corporation. Or, they may be
officers or directors of an entity that is not the subject of the lawsuit but which is affiliated
with the subject corporation.
In this regard, the situation of officers may be distinctly different, and more perilous,
than that of directors. Although both officers and directors are treated substantially
identically under section 3114, officers are probably more likely to be held to be subject
to personal jurisdiction under section 3104 than are directors. This is because it is offic-
ers rather than directors who typically take actions on behalf of corporations. Thus, an
officer of a non-defendant corporation may form a Delaware entity on behalf of the
non-defendant or may be the decisionmaker in choosing to make a filing in Delaware on
behalf of an existing Delaware entity.55
The actions of these peripheral people frequently have only a tenuous relationship with
Delaware. A few illustrations will make clear just how tenuous this relationship can be
and yet support jurisdiction, according to Delaware’s courts. It must be said that in this
52
See, e.g., Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 370-71 (Del. 1993); Universal
Studios Inc. v. Viacom Inc., 705 A.2d 579, 594 (Del. Ch. 1997).
53
See Transcript of Oral Argument on Defendants’ Motions to Dismiss and the Court’s
Rulings at 28, Badlands NGLs, LLC v. Cascade Capital Corp., No 11198-VCL (Del. Ch. Dec. 22,
2015); Sample v. Morgan 935 A.2d 1046, 1057 (Del. Ch. 2007).
54
Istituto Bancario Italiano SpA v. Hunter Engineering Co., 449 A.2d 210, 228 (Del. 1982).
55
For discussion of the different legal treatment of corporate officers, see 82017; Shaner
2015; Shaner 2014; Winship 2013; Shaner 2010; Hamermesh & Sparks 2005; Johnson & Millon
2005.
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area the Delaware courts have not been particularly consistent in the results that they
reach. However, the trend has been distinctly toward more clarity and toward expanding
the scope of section 3104. This expansion has mostly been under (c)(1), the transacting
business provision.
In Abajian v. Kennedy, the Court of Chancery refused to find that a California corpora-
tion that signed a lease and stock purchase agreement with a Delaware corporation was
“transacting business” in Delaware, even though the result of the agreement was the
nonresident becoming a stockholder in the Delaware corporation.56
In many cases the plaintiff has predicated section 3104 amenability on the creation of
a Delaware entity or the filing of documents with the Delaware Secretary of State. The
Delaware Supreme Court in Papendick v. Bosch held that simply forming a Delaware
entity is not a sufficient connection with Delaware under due process, but that forming a
corporation to effect a transaction upon which plaintiff sued to collect a finder’s fee was
sufficient.57
After Papendick, the Delaware courts tried to draw a meaningful distinction between
“merely” forming or owning a Delaware entity and doing so as a component of the claim
for relief. Where the former obtained there was no personal jurisdiction. Where the latter
was found, there was (Wolfe Jr & Pittenger 2011). Sometimes the distinction is phrased
as whether forming the entity is “an integral component of the total transaction to which
plaintiffs’ cause of action relates.” At other times the court more narrowly requires that
the formation be “done as part of a wrongful scheme.”58
The Delaware courts have also waffled in their treatment of other filings in Delaware
that do not create an entity but affect an already existing one. Again, the key inquiry is
whether, in the court’s judgment, the filing was sufficiently integral to the alleged wrong-
doing to support personal jurisdiction. As one recent case put it:
“[A] corporate director or officer of a foreign corporation cannot be haled into a Delaware court
for an act of the corporation simply because the officer or director has directed the corporation
to take that act.” In this case, [plaintiff] needs to establish that [the individual defendant] had a
“particularly meaningful role in bringing about [an entity’s] formation as a Delaware business
entity.”59
Section 3104 has also been used to assert jurisdiction over an individual who controlled
the entity that had control over the corporation in question.60 The court held that the
controlling stockholder corporation owed fiduciary duties to the corporation in question
56
Abajian v. Kennedy, 1992 WL 8794 (Del. Ch. Jan 17, 1992), reprinted in 18 Del. J. Corp. L.
179, 194 (1993).
57
Papendick v. Bosch, 410 A.2d 148, 152 (Del. 1979). Papendick did not arise under sec-
tion 3104 but rather under the sequestration statute; plaintiff argued that sequestration plus
minimum contacts would be sufficient for amenability.
58
See Republic Business Credit, LLC v. Metro Design USA, LLC, C.A. No N15C–09–233
JRJ, 2016 WL 3640349, at *6 nn. 53 and 54 (Del. Super. Ct. June 29, 2016).
59
Microsoft Corp. v. Patent Revenues Partners, LLC, C.A. No 8092-VCP, 2015 WL 6121373,
at *6 (Del. Ch. Oct. 15, 2015) (footnotes omitted) (citing Hamilton Partners L.P. v. Englard, 11
A.3d 1180 (Del. Ch. 2010).
60
Virtus Capital L.P. v. Eastman Chem. Co., C.A. No 9808-VCL, 2015 WL 580553 (Del. Ch.
Feb. 11, 2015).
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and that the individual, as the controller of the controlling entity, thus owed fiduciary
duties to the corporation in question also.61
Even more attenuated, section 3104 has been used to assert jurisdiction over the law firm
that represented the public corporation involved in the stockholder litigation. In Sample v.
Morgan the Court of Chancery upheld jurisdiction under section 3104(c)(1) and (3) over
Baker & Hostetler LLP and one of its partners who prepared a certificate of amendment and
transmitted it to Delaware for filing. The certificate of amendment was alleged to be central
to the directors’ scheme to enrich themselves at corporate expense. The court held that Baker
& Hostetler’s actions constituted transacting business in Delaware under section 3104(c)(1)
and also was a tort committed in Delaware in which the injury was sustained in Delaware
under section 3104(c)(3).62 The second holding is clearly erroneous, since the injury was not
sustained in Delaware in any meaningful sense. The first holding is a rather capacious—and,
some would say, ominous—expansion of the meaning of transacting business.
More recently, the Court of Chancery, in reliance on Sample, held that section 3104
applied to a law firm and lawyer that caused a Delaware filing to be made that was not
held to be wrongful in itself, as in Sample. Rather, the court held that it was sufficient
that the filing was “integral” to the disputed transaction.63 Surely such an act is neither
transacting business in Delaware nor a tort in Delaware causing injury there.
4. DELAWARE’S EVEN LONGER ARM: CONSPIRACY

THEORY OF JURISDICTION
But an implied consent statute of dubious constitutionality coupled with expansive

interpretations of a traditional long arm statute in the stockholder litigation context is not
enough for Delaware. Rather, Delaware invokes a conspiracy theory of jurisdiction. This
is a kind of second-order process—a common law amenability theory. The idea is that if
one actor is subject to personal jurisdiction in Delaware, those with whom that defendant
conspired are amenable to jurisdiction there too, even though their actions do not meet
any of the requirements of any amenability statute.64 Although the conspiracy theory is
61
Ibid. Perhaps the broadest reach under section 3104 would come under subsection (c)(4),
which grants general jurisdiction (i.e., permitting claims for relief unrelated to the actions in the
state) in tort (regardless of the state in which injury occurred) over a person who “[c]auses tortious
injury in the State or outside of the State by an act or omission outside the State if the person
regularly does or solicits business, engages in any other persistent course of conduct in the State
or derives substantial revenue from services, or things used or consumed in the State.” Del. Code
Ann. tit. 10, § 3104(c)(4) (2015). Wolfe, Jr. & Pittenger 2011 at § 3.05[a][1][iv] (subsection (c)(4)
is an assertion of general jurisdiction). It is clear that subsection (c)(4) is essentially a dead letter,
at least in terms of stockholder litigation, after Daimler AG v. Bauman, 134 S. Ct. 746 (2014) and
Goodyear Dunlop Tires Operations, S.A. v. Brown, 564 U.S. 915 (2011). See Israel Discount Bank
of New York v. Higgins, C.A. No 9817–VCP, 2015 WL 5122201 at *4 and n.22 (Del. Ch. Aug. 31,
2015). See also Genuine Parts Co. v. Cepec 137 A.3d 123 (Del. 2016).
62
Sample v. Morgan 935 A.2d 1046, 1057 (Del. Ch. 2007).
63
Transcript of Oral Argument on Defendants’ Motions to Dismiss and the Court’s Rulings at
25–28, Badlands NGLs, LLC v. Cascade Capital Corp., No 11198-VCL (Del. Ch. Dec. 22, 2015).
64
See Virtus Capital L.P. v. Eastman Chem. Co., C.A. No 9808-VCL, 2015 WL 580553 at *12
(Del. Ch. Feb. 11, 2015).
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broad, the Delaware courts are in fact insistent that at least one defendant be amenable
to jurisdiction under a statute.65
The original Delaware case adopting the conspiracy theory framed the elements that a
plaintiff must show as follows:
(1) a conspiracy to defraud existed; (2) the defendant was a member of that conspiracy; (3) a
substantial act or substantial effect in furtherance of the conspiracy occurred in the forum state;
(4) the defendant knew or had reason to know of the act in the forum state or that acts outside
the forum state would have an effect in the forum state; and (5) the act in, or effect on, the forum
state was a direct and foreseeable result of the conduct in furtherance of the conspiracy.66
Although the elements nowhere reference the due process concerns necessary to support
an assertion of personal jurisdiction, the Court of Chancery has recently mapped those
elements to the due process requirements.67 The third test is a proxy for, essentially, the
requirements of section 3104(c)(1). The first two tests are really just borrowed from
agency law that would make the defendant and putative defendant agents of one another.
The final two tests are analogous to the foreseeability aspect of due process.68
As noted earlier, although there is language in US Supreme Court cases supporting
foreseeability as a—perhaps the—central due process inquiry, the stronger inquiry is
whether the defendant purposefully availed him or herself of the benefits of the forum’s
laws. Under that approach, passive knowledge, especially imputed knowledge, would be
insufficient contact with the forum. Instead, the putative defendant should have in some
way intended the other actor to take action directed at the forum state. Only then could
there be sufficient nexus to the forum to support jurisdiction. Still, even in those instances
there remains the troublesome question whether a state’s courts can, or should, imply an
amenability process where the legislature has not done so. The General Assembly could,
of course, enact an amenability statute that captures and endorses the conspiracy theory.
Until it does so, though, that theory remains suspect.
5. CONCLUSION
Delaware’s statutes and cases have created a system that permits expansive jurisdiction
over nonresident directors and officers of Delaware corporations. The principal mecha-
nism for asserting jurisdiction is the implied consent statute (section 3114). If that statute
is unavailable, a traditional long arm statute, section 3104, permits jurisdiction over
directors or officers who transact business or cause tortious injury in Delaware. Finally,
if neither statute applies, the Delaware courts have crafted the “conspiracy theory” of
jurisdiction to establish jurisdiction over a defendant when jurisdiction over another
defendant is clear and the two defendants acted in concert.
Each of these mechanisms is problematic when applied to nonresident directors and
65
Chandler v. Ciccoricco, No Civ.A. 19842-NC, 2003 WL 21040185 at *10 (Del. Ch. May 5,
2003).
66
Istituto Bancario Italiano SpA v. Hunter Eng’g Co., 449 A.2d 210, 225 (Del. 1982).
67
Virtus Capital, 2015 WL 580553 at *12.
68
Ibid.
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officers. Section 3114 is suspect because the US Supreme Court has long rejected implied
consent as a permissible basis for personal jurisdiction. Moreover, the Delaware courts
place too much emphasis on mere foreseeability as a sufficient connection to support
Delaware jurisdiction. The conspiracy theory of jurisdiction is also subject to attack
because it relies too heavily on foreseeability. Finally, section 3104’s efficacy is doubtful in
the nonresident fiduciary setting because those defendants’ actions do not take place in,
nor do they cause injury in, Delaware.
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21. Stockholder litigation, fiduciary duties, and the
officer dilemma
Megan Wischmeier Shaner
1. INTRODUCTION*
A defining characteristic of the corporate form is its centralized, hierarchical decision-
making structure. Management of a corporation’s business and affairs is vested in the
board of directors, and corporate law provides directors with broad authority and wide
latitude in connection with this charge.1 Through delegation of the board’s authority,
officers also play a central role in the corporate enterprise,2 managing the day-to-day
affairs. Collectively, directors and officers are entrusted with control over vast aggrega-
tions of wealth, of which they may own very little, if any (Stout 2003; Steele 2012). There
is an inherent and, as prior corporate scandals have shown, very real risk in this type of
governance structure that corporate managers will exploit corporate resources for their
own personal gain (ABA Report 2009; Berle and Means 1932; Cheffins 2015).3 One way
in which corporate law combats this risk and constrains the broad authority and power
provided to these individuals is the imposition of fiduciary duties.4 Fiduciary duties set
forth the standards of conduct that we expect of corporate managers in discharging
their decision-making power—requiring directors and officers to exercise their author-
ity with care and loyalty to the corporation and its stockholders (Anabtawi and Stout
* It should be noted at the outset that this chapter primarily focuses on Delaware law with
respect to its discussions of fiduciary duties and stockholder litigation, as Delaware case law and
statutes are generally considered the leading source for corporate law. See Allen (2000) at 71 (stating
that the DGCL “is certainly the nation’s and indeed the world’s leading organization law for large
scale business enterprise”); Chandler and Strine (2003) at 959 (using Delaware law for their analysis
as it is “generally representative of state corporate laws”); Rehnquist (1992).
1
See Del. Code Ann. tit. 8, § 141(a) (2014); Model Bus. Corp. Act § 8.01(b) (2016).
2
For the purposes of this chapter, “officer” is intended to refer to senior executive officers such
as the chief executive officer, president, or chief financial officer. See DeMott (2017) for a discus-
sion of the indeterminacy in the definition of “officer” in corporate and securities law.
3
Prominent examples of harmful self-interested behavior by corporate managers include the
financial scandals at Enron and WorldCom, option backdating practices, and the events leading up
to and contributing to the financial crisis.
4
See Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) (“The existence and exercise of this power
carries with it certain fundamental fiduciary obligations to the corporation and its shareholders”);
Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1280 (Del. 1989) (“The fiduciary nature
of a corporate office is immutable”); Frankel (1983, 808) (“[T]he risk of abuse which all fiduciary
relations pose for the entrustors is the main feature which triggers the application of fiduciary law,
when the protective mechanisms outside of fiduciary law cannot adequately eliminate this risk”);
Alces (2009, 243) (“Fiduciary duties are considered the fundamental mechanism for monitoring
and disciplining corporate officers and directors, and appear to do the most to fix the standard of
behavior governing those corporate leaders”).
330
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Stockholder litigation 331
2008).5 Indeed, fiduciary duties have been cited as a central means of holding managers
accountable to stockholders (Shaner 2014; Shaner 2016a; Lebovitch and van Kwawegen
2016; Johnson and Ricca 2007). And stockholder litigation is “the primary mechanism
for enforcing the fiduciary duties of corporate managers” (Kraakman et al. 1994, 1733;
Thomas and Thompson 2012; Thompson and Thomas 2004; Shaner 2016b).
Scholars disagree on the effectiveness of fiduciary duties as a check on managerial
power and deterrent to malfeasance (for example, Taylor 2007; Johnson and Ricca 2007;
Alces 2009). This chapter is not engaging in that discourse; rather, the purpose here is to
highlight a vulnerability of corporate fiduciary doctrine—its sensitivity to and overreli-
ance on stockholder litigation for its content. Fiduciary duties are almost entirely, and in
jurisdictions such as Delaware completely, creatures of common law (DeMott 1988; Steele
2012). As a result, scholars have pointed out that plaintiffs’ attorneys play a prominent
role in shaping the law and governance practices by their litigation choices, particularly in
decisions surrounding which suits are filed and where those suits are litigated (Cheffins et
al. 2012; Shaner 2016a). The Achilles’ heel of fiduciary doctrine is thus its dependence on
stockholder litigation for the development and evolution of its content.6 The potentially
problematic situation that results from the dependent relationship between fiduciary
duties and stockholder litigation is illustrated by the absence of fiduciary doctrine relating
specifically to officers, as distinct from directors.
Contemporary discussions surrounding officers presume that the fiduciary obligations
of these individuals are identical to that of directors.7 Given the highly contextual nature
of fiduciary duties, however, a collective treatment of officer and director fiduciary obliga-
tions is at odds with the otherwise well-recognized distinction between officers’ and direc-
tors’ roles and rights in the corporation (Anabtawi and Stout 2008; Lamb and Christensen
2012; Shaner 2014; Johnson and Millon 2005; Shaner 2010; Balotti and Shaner 2011). The
5
See In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 114 n.6 (Del. Ch. 2009)
(“In defining [fiduciary duties], the courts balance specific policy considerations such as the need
to keep directors and officers accountable to shareholders and the degree to which the threat of
personal liability may discourage beneficial risk taking”).
6
Development of fiduciary duties is not limited to stockholder litigation; any litigation
brought before the court that raises fiduciary issues can contribute to the development of the
doctrine (e.g., board-instituted or creditor-instituted suits). The focus in this chapter is on
stockholder litigation because the overwhelming amount of fiduciary duty litigation occurs in that
context—direct (usually class action) or derivative suits instituted by stockholders (collectively,
“stockholder litigation”) (Kraakman et al. 1994, 1733; Thomas and Thompson 2012; Thompson
and Thomas 2004; Shaner 2016b).
7
See Gantler v. Stephens, 965 A.2d 695, 708–09 (2009) (describing officer fiduciary duties as
being “the same as those of directors”); In re Dole Food Co. S’holder Litig., consol. C.A. No 8703-
VCL, 9079-VCL, 2015 WL 5052214, at *40 (Del. Ch. Aug. 27, 2015). Examples of the clumping
of directors and officers for fiduciary duties discussions and analysis can be found in case law,
academic discussions, and legal practice. See, e.g., In re Citigroup Inc. S’holder Derivative Litig., 964
A.2d 106, 114 n.6 (Del. Ch. 2009) (“Delaware fiduciary duties are based in common law and have
been carefully crafted to define the responsibilities of directors and managers, as fiduciaries, to the
corporation”); Anabtawi and Stout (2008) at 1262–65 and 1307 (discussing officer and director
fiduciary duties in the same manner); Johnson and Ricca (2007) at 669 (finding that corporate
lawyers fail to regularly provide fiduciary duty advice to officers to the same degree they do for
directors).
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disconnect between differentiating directors from officers in the management hierarchy

and exercise of authority versus the fiduciary duty context is due, in large part, to the lack
of judicial guidance with respect to officers’ fiduciary duties. Delaware is well known for its
abundance of corporate case law, and its fiduciary doctrine is no exception (Rehnquist 1992;
Steele 2012; Parsons and Tyler 2013; Shaner 2014). Upon closer inspection, however, the
overwhelming majority of cases address director, not officer, fiduciary obligations (Shaner
2016b; Shaner 2016a; Balotti and Finkelstein 2014, 4.10[C]; Sparks and Hamermesh
1992; Johnson and Millon 2005). Indeed, traditional state law stockholder litigation rarely
focuses on officers or officer-specific action in breach of fiduciary duty claims (Shaner
2016b; Johnson 2017; Thompson and Sale 2003). The relative absence of guidance for
officers in this space has not gone completely unnoticed (for example, Johnson and Millon
2005; Lamb and Christensen 2012; Shaner 2014; Shaner 2016b; DeMott 2017; Johnson
2017). Even the Delaware courts acknowledge the deficiency in meaningful guidance in this
particular area of corporate law and the importance of filling that void.8
This chapter uses the current state of uncertainty and lack of attention to officer
fiduciary doctrine and surrounding principles as an illustration of the fragile relationship
between stockholder litigation and fiduciary duties. After briefly outlining the respective
roles and functions that corporate law assigns to directors and officers, this chapter
describes the divergence in the development of director and officer fiduciary doctrine. It
also discusses some of the main factors that contributed to the one-sided development
of fiduciary duties. In particular, stockholder litigation is sparingly used to hold officers
accountable for fiduciary breaches. An important consequence of this trend is that there
is no opportunity for the courts to adapt and elaborate on the application of the broader
fiduciary principles of care and loyalty to officers. The chapter then looks at emerging
trends in officer fiduciary accountability and the implications for stockholder litigation.
It concludes with some final thoughts on the importance of tailored fiduciary constructs
to address the particular problems attendant to the managerial role that officers occupy,
as distinct from directors, as well as the role of fiduciary duties in restoring a sense of
integrity and morality in corporate management.
2. DIRECTORS AND OFFICERS: A TALE OF TWO

FIDUCIARIES
Directors and officers of a corporation are frequently grouped together and described
as “management.” While these two groups collectively manage the corporate enterprise,
8
See, e.g., Chen v. Howard-Anderson, 87 A.3d 648, 666 n.2 (Del. Ch. 2014) (“A lively debate
exists regarding the degree to which decisions by officers should be examined using the same
standards of review developed for directors. Given how the parties have chosen to proceed, this
decision need not weigh in on these issues and intimates no view upon them”) (internal citations
omitted); Hampshire Grp., Ltd. v. Kuttner, No 3607-VCS, 2010 WL 2739995, at *11 (Del. Ch. July
12, 2010) (“There are important and interesting questions about the extent to which officers and
employees should be more or less exposed to liability for breach of fiduciary duty than corporate
directors. The parties in this case have not delved into any of those issues, and I see no justifiable
reason for me to do so myself ”).
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statutes and case law make clear that the roles, responsibilities, and authority of directors
and officers are fundamentally different (Balotti and Shaner 2011, 171; Shaner 2014;
Johnson and Millon 2005, 1601; Lamb and Christensen 2012). The board of directors is
the body statutorily tasked with managing the business and affairs of the corporation—a
charge that cannot be abdicated.9 Described as “the focal point of the corporate govern-
ance system,”10 the board’s centrality in corporate decisionmaking and the breadth of its
managerial power and responsibility is a bedrock principle of corporate law (Bainbridge
2003).11 In discharging their management authority, directors act collectively, exercising
deliberative decision-making as a group (O’Kelley and Thompson 2014, 149–50).
In comparison, an officer’s powers and duties are more limited, being fixed in the
bylaws or by resolution of the board of directors, and ultimately subject to the broad
discretion and authority of the board.12 At most public corporations, management of
the day-to-day operations is delegated by the board to the executive officers (Balotti and
Finkelstein 2014, §4.10[B]; Hill and McDonnell 2009, 343).13 “Typical functions of the
officers include entering into ordinary business transactions, devising business strate-
9
Del. Code Ann. tit. 8, § 141(a) (2014) (“[T]he business and affairs of every corporation . . .
shall be managed by or under the direction of a board of directors”); see also Kaplan ex rel Chase
Manhattan Corp. v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 729 (Del. 1988) (stating that it
is a “basic principal [sic] of [Delaware law] that the business and affairs of a corporation shall be
managed by the board of directors”); Grimes v. Donald, No CIV.A.13358, 1995 WL 54441, slip
op. at 17 (Del. Ch. Jan. 11, 1995) (the board may not formally or effectively abdicate its statutory
charge to manage the business and affairs of the corporation); Ash v. McCall, C.A. No 17132, slip
op. at 17 (Del. Ch. Sept. 15, 2000).
10
Standards Relating to Listed Company Audit Committees, Exchange Act Release No
33-8220, 68 Fed. Reg. 18,788, 18,789 (Apr. 16, 2003) (to be codified at 17 C.F.R. pts. 228, 229, 240,
249, 274), www.gpo.gov/fdsys/pkg/FR-2003-04-16/pdf/03-9157.pdf.
11
See Gorman v. Salamone, No C.A. 10183-VCN, 2015 WL 4719681, at *5 (Del. Ch. July 31,
2015) (“Section 141(a), which establishes ‘the bedrock statutory principle of director primacy’”);
see also McMullin v. Beran, 765 A.2d 910, 916 (Del. 2000).
12
See Del. Code Ann. tit. 8, § 142 (2001); see also Balotti and Finkelstein (2014) at § 4.10[A]
(“The term ‘management,’ however, is deemed to encompass ‘supervision, direction and control,’
while ‘the details of the business [may be] delegated to inferior officers, agents and employees”’
(quoting Canal Capital Corp. v. French, No 11764, 1992 WL 159008, at *3 (Del. Ch. July 2, 1992)));
Welch et al. (2016) at 4-358 (“Professor Folk commented in the first edition of this treatise that
apart from the bylaws or authorization by the board of directors, officers have relatively narrow
inherent or presumptive authority”). Officers have been distinguished from other employees in that
non-officer employees’ responsibilities do not arise from the bylaws. See Goldman v. Shahmoon, 208
A.2d 492, 493–94 (Del. Ch. 1965).
13
See Ribstein (2004) at 188 (“[T]he corporate form of centralized management involves
dividing management between professional full-time executives who manage the firm day-to-day
and directors who oversee the board and set policy”); Jana Master Fund, Ltd. v. CNET Networks,
Inc., 954 A2d 335, 340 (Del. Ch. 2008) (stating that “[officers] have the far more onerous task
of operating the company each day”); Grimes v. Donald, No CIV.A.13358, 1995 WL 54441, at
*8 (Del. Ch. Jan. 11, 1995) (“Of course, given the large, complex organizations through which
modern, multi-function business corporations often operate, the law recognizes that corporate
boards, comprised as they traditionally have been of persons dedicating less than all of their
attention to that role, cannot themselves manage the operations of the firm, but may satisfy their
obligations by thoughtfully appointing officers, establishing or approving goals and plans and
monitoring performance. Thus Section 141(a) of DGCL expressly permits a board of directors to
delegate managerial duties to officers of the corporation, except to the extent that the corporation’s
M4633-GRIFFITH_t.indd 333 30/10/2018 08:16

gies, setting business goals, managing risks, and generally working with subordinates to
‘[p]lan, direct, or coordinate operational activities”’ (Johnson and Ricca 2007, 78–9).
Unlike directors, officers are afforded more autonomy in performing their jobs, being
able to act individually and generally without the formalities of meetings or written
consent (Shaner 2016a).14 At all times, however, the board of directors retains its power
and authority to manage the corporate enterprise and officers are subject to the ultimate
control and oversight of the board (Ribstein 2004).15 Today, directors in the modern
public corporation select senior officers “and then step aside, intervening only in times
of crisis, or on very large issues such as a merger or major refinancing” (Stout 2003, 18).
Taken together as the managers of the corporation, directors and officers are allowed
to exercise power over vast aggregations of property of which they may hold very little
(Stout 2003; Steele 2012).16 Critical to the legitimacy of this separation of control from
ownership are the fiduciary duties that directors and officers owe to the corporation and its
stockholders. Described as “unyielding,” fiduciary duties do not “operate intermittently,”
but apply to directors and officers at all times in carrying out their responsibilities.17 As
explained by the Delaware Court of Chancery:
[The Delaware General Corporation Law] provides corporate directors and officers with broad
discretion to act as they find appropriate in the conduct of corporate affairs. It is therefore left
to Delaware case law to set a boundary on that otherwise unconstrained realm of action. The
restrictions imposed by Delaware case law set this boundary by requiring corporate officers
and directors to act as faithful fiduciaries to the corporation and its stockholders. Should these
corporate actors perform in such a way that they are violating their fiduciary obligations—their
core duties of care or loyalty—their faithless acts properly become the subject of judicial action
in vindication of the rights of the stockholders. Within the boundary of fiduciary duty, however,
these corporate actors are free to pursue corporate opportunities in any way that, in the exercise
of their business judgment on behalf of the corporation, they see fit.18
State common law provides the basis for the fiduciary constraint on management power
and abuse (Steele 2012; DeMott 1988).19 Fiduciary duties can be, and at least in the
c ertificate of incorporation or bylaws may limit or prohibit such a delegation” (citations omitted)),
aff’d, 673 A.2d 1207 (Del. 1996).
14
See, e.g., Del. Code Ann. tit. 8, § 141(f) (2014) (providing for director written consent); §
141(b) (providing for quorum and vote requirements for board meeting and actions); Model Bus.
Corp. Act § 16.01 (2016) (providing for specific corporate records).
15
As explained by the ABA Section of Business Law, “The board . . . typically delegates
significant authority for the day-to-day operations to a professional CEO and other executive
officers, who in turn derive their management authority from the board of directors. To the extent
that a board delegates its management, it must exercise reasonable oversight and supervision over
management.” ABA Report (2009) at 122–23.
16
Under state law stock ownership is not a requirement for service as either a director or officer
of a corporation. See, e.g., Del. Code Ann. tit. 8, § 141(b) (2014) (“Directors need not be stockhold-
ers unless so required by the certificate of incorporation or the bylaws”).
17
See Emerald Partners v. Berlin, 787 A.2d 85, 90 (Del. 2001); Mills Acquisition Co. v.
Macmillan, Inc., 559 A.2d 1261, 1280 (Del. 1998) (“The fiduciary nature of a corporate office is
immutable”).
18
In re Goldman Sachs Grp., Inc. S’holder Litig., No 5215-VCG, 2011 WL 4826104, at *1 (Del.
Ch. Oct. 12, 2011).
19
Even under the Model Business Corporation Act, which addresses the fiduciary duties of
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irector context frequently are, enforced by stockholders suing for breaches of those duties
d
(Thompson and Sale 2003). In fact, stockholder litigation has been described as essential
to a successful system of corporate governance and management accountability—giving
meaning to the abstract concepts of fiduciary duties, supporting the disciplinary effect of
those duties, and encouraging desirable conduct (Thomas and Thompson 2012; Schwartz
1986; Davis 2008; Kraakman et al. 1994; Nees 2010).20
As a creature of common law, fiduciary duties evolve through the opinions of the
Delaware courts. Dating back to 1926,21 volumes of Delaware decisions have carefully
crafted the fiduciary obligations of directors. Not only the dual fiduciary duties of
care and loyalty, but also the “specific subsidiary fiduciary rules that elaborate on the
application of [those broader primary duties]” such as the duties of good faith, oversight,
and disclosure, have become well-developed and refined (Sitkoff 2014, 198; Steele 2012;
Balotti and Finkelstein 2014).22 Moreover, the courts have explained the application of
directors’ fiduciary duties in numerous different contexts: mergers, defensive actions,
sales of assets, dividends, corporate opportunity, stock options, bylaw amendments,
stockholder meetings, and so on. As described by Edward Rock, notwithstanding “the
fact specific, narrative quality of Delaware judicial opinions, over time [those decisions]
yield reasonably determinative guidelines” for the role and duties of directors (Rock 1997,
1017).
The specific issue of officers’ fiduciary duties, by contrast, has been a neglected area of
Delaware law for more than 70 years (Shaner 2014; Johnson and Millon 2005; Johnson
and Ricca 2007; Sparks and Hamermesh 1992). While courts and commentators agree that
officers owe fiduciary duties of some sort, Delaware courts have been largely silent on the
particulars of the subject. By way of example, in a well-known treatise on Delaware corpo-
rate law the discussion of directors’ fiduciary obligations spans almost 300 pages while the
corresponding section for officers is only five (Welch et al. 2016, 4-25–4-312, 4-356–4-360).
Indeed, it was not until 2009 that the Delaware Supreme Court addressed “a matter of first
impression”—whether or not officers owe fiduciary duties identical to those of directors,
corporate directors and officers, the exact contours of the broad duties of care and loyalty are left
to be developed in case law.
20
See Lebovitch and van Kwawegen (2016) at 500 (“[T]he Delaware Supreme Court has
expressly affirmed the importance of the stockholders’ right to hold fiduciaries accountable
through litigation, stating that ‘[t]he machinery of corporate democracy and the derivative suit
are potent tools to redress the conduct of a torpid and unfaithful management’” (quoting Rales v.
Blasband, 634 A.2d 927, 933 (Del. 1993)).
21
See Bodell v. General Gas & Electric Corp., 132 A. 442 (Del. Ch. 1926), aff’d, 140 A.2d 264
(Del. 1927) (recognizing the fiduciary duties of directors of Delaware corporations); Holland
(2009) at 680 (pointing to Bodell as the likely first expression of director fiduciary duties).
22
See Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) (duty of care); Stone ex rel. AmSouth
Bancorp. v. Ritter, 911 A.3d 362, 370 (Del. 2006) (holding that directors owe the fiduciary duty of
care and the duty of loyalty and that the obligation to act in good faith is not “an independent
fiduciary duty that stands on the same footing as the duties of care and loyalty”); Guth v. Loft, Inc.,
5 A.2d 503, 510 (Del. 1939); In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 751 (Del. Ch.
2005); Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998) (duty of disclosure); Beam v. Stewart, 833 A.2d
961, 971 n.16 (Del. Ch. 2003) (“The ‘duty to monitor’ is not a separate fiduciary duty, but rather
stems from the core fiduciary duties of care and loyalty”), aff’d, 845 A.2d 1040 (Del. 2004); In re
Caremark Int’l Inc. Derivative Litig., 689 A.2d 959 (Del. 1996) (duty of oversight).
M4633-GRIFFITH_t.indd 335 30/10/2018 08:16

holding in the affirmative.23 In declaring the fiduciary obligations of officers and directors
to be the same, the Gantler court made reference to the familiar fiduciary duties of care and
loyalty.24 Given the significant differences in the roles and responsibilities of directors and
officers, however, it would be untenable to import the robust body of law governing direc-
tor fiduciary duties to officers without considerable tailoring. Thus, while superficially the
Gantler decision seems to resolve questions surrounding officers’ fiduciary duties, a more
accurate characterization is that the decision laid the groundwork for the future develop-
ment of officer fiduciary doctrine. Unfortunately, post-Gantler decisions have added only
sparingly to its initial principles (Shaner 2016b). Important aspects of an officer’s fiduciary
obligations such as the application of the business judgment rule, the standard of liability
for the duty of care, the application of the duty of good faith, oversight responsibilities,
disclosure obligations, and the potential role of the duty of obedience have to date been
left unexamined by the courts and, as a result, unsettled (Johnson and Garvis 2009; Shaner
2010; Shaner 2016b; Laster and Haas 2009; Johnson 2017; DeMott 2017).25
3. EXPLANATIONS FOR THE DIVERGENCE IN FIDUCIARY

DOCTRINE
There are several facets of corporate law and governance norms that contributed (some of
which continue to contribute) to the divergence in the development of director and officer
fiduciary duties. Because case flow is vital to the refinement of fiduciary obligations,
these factors coalesce around stockholder litigation.26 Scholars have largely attributed
the continued lack of clarity in this area of the law to the low amount of fiduciary duty
litigation involving officers (Shaner 2016b; Shaner 2016a). Even the Delaware courts
have seemingly recognized this trend in stockholder litigation, as well as the importance
of providing guidance on officer duties, extending invitations to the parties to raise these
issues so that the court may fully address them (Shaner 2016b). So why do officers receive
so little attention in stockholder litigation? This section describes the main factors and
explains how, at key times in economic history, they have resulted in missed opportunities
for the Delaware courts to elaborate on the fiduciary obligations of officers.
3.1 Explanations
One clear cause of the absence of officer case law is the Delaware courts’ historic lack of
jurisdiction over individuals serving as officers of Delaware corporations. Prior to 2004,
23
Gantler v. Stephens, 965 A.2d 695, 708-09 (Del. 2009).
24
Ibid at 709.
25
See, e.g., Palmer v. Reali, Civ. No 15-994-SLR (D. Del. Sept. 29, 2016) (noting that
“Defendants have cited to no cases where a Delaware court has held that the business judgment
rule applies to corporate officers”). See also Amalgamated Bank v. Yahoo! Inc., 2016 WL 402540, at
*18 n.24 (Del. Ch. Feb. 2, 2016); Chen v. Howard-Anderson, 87 A.3d 648, 666 n.2 (Del. Ch. 2014);
Hampshire Grp., Ltd. v. Kuttner, No 3607-VCS, 2010 WL 2739995, at *11 (Del. Ch. July 12, 2010).
26
“As surely Rome was built brick-by-brick, so too has Delaware developed its corporate
jurisprudence case-by-case” (Parsons and Tyler 2013, 483; Rehnquist 1992; Savitt 2012).
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the Delaware Code only provided for personal jurisdiction over nonresident directors of
Delaware corporations.27 Thus, until very recently nonresident officers were beyond the
reach of the Delaware courts.28 As a practical matter, the lack of jurisdiction was not an
insurmountable hurdle to holding many executive officers accountable for misconduct,
albeit not in their officer capacity. Historically a large percentage of executive officers
at public corporations also served on that corporation’s board of directors (Gordon
2007).29 Many executive officers were thus subject to personal jurisdiction in Delaware by
virtue of their director role. The effect of the widespread officer/director overlap meant
that for decades Delaware’s “case law has focused on the fiduciary duties of corporate
directors because boards have tended to include those key executives in a position to
extract private rents from the firm at the expense of the stockholders” (Chandler and
Strine 2003, 1002–3). For example, in the classic duty of care case Smith v. Van Gorkom,
the court repeatedly discussed the failings of chief executive officer Jerome Van Gorkom
in orchestrating the sale of Trans Union without board participation or knowledge.30
Including Van Gorkom, five of the ten directors on the Trans Union board were also
officers at the corporation.31 While the court recognized the different roles that certain
defendants occupied within the corporate management structure, its analysis of fiduciary
fidelity and assessment of liability for fiduciary breaches did not differentiate based on
management capacity and was focused only on the director role.32
The procedural law surrounding stockholder litigation, in particular derivative lawsuits,
also plays a central role in preventing the development of officer fiduciary duties.33 The pro-
cedural rules (and corresponding case law) governing derivative lawsuits create s ignificant
27
See 61 Del. Laws 328 (1977); Del. Code Ann. tit. 10, § 3114 (1999). For a more detailed
discussion of Delaware’s personal jurisdiction over corporate actors, see Chiappinelli (2017);
Chiappinelli (2014); Chiappinelli (2013); Jacobs (1979); Winship (2013).
28
See, e.g., Gebelein v. Perma-Dry Waterproofing Co., No 6210, 1982 WL 8776 (Del. Ch. Jan.
12, 1982) (holding that the court did not have personal jurisdiction over nonresident, nondirector
officers by reason of their officer status alone); Kelly v. McKesson HBOC, Inc., No 99C-09-
265WCC, 2002 WL 88939 (Del. Super. Ct. Jan. 17, 2002) (finding that Delaware state courts did
not have personal jurisdiction over nonresident executive vice president and chief financial officer
of Delaware corporation).
29
Professor Jeffrey Gordon, for instance, reports that the percentage of inside directors at
public corporations in 1950 was approximately 50 percent (Gordon 2007, 1471, 1473–75). See also
Velikonja (2014) at 857 (citing Spencer Stuart, 2010 Spencer Stuart Board Index 3 (2010)) (“In
1986, only three boards (or only 3% of the 100 boards reviewed) had the chairman/CEO as the
sole insider”).
30
Smith v. Van Gorkom, 488 A.2d 858, 874 (Del. 1985).
31
Ibid at 867–69.
32
Ibid at 889; Macey (2002). Another example is the lengthy Disney litigation surrounding
the hiring and firing of president Michael Ovitz and the plaintiffs’ late attempt to distinguish
defendants’ officer actions from their director conduct. In re Walt Disney Co. Derivative Litig.,
907 A.2d 693, 777 n.588 (Del. Ch. 2005) (“The parties essentially treat both officers and directors
as comparable fiduciaries, that is, subject to the same fiduciary duties and standards of substan-
tive review. Thus, for purposes of this case, theories of liability against corporate directors apply
equally to corporate officers, making further distinctions unnecessary”), aff’d, 906 A.2d 27 (Del.
2006).
33
It is important to note that the vast majority of breach of fiduciary duty claims against
officers will be derivative in nature. See Thomas and Thompson (2012) at 1784 (citing options
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hurdles for stockholders thereby deterring its use.34 To file derivative litigation without
first making a demand on the board of directors, a stockholder must allege particularized
facts creating a reasonable doubt that: (1) a majority of the board is disinterested and
independent; or (2) the challenged decision was a valid exercise of business judgment.35 If a
stockholder-plaintiff fails to meet this standard, the court will dismiss the complaint even if
the underlying breach of fiduciary duty claim against an officer is otherwise meritorious.36
Where officer but not also director conduct is being challenged, showing demand
futility is even more daunting. In this scenario, the test for determining whether demand
is excused is “whether or not the particularized factual allegations of a derivative stock-
holder complaint create a reasonable doubt that, as of the time the complaint is filed, the
board of directors could have properly exercised its independent and disinterested busi-
ness judgment in responding to a demand.”37 To be successful under this test, a showing
of deferential board behavior or even a role reversal in corporate management will not
be sufficient; rather, the inability to exercise independent judgment by a majority of the
board is required to survive a motion to dismiss.38 And further confounding stockholders’
efforts to satisfy their burden is a lack of discovery rights.39 Moreover, the combination of
backdating as an example of derivative suits being used to attack directors or officers for breach of
the duties of loyalty (including good faith) and care).
34
The problematic nature of the law governing stockholders’ ability to bring derivative lawsuits
has been widely documented. See, e.g., Coffee and Schwartz (1981); Fairfax (2005); Fischel and
Bradley (1986); Rodrigues (2009); Shaner (2014).
35
See Brehm v. Eisner, 746 A.2d 244, 253 (Del. 2000); Aronson v. Lewis, 473 A.2d 805, 814–15
(Del. 1984), overruled on other grounds by Brehm, 746 A.2d at 253. The particularity requirement
to show demand futility under Delaware Chancery Court Rule 23.1 is a more stringent standard
than the notice pleading standard that generally applies to complaints. See Balotti and Finkelstein
(2014) at § 13.12; see also Grobow v. Perot, 539 A.2d 180, 187 (Del. 1988) (stating that in considering
a derivative complaint “upon a motion to dismiss, only well-pleaded allegations of fact must be
accepted as true; conclusionary allegations of fact or law not supported by allegations of specific
fact may not be taken as true”), overruled on other grounds by Brehm, 746 A.2d at 253; In re Nat’l
Auto Credit, Inc., C.A. No 19028, 2003 WL 139768, at *12 n.69 (Del. Ch. Jan. 10, 2003) (stating
that the standard under Rule 23.1 is more rigorous than under Rule 12(b)(6)).
36
See Del. Ch. Crt. R. 23.1; Brehm, 746 A.2d at 253; Aronson, 473 A.2d at 814–15.
37
Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993). Two examples where stockholder claims
against officers and not directors were dismissed for failure to make a demand are Desimone v.
Barrows, 924 A.2d 908, 914 (Del. Ch. 2007) (dismissing suit for failure to make a demand because
none of the directors received the improper option grants made to the officers) and In re Sanchez
Energy Derivative Litig., No 9132-VCG, 2014 WL 6673895, at *13 (Del. Ch. Nov. 25, 2014) (dis-
missing claims against the officer-defendant because the stockholder was unable to show that the
board would be unable to consider a demand to file suit against the officer). Where stockholders
choose to go the demand refused route—challenging a board’s refusal of a stockholder demand
to bring suit against an officer—they are met with an even steeper road to climb. E.g., Zucker v.
Hassell, C.A. No 11625-VCG, 2016 WL 7011351 (Del. Ch. Nov. 30, 2016) (dismissing stockholder
action because board did not improperly reject demand to sue officers).
38
See Aronson, 473 A.2d at 816 (stating that “[t]he shorthand shibboleth of ‘dominated and con-
trolled directors’ is insufficient” to excuse demand); Orman v. Cullman, 794 A.2d 5, 27 (Del. Ch. 2002);
Balotti and Finkelstein (2014) at § 13.14[B] (“[A]n unsupported allegation of domination and control
of directors by one interested in the transaction is insufficient to demonstrate demand futility”).
39
See Rales, 634 A.2d at 934 n. 10 (“[D]erivative plaintiffs . . . are not entitled to discovery to
assist their compliance with Rule 23.1”).
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a lack of fiduciary duty case law and evidentiary challenges surrounding officer decision-
making, when taken in the context of derivative litigation and its procedural hurdles, make
it extremely difficult for a stockholder-plaintiff to survive a motion to dismiss for failure
to make a demand when challenging the actions of officers (Shaner 2014; Shaner 2016a).
Finally, the “director preference” in stockholder litigation—the apparent longstanding
preference in stockholder litigation involving fiduciary duty breaches to sue a corpora-
tion’s directors to the exclusion of the officers—has been attributed to agency costs
resulting from attorney self-interest (Shaner 2016a). Where, as is the case in stockholder
litigation, the financial aspects of a lawsuit are the practical drivers of decisions such
as inclusion or exclusion of certain defendants, there is a high risk that attorneys will
make those decisions in their own self-interest (Coffee 1986; Bainbridge 2002; Coffee
1985; Macey and Miller 1991). As compared to directors, corporate officers are more
challenging and expensive individuals to hold accountable for breaches of their fiduciary
duties—two factors that run contrary to the financial incentives of plaintiff’s counsel in
stockholder litigation (Shaner 2016a).40 This means that, except for instances of egregious
misconduct, legal counsel will pursue fiduciary duty claims against directors but not
officers.
In sum, no single factor is responsible for the fiduciary doctrine of officers lagging
far behind their managerial counterpart, the board of directors. Certain elements of
corporate law, however, likely play a larger role than others in deterring officer litigation
and stunting the progression in this area of the law. The amendment of Section 3114
in 2004 to provide for personal jurisdiction over certain executive officers alleviated a
significant barrier to the use of stockholder litigation as a tool to enforce officer fiduciary
obligations.41 Around this same time there was a dramatic shift underway in corporate
governance norms that had been buttressed by federal regulation to create greater board
independence from officers (Gordon 2007; Kahan and Rock 2010; Velikonja 2014).42
Despite these changes, over the past 12 years there has been little movement in the rate
at which officers are subject to stockholder litigation, and relatedly a lack of further
development in officer fiduciary doctrine (Shaner 2016b).43 The continued absence of
40
See Shaner (2016a) for a discussion of the challenges and expenses related to including
officers in stockholder lawsuits.
41
See Del. Code Ann. tit. 10, § 3114(b). The amendment to the statute became effective
January 1, 2004. Ibid (providing for personal jurisdiction over officers of Delaware corporations
with respect to all civil actions or proceedings where such officer “is a necessary or proper party, or
in any action or proceeding against such officer for violation of a duty in such capacity, whether or
not the person continues to serve as such officer at the time suit is commenced”); see also Chandler
and Strine (2003) at 962.
42
See Gordon (2007) at 1471, 1473–75 (estimating that the percentage of inside directors at
public corporations decreased from 50 per cent in 1950 to approximately 15 per cent in 2005, with
independent directors having increased their board representation from 20 per cent to 75 per cent
over the same time period); ibid (finding that the trend in greater director independence began
prior to the enactment of the NYSE, NASDAQ, and Sarbanes–Oxley requirements, indicating
a shift in best practices and corporate culture toward greater independence before it was legally
required); Kahan and Rock (2010) at 1024–25 (observing that the number of employee directors at
S&P 500 corporations declined from about 2.1 in 2000 to 1.5 in 2007).
43
Even adding in the Delaware Supreme Court’s 2009 decision in Gantler where the court
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officer-focused fiduciary duty litigation indicates that the tough doctrinal barriers that
apply to derivative litigation are continuing to have a major impact.
3.2 Missed Opportunities
Scholars have observed that “[e]very year or so, the caseload of the Delaware Court of
Chancery tends to gravitate toward one or more timely topics in the law of corporations”
(Parsons and Tyler 2013, 474). As a general matter, widespread corporate misconduct is
viewed as demonstrating a need for corporate law reform. Thus, not surprisingly, events
affecting the national economy tend to engender and affect the stockholder litigation
presented to the Delaware courts (Parsons and Tyler 2013, 477 and 487). This progression
by which corporate common law develops has been described as being beneficial, allowing
“Delaware courts [to] confront different facets of a current issue in the factual contexts of
multiple, roughly contemporaneous cases. The result often is a more nuanced treatment
of complex issues” (Parsons and Tyler 2016, 377; Savitt 2012).
Two instances where officer fiduciary duties were clearly a timely topic in corporate
law are, first, the financial fraud uncovered in 2001 at Enron, Worldcom, Adelphia, and
Tyco; and second, the financial crisis that began in 2007. In both cases, widespread officer
malfeasance was uncovered (Shaner 2014, 290–3; Hamilton 2003, 13–33; Dallas 2012,
281–93; Rodrigues 2009, 3). In the aftermath of such largescale scandals, the corporate
community began to reevaluate and rethink corporate governance norms and policy.44
Legislators and regulators took action by adopting Sarbanes–Oxley, Dodd–Frank, and
regulatory reform at the New York Stock Exchange and NASDAQ (Hamilton 2003, 40–5;
Shaner 2014, 290–3).45 Recognizing the role senior executives played in these events, part
of this reform was directly aimed at regulating the conduct of corporate officers (Shaner
2014, 290–3).46
sought to clarify officers’ fiduciary obligations, there has not been a noticeable impact on officer
fiduciary case law (Shaner 2016b).
44
See generally Sale (2007) at 720 (noting that corporate scandals “raise . . . questions about
the place of officers, the role of the board, the appropriate measure for fiduciary duties, and the
corporate-governance structure more generally”).
45
See Sarbanes–Oxley Act, Pub. L. No 107-204, § 302, 116 Stat. 745, 777 (2002) (codified at 15
U.S.C. §§ 78m, 78o); Dodd–Frank, Pub. L. No 111-203, 124 Stat. 1376 (2010) (codified in scattered
sections of 5 U.S.C., 7 U.S.C., 12 U.S.C., 15 U.S.C., 22, U.S.C., 26 U.S.C. and 28 U.S.C.); see also
Johnson and Millon (2005) at 1614–15 (discussing the various regulatory reforms); Sale (2007) at
456–57 (same). These legislative and regulatory efforts have, however, been criticized as ineffective
in correcting the perceived problems in corporate governance. See, e.g., Fisch (2013) at 745 (discuss-
ing the “relative deficiencies of federal alternatives” and stating that “[a]lthough it is too early to
evaluate Congress’ response under Dodd-Frank, the initial evidence is less than promising and rein-
forces commentators’ prior intuitions about the superiority of state regulation”); Romano (2005) at
1529–43, 1602 (evaluating the corporate governance mandates in Sarbanes–Oxley and finding that
“extensive empirical literature suggests that those mandates were seriously misconceived, because
they are not likely to improve audit quality or otherwise enhance firm performance and thereby
benefit investors”); Fairfax (2002) at 3–4 (“Yet if the current climate serves as any indicator, the
existing law has not served to promote personal responsibility among corporate officers”).
46
See, e.g., Dodd–Frank, Pub. L. No 111-203, §§ 951, 952, 124 Stat. 1376, 1899, 1900
(2010) (codified at 15 U.S.C. §§ 78j, 78n) (providing for stockholder advisory votes on executive
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Compared to the corporate governance reform taking place at the federal level, the
Delaware courts were relatively silent with respect to officers (Thompson and Sale 2003,
886). Each of these corporate and economic disasters would have provided a platform for
the Delaware courts to articulate the proper standards of conduct governing corporate
officers. Unfortunately, to the extent that stockholder litigation related to these events
implicated officer fiduciary issues, the barriers previously discussed—in particular, a lack
of personal jurisdiction and director/officer overlap—stopped those efforts.47
4. FUTURE DIRECTIONS FOR OFFICER ACCOUNTABILITY

As mentioned in the prior section, the stiff doctrinal barriers applicable to derivative
lawsuits are continuing to have a chilling effect on the use of stockholder litigation as
a tool to enforce officers’ fiduciary duties (Shaner 2014; Shaner 2016a). If this trend
continues, it will put pressure on other corporate governance mechanisms to counteract
the shortage in litigation accountability for officers.48 Those could include: (1) monitoring
and enforcement of fiduciary duties by the board; (2) hedge fund activism; (3) Say on Pay
votes; and/or (4) appraisal arbitrage (Stout 2003; Cox and Thomas 2016; LaCroix 2015;
Korsmo and Myers 2015). Of these possibilities, board oversight is frequently pointed to
as a check on officer power. In particular, the movement to greater board independence
from management at public corporations has been championed as creating a freer, more
active monitoring body (Kahan & Rock 2010; Elson & Gyves 2003). Scholars have,
however, cautioned against an overreliance on board oversight as a meaningful safeguard
against officer misconduct (Shaner 2016a; Dammann 2010). Taking a closer look at
independent directors, McDonnell and King point out that “there is no a priori attribute
of formal independence that necessitates a natural inclination” for directors to pursue the
interest of stockholders such as active monitoring and disciplining (when necessary) of
a corporation’s officers (McDonnell & King 2011, 3).49 In fact, their study of the market
for independent directors suggests that the directorial market is actually a managerialist
market—aligned with and promoting the interests of officers (McDonnell & King 2011, 6
c ompensation, independent compensation committees, and disclosure of executive compensation);

Sarbanes-Oxley Act, Pub. L. No 107-204, § 302, 116 Stat. 745, 777 (2002) (codified at 15 U.S.C.
§§ 78m, 78o) (requiring a public corporation’s chief executive officer and chief financial officer to
certify financial reports filed under the federal securities laws).
47
For example, related to the financial crisis, claims were brought against former directors
and officers of AIG and Citigroup in In re American International Group, Inc., 965 A.2d 763 (Del.
Ch. 2009), and In re Citigroup Inc., 964 A.2d 106 (Del. Ch. 2009). In both of these cases, however,
the court did not address the fiduciary duties of individuals as officers as distinct from directors
because the defendants served in a dual capacity for the corporations (and in the case of In re
American International Group, Inc., the court dismissed the claims against the non-director officers
and employees on jurisdictional grounds). See 965 A.2d at 814–15.
48
The section focuses on future directions for officer accountability at the state law level. For a
discussion of the different ways in which more robust legal activity involving corporate officers is
taking place at the federal level, see Johnson (2017).
49
See also Rodrigues (2008) at 463 (discussing criticisms of reliance on board independence,
including that defining formal independence in “terms of non-management status alone, does not
guarantee a good monitor”).
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and 18). And even the most well-intentioned, independent directors appear to be limited
in their actual ability to be an active monitor and rein in corporate management. As one
recent study on board oversight concluded, “it is unreasonable to expect boards to be
able to do an effective job at ongoing monitoring. We show that for most boards there
are significant barriers at the director, board and firm level that prevent them from being
effective monitors.” (Boivie, et al., 2016b). “[I]n many cases even the most motivated
directors will be unable to effectively monitor executives because of the many barriers
that limit the acquisition, processing and sharing of adequate information” (Boivie, et al.
2016a, 343).50
With respect to stockholders, there have already been modest attempts, using tools other
than litigation, to hold officers accountable for their behavior. For example, in Gorman
v. Salamone, a majority stockholder acting by written consent amended the bylaws to
provide, among other things, that “[a]ny officer may be removed, with or without cause,
at any time by the Board or by the stockholders acting at an annual or special meeting
or acting by written consent.”51 Relying on the amended bylaw, the stockholder then
removed the chief executive officer and elected himself to the position.52 The Court of
Chancery invalidated the bylaw, stating that “Delaware law does not allow stockholders to
remove directly corporate officers through authority purportedly conferred by a bylaw.”53
The court explained that Section 142 of the General Corporation Law only addressed the
manner in which officers could be selected or vacancies filled and did not expressly provide
guidance on removal of an officer, thus the bylaw was not authorized by the statute.54 The
court similarly rejected the argument that stockholders generally have the power under
Section 109 of the General Corporation Law to amend the bylaws in this manner. The
court held that a bylaw allowing stockholders to directly remove officers would “unduly
interfere with directors’ [141(a)] management prerogatives by preventing them from
discharging one of their most important functions”—the hiring and firing of executive
officers.55 Even before Gorman, scholars had similarly indicated that officer selection,
monitoring, and removal was a task that fell within the clear purview of the board, and
not the stockholders, in exercising its management power (Baird and Rasmussen 2007,
923; Eisenberg 1975, 403; Rodrigues 2013, 1075).56
Using a different tactic to leverage their stockholder status within the corporation to
affect corporate officers, activist stockholders have engaged in proxy battles to remove
50
See also Mitchell (2005) at 463 (“[I]f the only officer on the board is the CEO, then [a]s
the sole bridge between corporate management and the board, the CEO is put in an enormously
powerful position. He has a monopoly over the information delivered to the body ultimately
responsible for the integrity of corporate management and information”); Sharpe (2013).
51
C.A. No 10183-VCN, 2015 WL 4719681, at *2 (Del. Ch. July 31, 2015).
52
Ibid at *2.
53
Ibid at *4.
54
Ibid at *4–5.
55
Ibid at *4; see also Klassen v. Allegro Develop. Corp., C.A. No 8626-VCL, 2013 WL 5967028,
at *15 (Del. Ch. Nov. 7, 2013) (“Often it is said that a board’s most important task is to hire, moni-
tor, and fire the CEO”).
56
A possible way around the Gorman court’s holding would be to put the officer removal provi-
sion at issue in the certificate of incorporation instead of the bylaws.
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chief executive officers (CEOs) (Anabtawi and Stout 2008, 1285).57 Proxy campaigns
to remove an officer have, however, limited chances of success as a legitimate check on
management. First, scholars have questioned the actual effectiveness of a proxy contest
on disciplining incumbent managers (for example, Grundfest 1993). Second, and more
important, in light of Gorman’s limitation on stockholder removal of officers, a campaign
can, at best, only put pressure on the board to effectuate a removal, but cannot require
such action.58
In limiting other avenues for stockholders to hold officers accountable such as in
Gorman, the courts are intentionally or implicitly funneling stockholders back to litiga-
tion as the principal means for enforcing officer fiduciary duties. This is not to say that
these other tools are useless. To the contrary, nonlitigation mechanisms can be beneficial
in monitoring officer conduct and bolstering efforts to sue officers. Nevertheless, taking a
critical look at the current corporate governance structure, all of the mechanisms which
corporate law provides to stockholders to protect their interest vis-à-vis officers are
ineffective in light of the protected position that officers occupy within corporate man-
agement (Shaner 2014). Perhaps as an unintended consequence, the breadth of Section
141(a)’s language, the power it bestows on boards of directors, and the dedication with
which courts protect board authority and primacy from stockholder encroachment,59
have insulated officers from meaningful stockholder oversight and discipline. Indeed,
board primacy under Section 141(a) serves as the foundational basis for imposing tough
procedural rules governing stockholders’ ability to institute derivative lawsuits,60 and
57
See, for example, the proxy campaign organized by the California Public Employees’
Retirement System (CalPERS) to remove Safeway’s chairman and CEO. See Tom Petruno,
Backlash Confronts CalPERS, L.A. Times, May 20, 2004, at C1; James F. Pletz, Pension Funds
Seek to Oust Safeway Chairman, L.A. Times, Mar. 26, 2004, at C1; Jenny Strasburg, Safeway CEO
Burd Survives Vote: Campaign to Strip Him of Chairman Role Falls Short, S.F. Chron., May 21,
2004, at C1.
58
Moreover, at its worst, stockholder campaigns to remove officers may be motivated by
extracting benefits for themselves and not the corporation and stockholders more generally. See,
e.g., ibid (reporting that the grocery workers’ union was behind CalPERS and its proxy campaign
in an effort to influence a standoff the union was having with Safeway over pay and benefits);
Stephen Bainbridge, Unions as Shareholder Activists, ProfessorBainbridge.com (Mar. 16, 2006),
www.professorbainbridge.com/professorbainbridgecom/2006/03/unions-as-shareholder-activists.
html (discussing examples of unions acting in a self-interested manner in this context). Occurring
outside of the courthouse, stockholder proxy campaigns lack the check on stockholder self-interest
from the court that is present in stockholder litigation. See, cf. Anabtawi and Stout (2008) (advocat-
ing for fiduciary duties for activist stockholders).
59
See, e.g., Paramount Commc’ns, Inc. v. Time Inc., 571 A.2d 1140, 1150 (Del. 1989) (describing
the “broad mandate” in Section 141(a)); Gorman v. Salamone, C.A. No 10183-VCN, 2015 WL
4719681, at *5 (Del. Ch. July 31, 2015) (“Section 141(a), which establishes ‘the bedrock statutory
principle of director primacy,’ specifies that ‘[t]he business and affairs of every corporation . . . shall
be managed by or under the direction of a board of directors, except as may be otherwise provided
in this chapter or in its certificate of incorporation’”); In re CNX Gas Corp. S’holders Litig., 2010
WL 2291842, at *5 (Del. Ch. May 25, 2010) (“[D]irector primacy remains the centerpiece of
Delaware law, even when a controlling stockholder is present”); see also CA, Inc. v. AFSCME
Emps. Pension Plan, 953 A.2d 227, 232 (Del. 2008).
60
See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), overruled on other grounds by Brehm v.
Eisner, 746 A.2d 244 (Del. 2000).
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preventing stockholders from removing officers from office.61 As described by Lyman

Johnson, “we don’t legally ‘see’ the officer aspect of Delaware law because our observa-
tion is clouded by the more conspicuous director-primacy aspect of Delaware law that
stands in the forefront” (Johnson 2018, 193). Thus, it may take another “perfect storm”
of widespread officer malfeasance, as was the case in 2001 and 2007, to spur not only the
volume of litigation necessary (Parsons and Tyler 2013) but also a convincing case for
plaintiffs and the courts to push past the protective barriers of Section 141(a) and address
officer conduct and fiduciary duties.
Finally, so long as the absence of officers in stockholder litigation continues, the
Delaware courts will not have the opportunity to develop the law governing these individu-
als. The only other avenue then left available for articulating their obligations would be by
statutory amendment. This is, however, highly improbable due to the fact that fiduciary
duties are solely a creature of common law in Delaware, and that fundamental tradition
is unlikely to change. Even setting aside this hurdle, significant shifts in corporate law via
statutory amendment in Delaware are few, usually responding to significant legal or eco-
nomic developments (Parsons and Tyler 2013, 485).62 Thus, as with stockholder litigation,
it would take a large-scale corporate scandal to precipitate any movement on this front.
5. FINAL THOUGHTS: OFFICER FIDUCIARY DUTIES

AS A WAY TO RESTORE INTEGRITY IN CORPORATE
MANAGEMENT
“One of the central problems of corporate law has always been how to create a system
whereby diffuse stockholders feel comfortable entrusting their capital to centralized
management” (Chandler and Strine 2003, 993). A key to that system is fiduciary duties.
Corporate law tempers the power and authority provided to directors and officers in
exercising control over another’s property with unyielding fiduciary obligations.63 As
explained by former Chief Justice Steele, “We, as a society, encourage corporate invest-
ment, which is ‘socially desirable, but vulnerable,’ by designing a liability framework
that (1) incentivizes fiduciary conduct on terms with which investors can relate and (2)
proves itself an effective protector of investor interests” (Steele 2012, 22). And “[w]ithout
the ability to create their own remedies or protective devices, shareholders must depend
on courts to enforce fiduciary duties to make directors and officers, entrusted with
shareholder property, walk the proverbial ‘straight and narrow’” (Steele 2012, 22). Thus,
corporate law places great weight on the concept of fiduciary duties, vesting power in the
courts as the keepers of those duties in setting, maintaining, and enforcing the standards
of conduct expected of managers (Taylor 2007; Strine 2002; ABA Report 2009; Allen et
al. 2001; Allen 2000).
Fiduciary duties serve several purposes in corporate law. In connection with an established
61
See Gorman, 2015 WL 4719681, at *5; Klassen v. Allegro Develop. Corp., C.A. No 8626-VCL,
2013 WL 5967028, at *15 (Del. Ch. Nov. 7, 2013).
62
See, e.g., Del. Code Ann. tit. 8 § 102(b)(7) (2015) (adopted in response to Smith v. Van
Gorkom and the D&O insurance crisis).
63
See Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984).
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liability framework, fiduciary duties can incentivize value-maximizing behavior, deter

self-interested and careless behavior, and sanction and compensate for harm if misconduct
does occur (Shaner 2016a; Steele 2012). Relatedly, fiduciary duty litigation has the ability to
positively shape legal norms and best practices (Rock 1997). In these ways, fiduciary duties
can “support economic prosperity” and “fuel investment and innovation” (Steele 2012, 3).64
Another, though no less important, purpose of fiduciary duties is to serve as the moral pulse
of corporate America (Steele 2012; Allen 1998). Through their opinions, the Delaware courts
express and reinforce community expectations and ideals about proper managerial behavior
and fidelity to fiduciary principles (Steele 2012; Allen 1998; Stout 2003; Rock 1997).65
The value of fiduciary duties may only be realized, however, if there is enforcement
of those duties and corresponding case law/guidance from the courts (Shaner 2014).
Currently, officers are without moral guidance from the courts. While the Delaware
Supreme Court has held that the broad principles of care and loyalty apply to officers, the
specific subsidiary rules that elaborate on the application of these duties to officers are
unclear.66 This lack of clarity, coupled with a lack of accountability, can encourage offic-
ers to “push the envelope.” Further, while one can debate the exact amount of power that
officers as compared to directors wield in the corporate enterprise today, it is undisputed
that these individuals still occupy important positions within the corporate management
structure and society more broadly (Shaner 2014; Shaner 2016a; Shaner 2016b; Stout
2003; Kahan and Rock 2010; Dammann 2010). Accordingly, the area of officer fiduciary
duties is a place in which corporate law can align with societal expectations of executive
conduct.67 This can help legitimize the corporate endeavor in a society that is very suspi-
cious of, and mistrustful toward, corporate activity. Meaningful fiduciary accountability
through stockholder litigation can enhance that legitimacy.
BIBLIOGRAPHY
Alces, Kelli A. (2009), “Debunking the Corporate Fiduciary Myth,” 35 Journal of Corporation Law 239.
Allen, William T. (1998), “The Corporate Director’s Fiduciary Duty of Care and the Business Judgment Rule
Under U.S. Corporate Law,” in Comparative Corporate Governance: The State of the Art and Emerging
Research (Klaus J. Hopt et al. eds.) 307, 328–9.
64
See ABA Report (2009) at 147 (“The current state law framework that gives the board
authority for the business and affairs of the corporation within a framework of fiduciary duties
owed to shareholders creates an efficient decision-making structure for engaging in entrepreneurial
actions for the benefit of the equity providers and ultimately our economy at large”).
65
The value and influence of the Delaware courts’ opinions on corporate governance and
managerial behavior is, however, dependent on if and how they are conveyed to the corporate
community. See Johnson 2009.
66
As explained by Robert Sitkoff, “[t]he highly contextual nature of [fiduciary duties] makes
prediction more difficult and requires a more intensive judicial role . . . However, the normal accre-
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true for corporate directors, it is not for officers, leaving officers to wade through the undefined
“mushiness of Delaware fiduciary duty case law” (Rock 1997, 1101).
67
Another benefit of delineating officer fiduciary duties which is highlighted by Lyman Johnson
is that it would “bolster Delaware’s foundational director primacy philosophy” (Johnson 2017, at 30).
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Monitor Companies,” Harvard Business Review.
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PART V
COMPARATIVE AND
INTERNATIONAL
SHAREHOLDER LITIGATION
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Section A
The Globalization of Shareholder Litigation
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22. The globalization of entrepreneurial litigation:
law, culture, and incentives
John C. Coffee, Jr.*
1. INTRODUCTION
The fiftieth anniversary of Rule 23’s amendment in 1966 provides an opportunity to
consider how legal change occurs. Clearly, law, culture, and incentives all play a role.
But which dominates? The adoption of Rule 23 preceded a significant surge in the use
of the class action (Coffee, 2015a),1 and some fields of litigation (for example, securities
litigation, antitrust litigation, and, for a time, mass torts litigation) came to depend on its
availability (Coffee, 1995).2 Perhaps even more importantly, Rule 23 spurred the growth
of the plaintiff’s bar, enabling small firms with a handful of lawyers to develop into
major institutional firms of one hundred or more attorneys. Where once plaintiffs’ firms
handled mainly personal injury cases, now they grew to the point that they could finance
and sustain major class action litigation for years and incur millions of dollars in expenses
in the hopes of receiving an ultimate, but contingent, class action fee award.3 With this
metamorphosis also came the fullscale appearance of “entrepreneurial litigation.” For our
* An earlier version of this chapter was first published in John C. Coffee, Jr., The Globalization
of Entrepreneurial Litigation: Law, Culture, and Incentives, 165 University of Pennsylvania Law
Review 1895 (2017).
1
That surge began to be first noticed in the early 1970s, but it was not only the product of Rule
23’s amendment, but also the recognition of a private cause of action under SEC Rule 10b-5 and
the development of private antitrust litigation in the wake of the Justice Department’s criminal
prosecution of General Electric, Westinghouse, and other major manufacturers of heavy electrical
equipment in the 1960s for price fixing. Coffee (2015a: 54–64) provides an overview. Thus, the
plaintiff’s bar responded to multiple new incentives to bring class actions, but there was some lag
time. For a close analysis of the drafting of Rule 23 (by a participant in that process), see Miller,
1979.
2
Private antitrust litigation began to surge before, but increased further after, the amendment
of Rule 23, as private plaintiffs brought followon actions in the wake of Department of Justice
prosecutions. For early cases certifying class actions prior to Rule 23’s amendment, see Union
Carbide & Carbon Corp. v. Nisley, 300 F. 2d 561 (10th Cir. 1962); Nagler v. Admiral Corp., 248
F. 2d 319 (2d Cir. 1957). Securities class actions came to dominate the class action field from the
mid-1970s on, but it was first necessary for courts to resolve the scope of the private cause of action
under Rule 10b-5 and to recognize the “fraud on the market” doctrine (which eliminated the need
to prove individual reliance). Mass tort class actions enjoyed a brief period of popularity in the
1990s (Coffee, 1995). But these came to a screeching halt with the Supreme Court’s decisions in
Amchem Prods., Inc. v. Windsor, 521 U.S. 591 (1997) and Ortiz v. Fibreboard Corp., 527 U.S. 815
(1999), both restricting the use of the class action device in mass torts.
3
For example, in the Enron securities litigation, the lead plaintiffs’ counsel incurred a “lode-
star” of $127 million, reflecting 289,593.35 hours of work on the action at a blended hourly rate
of $456. Newby v. Enron Corp., 586 F. Supp. 2d 732, 741 (S.D. Tex. 2008). This is an extraordinary
investment of time and effort on a contingent fee basis, and it shows the scale of entrepreneurial
351
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purposes, “entrepreneurial litigation” can be defined as litigation in which the attorney

acts as a risktaking entrepreneur, both financing and managing litigation for numerous
clients, who necessarily have smaller stakes in the litigation than the attorney does.4 Put
another way, the attorney acts less as an agent and more as a principal. In this world, it is
truer to say that the attorney hires the client than that the client hires the attorney.
Because entrepreneurial litigation, in the form of the derivative suit, predated Rule
23’s amendment in 1966 (Coffee, 2015a),5 the question becomes what really explains
the explosion of class action litigation in the United States. Was it a legal change (that
is, was Rule 23 the cause)? Or, is the United States’ unique level of aggregate litigation
better explained by a preexisting legal culture that Rule 23 enabled to blossom more
fully? Finally, have the economic incentives for attorneys to bring class actions increased
significantly? This chapter will not resolve all these issues, but rather looks at how entre-
preneurial litigation is spreading globally in order to shed light on the relative impact of
law, culture, and incentives. In contrast to the American experience, the global expansion
of class action litigation pits these forces against each other, as the local culture is often
hostile to entrepreneurial litigation. Thus, we may be witnessing a natural experiment in
which force dominates.
Before beginning this tour, a word of caution is needed: we must recognize that entre-
preneurial litigation was and remains highly controversial. Periodically, both Congress
and the Supreme Court have attempted to curb it.6 Unsurprisingly, major scandals
erupted in the United States as the size and settlement value of class actions grew over
recent decades. Symptomatically, the law firm that was (at least for a time) the leading
practitioner of this style of litigation saw its principal name partners indicted and con-
victed in 2006 for their practice of using and compensating inhouse clients.7 Nonetheless,
entrepreneurial litigation survives in the United States, even though it has had a history
of cliffhanging narrow escapes.8
litigation. The fee award in Enron was ultimately $688 million (ibid at 828), and thus shows that
this investment paid off.
4
Coffee (2015a: 18–32) provides a fuller description.
5
Earlier in the twentieth century, the derivative action developed as the initial context in which
a risktaking plaintiff’s attorney represented a largely nominal client (a small shareholder) in order
to sue corporate officers and directors in the hopes of receiving a court-awarded fee, if successful.
Although these cases were smaller in scale, they had the essential attributes of entrepreneurial
litigation. Coffee (2015a: 33–51) offers a brief history of the development of derivative litigation.
6
The Private Securities Litigation Reform Act of 1995 (“PSLRA”) curbed securities litiga-
tion by enhancing the pleading standards for securities litigation and creating a safe harbor for
“forward-looking” information. See Sections 21D and 21E of the Securities Exchange Act of 1934,
15 U.S.C. §78u-4 and 78u-5. The Supreme Court has repeatedly made class certification more
difficult in recent years (and expanded the ability of defendants to impose mandatory predispute
arbitration clauses on their clients and customers). Wal-Mart Stores, Inc. v. Dukes, 131 U.S. 2541
(2011). AT&T Mobility LLC. v. Concepcion, 131 S. Ct. 1746 (2011).
7
The name of the Milberg, Weiss firm has changed periodically over the past 20 years, but
Melvin Weiss, William Lerach, David Bershad, and Steven Schulman were all “name” partners
in the firm’s title, and all pled guilty to criminal felonies in connection with the firm’s practice of
compensating small plaintiffs to serve as their class representatives in class actions (Coffee, 2015a;
Dillon and Cannon, 2010; Elkind, 2006).
8
Among these narrow escapes have been: (1) the passage of the PSLRA, which in its original
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The globalization of entrepreneurial litigation 353
Much of the rest of the world remains skeptical of American-style “entrepreneurial liti-
gation,” and only Australia, Canada, and Israel have developed systems that approximately
parallel the United States’ “opt out” class action (Clark and Harris, 2008; Pritchard and
Sarra, 2009; Magen and Segal, 2007).9 Elsewhere, the trio of legal rules that support and
sustain entrepreneurial litigation—the opt out class action, the contingent fee, and the
“American Rule” under which each side bears its own legal expenses—remain conspicu-
ous by their absence.10 Instead, around most of the world, plaintiffs’ attorneys may not
receive contingent fees; a “loser pays” rule chills the incentive to litigate; and “opt-in” class
actions prevail and limit class size (in addition, there are often strict rules limiting who
can serve as the representative plaintiff for the class) (Hensler, 2011; Palmisciano, 2012).11
Now comes the surprise: despite the apparent hostility of other jurisdictions to entre-
preneurial litigation, that system has leapt the national boundaries of the United States
and recently moved to both Europe and Asia (Kaal and Painter, 2012; Russell, 2013).12
Moreover, this has happened without any legislative or judicial changes to welcome it. The
focus of this chapter will be on how this has happened and the forces that have driven it.
In overview, the chapter will argue that demand arose for legal services in which someone
other than the client assumed the costs and downside risks of the litigation in return for a
contingent fee. If lawyers could not receive a contingent fee, others could. Entrepreneurs,
draft versions would have been far more restrictive than the version ultimately adopted; (2) the
Supreme Court’s recent decision to reconsider the “fraud on the market” doctrine, which doctrine
it ultimately let stand without serious change: Halliburton Co. v. Erica P. John Fund, Inc. 134 S. Ct.
2398 (2014)); (3) the Delaware Supreme Court’s even more recent decision to permit the adoption
of a “loser pays” bylaw amendment in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A. 3d 554 (Del.
2014), which the Delaware legislative overruled a year later after it became clear that cases might
flee Delaware. For review of this and other crises in class litigation under Rule 10b-5 see Coffee,
2015b. Had the result in any of these cases come out the opposite way, the future of the class action
would have become uncertain.
9
Both Canada and Australia have an “opt out” class action (meaning that the plaintiff’s
attorney can define the scope of the proposed class and the proposed class members can choose,
if they wish, to exit the class by “opting out”). Canada permits the contingency fee, but Australia
permits it only to a very limited degree; both have a “loser pays” rule but the amount so shifted is
regulated by the courts and consists of less than all the winning side’s expenses.
10
The United Kingdom has recently adopted an “opt out” for antitrust class actions, but
otherwise does not permit such a class. South Korea authorizes an opt out class, but exclusively
for securities class actions. With the exceptions of Australia, Canada, and Israel, these are the only
examples in which developed nations permit the American-style opt out class. The Netherlands, of
course, authorizes an opt out settlement class action, but a settlement is a precondition to its use.
11
In a number of European countries, the class representative must be a public official or a
nonprofit organization approved by the government. This is a limitation on standing that may
deny many plaintiff’s attorneys the practical ability to bring a class action (Hensler, 2011: 307;
Palmisciano, 2012: 1868).
12
In the wake of Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), some com-
mentators have predicted that interjurisdictional competition would arise to obtain the cases that
could no longer be heard in the United States. See, e.g., Kaal and Painter, 2012; Russell, 2013.
But what seems to be happening is something different. Little evidence shows European or other
jurisdictions competing to obtain cases that were formerly brought in the US. Rather, entrepre-
neurs located in the US are organizing teams to try or settle cases in the EU, most notably in the
Netherlands or Germany. Other cases have recently been exported to Japan, sometimes after an
initial and smaller case was settled in the US.
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mainly from the US, have found ways to design around the legal barriers in at least some
jurisdictions, and clients are now taking their cases to those jurisdictions. The result is
not a perfect substitute for the US system (indeed, the legal services are provided at much
higher cost), but plaintiffs do obtain what they wanted most: a forum in which their claims
can be asserted on an aggregate basis and without liability for costs if they lose.
To be sure, there could yet be a counterreaction, but creative lawyering has seemingly
developed substitute relationships that achieve a functionally similar form of entrepre-
neurial litigation in which (1) the risk capital is provided by hedge funds and other “third
party funders,” and (2) the problem of “loser pays” feeshifting is dealt with through
insurance. All this will be examined in more detail later, but the point to be made at the
outset is that the role of legal rules can be overstated. When both clients and entrepreneurs
want to shift risks away from the client, means can be found to accommodate that desire.
As with many legal innovations, the spread of entrepreneurial litigation abroad was a
response to a crisis. When the US Supreme Court ruled in 2010 in Morrison v. National
Australia Bank Ltd.13 that US courts lacked the authority to hear the securities fraud
claims of plaintiffs who had purchased their securities outside the United States, extrater-
ritorial plaintiffs were faced with a crisis. They had come to rely on a US forum and on
US plaintiffs’ attorneys willing to take their cases on a contingent fee basis. The result was
a search, led by US plaintiffs’ attorneys, for an alternative forum in which claims could
be broadly aggregated, contingent fees could be charged, and the risks of adverse fee
shifting under a “loser pays” rule could be mitigated. All of this took some creative legal
engineering, as next described.
2. THE EUROPEAN FRONT: BARRIERS OUTFLANKED
For some time, the European Union has recognized the need for an aggregate litigation
remedy. The key rationale for such a remedy is the existence of “negative value” claims,
that is, claims where the costs of litigation would exceed the recovery even if victory
were certain. Take, for example, a defective consumer product—hypothetically, a toaster
that cost $50. No individual can afford the likely legal costs of establishing the toaster’s
defects on an individual basis (assuming that the defendant would not concede them).
The answer to this problem is broad claim aggregation; that is, if 1,000 plaintiffs could
combine to litigate in a single case, they could afford the costs of the litigation. This does
not necessarily require the American “opt out” class action; an “opt-in” class in which
class members expressly opt to join in the litigation could also work, but then it would be
necessary for someone to play the role of “claim aggregator,” soliciting persons who may
have been injured to join the action. This is costly and in some jurisdictions there may be
ethical restrictions on attorneys soliciting business. The point here is that the “opt out”
class action may be the lowest cost mechanism for aggregating claims, but it is not the
only mechanism.
Desiring a mechanism for “collective redress,” but apprehensive about creating a system
of entrepreneurial litigation that resembled that of the United States, in June 2013 the
13
561 U.S. 247 (2010).
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European Union published a “recommendation” (the “EU Recommendation”) setting

forth the principles that EU member states should adopt in order to create collective
redress mechanisms.14 As is customary, the EU Recommendation was nonbinding,
but it clearly rejected most of the key elements of the US system. Specifically, the EU
Recommendation insisted on:
An “opt-in” principle requiring the “express consent” of all claimants to be represented in the
class;
A prohibition on contingent fees;
A “loser pays” rule under which the winning party is paid its legal costs by the losing party;
A prohibition on punitive damages;
Mandatory use of non-profit entities to lead the class action (in order to minimize the danger
of lawyer-controlled classes); and
Close regulation of litigation funding by third parties (with a special requirement of its disclo-
sure to the court).15
These restrictions show a pronounced fear that in attempting to design a “collective

redress” remedy, Europe could catch the “American disease.” Whether a remedy designed
in compliance with these limitations would prove feasible is open to question, but reveal-
ingly, no one has tried to follow this route. Instead, plaintiffs have innovated, using other
means to achieve broad claim aggregation, contingent claim financing, and protection
from “loser pays” feeshifting.
2.1 The Fortis Litigation
In 2008, incident to the general global financial collapse, the Dutch/Belgian banking
and insurance conglomerate Fortis failed and had to be bailed out by the Netherlands,
Belgium, and Luxembourg at an estimated cost of more than $11 billion (Kaal and
Painter, 2012). As in the US, the general public was angered by expensive bailouts (and by
various acts of alleged malfeasance that attracted substantial press attention and political
criticism in Europe). Fortis’s shareholders sued its officers and directors, initially in a US
court. Even prior to Morrison, however, that US court found that it lacked jurisdiction
and dismissed the action, because it found that too little “conduct or effect” had occurred
in the United States to support subject matter jurisdiction, even under the more liberal
US standard of that era.16
14
“Commission Recommendation of 11 June 2013 on principles for injunctive and compensa-
tory collective redress mechanisms in the Member States concerning rights granted under Union
Laws,” Official Journal of the European Union (2013/386/EU), L. 201/60. This Recommendation
does not apply to all possible causes of action, but only to “rights granted under Union law,” which
would include cases asserting consumer protection, antitrust, environmental protection, or finan-
cial service claims. Under EU law, a Recommendation has no binding effect and simply suggests a
course of action without imposing any obligation.
15
In a careful review of this Recommendation, Stadler (2013: 488) concludes that the effort
was disappointingly modest: “With its Recommendation on collective redress, the Commission has
backed down after strong opposition in some Member States to even a moderate reform of private
enforcement tools.”
16
Copeland v. Fortis, 685 F. Supp. 2d 498, 500 (S.D.N.Y. 2010).
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Actions were filed by Fortis investors in both the Netherlands and Belgium early in
2011,17 but they moved slowly, in large measure because neither jurisdiction authorized
plaintiffs to sue in a class action. Meanwhile, two American plaintiff’s law firms, who
had represented some of the clients in the unsuccessful US action, appeared on the
scene to represent largely those same clients. To do so, they faced multiple obstacles. Put
simply, they had to find a mechanism that achieved broad claim aggregation, secured
contingent funding of the action, and obtained protection against “loser pays” fee shift-
ing. To accomplish the first goal—broad claim aggregation—they used the device of the
“stichting”—a Dutch legal entity with limited liability.18 The stichting had regularly been
used in the Netherlands as a vehicle for litigation, as it essentially permits the separation
of ownership and control.19 Plaintiff shareholders transfer their legal claims to the
stichting, while still holding title to their shares. The stichting is governed by a board
of directors appointed by the instrument that creates it (typically a deed). As a result,
the stichting board has full power to litigate, settle the litigation, or seek funding for the
litigation, but the proceeds of any settlement revert to the shareholders. The net result is to
permit a board consolidation of claims and centralized control of the litigation, without
the need for a class action, but every plaintiff must opt into the stichting. In effect, the
17
The essential claims in both jurisdictions were that Fortis had misrepresented its exposure to
the decline in the American subprime mortgage market. At the time, Belgium had no class action
procedure for collective redress (Karlsgodt, 2012). Mr Mischael Modrikamen, a prominent Belgian
attorney who had earlier successfully challenged Fortis’s sale of assets to BNP Paribas, brought suit
on behalf of more than 2,000 institutional and individual shareholders in the Commercial Court of
Brussels against Fortis and various other persons (Fortis’s investment banker, Merrill Lynch, and
its accountant, PriceWaterhouse & Co). Bringing such coordinated individual actions was proce-
durally cumbersome because, for example, each of the individual plaintiffs’ names had to appear
on the briefs. Other lawyers also brought suit on behalf of numerous clients, and a few institutions
sued individually, all in the Commercial Court of Brussels. Deminor, a European firm specializing
in investor protection, also brought suit on behalf of numerous shareholders that it represented.
Thus, multiple lawyers had a role, with no individual lawyer in charge of the action or able to
coordinate strategies. Meanwhile, in The Netherlands, actions were filed in the Court of Utrecht
by VEB (Vereniging van Effectenbezitters), the official Dutch shareholders association, and by two
associations (“stichtings” in Dutch), which were formed for the special purposes of representing
Fortis shareholders. One of these, “StichtingFortisEffect,” appears to have been organized by
Deminor, and the other, Stichting Investor Claims Against Fortis (or “SICAF”), was organized
by two American law firms, Grant & Eisenhofer and Kessler, Topaz, Meltzer & Check, LLP, for
the sole purpose of representing Fortis investors. The American-organized stichting (“SICAF”)
represented 140 institutional investors and 2,000 individuals from the United States, Europe, the
Middle East, and Australia (http://investorclaimsagainstfortis.com). Press Release, International
Investors Join Forces in Support of Lawsuit Against Fortis Over Massive Interpretation Ahead of
Bank’s Collapse in 2008 (Jan. 10, 2010) by Grant & Eisenhofer, P.A.
18
The stichting—the Dutch word for foundation—has a long history in Dutch law and is
frequently utilized for a variety of purposes, including providing a vehicle for shareholder groups.
Technically, it is a legal entity that has no owner or shareholders and is controlled by a board of
directors. It may acquire and dispose of assets, borrow and grant security, and make guarantees
(Profusek et al. 2016). The stichting received much publicity in 2015 when it was used by Mylan
N.V., a company incorporated in the Netherlands, as a device for defending against a takeover
(Raice and Patrick, 2015).
19
In fact, the two US law firms did not organize the first stichting to sue the Fortis defendants.
An earlier stichting—“StichtingFortisEffect”—was formed by Deminor and others.
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stichting is the functional equivalent to an “opt-in” class action, which is otherwise not
authorized in the Netherlands.
Although the stichting provided a useful vehicle, the stichting by itself could not
approach the goal of full claim aggregation. First, someone had to solicit the investors in
Fortis to join in the action. Second, the stichting could not bind absent parties that do not
join it (whether because of apathy, lack of notice, or intentional decision). To some extent,
the American law firms already had contacts with injured institutional investors from the
earlier US action. To reach additional investors, the American law firms joined forces
with two European organizations which had also sought to organize a collective action:
Deminor, a Brussels-based firm that specializes in representing minority shareholders;20
and VEB, the Dutch shareholders association.21 Both had broader contacts and credibil-
ity with European investors, and thus they could expand the number of clients who joined
the stichtings. Together, the two law firms, VEB, and Deminor formed the negotiating
team that settled with the Fortis defendants. But the issue of absent parties still remained.
To obtain financing, the American law firms went to a hedge fund, which agreed to
advance the costs of the litigation in return for a percentage of the recovery. This was
a contingent fee, but European rules only prohibit lawyers from being compensated on
this basis. The hedge fund also agreed to advance the cost of the insurance premium
that protected the plaintiffs from “loser pays” feeshifting (which cost apparently came
to several million dollars). Feeshifting posed a lesser risk in the Netherlands, where the
fees subject to feeshifting are regulated and more modest than in other countries, such as,
most notably, the United Kingdom. The percentage of the recovery that the hedge fund
and the American lawyers contracted to receive for their services has not been disclosed,
but “third party funders” in Europe sometimes contract to receive as much as 50 percent
of the recovery.
The two American law firms—Grant & Eisenhofer, located in Delaware and New York,
and Kessler, Topaz, Meltzer & Check LLP, based in Philadelphia—played an essentially
entrepreneurial role. Although both firms are highly experienced in securities litigation,
neither was admitted to practice in the Netherlands. Of necessity, they hired local counsel
to represent the plaintiffs, and such counsel was compensated on an hourly basis out of
the funds advanced by the hedge fund. Thus, the prohibition against contingent fees was
sidestepped, because the American law firms did not practice law in the Netherlands and
the Dutch lawyers did not receive a contingent fee.
The Fortis case was not these American firms’ first experience of securities litigation
in the Netherlands. Several years earlier in 2009, Grant & Eisenhofer had settled a
major securities class action against Royal Dutch Shell for $382 million—then a record
European securities litigation settlement.22 That action had followed on the heels of a
20
Deminor’s website describes it as “since 1990, the leading European consultancy firm whose
core businesses encompass the defense of shareholder interests, corporate governance and investor
protection through collective damage recovery claims.” See “About Deminor” at www.deminor.
com (visited 9/7/16). Clearly, it is an intermediary specializing in matching clients with collective
damage recovery actions.
21
VEB stands for Vereniging van Effectenbezitters. See http://www.veb.net/actiecontent/
actie-fortis.
22
See Hof’s-Amsterdam 29 Mei 2009, JOR 2009, 197 M.Nt. AJIA Leitjen [ECLI:NL:GHAMS:
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parallel, but earlier, US securities class action against the same defendant,23 and Grant
& Eisenhofer undertook to represent only the non-US plaintiffs in the European settle-
ment. In overview, it appears that Royal Dutch Shell decided it was in its interest to settle
the securities litigation in two parts, settling with the US plaintiffs in the US action and
with all others in the Netherlands action. Although the US law firm representing the US
plaintiffs had initially objected to this division, the US court decided that, even under the
pre-Morrison law then in effect, it might not have jurisdiction over the foreign investors,
and further found the existence of the Netherlands settlement to be a reason for it to
exclude the foreign investors from its settlement.24 Eventually, after some friction, the two
rival teams of plaintiffs’ attorneys compromised and bifurcated the settlement between
them, so that the US investors settled in the US and the others in the Netherlands.
To cover absent parties, the plaintiffs’ law firms in Fortis turned to a unique Dutch
statute, the “Act on Collective Settlement of Mass Claims” (or “WCAM”).25 Enacted
in 2005 in response to a mass torts crisis involving a defective drug that caused birth
defects,26 the WCAM statute permits the Amsterdam Court of Appeals to approve a
settlement class action, but no Dutch statute authorizes plaintiffs to bring a class action
for litigation purposes (even an “opt-in” class action). In short, it is possible to settle on
a classwide basis in the Netherlands, but not to sue on either an opt-in or opt out basis.
Thus, although plaintiffs in the Netherlands can use one or more stichtings to achieve
considerable aggregation of claims, they could not represent all persons allegedly injured
by the defendant’s conduct—unless the defendant consented to a settlement class action.
It is thus up to the defendant to decide if the settlement should cover everyone (including
those who declined to join the stichting).
But why would a defendant consent to such a settlement class? In both the Royal Dutch
Shell case and the Fortis litigation, the defendants did consent to a settlement class, and
their motivation would appear to be that they wanted the settlement to bind “absent” class
members—and at a lower cost. That is, defendants wanted to cover the person who had
not affirmatively sued, but who would be covered by a US-style “opt out” class action.
Why? The defendants may rationally have wanted universal coverage, either because they
wanted global peace or because they feared that these absent persons might eventually
2009:B15744] (Shell Petroleum NV/Dexia Bank Nederland NV). For discussions of this settlement,
see Legal Alert, “Shell Landmark Decision Regarding International Collective Settlement of Mass
Claims,” De Brauw Blackstone Westbroek, 3 (June 2, 2009); Kaal and Painter, 2012).
23
In re Royal Dutch/Shell Transport Sec. Litig., 552 F. Supp 2d 712 (D. N.J. 2007).
24
Ibid at 723–24.
25
“WCAM” stands for Wet Collectieve Afwikkeling Massaschade. Van Lith (2010) provides a
full review of this statute. See also Krans, 2014.
26
The drug was DES and it caused serious injuries to the daughters of women who took the
drug. The defendants resisted liability on causation grounds, because few of the injured daughters
could establish which manufacturer produced the drug that their mothers had taken years (or dec-
ades) earlier. The WCAM statute was intended to facilitate a settlement of this litigation, but the
Dutch Ministry of Justice, which drafted it, wanted to avoid ad hoc legislation that addressed only
one dispute. WCAM was the result (Krans 2014: 284). Looking at American mass torts, the Dutch
Ministry of Justice concluded that mass torts were usually resolved by settlement and not by trial
(so that only permission for a settlement class was needed). This history of the WCAM statute’s
origins is inconsistent with the interpretation offered by some academics that the Netherlands
wanted to attract litigation in an interjurisdictional competition.
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sue in some other court. For example, if the settlement with the initial plaintiffs attracted
attention, other lawyers (and in other jurisdictions) may sue for greater damages. One
way to forestall this is to cover everyone in the Netherlands. A WCAM settlement class
action can cover all similarly situated persons with claims against the defendant (subject
to these absent class members having a right to opt out). But few are likely to exercise
that opt out right. More importantly, if one assumes that absent class members will
remain passive, their claims can be extinguished in a global settlement class, without the
defendant necessarily increasing the size of the settlement proportionately. In effect, such
global settlement may come cheap. Thus, both sides can gain from a global settlement:
The plaintiff’s side will gain a larger recovery (much or most of which will go to the third
party funder and the other entrepreneurs) and the defendants will be able to extinguish
the claims of absent class members (at least if they do not opt out).
In March, 2016, Ageas (the successor to Fortis), the various D&O insurers, and the two
stichtings announced a settlement pursuant to the WCAM statute for $1.337 billion.27 This
was by far the largest settlement of shareholder claims in Europe (nearly four times the
size of the earlier Royal Dutch Shell settlement). The settlement attracted much publicity
and alerted those not yet aware of it to the potential for largescale settlements under the
WCAM statute. Although approval of the settlement is still pending, the Amsterdam Court
of Appeals has approved nearly all the prior WCAM settlements presented to it.28 Under
established European law, any settlement approved by the Amsterdam Court of Appeals is
enforceable throughout Europe and will extinguish all covered European claims.29
27
See Ageas Press Release, 2016, Ageas, Deminor, Stichting FortisEffect, SICAF and VEB
Reach Agreement Aiming at Settling All Fortis Civil Legacies. In this press release, Ageas explained
the settlement as allowing “the company to regain its full strategic and financial flexibility and to
focus entirely on its insurance business.” See also Ralph, 2016. LaCroix, 2016 described it as “by far
the largest investor settlement ever under the Dutch collective settlement procedure.”
28
Since the enactment of the WCAM statute, seven applications have been made to the
Amsterdam Court of Appeals for approval of a WCAM settlement, and six have been approved
(Krans, 2014: 282). If the settlement is approved, no appeal is possible. Ibid at 288. If the settlement
is not approved, the parties may jointly appeal to it.
29
Within the EU, all member states are required by the Brussels I Regulation to honor and
enforce legal judgments from other member states’ courts. See Council Regulation 44/2001,
“Jurisdiction and the Recognition and Enforcement of Judgments in Civil and Commercial
Matters,” arts 33–34, 38,41, 2000 O.J. (L 12) 1 (EC). To satisfy this standard, the Amsterdam Court
of Appeals labels its approvals of a settlement under WCAM as a “judgment” (van Lith, 2010: 125).
As a matter of Dutch law, under the Dutch Code of Civil Procedure, Dutch courts can
assert jurisdiction over non-Dutch persons so long as at least one petitioner is domiciled in The
Netherlands (van Lith, 2010: 33–34; Palmisciano, 2012: 1879–80). This condition is always seem-
ingly met because the WCAM statute requires that a Dutch association (or stichting) serve as the
lead plaintiff.
The one area where serious doubt remains as to the enforceability of a WCAM judgment involves
whether US courts will recognize and give effect to a WCAM settlement with respect to covered US
plaintiffs. The Full Faith and Credit Clause of the US Constitution (art. IV § 1) does not apply to
judgments of foreign courts. Although principles of comity are recognized by US courts, they are
trumped by the Due Process Clause. Thus, if US persons were included in the plaintiff class, but did
not receive adequate notice or an opportunity to opt out, they could likely resist the enforcement of
the judgment against them in US courts. Exactly what adequate notice would require in this context
is beyond the scope of this chapter.
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Equally important, the Fortis settlement suggested the desirability of a two-step

strategy: (1) sue first through one or more stichtings and demonstrate the viability of
the plaintiff’s claims; (2) then, once a settlement becomes likely, expand the action under
the WCAM statute to cover all absent plaintiffs in Europe (and potentially elsewhere). The
latter step may increase the size of the settlement, but may protect the defendant from
expensive litigation in other jurisdictions.
2.2 The Volkswagen Litigation
No sooner had Fortis settled than the same American law firms began litigation against
Volkswagen. Again, as in Fortis, the facts of the case were well known throughout Europe:
Volkswagen had used hidden “defeat devices” to hide the emissions from its diesel engines,
and had conceded these actions to regulators in the United States. Although Volkswagen
had a variety of defenses available to it in Europe, it was still an inviting target for the
plaintiffs’ bar.
In March 2016, almost simultaneous with the Fortis settlement, Grant & Eisenhofer
and Kessler, Topaz caused a suit alleging securities fraud against Volkswagen to be filed in
Germany on behalf of 278 institutional investors from around the globe (Boston, 2016).30
Damages of more than $4 billion are sought. Again, the American law firms retained a
local German law firm,31 which will not receive a contingent fee. Litigation funding is
being provided by various “third party funders,”32 and again firms in Europe and the US
are providing “claims aggregation” services, seeking to find institutional plaintiffs.
Once again, the German action is not an American-style class action. Instead, Germany
has a special statute—the German Act on Model Procedures for Mass Claims in Capital
Market Cases (or the “KapMuG” law, as it is popularly known)—under which con-
solidated cases can be resolved through a “bellwether” trial.33 This procedure is essentially
applicable only to securities litigation and it does not bind absent parties. Although the
Volkswagen case is still at an early stage, Volkswagen has already lost the first round, as the
initial court, following the German procedure, referred the matter to an appellate court,
which will select a representative case for a bellwether trial (Boston, 2016; Germaine, 2016).
Still, it is far from clear that this action will be resolved in Germany. The plaintiffs’ strat-
egy may be to sue in Germany (which likely is the only European country with jurisdiction
over the case, as Volkswagen’s stock trades only on the German stock exchange), but
30
For the 278 number, see Press Release, KesslerTopazMeltzerCheck, 2016, Global Institutional
Investor Group Files Large-Scale German Securities Suit against Volkswagen AG over Diesel
Emission Scandal. Many of these were US investors, such as CalPERS, the California pension
fund, which had bought shares abroad. Subsequently, more than 1,000 additional investors have
joined the action.
31
The local German firm is TISAB, which filed suit in the district court of Braunschweig
(which court has jurisdiction over the German city where Volkswagen is based). Ibid.
32
Claims Funding Europe, Ltd, an Ireland-based litigation funding company, is providing the
financing to the American law firms. See ibid. Other third party funders are also funding German
litigation against Volkswagen. LaCroix (2015) describes the role of Bentham Europe Limited, a
joint venture of IMF Bentham, a publicly listed third party funder based in Australia, and Elliot
Management Corporation, a US-based investment advisor and hedge fund manager.
33
Stadler (2013) provides an overview. See also Kaal and Painter, 2012: 161.
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then to settle in the Netherlands under the WCAM statute. An important case in the
Netherlands has approved a global settlement in which all the defendants and virtually all
the plaintiffs were foreign to the Netherlands.34 Apparently, no more than a token Dutch
presence may be necessary for WCAM to become applicable. Still, one can imagine the
Amsterdam Court of Appeals retreating from this position if the Netherlands began to
become a magnet for the resolution of European or even global claims.
The attraction of the Dutch approach is again that the settlement could cover all
absent plaintiffs (other than the few that may opt out). However, the two American firms
(Grant & Eisenhofer and Kessler, Topaz) face competition in the Volkswagen litigation,
as other American law firms have appeared on the scene and are apparently lining up
clients in the Netherlands. In particular, Bernstein, Litowitz, Berger & Grossman and
Labaton Sucharow, both of which are experienced and well-known plaintiff’s firms that
specialize in securities litigation, have reportedly formed stichtings in the Netherlands
with a view to structuring a WCAM-style settlement (Frankel, 2016). Given competition
in the Netherlands and potentially rival stichtings, the original plaintiffs in Germany
might prefer to settle there to avoid a contest over control of the WCAM litigation
in the Netherlands. Alternatively, the existence of competition on the plaintiff’s side
could increase the leverage available to Volkswagen. It could choose between settling in
Germany or in the Netherlands, depending on which plaintiff’s team agrees to a cheaper
settlement. At this point, it is too early to predict what strategy—the German approach,
the Dutch approach, or a reverse auction35—will dominate.
For the future, the new playbook may be to sue on a consolidated basis (using aggrega-
tive devices such as the stichting), but then settle on a global basis in the Netherlands to
provide the defendant assurance that other plaintiffs will not later come out of the wood-
work. But competition within the plaintiff’s bar is likely, as entrepreneurial lawyers are
nimble and quick to seize new opportunities. This factor could alter tactics in unpredict-
able ways. In the United States, these problems are largely mitigated by the existence of
the Judicial Panel on Multidistrict Litigation, which assigns a case to a particular federal
district court, thereby minimizing interjurisdictional competition.36 Europe has not yet
faced the problem of dueling mass actions or reverse auctions, but it is on the horizon.
34
In 2012, the Amsterdam Court of Appeals approved a settlement under WCAM in the
Converium/SCOR case. See Hof. Amsterdam (SCOR Holding, Switzerland) AG/Lichtensteinsche
Landesbank AG). The defendants had no contact with the Netherlands and only a small minority
of the plaintiffs were domiciled there. This case stands as the strongest demonstration that a case
can be exported to the Netherlands so long as a nominal plaintiff is resident there. Interestingly,
a US court had first dismissed all the foreign investors from a US class action against the same
defendant. In re SCOR Holding (Switzerland) AG, Litigation, 537 F. Supp 2d 556, 559 (S.D.N.Y.
2008). The American plaintiffs’ law firms in that case then essentially escorted these clients to the
Netherlands for a settlement.
35
A “reverse auction” involves the defendant playing off rival plaintiff’s attorneys to see which
will make the lower settlement offer. Because the class action settlement will effectively preclude
similar litigation, the low bidder is rewarded, but the class members are prejudiced. The term was
coined by this author (Coffee, 1995).
36
Herrmann and Bownas (2008) provide a description of the events leading up to the adoption
of the JPMDL.
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2.3 Asia: A Shift toward Entrepreneurial Litigation
Asia stands today near the midpoint between the United States’ acceptance of entre-
preneurial litigation and Europe’s rejection of it. Of the Asian nations with significant
securities markets, none authorizes the American “opt out” class action, with the signifi-
cant exception of South Korea (which authorizes it only for securities-related actions).
However, the “opt-in” class action is generally permitted.37 Moreover, although contin-
gency fees are rejected as scandalous in most of Europe, most of these Asian nations
permit contingency fees.38 All the major nations in Asia have “loser pays” rules, but most
soften that rule’s impact by limiting the feeshifting to a court fee only.39 Also, Japan and
Korea permit legal expense insurance, which can cover feeshifting liabilities.40 In short,
with opt-in classes prevalent, contingent fees permitted, and “loser pays” softened, Asia
does not share Europe’s hardline opposition to entrepreneurial litigation.
But this does not mean that class actions are common in Asia. In fact, only two Asian
jurisdictions—Japan and Korea—have had real experience with class action litigation
(and even that experience is limited). The greater receptivity of Japan and Korea to the
class action may reflect legal cultures that were strongly influenced by the US, either
during its occupation of Japan or in its close alliance with Korea during the Cold War.
However, each has had a marginally different experience.
2.3.1 Japan
The 2004 reform of Japanese securities law intentionally invited more securities litigation,
particularly in the secondary market context.41 Under these amendments, plaintiffs no
longer had to establish individual reliance on the misstatement or omission, and this
amounted to at least a partial adoption of the “fraud-on-the-market” doctrine (which
had earlier caused an acceleration in securities litigation in the United States as well). The
number of securities lawsuits rose in the early 2000s, from almost none to double-digit
numbers.42
Although the number of cases fell again between 2010 and 2015, Zhang (2014) predicts
that the Olympus case will lead to an increase in securities litigation in Japan.43 Once
37
Japan, Taiwan, and China permit “opt-in” class actions, but only Japan has had any real
experience with them.
38
The exception is Hong Kong, which prohibits the contingency fee, apparently because its
legal origins derive from England. It also follows the strong “English Rule” on fee-shifting, requir-
ing the loser to compensate the winner. Oda and Kagan (2015) and Shoo (2014: 262–75) provide
overviews.
39
This is the case in Japan, China, and Taiwan. Hong Kong, however, has the “English Rule,”
which requires full fee-shifting. In South Korea, the loser pays a court fee but also must reimburse
a portion of the winner’s legal expenses (Chung et al., 2015).
40
Legal expense insurance has been available in Japan since 2000, and its availability was
important to the Olympus litigation, where the plaintiffs obtained such insurance.
41
In 2004, an amendment to Japan’s Financial Instruments and Exchange Act (“FIEA”)
loosened the burden of proof for plaintiffs by eliminating the need to prove individual reliance.
Effectively, this amounted to at least a partial adoption of the US’s “fraud on the market” doctrine
(Goto, 2016; Maderra, 2014).
42
Ibid; see also Shinkawa, 2012.
43
Olympus had apparently hidden losses for 13 years before this came to light in 2011.
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again, this change reflects the impact of the Morrison decision. In the Olympus securities
litigation, the initial action was filed in the United States.44 But the defendant only had
American depository receipts (ADRs) traded on any US exchange, and these reflected
only a small portion of its total capitalization. Morrison implied that US investors who
had bought their shares abroad could not sue in the US. The ADR action was resolved
with a favorable, but modest, settlement in 2014, and this may have motivated legal
entrepreneurs to look for an alternative forum where the holders of Olympus’s common
stock could sue. As with Fortis, an American law firm organized a class action, which was
to be filed in Japan by undisclosed Japanese lawyers. The parties reached a preliminary
settlement in October 2013, but the settlement process was slowed by a mediation that
extended for 16 months. Eventually, in April 2015, the parties settled for $92 million in an
out of court settlement, which was vastly in excess of the $2.6 million settlement reached
on the ADRs in the US litigation (Salvatore, 2015).
Olympus is distinctive from Fortis in that it was parallel litigation that succeeded in both
jurisdictions (whereas Fortis resulted in a plaintiff’s defeat in the US). The two settlements
in Olympus were also less than two years apart (whereas five years separated the US action
and the Netherlands settlement in Fortis).
A key entrepreneur in Olympus was a Miami-based law firm, DRRT, which advertises
itself as focused on global litigation.45 Because contingent fees are permissible in Japan
(whereas “third party funding” is not), DRRT presumably received a significant contin-
gent fee for its efforts. Apparently it was more than satisfied with its success, because it has
subsequently caused two class action cases to be filed in Japan against Takata Corp. and
Toshiba.46 In some of these cases (including Olympus), the Japanese class action followed
on the heels of an earlier US class action covering securities sold in the United States.
Possibly, this suggests that there may be a synergy in parallel class actions, with plaintiffs
obtaining discovery in the US under the more liberal US rules and utilizing it in the later
Japanese action. Alternatively, a successful recovery in the US is at least some evidence
that the case is meritorious, and thus a follow-on class action in a foreign country may
carry less risk.
On its website, DRRT advertises that it has recovered more than $1 billion for its
clients and represents over 400 institutional investors.47 Much like Deminor in Europe,
DRRT seems to be more of an intermediary and matchmaker than a traditional law firm.
This role of the American law firm as an entrepreneur and legal innovator is the most
44
That case was Graham v. Olympus Corporation, filed in 2011 and settled (with court
approval) in 2014. See Stanford Law School, Securities Class Action Clearinghouse (“Olympus
Corporation”).
45
DRRT’s web site advertises “Global Institutional Investor Protection” and “Global Claims
Filing Services,” adding that it is “uniquely positioned to serve institutional investors in all aspects
of global securities litigation, loss recovery, and claims filing.” See http://globalsecuritieslitigations.
drrt.com.
46
DRRT discusses its efforts in both of these cases on its “Current Cases” page of its website.
See Current Cases/Global Securities Litigation/drrt.com. Both actions were filed in 2016.
47
See http://globalsecuritieslitgiation.drrt.com. The website further states that DRRT “is
active in 11 countries and currently handles cases of investor loss recovery exceeding $10 billion.”
DRRT also participated in the Fortis litigation, suggesting that the major international players all
know each other.
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interesting common denominator between Fortis and Olympus, and both cases represent
an extraordinary recovery for their respective jurisdictions.
2.3.2 Korea
Adopted in 2005 in response to financial scandals, Korea’s Securities-Related Class
Action Law (or “SRCAL”) was a deliberate attempt to emulate the American class action
model.48 Uniquely in Asia, it authorizes an American-style “opt out” class action (but
only with respect to securities-related claims). SRCAL also contains several measures
to curb nuisance suits, which similarly seem to have been modeled on the United States’
Private Securities Litigation Reform Act (Korpus, 2006: 53).
Yet, despite the wholesale legislative adoption of the US approach by Korea, only a
few class action suits have been filed under SRCAL, and as of the close of 2015, only one
case had apparently settled (Lee, 2013). Why? The answer may be that Korea has fewer
multinational corporations in which global institutional investors hold equity stakes.
Accordingly, the demand for a new remedy in the wake of Morrison is less pressing in
Korea. In addition, there are upfront costs in Korea that are based on the size of the claim
(a tax of approximately 0.5 percent of the claim must be paid on filing). Standing to bring
such a suit is also limited.49 Third party funding is discouraged in Korea. Hence, Korean
procedural law may to a degree undercut the announced purpose of SRCAL.
To date, one law firm has brought the majority of securities class actions filed in
Korea,50 and no American legal entrepreneur appears to have attempted to bring or
organize a class action in Korea. This may be a further evidence of a lack of demand
among institutional investors for a Korean venue. In short, legal rules, even if intentionally
friendly to class actions, do not necessarily produce a marked increase in their use. That
requires demand-side interest on the part of investors, which in turn may require global
companies with multinational ownership.
3. IMPLICATIONS AND ANALYSIS
3.1 How Should We Understand this New Phenomenon?
As we have just seen, some non-US jurisdictions have developed (or at least tolerated
the appearance of) a second-best substitute to the American opt out class action, and
cases may be migrating to these jurisdictions when plaintiffs are excluded from the US by
the impact of the Morrison decision. The clearest example is the Netherlands’ WCAM
48
SRCAL became effective on January 1, 2005. Financial Supervisory Service, A Primer on
Korea’s New Securities Class Action Suit Law, 2005.
49
At least 50 shareholders must join in the suit’s filing, and they must hold in the aggregate
0.01 percent of the equity in the corporation (Choi, 2004: 1521). In the case of a large corporation
with a multibillion-dollar market capitalization (say, Samsung), this could require an investment of
several hundred thousand dollars to confer standing.
50
This is the Hannuri Law Firm, which maintains an active website (Hannuri Law). A number
of the class actions that it has filed have been certified by the Korean courts, but there is no report
of a settlement of any of these.
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statute, but opt-in class actions in Japan and Korea may eventually produce a functionally
similar result to the extent that institutional investors hold the vast majority of the stock
of multinational corporations. The following chart summarizes the key differences:
Table 22.1 The potential for entrepreneurial litigation—a comparison across legal
systems
Element US system Non-US alternative

Claim aggregation Opt out class WCAM settlement class or aggregative
mechanisms (such as the stichting)
Litigation finance Contingent Fee Third party funding
Feeshifting American Rule (no feeshifting Liability insurance or reduced
normally) feeshifting
What is driving this activity? Some academics have suggested that it is regulatory
competition, as European or other states seek to acquire the cases and plaintiffs that the
US lost with the Morrison decision (Bookman, 2015; Kaal and Painter, 2012; Russell,
2013). Although such a theory may enable academic theorists to use models of regula-
tory competition that they learned in graduate school, this theory does not comport well
with the actual facts. As we have seen, in 2013, the European Union rejected most of the
key elements of the American model for entrepreneurial litigation. Arguably, an outlier
jurisdiction (such as, possibly, the Netherlands) could dissent from that consensus and
seek to garner revenues by filling the void left by the United States. But WCAM was
passed in 2005, after a much publicized mass tort crisis involving birth defects caused
by a specific drug, and thus it was not a response to the later 2010 decision in Morrison.
WCAM’s design is apparently based on the Dutch Ministry of Justice’s belief that the
American experience with mass torts for defective drugs showed these cases settled natu-
rally, without any need for a trial (Krans, 2014). Further, if the Netherlands had wanted
to attract litigants, it could have enacted at least an “opt-in” class action (which it has not
done). Indeed, if the goal were to implement a system that can litigate “negative value”
claims, the Netherlands could have adopted a number of other US rules, which provide
a significantly lower-cost alternative. To give but one example, abolishing the “loser
pays” rule is far less costly to plaintiffs than permitting insurance of the liabilities that a
“loser pays” rule creates. But the Netherlands did not move in this direction. Put simply,
the Netherlands’ only clearly discernible goal was to facilitate settlement, not encourage
entrepreneurial litigation.
For the most part, Europe continues to believe that the US system creates an excessive
incentive to litigate,51 and nothing suggests that the Netherlands is an outlier to this con-
sensus. Authorizing settlements under WCAM can be viewed as a “procorporate” stance
(as leading Dutch companies like Royal Dutch/Shell and Fortis have used WCAM), while
enacting a class action statute authorizing plaintiffs collectively to sue Dutch corporations
is hardly “procorporate” (and the Netherlands has not done this).
51
Warren (2013) offers a similar view, predicting that it is “highly unlikely” that Europe will
move closer to the American model.
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These observations lead to a simpler explanation for what we are observing in

Europe and Japan: namely, that legal entrepreneurs have discovered an unmet market
demand (institutional investors who want to recover market losses) and they are
experimenting with substitute forums for their former US base. Although conceivably
they could use consolidated proceedings (as they did in fact do in Belgium early in the
Fortis litigation) as an alternative to class resolution, they have rationally preferred the
jurisdiction (the Netherlands) that offers both a device for broad aggregation (that is,
the stichting) and a means for expanding that device into a global settlement (WCAM,
at least if the defendants will settle). From this perspective, it was essentially fortuitous
that the Netherlands supplied the latter need with its WCAM statute, but resourceful
entrepreneurs will predictably scour the legal landscape to find what opportunities
exist. The bottom line then is that jurisdictions have been passive, while entrepreneurs
have been active.
As litigation moves to Europe and elsewhere, new patterns, new players, and new issues
are emerging, including the following.
3.2 New Players
When only an opt-in class action is permitted, the plaintiffs’ legal team needs to find a
“claim aggregator.” These are agents that have relationships with institutional investors
(or other groups of potential plaintiffs) and can solicit them to join the opt-in class or
an alternative aggregative mechanism (such as the stichting). In the Fortis litigation, both
Deminor and VEB performed this function, based on their longtime roles as shareholder
champions. Law firms themselves generally have less capacity to play this role (although
DRRT in the United States may now be attempting to specialize in claim aggregation).
The lesser ability of law firms is clearest when the law firm is attempting to litigate on a
global scale and hence will be bringing or organizing cases far from its home base where
it is better known. Plaintiffs’ law firms obviously have a personal interest in “selling”
their proposed law suit, and intermediaries probably can provide a more objective assess-
ment of the costs and benefits of joining the litigation. Of course, to the extent that the
intermediary is compensated by the plaintiff’s law firm (or some other entrepreneur), its
perceived objectivity may be illusory.
3.2.1 The third party funder: superior or inferior?

On the one hand, a hedge fund (or other financial intermediary) has better access to
the capital markets than a law firm, and it can pick and choose among numerous cases
presented to it and thereby exercise some objective judgment. Necessarily, a plaintiffs’ law
firm has a more limited number of cases which it can finance and litigate on a contingency
fee basis. But third party funding seems to be more expensive (often charging half the
prospective recovery). Why? One answer is that the third party funder always faces the
problem of adverse selection. Plaintiffs’ lawyers have the incentive to bring to the third
party funders cases that they would not dare to finance themselves. If a law firm can
obtain financing from others for a case which, it privately estimates, has less than a 50
percent chance of success, it may be entirely rational for it to proceed. If it loses, it still is
compensated for its time at its hourly rate; if it wins, it gains reputational capital and may
find a way to receive a “success fee” without violating the rules of the local jurisdiction.
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Knowing this, third party funders need to demand a larger share of the recovery to
compensate for this risk.
Conceivably, as the market develops, competition may drive down the cost of “third
party” litigation finance, but the problem of adverse selection will never disappear.
3.2.2 Reverse auctions

If parallel litigation can be brought in different jurisdictions (as will often be the case in
Europe because of the WCAM option), defendants may be able to exploit this pattern
and induce rival plaintiff teams to bid against each other, with the low bidder winning
the right to settle with the defendant. This problem is aggravated to the extent that the
WCAM statute permits at least a European-wide settlement of claims.
In the United States, a partial answer to this problem has been the Judicial Panel on
Multidistrict Litigation, which typically puts one judge in charge of the litigation and
thereby limits defendants’ ability to run an auction. Europe lacks such a body, and no
substitute mechanism is in sight.
3.2.3 Unequal distribution?

In the United States, a class action settlement will basically be disbursed on a per share
basis, possibly modified by the time at which the class members made their purchases
(which can affect the strength of their claims). But in the Fortis settlement, “active”
shareholders will receive more than those who joined only by virtue of the WCAM
settlement. “Active” shareholders are those who joined the stichting before the global
settlement was reached. If latecomers can be paid less, this increases the attractiveness
of a WCAM global settlement to the defendant, but leaves class counsel faced with a
glaring conflict of interest. Although conceivable justifications can be advanced for such
a disparity, equality of treatment among similarly situated class members is not yet a
goal recognized in Europe, and the parties will often have their own private reasons for
deviating from equality.
3.2.4 Will the American entrepreneurs fade away?

In the recent cases of Fortis and Olympus, and also in the pending Volkswagen litigation,
US plaintiff law firms have played a critical organizing role. But is this only a transitional
phenomenon? Arguably, European firms (such as Deminor or VEB) or investment banks
could play this same entrepreneurial role and negotiate financing with third party funders.
On the other hand, most of these early cases have involved litigation that began in the
United States. Even in the Volkswagen case, there is ADR litigation pending in the US,
and the plaintiff’s law firm handling that case is also seeking to open a European front in
the Netherlands. Conceivably, there is lower risk in seeking to file a follow-on litigation
in Europe or Asia than in commencing a totally new case in the foreign jurisdiction. No
prediction is made here, but this will be one of the issues to watch.
3.2.5 Counterreaction?
It is still early. Europe may yet find the invasion of American plaintiffs’ lawyers distasteful
or even shocking. The EU could in time take the nonbinding principles announced in its
2013 Recommendation and make them mandatory. But to be effective, this would require
the EU to overrule the Netherlands’ WCAM statute, and that seems less than likely. After
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all, WCAM only permits the parties to settle. In many cases, a defendant may not want
a global settlement; that is, it may be happy to settle with those who sue it by means of a
stichting or in an opt-in class action, and it will not opt to cover absent parties as well. The
choice effectively is the defendant’s. European attitudes toward the WCAM procedure are
still unclear, but the concept of fostering settlements is not antithetical to the European
mind.
Much may depend on the public’s reaction to these early cases. Both Fortis and
Volkswagen are recognized in Europe as legitimate scandals, and there is relatively
little sympathy for either defendant. But that could change if the press reports that the
American law firms received allegedly “obscene” fees while the class members obtained
little. On this question, the jury is still out.
3.2.6 Future directions

To date, the major cases in which aggregate resolution is being attempted in Europe
and Asia have all involved securities claims: Fortis, Royal Dutch Shell, Volkswagen, and
Olympus. Although the United Kingdom has authorized an opt out class action for
antitrust claims (and only them), that area has not yet seen much activity.
Why have securities law claims so dominated? One answer may be that large holders
(that is, institutional investors) own most of the stock in Europe (where the middle-class
individual is less likely to own shares directly than is the case in the United States). Large
shareholders are less apathetic and easier to organize, because they suffer larger losses
and are professionals. But if this is the reason for the dominance of securities claims, an
irony results: The class action and other aggregate litigation remedies have not yet begun
to serve “negative value” claimants outside the United States. This is virtually definitional,
as those willing to join a stichting or opt into a class are not small economic actors. Nor
are claims aggregators searching for small investors. Only those with large claims have
adequate incentive to participate. As a result, Europe still seems a long distance from its
goal of developing an aggregate litigation remedy for “negative value” claims.
4. CONCLUSION
Let’s return to the anniversary of Rule 23. Did the amendment of Rule 23 in 1966 initiate
a major revolution in US litigation practice? To answer yes (as I think many proceduralists
would) assumes that legal rules are decisive and dispositive. But here, it is useful to pose a
further question: Suppose the Advisory Committee had not adopted Rule 23(b)(3), which
authorized for the first time a money damages class action (and was controversial within
the Advisory Committee). Would large scale money damages actions have still developed
in the US? I believe the answer is yes: they would have! Instead of a Rule 23(b)(3) class,
we might have seen an alternative procedure expand to fill this void, such as the type of
consolidated proceeding now seen in mass tort cases.52
52
Judge Jack Weinstein has properly referred to large consolidated proceedings, such as those
used to deal with asbestos cases, as “quasi-class actions.” See Weinstein, 1994; see also Silver and
Miller, 2016. Yale Law Professor Abbe Gluck estimates that such mass consolidated actions now
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Both now and then, the key actors were probably the legal entrepreneurs who responded
to these enhanced incentives. In the US, the contingent fee was recognized and accepted
by the turn of the twentieth century, as it came to fund the personal injury litigation that
an industrializing nation produced in volume (Coffee, 2015a). During the late 1930s, an
entrepreneurial plaintiff’s bar developed in the US, concentrating mainly on derivative
actions. In the 1960s, it moved to private antitrust litigation, responding to the Department
of Justice’s vigorous enforcement of pricefixing cases, and these counsel brought largely
follow-on actions. Then, in the 1970s, with the judicial recognition of a private cause of
action under Rule 10b-5, many shifted to securities litigation. This is not to minimize the
importance of Rule 23, but there was a professional culture already developed and able to
sustain entrepreneurship, because that culture was already comfortable with contingent
fee litigation and risk taking. Further, the concept of the “private attorney general” was
well understood and respected in the United States, but not elsewhere.53
Today, legal entrepreneurs are moving to the global stage and have effectively invented
a “synthetic” class action. But they are seeking to export this technology beyond the
domain of their culture. Although they have had early success, they may well encounter
greater resistance abroad (where the local culture is at least skeptical and arguably hostile
to entrepreneurial litigation). Still, they do have a clientele that wants their services, strong
economic incentives, and no shortage of scandals to litigate. It is still early, but some gen-
eralizations do suggest themselves. First, legislation (including rule amendments) will not
alone produce significant change (as the experience in Korea and Japan shows). Second,
entrepreneurs (both domestic and foreign) will scour the legal landscape for opportunities
to exploit (as the recent experience with the WCAM statute illustrates). Third, except in
the presence of deep cultural hostility, entrepreneurs will find a means to structure settle-
ments attractive to the parties (but possibly not beneficial to the entire class).
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23. The Teva case: a tale of a race to the bottom in
global securities regulation
Sharon Hannes and Ehud Kamar* 54
?
1. INTRODUCTION
This chapter tells the story of our class action against Teva Pharmaceutical Industries as
an illustration of the global race to laxity in the regulation of capital markets.
Teva is an Israeli company traded in Israel and the United States. It is the largest generic
drug maker in the world. Its market value at the end of 2012 was 37 billion dollars—higher
than, say, Deutsche Bank’s. This was the time at which we filed a shareholder class action
in the Tel Aviv District Court to compel Teva to disclose executive pay on an individual
basis, as required under Israeli law and US law. Teva settled the case with us by agreeing
to disclose this information. To ensure other companies did the same, Israel adopted a
rule affirmatively requiring this disclosure of all Israeli companies traded abroad. These
companies comprise Israel’s entire technology sector and half of all public firms by
market value.
Teva’s failure to disclose compensation individually was not the result of oversight.
Rather, Teva told us, its practice was legitimate under provisions in the Israeli securities
statute that allow companies listed on a national exchange in the United States or the
United Kingdom to file in Israel the reports they file abroad.
To us, the claim that Teva could disclose only aggregate pay figures—making it impos-
sible to know, for instance, how much it paid its chief executive—was illogical. Both Israel
and the United States require public companies to disclose executive compensation on
an individual basis, and each country recognizes the other’s requirements. How could a
company traded in both countries be exempt?
That Teva took this position was not surprising, however. Companies frequently prefer
to withhold sensitive information if possible. Somewhat more surprising was that the
Israel Securities Authority (ISA) never questioned this practice—and ultimately backed
it. When Teva chose not to file an answer and settle, the ISA intervened anyway. It advised
the court that, though it welcomed the disclosure Teva would make under the settlement,
the suit was without merit.
In retrospect, the motivation behind this position is easy to grasp. It was a manifesta-
tion of a global trend of watering down local securities regulation to attract listings. The
crosslisting laws in Israel and the United States that gave rise to the suit are part of this
trend. Their goal is to attract listings. The ISA, in our view, simply went beyond the scope
of these laws to advance this goal.
The story had a happy ending. The new rule adopted in the wake of the suit offered
* We thank our lawyers in the Teva case, Gil Ron and Aharon Rabinovitz, for a long, strange
trip together. We also thank Lee Weinstein for research assistance.
372
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The Teva case 373
something for everyone: It achieved our goal of bringing pay disclosure by Israeli
companies listed abroad up to the standard in Israel, it addressed the ISA’s concern of
delistings, and it reassured companies they would not face suits for their failure to disclose
this information in the past. It also vindicated the ISA.
Today, all these companies must report executive pay on an individual basis. However,
the race to laxity persists on other fronts. Foreign issuers in the United States, for example,
continue to disclose less information than do US issuers even if their stock trades only
in the United States. Law in the US allows them to file abbreviated annual reports and
exempts them from the duty to file quarterly and current reports, insider trading reports,
and proxy statements. If they crosslist in Israel, they can file the same reports in Israel as
well. Although their stock trades in both countries, they are less transparent than either
country normally requires. Their foreign listing thus wins them regulatory concessions
both domestically and overseas. We do not argue that regulatory laxity is always bad.
However, when it comes to the disclosure of executive pay, we believe it is. There are clear
indicators that shareholders want this disclosure and benefit from it.
In section 2 we review the theory of the race to laxity between countries competing
over securities listings and show that legislation and enforcement in Israel and the United
States are products of this race. In section 3, we describe our case against Teva. We show
how Teva ceased to report executive pay on an individual basis following the enactment
of the crosslisting legislation in Israel. We next explain how Teva succeeded in avoiding
disclosure for more than a decade. We describe, among other things, the preceding events,
the filing of the class action, and the settlement. Thereafter we discuss the intervention by
the ISA while the settlement was pending court approval, and the decision of the court.
In section 4 we present the changes in Israeli law that followed the suit. We then conclude.
2. THE GLOBAL RACE TO LAXITY IN SECURITIES

REGULATION
The race to laxity is well known in corporate law scholarship. For many years, com-
mentators argued that American states compete to attract incorporations (Bebchuk 1992;
Cary 1974). Recent commentary, however, maintains that Delaware is the only state so
motivated (Kahan and Kamar 2002; Bebchuk and Hamdani 2002; Roe 2003). Either way,
the theory of the race to laxity is that this dynamic produces permissive rules because
managers favor them.1
A similar dynamic characterizes the competition between countries to attract securi-
ties listings. The desire to attract listings drives countries to lower disclosure standards
because managers consider these standards when deciding where to list securities for
trade. If possible, for example, managers prefer to disclose less about the terms of their
employment or about related party transactions (Licht 2000).
1
Justice Louis Brandeis famously described this in Louis K. Liggett Co. v. Lee, 288 U.S.
517, 557–60 (1933): “Lesser States, eager for the revenue derived from the traffic in charters, had
removed safeguards from their own incorporation laws . . . The race was one not of diligence but
of laxity . . . and the great industrial States yielded in order not to lose wholly the prospect of the
revenue and the control incident to domestic incorporation.”
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Licht (2001) argues that this dynamic mostly affects the laws of countries with small
capital markets. To overcome their disadvantage, stock exchanges in these countries
lobby lawmakers to exempt foreign issuers from local disclosure requirements. However,
competition affects countries with large capital markets too. Even the United States,
which has the largest capital markets in the world, makes concessions to foreign issuers.
We discuss this next.
2.1 The Crosslisting Legislation in the United States
Modernday regulation of foreign private issuers in the United States grew out of the
integrated disclosure system adopted by the Securities and Exchange Commission (SEC)
in 1979.2 Before this reform, foreign issuers and US issuers had had to disclose similar
information (Edwards 1993). The reform began a long and steady deregulation process
geared at attracting foreign issuers.
Initially, the SEC resisted the pressure to ease the disclosure requirements of foreign
issuers, maintaining it was ‘difficult to justify one level of disclosure for domestic securi-
ties and another for foreign securities when the standard for both is the protection of
United States investors.’3 In the 1980s and 1990s, however, its view began to shift (Fanto
and Karmel 1997). During that period, the New York Stock Exchange pushed for lighter
regulation of foreign issuers. As a result, the SEC agreed to exempt foreign issuers from
major requirements, including the proxy rules, the duty to file quarterly reports, the duty
to file current reports, and the ban on short swing profits by corporate insiders (Davidoff
2010).
In the new millennium, the discourse about foreign issuers focused on the need to keep
US capital markets competitive. This was partly in response to the success of the United
Kingdom in attracting foreign issuers (Romano 2005). The SEC thus took additional
steps to facilitate listing by foreign issuers, including relaxing the rules governing cross-
border transactions, facilitating deregistration by foreign issuers, and allowing reporting
according to international accounting standards (Davidoff 2010). The departure from the
principle of a level playing field for foreign issuers and US issuers was complete.
2.2 The Crosslisting Legislation in Israel
Crosslisted companies constitute a large share of the Israeli securities market. According
to the website of the Tel Aviv Stock Exchange, 70 of the 454 companies traded on the
exchange at the end of March 2017—accounting for 52.6 percent of the market value of
companies traded on the exchange—are crosslisted. Of these, 56—accounting for 44.7
percent of the market value of companies traded on the exchange—filed foreign reports
in Israel, typically under US law.
Their regulation dates back four decades. In 1983, the Israeli securities market experi-
enced a severe crisis. After a brief recovery, in 1994, another crisis took place. Stock prices
2
See Rules, Registration and Annual Report Form for Foreign Private Issuers, 44 Fed. Reg.
70,132 (29 November 1979).
3
Foreign Private Issuers, 42 Fed. Reg. 58,684, 58,685 (2 November 1977).
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The Teva case 375
plummeted and initial public offerings dwindled. During these years, the technology
sector developed rapidly and scores of Israeli technology companies went public on
NASDAQ. They favored NASDAQ due to its size, depth and proximity to customers
(Yehezkel 2006). As an added bonus, they faced light disclosure requirements as foreign
issuers. More than a hundred companies followed this path. It was a large number even
by international standards (Licht 2001).
In 1996, the Tel Aviv Stock Exchange lobbied for an exemption of companies traded
both in Israel and in the United States from Israeli securities regulation. The ISA rejected
the idea. However, the exchange did not give up and, in 1998, the ISA appointed a com-
mittee to consider the proposal.
The committee concluded that, while the disclosure required of foreign issuers in
the United States was lacking, the disclosure required of US issuers was similar to
the required disclosure in Israel. The committee accordingly recommended granting
relief only to crosslisted companies meeting the disclosure requirements of US issuers
(Report of the Committee on Cross Listing of Securities 1998). The ISA endorsed the
committee’s recommendation. However, the Israeli Association of Publicly Traded
Companies and the Tel Aviv Stock Exchange pressured the Israeli government to
extend the relief to issuers that meet the lighter disclosure requirements of foreign
issuers in the United States. They warned that companies would leave the Israeli market
otherwise.
The pressure worked. In 2000, the Knesset enacted the so-called Cross Listing Law,
which added to Israel’s securities statute a chapter that allows companies traded on a
national exchange in the United States or the United Kingdom to list their securities in
Israel while filing the same reports they file abroad.4
2.3 The Weak Enforcement of the Law on Crosslisted Companies
Commentary on regulatory competition customarily focuses on content. By this measure,

a race to laxity is one that produces permissive rules. In the area of securities regulation,
however, a race to laxity can also produce weak public enforcement.5 Demanding less
of foreign issuers and monitoring their compliance less closely have similar effects and,
between the two, the latter is cheaper both financially and politically. This explains why
both the ISA and the SEC show little interest in monitoring compliance by crosslisted
companies.
Many regard the SEC as an effective enforcer of securities law (Eckstein 2015).
However, this perception reflects only its enforcement of the law regarding US issuers.
Foreign issuers get much less attention.
Siegel (2005) studies the public enforcement efforts toward Mexican companies traded
in the United States that experienced a crisis and reportedly committed fraud. He finds
no criminal proceedings against these executives and only a single civil proceeding. In fact,
he reports, since its establishment in 1933 the SEC took meaningful steps against foreign
4
See Securities Law (Amendment No 21), 2000 (adding Part E3 to the Securities Law, 1968).
5
Private enforcement of securities law is only indirectly controlled by regulators and is other-
wise less effective than public enforcement (Jackson and Roe, 2009; Licht et al, 2018).
M4633-GRIFFITH_t.indd 375 30/10/2018 08:16

issuers only 15 times. Moreover, the chance that executives of these companies will be
involved in appropriation of company assets is 37.4 percent higher than that of Mexican
companies not listed in the United States and therefore not subject to SEC supervision.
Other studies concur. Shnitser (2010) reports that the enforcement of US law on foreign
issuers is lacking. Silvers (2015) reports that, while SEC monitoring of foreign issuers
increased after 2002, the stock market still exhibits surprise at any enforcement event.
Naughton et al (2018) report more nuanced findings. They too find that foreign issuers
face less SEC enforcement than do US issuers. However, they find a negative relation
between the level of SEC enforcement and the enforcement level in the foreign issuer’s
home country. Additionally, they find that foreign issuers face a higher level of SEC
enforcement when they are more important to American investors in terms of market
value and trading volume in the United States.
The ISA does even less than the SEC. As a matter of policy, it leaves the supervision of
companies reporting under foreign law—including ones incorporated and headquartered
in Israel—to the foreign regulator, typically the SEC.6
Reliance on public enforcement of securities law on Israeli issuers traded in the United
States thus raises a concern. One simply cannot assume that either national regulator
will do the work. The Teva case illustrated the problem. The ISA decided not to monitor
disclosure by issuers reporting under SEC rules and the SEC was unfamiliar with the
disclosure requirements in Israel referenced by SEC rules and did not inquire what the
requirements were. Teva was a regulatory orphan.
2.4 Can Laxity Be Good?
In theory, permissive rules and weak enforcement can be just what shareholders want and
need. It is possible in corporate law (Romano 1993; Daines 2001; Fischel 1982; Winter
1977) as it is in securities law (Romano 2001; Fox 1997). Examining this possibility in
general is beyond the scope of this chapter. Suffice to say that it is hard to see how allowing
executives to conceal their pay can serve shareholders. Here, a race to laxity is clearly a
race to the bottom.
For one thing, shareholders show intense interest in executive pay and penalize execu-
tives they consider overpaid (Brav et al 2009). For another thing, empirical studies find that
disclosing this information benefits shareholders (Lo 2003; Laksmana et al 2012; Robinson
6
See ISA Assembly Resolution in the Corporations Area No 2015–1, Recommendation to Include
the London Stock Exchange’s Main Market, High Growth Segment in the Third Supplement to the
Securities Law (31 March 2015) (in Hebrew), www.isa.gov.il/%D7%92%D7%95%D7%A4%D7%99%
D7%9D%20%D7%9E%D7%A4%D7%95%D7%A7%D7%97%D7%99%D7%9D/Corporations/Staf_
Positions/Plenary_Decisions/Documents/142015.pdf: “The policy of supervising Cross Listing com-
panies is a policy of reliance on the foreign regulator, that is, the Authority does not examine Cross
Listing companies at all in its routine examinations . . . [S]upervision by the Authority would require
an enormous investment in learning foreign laws, and even then it is doubtful that the Authority’s staff
could examine interpretive questions of foreign laws, as the authorized body for this is the foreign regu-
lator. Furthermore, it is reasonable to assume that, if Cross Listing companies were to be supervised by
two regulators in relation to the same reporting requirements, they would not list [in Israel].” Section
35(34)(b) of the Securities Law, 1968, added by the Cross Listing Law, only provides that the ISA may
consult the foreign regulator before taking an enforcement action against a crosslisted company.
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The Teva case 377
et al 2011; Vafeas and Afxentiou 1998; Craighead et al 2004; Park et al 2001). Moreover,
regulators both in Israel and in the United States require domestic issuers to disclose execu-
tive pay, and consider the exemption of crosslisted issuers from this duty to be a concession
to attract listings. Regulators in other countries agree. They require both disclosure and
shareholder approval (Thomas and Van der Elst 2015). This consensus is telling.
3. OUR CASE AGAINST TEVA
Teva is the largest Israeli company by any measure. Since the 1950s its shares have been
listed on the Tel Aviv Stock Exchange, and since 1982 they have been listed also in the
United States—first on NASDAQ, and from 2012 on the New York Stock Exchange. At
the end of 2012, the year in which we sued Teva, its market value was 22 percent of the
market value of all companies on the Tel Aviv Stock Exchange (Tsuk 2013).
3.1 Teva Stops Reporting Individual Executive Pay
Before 2000, Teva had disclosed the compensation of each of its five highest paid
executives in annual reports in Israel and the United States.7 In Israel, it filed a standard
report under Israeli law, which required this disclosure.8 In the United States, it filed an
abbreviated report as a foreign issuer under US law, which required this disclosure because
it was required in Israel.9
That practice changed with the enactment of the Cross Listing Law, which allowed Teva
to file in Israel the reports it filed in the United States.10 Although individual compensa-
tion disclosure was the standard in both countries, Teva decided the countries’ mutual
deference somehow allowed it to disclose only aggregate compensation. It obtained
shareholder approval for filing US reports in Israel without informing shareholders of its
plan and stopped disclosing individual compensation in both countries. Other companies
followed Teva. It became impossible to know how much any executive earned.
The outcome was peculiar. At a time when executive pay preoccupied the public in
7
See Teva Pharmaceutical Industries Limited, Board of Directors Report for the Year and
Quarter Ended December 31, 1999, Rule 21, at 100 (in Hebrew) (on file with authors) (disclosing the
individual compensation of each of the five highest paid officers); Teva Pharmaceutical Industries
Limited, Annual Report for the Fiscal Year Ended December 31, 1999, Item 11, at 80 (on file with
authors) (disclosing the aggregate compensation of 42 directors and officers and the individual
compensation of each of the five highest paid officers).
8
The requirement was in Section 21 of the Securities Regulations (Periodic and Immediate
Reports), 1970. It is still the requirement for companies that are not crosslisted.
9
The requirement was in Item 11 of Form 20–F under the Securities Exchange Act of
1934. See Adoption of Foreign Issuer Integrated Disclosure System, 47 Fed. Reg. 54,764–02
(6 December 1982). Effective September 30, 2000, the requirement is in Item 6.B of Form 20–F:
“Disclosure of compensation is required on an individual basis unless individual disclosure is not
required in the company’s home country and is not otherwise publicly disclosed by the company.”
See International Disclosure Standards, 64 Fed. Reg. 53,900 (5 October 1999).
10
See Teva Pharmaceutical Industries Limited, Annual Report for the Fiscal Year Ended
December 31, 2000, Item 6, at 56 (on file with authors) (disclosing the aggregate compensation of
42 directors and officers).
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Israel no less than in the United States, a large fraction of the public companies in Israel
were hiding it. In 2012, for example, only 74 of the 100 largest issuers in Israel reported
individual pay (Gur-Gershgoren et al 2016). The rest were crosslisted companies and a
handful of limited partnerships.
3.2 Where Were the Regulators?
Thus for a dozen years, from the enactment of the Cross Listing Law until the signing
of the settlement, Teva disclosed only the total amount it paid its directors and officers.
Teva is so central a company in Israel that this practice must have drawn attention. It was
no trifling matter. Pay practices in public companies and the efforts companies make to
hide them have drawn much criticism (Bebchuk and Fried 2004). It is a sensitive subject,
which, in the eyes of many, epitomizes the conflict of interest between shareholders and
managers. Nevertheless, both the ISA and the SEC were silent.
3.3 How Did Teva Succeed in Avoiding Its Duty for So Long?
Teva avoided legal challenge partly by saying nothing in public about the change in its
executive pay disclosure. Before suing Teva, we spent months familiarizing ourselves with
the regulation of foreign issuers in the United States. We studied its history, read filings of
foreign issuers from around the world, and pored over SEC releases and no-action letters.
We assumed a company of Teva’s stature would be sure to find authority before making
such a risky move as stopping to report executive compensation. However, there was no
authority. It is easy to see how other shareholders made the same mistake.
Furthermore, Teva never ran its self-serving interpretation of the law by regulators.
With the disclosure of executive pay being an area of clear conflict between shareholders
and managers, one would have expected Teva to ask the ISA and the SEC if they agreed
with its legal interpretation. Teva preferred not to ask.
3.4 Why Did Neither the ISA Nor the SEC Ever Question Teva’s Practice?
The ISA and the SEC also did not ask. First, the overlapping jurisdiction of the two
regulators made it easier for Teva to fall between the cracks. After the enactment of
the Cross Listing Law the ISA quit monitoring crosslisted companies and let the SEC
take the lead. However, the SEC, as noted previously, monitors foreign issuers with
much less zeal than US issuers. The lethargy of both regulators is unsurprising given
their avowed interest in attracting crosslistings.11 Moreover, the relevant American law
referenced Israeli law and the SEC was unfamiliar with Israeli law. Teva was thus left
in a twilight zone between the two legal systems. Paradoxically, the SEC depended on
Teva to educate it about the law it should enforce.
Second, executive compensation came to the forefront in Israel only near the end
11
For example, the chairman of the SEC listed “encouraging companies to list on U.S. mar-
kets” as one of his “key successes” in the annual report for 2000. See SEC 2000 Annual Report x
(1 January 2000), www.sec.gov/pdf/annrep00/ar00full.pdf.
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The Teva case 379
of the first decade of the millennium. The watershed event was the appointment of a
government committee on the subject in 2010 (Licht et al 2013; Filut 2010; Weissman
2012; Zrahiya 2011). By that time, everyone had grown used to crosslisted companies
not revealing executive pay. Thus, the media, public figures, and the authorities chastised
transparent companies that traded only in Israel for their pay practices, while sparing
crosslisted companies that kept the information secret.
3.5 The Suit
Our interest in compensation disclosure by crosslisted Israeli companies grew out of

our academic work. We noticed these companies did not disclose compensation on an
individual basis like other issuers in Israel and like US issuers in the United States, and
could not find any justification for this. We decided to challenge Teva about this practice.
Teva was by far the largest company in Israel and we both held its shares. If Teva changed
its practice, we believed, other crosslisted companies would too.
In February 2012, as Teva shareholders, we faxed to Teva’s Chief Financial Officer
(CFO) a demand that the company disclose executive compensation on an individual
basis. The CFO replied by phone that Teva rejected our demand, based on legal advice
it had received. He added that the company had seen no need to seek SEC approval for
its practice. A couple of weeks later Teva filed an annual report, again disclosing only
an aggregate pay figure. A month later Teva’s legal department rejected our demand in
writing. It did not explain why.
In May 2012, we wrote to Teva again, noting it had not explained its practice and stating
we intended to sue the company on behalf of all its shareholders. Our goal was to bring
Teva to disclose individual executive compensation figures and thus to set an example for
other crosslisted companies. Teva did not reply.
In October 2012, we filed a class action at the Tel Aviv District Court seeking an order
to compel Teva to disclose the individual compensation of each of its directors and offic-
ers for the past seven years (due to Israel’s statute of limitations) and in future annual
reports. We claimed Teva had been violating its duty to disclose this information since
2000. Our complaint was supported by an affidavit of Professor Jesse Fried of Harvard
Law School. Fried had authored a leading book on executive pay (Bebchuk and Fried
2004) and a series of related articles (Bebchuk and Fried 2005; Fried 2006; Bebchuk and
Fried 2010; Fried 2011).
Fried opined that Teva had to disclose executive compensation on an individual basis
because the default rule for foreign issuers in the United States was individual disclosure
and Israeli law merely allowed Teva to file the same reports in Israel. This conclusion, he
explained, was consistent with the goal of the law governing foreign issuers in the United
States: to spare foreign issuers the need to disclose more than they would if they traded
only in their home country, rather than to enable them to disclose less. The suit received
wide press coverage (Gabison 2012; Baum 2013a; Wainer 2013a).
Teva never filed an answer. After receiving several extensions from the court, it reached
a settlement with us in which it committed to disclose executive pay individually in future
annual reports. In return, we gave up our demand that Teva disclose this information for
previous years. We signed the settlement agreement minutes before the first hearing, on
June 19, 2013, and the court scheduled a settlement hearing for September 3, 2013.
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The significance of the settlement was clear. It committed Teva to breaking with its
longtime practice and disclosing executive compensation on an individual basis. We
thought our work was done: Teva accepted our demands and other crosslisted companies
were likely to mimic its new disclosure policy. Like the suit, the settlement received wide
press coverage (Gabison 2013a; Wainer 2013b). Shortly after signing the settlement agree-
ment, Teva revealed the compensation of its chief executive officer in a proxy statement
related to his annual bonus. This too drew media attention (Gabison 2013b). However, at
that stage the regulatory race to laxity heated up again.
3.6 Enter the ISA
Before filing the suit, we had asked the ISA for support under a law authorizing it to
finance class actions in the public interest. The ISA fumbled. Its first reaction was that
it had a policy of leaving the disclosures of companies filing US reports to the SEC.
After a while, it wrote to us saying it wanted to read Teva’s answer to the complaint.
Nevertheless, when Teva chose to settle instead of filing an answer, the ISA entered the
fray anyway—and vigorously opposed our no longer contested claims.
Its newly found interest in the suit reflected its fear of litigation targeting additional
crosslisted companies. While the settlement released claims against Teva, similar claims
could still be made against other companies, and while we sought only disclosure,
shareholders of other companies could seek damages as well. The ISA worried that
these companies would delist from the Tel Aviv Stock Exchange to protest and possibly
to reduce litigation exposure (delisting of crosslisted companies from the Tel Aviv Stock
Exchange does not require shareholder approval).
Coincidentally, a major company, Mellanox Technologies, decided to delist shortly
before the signing of the settlement, citing difficulties it faced as a crosslisted company.
Mellanox had regularly disclosed executive compensation on an individual basis, and the
reasons it gave for its delisting did not concern disclosure. Nevertheless, its delisting drew
considerable attention (Nissan 2013; Raich 2013; Solomon and Picker 2013). The ISA
was thus under pressure to reaffirm its liberal approach toward crosslisted companies
(Baum 2013b).
Thus, two weeks before the settlement hearing, the ISA issued a statement.12 Contrary
to the shared view of the parties to the suit—Teva and ourselves—the ISA claimed that
the case did not require an analysis of US law. Rather, the ISA argued, the intent of Israel’s
Cross Listing Law was enough, and it was to enable companies listed abroad to list their
securities also in Israel without additional disclosure. Because Teva would not have had
to disclose individual executive pay had it traded only in the United States—as Israeli
securities law applies only to issuers traded in Israel and therefore would have required
no disclosure—the ISA concluded that Teva did not have to disclose individual pay when
traded also in Israel.
Shortly thereafter, the Attorney General of Israel filed an amicus brief with the court
12
ISA, Corporate Finance Department, Legal Position No 199–11: ReportingRequirements of
Dual Listed Companies (18 August 2013), www.isa.gov.il/sites/ISAEng/Supervised%20Departments/
Public%20Companies/Dual_Listing/Documents/IsaFile_1101154.pdf.
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The Teva case 381
containing the ISA statement. The brief explained that the ISA worried the settlement
would deter companies from crosslisting in Israel. The brief emphasized, however, that
the ISA did not oppose the settlement, and indeed was considering new regulation to
impose uniform compensation disclosure requirements on all Israeli companies traded
abroad.
3.7 The Decision of the Court
On September 29, 2013, the court handed down its decision. It approved the settlement
without addressing the merits of the case.13 The court held, however, that the settlement
was highly beneficial to the shareholders, noting that the ISA acknowledged this value and
was considering new regulation that would require all Israeli companies traded abroad to
disclose executive pay.
4. THE AFTERMATH
The new regulation mentioned by the ISA was our initiative. We had anticipated that
the settlement with Teva would unnerve crosslisted companies, which would fear facing
similar suits, and the ISA, which would fear losing listings. To stem these concerns, soon
after signing the settlement agreement we proposed to the Ministry of Justice the adop-
tion of a rule requiring all Israeli companies traded abroad, regardless of whether they
were traded in Israel, to disclose executive compensation on an individual basis. A rule
mandating individual disclosure, we reasoned, would end the practice of hiding executive
pay and, by implying there had been no such requirement before, would deter litigation
related to disclosure in the past.
The applicability of the rule also to Israeli companies listed only abroad was essential.
Aside from being sensible—the United Kingdom has a similar rule14—this design ensured
the rule would not encourage delisting from Israel, assuaging the fears of the ISA. The
only way companies could avoid the rule was by incorporating in a country other than
Israel or the United States that did not require disclosure. This is rarely a viable option.
Young technology companies need to incorporate in Israel to obtain government funding,
and reincorporating later abroad requires shareholder approval.
The Ministry of Justice agreed with us and prepared the rule for approval by the
Knesset’s Constitution, Law and Justice Committee and the Minister of Justice. In June
2014, the final rule was published.15 It requires any Israeli company listed abroad to
13
See Class Action (Dist. Tel Aviv) 18040–11–12 Hannes and Kamar v. Teva Pharmaceutical
Industries Ltd. (29 September 2013) (in Hebrew).
14
See Sections 385, 420, and 439 of the Companies Act 2006 (requiring UK companies listed
in the United Kingdom, in a European Union member state, on the New York Stock Exchange or
on NASDAQ to prepare a directors’ remuneration report annually and present it for shareholder
approval). The format of the report is set forth in the Directors’ Remuneration Report Regulations
2002. The Unregistered Companies Regulations 2009 apply similar requirements to private UK
companies if their principal place of business is in the United Kingdom.
15
See Companies Regulations (Announcement and Notice of a Shareholder Meeting and a
M4633-GRIFFITH_t.indd 381 30/10/2018 08:16

disclose the compensation of its five highest paid officers on an individual basis in its
annual proxy statement or in its annual report.
5. CONCLUSION
In 2012, the year we sued Teva, dozens of companies crosslisted in Israel and the United
States disclosed only aggregate executive pay. Consequently, the pay practices of 26 of the
100 largest issuers in Israel were unknown (Gur-Gershgoren et al 2016).
In 2014, for the first time since 2000, Teva revealed this information under the terms of
its settlement with us.16 In 2015, more than 80 Israeli companies listed in the United States,
including ones not listed in Israel, were required to do the same (Habib Waldhorn 2016).
Today this disclosure is standard. As of April 9, 2016, for example, 21 of the 100 highest
paid executives on the Tel Aviv Stock Exchange were from crosslisted companies (Levy
2017). Teva executives, incidentally, occupied five of the top six places. It is hard to believe
that, only three years earlier none of this was known, all because of the global competition
for securities listings.
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The Teva case 385
APPENDIX
In the District Court of Tel Aviv Class Action 18040–11–12

The Economic Division
1. PROFESSOR SHARON HANNES, ADV.

2. PROFESSOR EHUD KAMAR, ADV.
Movants,
By their attorneys Gil Ron, Keinan & Co., Advocates,

and Aviad, Seren & Co., Advocates,
whose address for the purpose of this procedure shall be at
Gil Ron, Keinan & Co., Lessin Theater House, 32 Weizmann Street,
Tel Aviv 62091, Phone: 03-6967676, Fax: 03-6967673
v.
TEVA PHARMACEUTICAL INDUSTRIES, LTD.
Public Company No. 520013954
5 Basel Street, Petach Tikva 49131 (“Teva”)
Respondent.
Motion for Certification of a Class Action under the Class Actions Law, 2006
The Movants are honored to present this Motion to Certify a Class Action under the
Class Actions Law, 2006 (“the Class Actions Law”). The suit whose certification is sought
is attached as Appendix 1. The motion is by all Teva shareholders.
The suit concerns Teva’s duty to disclose the compensation of its senior managers and
directors on an individual basis in the periodic reports it is required to file annually. Teva
violates this duty starting with the periodic report for the year 2000 (filed in 2001). It dis-
closes the aggregate compensation of its senior managers and the aggregate compensation
of its directors; hence it is not possible to know the compensation of the Chief Executive
Officer and of each of its other senior managers.
Italics in quotations that appear in this Motion was added by the Movants, unless stated
otherwise.
Table of Contents
Part A—Main Arguments 386

A.1 General 387
A.2 Teva’s Reports Before the Enactment of the Dual Listing Law 387
A.3 Disclosure Obligations Under the Dual Listing Law 387
A.4 Teva’s Reports After the Enactment of the Dual Listing Law 388
A.5 Teva’s Failure to Disclose the Compensation of Directors Creates the Illusion of
a General Exemption from a Duty to Disclose 389
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A.6 Teva’s Interpretation of the Duties to Disclose Executive Compensation

Contradicts Its Interpretation of the Duties to Disclose Their Age 390
A.7 Teva Did Not Reveal to Its Shareholders the Intention to Hide the Executives’
Compensation 390
A.8 Continuation of the Violation of Law 391
A.9 Teva Cannot Create for Itself an Exemption from Disclosure of Material
Information That the Legislature Has Not Expressly Granted 391
A.10 Turning to the Court as Last Resort 392
Part B—The Dual Listing Law and the Duty to Disclose Executive Compensation in
Detail 393
B.1 The Brodet Committee 393
B.2 The Expansion of U.S. Disclosure Duties Regarding Executive Compensation of
Foreign Issuers 393
B.3 Israeli Law Requires Teva to Disclose Its Executives’ Compensation on an
Individual Basis 394
B.4 U.S. Law Requires Teva to Disclose Its Executives’ Compensation on an
Individual Basis 395
B.5 Teva’s Disclosure Before and After the Dual Listing Law 397
B.6 Importance of Disclosing Executive Compensation on an Individual Basis 400
B.7 Companies That Report Under the Dual Listing Law and Disclose Executive
Compensation on an Individual Basis 404
B.8 Teva’s Interpretation of the Duties to Disclose Executives’ Compensation
Contradicts Its Interpretation of the Duties to Disclose Their Age 404
B.9 An Israeli Court as the Only Forum for Hearing the Suit 405
Part C—About the Movants 406
C.1 The Movants 406
C.2 Turning to the Court as Last Resort 407
Part D—The Causes of Action 408
Part E—The Motion to Certify the Suit as a Class Action 409
E.1 Class Definition and Conditions for Class Action Certification 410
E.2 Burden on the Movants, Existence of a Class 410
(A) Burden on the Movants 410
(B) Existence of a Class 410
E.3 Satisfaction of the Conditions for Class Action Certification 411
Part VI—Remedies and Summary 411
Part A—Main Arguments
A.1 General
1. This Motion deals with Teva’s failure to disclose the compensation of each of its
senior managers and each of its directors individually in its periodic reports. By doing so
Teva violates the provisions of Israeli law, which incorporates the reporting requirements
of U.S. law, thus Teva violates the two legal regimes.
2. Teva is a company incorporated in Israel; its shares are traded on the Tel Aviv Stock
Exchange since 1951. Since 1982, Teva’s shares have been traded concurrently in the
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The Teva case 387
United States (through American Depository Shares), first on NASDAQ and since May
30, 2012 on the New York Stock Exchange (NYSE).
A.2 Teva’s Reports Before the Enactment of the Dual Listing Law
3. In March 2000, Teva filed in Israel an annual report for the year 1999 under the
provisions of Chapter VI of the Securities Law, 1968 (“the Securities Law”). In June
2000, Teva filed an annual report in the United States for the year 1999 using the 20–F
Form, since it was a “foreign private issuer” there. Both reports disclosed on an individual
basis the compensation of each of Teva’s five most senior managers. The disclosure in the
report filed in Israel was required under Section 21 of the Securities Regulations (Periodic
and Immediate Reports), 1970 (“the Regulations on Periodic and Immediate Reports”).
The disclosure in the report filed in the United States was required, at that time, in Item
11 of Form 20–F.
A.3 Disclosure Obligations Under the Dual Listing Law
4. In August 2000, the Securities Law (Amendment No. 21), 2000 (“the Dual Listing Law”)
was enacted. It allows dual-listing companies (traded both in Israel and on a stock exchange
outside Israel) traded on certain exchanges in the United States or United Kingdom to
file the reports they are required to file abroad in Israel. As explained below, this reporting
format also requires disclosure of executive compensation on an individual basis.
5. U.S. law requires disclosure of executive compensation on an individual basis in
annual reports for both U.S. issuers (which file annual reports on Form 10–K) and foreign
private issuers like Teva (which file annual reports on Form 20–F).
6. U.S. issuers are required to disclose executive compensation on an individual basis.
This requirement is set forth in Item 402 of Regulation S–K, to which Form 10–K refers.
Foreign issuers are also required to disclose executive compensation on an individual
basis, but are allowed to disclose the compensation in aggregate if their home country’s
law does not require disclosure on an individual basis and they do not otherwise disclose
individual information. This rule is set forth in Instruction 1 to Item 6.B of Form 20–F,
which requires disclosure of compensation of directors and members of the issuer’s
administrative, supervisory or management bodies. For all of these individuals, the fol-
lowing disclosure is required:
Disclosure of compensation is required on an individual basis unless individual disclosure is not

required in the company’s home country and is not otherwise publicly disclosed by the company.
7. That is, the default U.S. law that applies to Teva is disclosure of compensation of
each of the senior managers on an individual basis. In order to avoid making the required
disclosure and instead disclose aggregate compensation, Teva needs to show that Israeli
law does not require disclosure on an individual basis and also that it does not otherwise
publicly disclose compensation on an individual basis. Israeli law’s reference to the report-
ing requirements in U.S. law shows that Israel adopts the default U.S. law and does not
exempt companies traded in Israel and the United States from disclosing information on
an individual basis.
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8. This Motion is supported by a written opinion of Professor Jesse Fried from Harvard
Law School. Professor Fried is a prominent scholar of executive compensation in the
United States and a preeminent professor and researcher in the fields of corporate law,
corporate governance, executive compensation, and venture capital. Professor Fried has
published over two dozen articles on executive compensation, securities law, corporate
governance, and venture capital. His well-known book on executive compensation, Pay
Without Performance: The Unfulfilled Promise of Executive Compensation (Harvard
University Press, 2004), written with Professor Lucian Arye Bebchuk of Harvard Law
School, has been acclaimed both in the academy and the capital market and has been
translated into Chinese, Japanese, and Italian.
9. Professor Fried opines as follows:
I have been asked whether, since 2000, Teva . . . has been required under U.S. law to disclose the
compensation of its directors and members of its administrative, supervisory or management
bodies (hereinafter, “officers”) on an individual basis in Item 6. B of its annual report on Form
20–F, given that Teva has been (a) incorporated in Israel and (b) listed on the Tel Aviv Stock
Exchange (“TASE”) as well as on either NASDAQ’s Global Capital Market (“NASDAQ’s
GCM”) or the New York Stock Exchange (“NYSE”) throughout this period. My answer is: yes.
10. Professor Fried explains further in his written opinion what is obvious from read-
ing Form 20–F alongside the provisions of Israeli law. Item 6.B of Form 20–F requires
disclosure of compensation on an individual basis unless the foreign private issuer is
exempt from such disclosure in its home country and does not otherwise disclose this
information. Teva cannot show that it is exempt from disclosure on an individual basis
in Israel. First, the Securities Law refers Teva to the disclosure duties in Item 6.B, which
in turn require disclosure on an individual basis by default. Second, the purpose of Item
6.B is not to reduce the disclosure duties in periodic reports pursuant to the Securities
Law, which require disclosure on an individual basis. Furthermore, the Companies Law,
1999 (“the Companies Law”) requires Teva to obtain the general meeting’s approval for
its directors’ compensation and to this end to disclose the compensation. Teva does so
routinely, creating an independent duty to disclose the compensation on an individual
basis in Form 20–F with respect to its directors.
A.4 Teva’s Reports After the Enactment of the Dual Listing Law
11. On December 18, 2000, Teva’s general meeting approved a transition to the report-
ing format of the Dual Listing Law. On the following day, Teva announced the transition
in Israel and enclosed the periodic report for 1999 and the reports for the first three
quarters of 2000, which it had filed in the United States. That periodic report included
disclosure of the compensation of Teva’s senior managers on an individual basis.
12. This was the last time Teva fulfilled the duty to disclose the compensation of senior
managers on an individual basis. Since then, Teva stopped disclosing the compensation of
its senior managers on an individual basis in periodic reports in the United States and Israel.
The compensation of all senior managers and directors appears in aggregate. It is impos-
sible to know how much the Chief Executive Officer or any other senior manager earned.
13. Following Teva, most dual-listing companies reporting in Israel under the Dual Listing
Law do not disclose the compensation of their senior managers on an individual basis.
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The Teva case 389
14. The result is inconceivable: all U.S. public companies disclose the compensation of
their senior managers on an individual basis. All companies traded in Israel disclose the
compensation of their senior managers on an individual basis. However, Teva and the
dual-listing Israeli companies that followed it conceal this information. In other words,
the largest company in Israel and one of the largest companies in the United States
does not meet the requirements that all companies on the market meet on a particularly
sensitive issue.
15. This is not a trivial matter. Executive compensation is nowadays at the focus of
attention for the authorities and the public. To many it epitomizes the conflict of interest
between company management and public shareholders. And yet Teva chose to disregard
the law, avoid disclosure, and free itself from scrutiny.
A.5 Teva’s Failure to Disclose the Compensation of Directors Creates the Illusion of a
General Exemption from a Duty to Disclose
16. Teva violates the disclosure duty in a particularly flagrant way regarding directors.
The difference between directors and managers who are not directors stems from Section
273 of the Companies Law, to which Teva is subject as a company incorporated in Israel.
Section 273 of the Companies Law provides that the general meeting of shareholders
needs to approve the compensation of directors. In contrast, as of the filing of this
Motion, the compensation of other senior managers requires approval only by the board
of directors under Section 272 of the Companies Law.
17. Under Section 273 of the Companies Law, Teva must obtain the general meeting’s
approval for directors’ compensation and so it must disclose the compensation that
requires approval. Teva must also provide a summary of the resolutions to be adopted
at the general meeting under the Companies Regulations (Notice and Advertisement
of a General Meeting and Class Meetings in Public Companies), 2000 (“the Notice and
Advertisement Regulations”). To meet the requirements of the Companies Law and the
requirements of the Notice and Advertisement Regulations, Teva turns to its sharehold-
ers from time to time to obtain their approval for setting and amending the directors’
compensation, and in the course of doing so reveals the compensation on an individual
basis. After the general meeting is held, Teva publishes the results of the meeting.
18. Even though Teva is required to disclose the compensation of its directors on an
individual basis in the course of its approval, and does so, it systematically avoids disclos-
ing it in periodic reports. By doing so it clearly violates the requirement of Item 6.B of
Form 20–F in every possible way: first, the exemption from disclosure on an individual
basis applies only if such disclosure is not required in Israel. However, this disclosure is
required in Israel—both in general meeting notices (because the Companies Law requires
the general meeting’s approval for the compensation of all of Teva’s directors, and the
Notice and Advertisement Regulations require a description of items on the agenda in the
general meeting notice), and due to the Israeli law’s reference to the U.S. disclosure duty,
which requires this disclosure by default (as we explained, in relation to all directors and
officers). Second, the exemption also depends on Teva not otherwise publicly disclosing
compensation on an individual basis—but Teva does publicly disclose this information
on an individual basis in general meeting notices.
19. This failure to disclose is puzzling. The violation of the disclosure duty here is even
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more obvious than in the case of managers who are not directors, where Teva violates only
the first clause of the disclosure provision. In the case of directors whose compensation
has already been publically disclosed to the shareholders, the disclosure duty in U.S. law
stems both from the duty in Israeli law and from the fact that Teva has already publicly
disclosed the compensation. This duty cannot be disputed.
20. However, the failure to disclose the compensation of directors on an individual
basis in periodic reports saves Teva the need to answer questions of U.S. readers of the
report regarding the duty under Israeli law to disclose the compensation of managers,
which is the focus of attention and public scrutiny. Had Teva disclosed the compensation
of its directors on an individual basis in periodic reports, it would have raised questions
from the authorities in the United States and investors regarding the justification for
distinguishing between directors and members of senior management. The sweeping
nondisclosure of the compensation of both groups creates the false impression that Israeli
law is not interested in disclosure of their compensation on an individual basis, and so the
U.S. law also forgoes the disclosure.
A.6 Teva’s Interpretation of the Duties to Disclose Executive Compensation Contradicts

Its Interpretation of the Duties to Disclose Their Age
21. Examination of the periodic reports that Teva files annually in Israel and the United
States shows that Teva too understands it is required to disclose the senior managers’
compensation on an individual basis. This can be learned from Teva’s disclosure policy
regarding their age.
22. The disclosure duty under U.S. law regarding age is lenient compared to the disclo-
sure duty regarding compensation in that, in the case of age, the default is exemption from
disclosure. Instruction 3 to Item 6.A of Form 20–F provides that senior managers’ age
is to be disclosed only if it is subject to disclosure in the home country. Israeli law in this
regard is similar to the law on disclosure of senior individuals’ compensation: companies
filing periodic reports under Chapter VI of the Securities Law are required to specify the
birth dates of the senior managers under Section 26A(2) of the Periodic and Immediate
Reports Regulations, and companies reporting under the Dual Listing Law are required
to file in Israel the reports they are required to file abroad. However, while Teva does
not disclose its senior managers’ compensation in its reports despite the default duty to
disclose, it does disclose their age despite the default exemption from disclosure.
A.7 Teva Did Not Reveal to Its Shareholders the Intention to Hide the
Executives’ Compensation
23. Teva has never informed its shareholders it would exempt itself from disclosure of
compensation on an individual basis. On November 13, 2000, Teva called a special general
meeting of the shareholders to approve the transition from reporting under Chapter VI of
the Securities Law (which included disclosure of compensation on an individual basis) to
reporting under U.S. law (attached as Appendix 2). The notice did not mention any relief
Teva would claim starting that day in periodic reporting under U.S. law.
24. A reasonable shareholder could understand from this that, after the approval, Teva
would stop periodic reporting using the Israeli format, but reporting under U.S. law
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The Teva case 391
would remain as before. Since before that day Teva had filed periodic reports under U.S.
law and in them disclosed executive compensation on an individual basis, a reasonable
shareholder could assume that it would continue to do so. Stopping to disclose executive
compensation individually thus amounts to misleading the shareholders who approved
the transition.
A.8 Continuation of the Violation of Law
25. How could Teva’s nondisclosure practice persist for so long? First and foremost, the
answer is that Teva falls between the cracks regarding the compensation disclosure provi-
sions between the U.S. Securities and Exchange Commission and the Israel Securities
Authority. Although both have authority over Teva, to ensure consistency in disclosure
duties, the Israeli Authority defers to the U.S. Commission, which is in charge of review-
ing periodic reports prepared according to U.S. law. However, the U.S. Commission is
not familiar with the Israeli law to which the U.S. reporting form refers. As a result, Teva
eludes its duties unscathed to this day despite the blatant practice of nondisclosure.
26. Second, reality shows that it is possible to evade disclosure duties for many years in
the capital market, even when it comes to material information. The Iscar case (Petition
for Criminal Appeal 11476/04, State of Israel v. Discount Investment Corporation Ltd.,
Nevo, Supreme Court (2010) (“Discount Investment”)) is indicative. That case began in an
earlier proceeding, in which the Court ordered Discount Investment Corporation to dis-
close the reports of the private company Iscar, in which Discount Investment Corporation
made a significant investment. Nevertheless, Discount Investment Corporation failed to
publicly disclose the reports for many years with no interference. The affair ended in a
criminal proceeding in which the Supreme Court condemned the act.
27. Third, the public scrutiny and the legislation regarding executive compensation in
public companies have intensified only in recent years. By the time this process culmi-
nated, the market had adjusted to the fact that Teva does not reveal the compensation
of its senior managers on an individual basis. While the media, investors, elected officials
and authorities berate companies that disclose their senior managers’ compensation,
dual-listing companies that do not disclose their senior managers’ compensation are
not criticized and no one questions the legality of their actions. Even the Movants were
amazed to find no interpretive basis in the United States for Teva’s practice when they
examined the issue thoroughly. Teva disregards the law in one of the most sensitive areas
in which a public company is subject to reporting duties.
A.9 Teva Cannot Create for Itself an Exemption from Disclosure of Material
Information That the Legislature Has Not Expressly Granted
28. In the absence of clear provisions easing the burden of disclosure on dual-listing
companies, a company cannot make up reliefs at its convenience, certainly not ones that
mean exemption from disclosure of material information to investors, in contrary to the
purpose of the law and common sense. The Israeli legislature knew to clarify its intent
when it wanted the disclosure burden on Teva and other dual-listing companies to be
lighter than both the burden on Israeli companies that are not dually listed and the burden
on U.S. companies in the United States.
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29. Thus, for example, the Israeli legislature accommodated dual-listing companies
regarding the deadline for filing periodic reports. Until recently, Teva had been allowed to
file periodic reports in Israel up to six months after the end of its fiscal year and, starting
with the periodic report for 2011, it is allowed to file periodic reports up to four months
after the end of its fiscal year (Section 35EE(c) of the Securities Law and Section 4 of the
Securities Regulations (Periodic and Immediate Reports of a Foreign Company), 2000
(“the Regulations on Periodic and Immediate Reports of a Foreign Company”), which refers
to Instruction A(b) of Form 20–F). These deadlines are more liberal than both Israeli
law regarding companies that are not dually listed (three months according to Regulation
7 of the Regulations on Periodic and Immediate Reports) and U.S. law regarding large
U.S. companies in the United States (sixty days according to Instruction A(2)(a) of Form
10–K). Unlike compensation disclosure, the clear provisions setting forth the disclosure
deadline grant special relief to dual-listing companies.
30. As for the disclosure of executive compensation on an individual basis, the Israeli
legislature granted no relief.
A.10 Turning to the Court as Last Resort
31. The Movants turn to the Court after giving up hope of the possibility of convincing
Teva to fulfill its legal obligations. Nine months ago, the Movants contacted Teva and
asked it to change its practice, but it rebuffed them. The Movants have no choice but to
submit this Motion on behalf of Teva shareholders who are affected by its behavior in
order to protect their rights. The Movants informed Teva they would do so about six
months ago.
32. It is requested to certify a claim for court orders declaring Teva’s duty to disclose the
compensation it pays senior managers and directors on an individual basis in its periodic
reports, ordering Teva to disclose this information for the years since 2000, as well as
ordering Teva to disclose this information in future periodic reports.
33. Correcting Teva’s improper practice of not disclosing the compensation of direc-
tors on an individual basis in annual reports is particularly important because, in the
future, Teva will be required to also bring the Chief Executive Officer’s compensation
for shareholder approval. This is the requirement in Section 6(3) of the Companies Law
(Amendment No. 20), 2012, enacted recently. Once this amendment takes effect, the Chief
Executive Officer’s compensation, which until today had to be disclosed on an individual
basis according to the first clause of Item 6.B of Form 20–F, will have to be disclosed on
an individual basis also according to the second clause. However, while the Amendment
reinforces this Motion, it is not a substitute for it because it will force Teva to reveal
only the Chief Executive Officer’s compensation, and even this only when modifying the
compensation or replacing the Chief Executive Officer. Since Teva appointed a new Chief
Executive Officer just recently, in May 2012, a long time is expected to pass before the
compensation of the Chief Executive Officer is disclosed, and even then the disclosure
will not be made annually. It is also clear that the new law will not cure the violation of
the disclosure duty that transpired till today.
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The Teva case 393
Part B—The Dual Listing Law and the Duty to Disclose Executive Compensation
in Detail
This part presents the legislative history of the Dual Listing Law, the developments in the
rules of executive compensation disclosure by foreign issuers in the United States, and
the interpretation of these rules from the U.S. perspective. Teva’s wrongful conduct will
be presented as well.
B.1 The Brodet Committee
34. On February 15, 1998, the head of the Israel Securities Authority appointed a
committee chaired by Mr. David Brodet to examine the dual listing of securities for
trade in Israel and abroad. On September 8, 1998, the committee submitted a final
report (attached as Appendix 3). The report concluded that the requirements of U.S.
law on foreign private issuers did not provide adequate protection for Israeli investors.
The committee therefore recommended that relief from reporting under Israeli law be
granted to dual-listing issuers only if they met the disclosure duties of U.S. issuers in
the United States, rather than the lower standard set for foreign private issuers in the
United States.
35. On June 26, 2000, the Draft Bill of the Dual Listing Law was presented (Draft Bill
of the Securities Law (Amendment No. 21) (Dual Listing), 2000, attached as Reference 1).
On July 25, 2000, the Law was passed by the Knesset. Although the Explanatory Notes
to the Bill states that the “core of the proposal is based on the Report of the Committee
on Dual Listing of Securities chaired by Mr. David Brodet, which was appointed by
the Chairperson of the Israel Securities Authority”, the Draft Bill actually adopted the
concept that had been rejected by the Brodet Committee, to allow dual-listing companies
to file in Israel the reports they are required to file in the United States, even if they report
there as foreign private issuers.
B.2 The Expansion of U.S. Disclosure Duties Regarding Executive Compensation of

Foreign Issuers
36. Following the submission of the Brodet Committee Report and prior to the pub-
lication of the Draft Bill of the Dual Listing Law, the reporting duties of foreign private
issuers in the United States were expanded, among other things, with respect to executive
compensation disclosure duties.
37. As the Brodet Committee Report indicates, when it was submitted, the default
under U.S. law was disclosure of aggregate compensation. The disclosure duty was set
forth in Item 11 of Form 20–F (Appendix 7 to the Brodet Committee Report):
General Instructions. If the registrant discloses to its shareholders or otherwise makes public
the information specified in this Item for individually named directors and officers, then such
information shall also be included in response to this Item.
(A) State the aggregate amount of compensation paid by the registrant and its subsidiaries
during the registrant’s last fiscal year to all directors and officers as a group, without naming
them, for services in all capacities.
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38. On November 10, 1999, after the submission of the Brodet Committee Report and
before the publication of the Draft Bill of the Dual Listing Law, this disclosure item was
amended to its current version and renumbered as Item 6.B. It applies to Teva starting
with its annual report for 2000. The current version of Form 20–F is attached to the
written opinion and Item 6.B is attached as Appendix 4.
39. As Appendix 4 shows, a number of changes were included in the amendment.
First, compensation disclosure on an individual basis was established as the default. This
default is the opposite of its predecessor. Now a foreign private issuer that wishes to avoid
disclosure of executive compensation on an individual basis in the United States must
show the absence of a duty of individual disclosure in its home country (in addition to
the other requirements). Moreover, the duty of disclosure on an individual basis no longer
depends on the issuer having disclosed the information. It is enough that such a duty exists
in the home country or that the issuer otherwise disclosed the information.
B.3 Israeli Law Requires Teva to Disclose Its Executives’ Compensation on an

Individual Basis
40. The Dual Listing Law granted significant relief to issuers listed both on the Tel Aviv
Stock Exchange and on one of select markets abroad. These issuers may choose to file in
Israel the reports they are required to file under the foreign law in lieu of the documents
required by Chapter VI of the Securities Law. The duty that applies to companies that
have chosen this option is set forth in Section 3(a) of the Regulations on Periodic and
Immediate Reports of a Foreign Company:
The company shall submit a reporting document that includes the name of the company and
the items stated in Section 8 of the Securities Regulations (Details, Structure and Form of a
Listing Document), 2000, and a report for the period of one year that it is liable to submit or
publish under the foreign law (hereinafter – the periodic report), or a half yearly report that it
is liable to submit or to publish under the foreign law (hereinafter – the half yearly report), or a
quarterly report that it is liable to submit or to publish under the foreign law (hereinafter – the
interim report), accordingly.
This provision implements Section 35EE(c) of the Securities Law which provides,
among other things:
The Minister of Finance shall, in accordance with an [Israel Securities Authority] proposal or
after consulting with the [Israel Securities Authority], and with the approval of the Knesset
Finance Committee, enact regulations in regard to reports and notices by a company described
in Subsection (a), and in regard to their form and the dates of their preparation and submission,
all including the matters stated in Section 56(d)(2) and (3); regulations enacted pursuant to this
Section shall determine:
(1) With regard to corporations described in Subsection (a), the securities of which are listed
for trade on a foreign stock exchange specified in the Second Schedule—the documents that the
company is required to publish or to file pursuant to the foreign law and the documents published
by the company, as well as identifying information of the company, its securities and the holders
of its securities which are to be included in the report or the notice.
41. The combination of Section 35EE(c) and the U.S. law to which it refers in the case
of a company traded in the United States (that is, Item 6.B of Form 20–F) requires the
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The Teva case 395
company to disclose the compensation of its senior managers on an individual basis. This
interpretation is based both on the language of the provision and on its purpose.
42. The language of the provision is clear. It requires that the company file the reports
it is required to file in the United States. These reports require individual disclosure by
default. The exemption from individual disclosure does not apply to companies traded
in Israel because it is conditional, among other things, on individual disclosure not
being required under Israeli law. This condition is not met because Israeli law adopts the
disclosure obligations of U.S. law. This alone is sufficient grounds to grant this Motion.
43. Moreover, the purpose of the provision leads to a similar result even without relying
on the default U.S. law. Section 21 of the Periodic and Immediate Reports Regulations
requires companies that do not report under Chapter V.3 of the Securities Law (added
by the Dual Listing Law) to disclose the compensation of their senior managers on an
individual basis. This covers, among others, the compensation of each of the five senior
managers earning the highest compensation in the company or a company it controls, and
each of the three senior managers earning the highest compensation in the company itself
(if not included among the aforementioned five senior officers). This is a core requirement
that is strictly enforced by the Israel Securities Authority, which attracts the attention of
investors and exposes corporate managers to scrutiny. An interpretation according to
which the reference in the Securities Law to U.S. law exempts companies traded in Israel
from this requirement by implication and incidentally, only because the U.S. form refer-
ences Israeli law, without explicitly granting such an exemption, is contrary to the purpose
of the law, which is to protect the shareholders.
44. Therefore, even if we accommodate Teva and interpret the reciprocal references
in Israeli law and U.S. law favorably to it, it must at least disclose on an individual basis
the compensation of those directors and members of administrative, supervisory and
managerial bodies whose compensation would require disclosure on an individual basis
if Section 21 of the Periodic and Immediate Reports Regulations applied.
B.4 U.S. Law Requires Teva to Disclose Its Executives’ Compensation on an

Individual Basis
45. The U.S. disclosure provision in Item 6.B of Form 20–F (Appendix 4) refers to
Israeli law, hence the importance of examining the Israeli law’s position regarding the
disclosure of executive compensation. However, the matter concerns a provision of U.S.
law, and so its proper interpretation from a U.S. perspective must be examined as well.
Below we demonstrate that, also from this perspective, the combination of Israeli law
and U.S. law mandates the disclosure of executive compensation on an individual basis.
46. Item 6.B requires the company to disclose the compensation of its directors and
members of the administrative, supervisory, or management bodies. The compensation
of each of these must be individually disclosed unless the company is exempt from such
disclosure in its home country and does not otherwise disclose it:
Disclosure of compensation is required on an individual basis unless individual disclosure is not
required in the company’s home country and is not otherwise publicly disclosed by the company.
47. In a written opinion attached to this Motion, Professor Jesse Fried of Harvard
University opines that Item 6.B of Form 20–F requires Teva to disclose senior managers’
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compensation on an individual basis. He reaches this conclusion based on the provisions

of U.S. law and information provided by the Movants concerning Teva and Israeli law,
as specified in his written opinion. Professor Fried adds that this result not only derives
from the law, but is also the appropriate result.
48. A number of considerations lead Professor Fried to the conclusion that, from
the perspective of U.S. law, the combination of Israeli law and U.S. law mandates the
disclosure of executive compensation on an individual basis.
49. First, the default U.S. law is disclosure on an individual basis. This is the U.S. law
and, by referring to it, Israeli law adopts this default.
50. Second, even without relying on this default, the result is the same. The purpose of
Item 6.B of Form 20–F is to avoid imposing a burden on a foreign company seeking to
be listed for trade in the United States. The goal is not to liberate such a company from
the disclosure obligations that would have applied to it in its home country if it had not
listed for trade in the United States. Absent a U.S. listing for trade, a company traded
in Israel is obligated by Israeli law to disclose the compensation of its senior managers
on an individual basis. The U.S. Securities and Exchange Commission did not intend to
transform the major stock exchanges of the United States into safe havens that would
enable issuers to conceal from investors important and sensitive information, which
they would have been required to disclose in their home country were it not for their
U.S. listing. The senior executives of Teva prefer to maintain the confidentiality of the
compensation they pay themselves from the company coffers and avoid the scrutiny
of the shareholders who finance their compensation, but U.S. law prefers to protect
shareholders.
51. The U.S. law applying to Israeli companies traded both in Israel and the United
States is thus different from the U.S. law applying to Israeli companies traded only in the
United States. Since the securities law of the State of Israel does not apply to companies
traded only abroad, they are not required to disclose executive compensation on an
individual basis in the United States. This approach is consistent with the goal of Item
6.B of Form 20–F not to expand the executive compensation disclosure requirements of a
company listed for trade in the United States beyond what is required of it in the absence
of this listing.
52. Teva’s status under U.S. law is different from that of an Israeli company traded only
in the United States. It is undisputed that, were it not for its U.S. listing, Teva would be
required to disclose executive compensation on an individual basis in Israel because it is
traded in Israel. Thus, from the perspective of U.S. law, requiring individual disclosure
does not impose a burden on Teva and so the proper interpretation of U.S. law requires
it to provide such disclosure. Teva never requested the approval of the U.S. Securities
Exchange Commission for any other interpretation (paragraph 89 below elaborates).
Rather than risk rejection of its request, Teva chose to conduct itself as though Israeli law
did not require such disclosure. A clear statement that Israeli law refers to U.S. law would
have gotten Teva a response it had no interest in getting, namely, that U.S. law requires it
to disclose the compensation of Teva’s senior managers on an individual basis.
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The Teva case 397
B.5 Teva’s Disclosure Before and After the Dual Listing Law
53. In 2000, before the Dual Listing Law came into force, Teva individually disclosed
the compensation of each of its five senior managers. It did so both in the periodic report
filed under Chapter VI of the Securities Law and in the annual report it filed in the United
States on Form 20–F as a foreign private issuer. Teva’s periodic report for 1999, filed on
March 5, 2000, is attached as Appendix 5. Teva’s Form 20–F for 1999, filed on June 30,
2000, is attached as Appendix 6.
54. On December 18, 2000, Teva’s shareholders approved a transition to the new report-
ing format that the Dual Listing Law allowed. On the following day, Teva announced the
transition in Israel and attached to the notice the periodic report for 1999 it had filed in the
United States. The report included executive compensation disclosure on an individual
basis, as well as the reports for the first three quarters of 2000 it had filed in the United
States (the notice is attached as Appendix 7). From that day on Teva stopped disclosing
executive compensation on an individual basis in its annual reports in the United States
(on Form 20–F), which it also files in Israel. The compensation of senior managers
appears in aggregate and it is not possible to know how much the Chief Executive Officer
or any other senior manager was paid.
55. For example, in Item 6.B of Teva’s Form 20–F for 2011, attached as Appendix 8,
Teva reported that the aggregate compensation of 13 senior managers and 15 directors
is 21.1 million U.S. dollars, from which 2.7 million U.S. dollars is the aggregate com-
pensation of directors who are not company employees. This amount does not include
reimbursement of directors’ expenses. In addition, senior managers received options to
buy 2,894,026 shares and 442,213 restricted share units. Since none of the directors is a
company employee according to the description of directors in Item 6, this disclosure
means that the aggregate compensation of 15 directors is 2.7 million U.S. dollars and
the aggregate compensation of 13 senior managers is 18.4 million U.S. dollars, options
to buy 2,894,026 shares and 442,213 restricted share units. Furthermore, even though
the provisions of Item 6.B require Teva to disclose the exercise price and the expiration
date of the options, Teva only reported the average exercise price and did not disclose
expiration dates.
56. A close examination of Teva’s practice shows that it violates the disclosure duty
most blatantly when it comes to directors. The difference between managers who are not
directors and directors stems from the provisions of the Companies Law, to which Teva is
subject as a company incorporated in Israel. As of the filing date of the Motion, whereas
under Section 272 of the Companies Law the approval of the board of directors is enough
for compensation of managers, under Section 273 of the Law, Teva needs to obtain
the general meeting’s approval for the compensation of directors and therefore it must
disclose the compensation that requires approval (the compensation of each of Teva’s
directors exceeds the amount exempt from the general meeting’s approval under Section
1A of the Companies Regulations (Relief in Transactions with Interested Parties), 2000).
Moreover, Section 4(a) of the Notice and Advertisement Regulations requires Teva to
include a summary of the proposed resolutions in the shareholder meeting notice. To
comply with these requirements, Teva turns to its shareholders from time to time to obtain
their approval for changes in the directors’ compensation and discloses the existing
compensation and the proposed compensation on an individual basis. Teva did so, for
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example, in the general meeting notices in 2006, 2008, 2010, 2011 and 2012. Following
each meeting, Teva reported the results of the meeting.
57. For example, in Teva’s general meeting notice dated August 8, 2012, attached as
Appendix 9, the shareholders were asked to approve the following compensation:
Proposal 3: Directors’ Remuneration

Unlike U.S. law, the Israeli Companies Law requires shareholder approval of remuneration paid
to directors.
. . .
(a): Approval of Directors’ Remuneration
Shareholders are asked to approve the payment to each of the Company’s directors currently
in office and any additional directors as may be appointed from time to time, without the need
for further act or approval, other than the Chairman and the Vice Chairman of the Board of
Directors (who are addressed in proposals (b) and (c) below), with effect on and from the date
of approval by shareholders, of an annual fee in the NIS equivalent of US$190,000 (an increase
from the average annual fee paid in connection with their 2011 service of US$76,283) plus a per
meeting fee of US$2,000 (in lieu of the current per meeting fees ranging from approximately
US$2,000 to US$3,000 depending on whether the meeting required air travel). This remuneration
will be paid plus VAT (as applicable), will be based on the exchange rate on the date of approval
by shareholders and will be adjusted based on the Israeli Consumer Price Index subsequent to
the date of approval by shareholders.
(b): Approval of Remuneration/Reimbursement of Chairman of the Board
. . . In recognition of the increased demands on Dr. Frost that are expected to continue in his
capacity as Chairman of the Board of Directors upon his reelection at this Meeting, sharehold-
ers are asked to approve:
(i) the reimbursement to Dr. Frost, Chairman of the Board of Directors, of an amount of
US$298,000, for his out of pocket travel expenses exceeding US$700,000 incurred during 2011
(the reimbursement of which was previously approved by shareholders), in connection with
his participation in meetings of the Board of Directors and committees of the Board and
other Company activities. Such additional amount reflects the unanticipated travel Dr. Frost
undertook in connection with his increased Company activities last year;
(ii) remuneration to Dr. Frost for his service as Chairman of the Board of Directors, effective
from and after the date of approval by shareholders, of an annual fee in the NIS equivalent of
US$900,000 (according to the exchange rate on the date of the approval by shareholders) plus
VAT (as applicable), for such time as Dr. Frost continues to serve as Chairman of the Board of
Directors. Such payments will be adjusted based on the Israeli Consumer Price Index subsequent
to the date of approval by shareholders. There will be no supplemental per meeting fee in
addition to this annual fee. Such annual fee represents an increase from the payments made in
connection with his 2011 service of US$516,677 (including per meeting fees); and
(iii) the reimbursement of Dr. Frost in his capacity as Chairman of the Board of Directors
of his out of pocket transportation costs related to the use of his airplane for the purpose
of participation in meetings of the Board of Directors, committees of the Board and other
Company activities, up to an annual amount of US$700,000 (i.e., the same amount previously
approved by shareholders), for such time as Dr. Frost continues to serve as Chairman of the
Board of Directors.
As previously approved by shareholders, Teva will continue to provide Dr. Frost, in his capacity
as Chairman of the Board of Directors, with an office and secretarial services and will, in
accordance with Teva practice, also reimburse him for other reasonable and necessary expenses
incurred in the course of his service to the Company.
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The Teva case 399
(c): Approval of Remuneration of Vice Chairman of the Board

. . . In recognition of the increased demands on Prof. Many that are expected to continue in
his capacity as Vice Chairman of the Board of Directors, shareholders are asked to approve
remuneration to Prof. Moshe Many for his service as Vice Chairman of the Board with effect
on and from the date of approval by shareholders, of an annual fee in the NIS equivalent of
US$400,000 (according to the exchange rate on the date of the approval by shareholders) plus
VAT (as applicable), for such time as Prof. Many continues to serve as Vice Chairman of the
Board of Directors. Such payments will be adjusted based on the Israeli Consumer Price Index
subsequent to the date of approval by shareholders. There will be no supplemental per meeting
fee in addition to this annual fee. Such annual fee represents an increase from the payments made
in connection with his 2011 service of US$313,700 (including per meeting fees). As previously
approved by shareholders, Teva will continue to provide Prof. Many, in his capacity as Vice
Chairman, with an office and secretarial services and will, in accordance with Teva practice,
also reimburse him for other reasonable and necessary business expenses incurred in the course
of his service to the Company.
58. Teva does not deny that it discloses the compensation of its directors on an indi-
vidual basis in the course of its approval. On the contrary, in response to the Movants’
demand of Teva to disclose the compensation of its senior managers on an individual
basis in periodic reports (the Movants’ letter to Teva’s Chief Financial Officer, dated
February 5, 2012, is attached as Appendix 10), Uri Landau, an attorney with Teva’s legal
department, replied to the Movants as follows (Mr. Landau’s letter to the Movants, dated
March 25, 2012, is attached as Appendix 11):
The compensation of directors is brought for approval at the general meeting of shareholders
of the company, and therefore these compensation figures are listed in notices on convening
general meetings of the company which include director compensation on the agenda. That is,
compensation figures of the directors of the company are reported to the public.
59. Nevertheless, although Teva reveals the compensation of its directors in order to
approve it, Teva systematically fails to disclose it in periodic reports. Teva thus violates
both the part and the second clause of Item 6.B of Form 20–F. The first clause grants
an exemption from disclosure on an individual basis if such disclosure is not required
in Israel. However, as noted, such disclosure is required in Israel: not only does Section
35EE of the Securities Law incorporate the default individual disclosure requirement
of Item 6.B into Israeli law (as explained in detail, regarding all directors and officers),
but Section 273 of the Companies Law requires Teva to bring the compensation of
directors for the general meeting’s approval. In addition, Section 4(a) of the Notice
and Advertisement Regulations requires Teva to publicly disclose the proposals that
are to be discussed at the general meeting. We thus have two separate sources in Israeli
law for Teva’s duty to disclose the compensation of its directors on an individual
basis. Furthermore, Teva violates the second clause of Item 6.B as well, which makes
the exemption conditional on Teva not otherwise disclosing the compensation on an
individual basis. As noted in paragraph 58 above, Teva admitted to the Movants to
making this disclosure.
60. An exemption requires meeting two conditions. First, it must be shown that the
law in the home country does not require the release of the information. Second, it must
be shown that the information is not released. Teva does not meet either condition. The
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violation of the disclosure duty here is even more flagrant than it is for managers who
are not directors, for whom Teva violates only the first clause of the disclosure provision.
61. Once Teva incorrectly concluded it had found a loophole in the disclosure require-
ments, it acted to exploit it to the fullest. After the transition to reporting under the Dual
Listing Law, Teva reduced the number of senior managers on the board of directors until
none were left. In 2000, before the enactment of the Dual Listing Law, two senior manag-
ers served on Teva’s board of directors: the Chief Executive Officer, who had served as a
director since 1968, and the Chief Financial Officer, who had served as a director since
1981. This is reflected in Teva’s periodic report for 1999 (Appendix 5, page 6). The Chief
Financial Officer resigned from the board of directors in 2001, although he continued to
serve as Chief Financial Officer of Teva until his retirement in 2008. This is reflected in
Teva’s periodic report for 2007 (the relevant pages are attached as Appendix 12). In 2010,
two years after retiring from his position as Chief Financial Officer, he was appointed to
the board of directors and his term will end in 2014. This is reflected in Teva’s periodic
report on Form 20–F for 2011 (Appendix 8, page 84). The Chief Financial Officer who
succeeded him, and still serves in this capacity, is not a member of the board of directors.
This is reflected in Teva’s periodic report for 2011 (Appendix 8, pages 84–85). The Chief
Executive Officer continued to serve as Chief Executive Officer until his retirement
in 2002, when he was replaced by a Chief Executive Officer who is not a member of
the board of directors. This is reflected in Teva’s periodic report for 2002 (attached as
Appendix 13, pages 42–41). The Chief Executive Officer who was subsequently appointed
and retired in May 2012 also did not serve as a member of the board of directors. This is
reflected in Teva’s periodic report for 2011 (Appendix 8, page 84).
62. Thus, by no coincidence, since 2002, no members of management serve on Teva’s
board of directors and therefore the company is exempt from bringing the compensation
of its senior managers for approval at the general meeting. The last years in which the
Chief Financial Officer and the Chief Executive Officer served on the board of directors,
2001 and 2002, respectively, are therefore the only years after following the enactment
of the Dual Listing Law in which their compensation was known. On July 29, 2001,
Teva called a general meeting and disclosed in the notice, among other things, the Chief
Executive Officer’s compensation and the Chief Financial Officer’s compensation to
be approved (the notice is attached as Appendix 14). On March 13, 2002, Teva called
a general meeting and disclosed in the notice, among other things, the Chief Executive
Officer’s compensation to be approved (the notice is attached as Appendix 15). As usual,
Teva’s periodic report for 2002 (Appendix 13) did not mention the compensation that
shareholders had approved.
B.6 Importance of Disclosing Executive Compensation on an Individual Basis
63. The capital market ascribes critical importance to disclosure of complete informa-
tion about the compensation of a company’s senior managers. One should therefore not
underestimate Teva’s failure to disclose director compensation on an individual basis in
periodic reports despite its disclosure in general meeting notices. There is good reason for
requiring foreign private issuers in the United States to disclose executive compensation
on an individual basis even in the absence of a duty to provide individual disclosure in
their home country, once they publicly disclosed it elsewhere. To achieve transparency that
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The Teva case 401
will inform investors how the company’s senior managers are compensated, it is necessary
to calculate the value of all compensation components paid during the year and present
it clearly in Item 6.B of Form 20–F. Prior disclosure of formulas for determining the
compensation elsewhere is not enough. Professors Lucian Arye Bebchuk and Jesse Fried,
preeminent researchers on the subject in the United States, emphasize the importance of
compensation transparency in their book, Lucian Bebchuk & Jesse Fried, Pay Without
Performance: The Unfulfilled Promise of Executive Compensation 192–193 (Harvard
University Press, 2004). The pages are attached as Reference 2:
The ability of plan designers to favor managers depends on how compensation arrangements are
perceived by a wide group of investors and other outsiders. Because of market forces and social
dynamics, managers and directors are concerned about possible disapproval from institutional
investors and other reference groups, such as the business press. We have seen that compensa-
tion designers often seek to make the amount of pay, or the extent to which pay is decoupled
from performance, less transparent. For disclosure to constrain compensation effectively, the
disclosed compensation must reach more than just a select group of market professionals and
arbitrageurs. Raw facts buried in a mountain of technical disclosure probably will not suffice.
The salience of disclosure and degree of transparency are important.
64. In the matter of Discount Investment, the Supreme Court noted the importance of
disclosure of information as required by law and said, in paragraph 122 of the Judgment:
The disclosure duty is intended to provide a complete and current picture of the state of the
company required to provide disclosure, for better or worse, as the case may be. It was designed
to enable the investor to make an informed decision regarding the viability and wisdom of
investing in the security or selling it.
And, in paragraph 148 of the Judgment, the Court emphasized that:
Nondisclosure of material information in the report constitutes a failure to disclose and is likely
to mislead a reasonable investor in the securities market.
65. As for the importance of disclosure of compensation of senior managers, it is

worthwhile to quote more from Professors Bebchuk and Fried. Bebchuk and Fried
explain that managers are keenly interested in concealing the details of their compensa-
tion, and that failure to provide full disclosure leads to excessive compensation and
inappropriate compensation structure, which creates distorted incentives. In an article
that has been translated to Hebrew they explain:
One important building block of the managerial power approach is “outrage” costs and con-
straints. The tightness of the constraints managers and directors confront depends, in part, on
how much “outrage” a proposed arrangement is expected to generate among relevant outsiders.
Outrage might cause embarrassment or reputational harm to directors and managers, and it
might reduce shareholders’ willingness to support incumbents in proxy contests or takeover
bids. The more outrage a compensation arrangement is expected to generate, the more reluctant
directors will be to approve the arrangement and the more hesitant managers will be to propose
it in the first instance. Thus, whether a compensation arrangement that is favorable to executives
but suboptimal for shareholders is adopted will depend on how it is perceived by outsiders.
There is evidence that the design of compensation arrangements is indeed influenced by how
outsiders perceive them. . . during the 1990s, CEOs of firms that were the target of shareholder
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resolutions criticizing executive pay had their annual compensation reduced over the following
two years by an average of $2.7 million.
The potential significance of outsiders’ perception of a CEO’s compensation and of outrage
costs explains the importance of yet another building block of the managerial power approach
— “camouflage.” To avoid or minimize the outrage that results from outsiders’ recognition of
rent extraction, managers have a substantial incentive to obscure and try to legitimize — or, more
generally, to camouflage — their extraction of rents. The strong desire to camouflage might lead
to the adoption of inefficient compensation structures that hurt managerial incentives and firm
performance.
. . . The importance of how compensation arrangements are perceived means that, in the
executive compensation area, the transparency of disclosure matters. Financial economists
often focus on the role of disclosure in getting information incorporated into market pricing.
It is widely believed that information can become reflected in stock prices as long as it is
known and fully understood by a limited number of market professionals. In the executive
compensation context, however, the ability of plan designers to choose arrangements that
favor managers depends on how these arrangements are perceived by a much wider group of
outsiders. As a result, the transparency and salience of disclosure can have a significant effect
on CEO compensation.
The article, Lucian Arye Bebchuk & Jesse M. Fried, Executive Compensation as an
Agency Problem, Ta’agidim [Companies] A/4, 3, pp. 7–8 (October 2004), is attached as
Reference 3. This article is a translation of the article Lucian Arye Bebchuk & Jesse
M. Fried, Executive Compensation as an Agency Problem, 17 Journal of Economic
Perspectives 71 (2003).
66. Professor Fried reiterates these statements in relation to Teva in the written opinion
attached to this Motion. He says:
As Professor Lucian Bebchuk and I have emphasized in our joint work and separately, execu-
tives and directors are keen to hide the details of executive compensation, especially when it is
excessive and poorly structured. In particular, “camouflaging” the amount and performance-
insensitivity of executive compensation enables executives and directors to reduce shareholder
“outrage,” thereby making it easier for executives to obtain excessive pay and remuneration
decoupled from their performance.
Camouflaging compensation thus hurts public shareholders in two ways. First, it results in
higher compensation; every extra dollar of compensation reduces public shareholders’ returns
by one dollar. Second, it leads to more poorly structured compensation, undermining and
distorting executives’ incentives and generating losses for shareholders that far exceed the extra
amounts paid to the executives.
Better disclosure of compensation at Teva will enable public shareholders to more effectively
pressure directors to adopt better pay arrangements. This pressure, in turn, can be expected to
lead to lower amounts of pay; every dollar saved will mean an extra dollar in public sharehold-
ers’ pocket. This pressure will also lead to improved pay–performance sensitivity, which will
strengthen executives’ incentives to generate value for shareholders, yielding potentially large
payoffs to Teva and its shareholders. (Footnote omitted)
67. Many scholars deal with distortions caused by the absence of disclosure. For exam-
ple, one article reports that companies whose reporting on the chief executive officer’s
compensation was found to be lacking tend to overcompensate him: John R. Robinson,
Yanfeng Xue & Yong Yu, Determinants of Disclosure Noncompliance and the Effect of the
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The Teva case 403
SEC Review: Evidence from the 2006 Mandated Compensation Disclosure Regulations, 86
The Accounting Review 1415 (2011). The article is attached as Reference 4.
68. A similar article demonstrates that companies whose reporting on the compensa-
tion of the chief executive officer is difficult to understand tend to overcompensate the
chief executive officer: Indrarini Laksmana, Wendy Tietz & Ya-Wen Yang, Compensation
Discussion and Analysis (CD & A): Readability and Management Obfuscation, Journal
of Accounting and Public Policy 185 (2012). The article is attached as Reference 5.
69. Another article shows that, in the case of companies that acted vigorously against
increasing the reporting requirements on executive compensation in the United States,
investors gained stock price excess returns of 6 percent upon the entry into force of the
reporting duties. The authors conclude that the market figured the new duties could
enhance compensation structure in companies that had opposed the increased disclo-
sure: Kin Lo, Economic Consequences of Regulated Changes in Disclosure: The Case of
Executive Compensation, 35 Journal of Accounting and Economics 285 (2003). The
article is attached as Reference 6.
70. Another article relays that, with the expansion of the disclosure duty to retire-
ment arrangements in the United States in 2007, the share prices of companies whose
managers were found to have had particularly generous retirement arrangements dropped
significantly: Chenyang Wei & David Yermack, Investor Reactions to CEOs’ Inside Debt
Incentives, 24 Review of Financial Studies 3813 (2011). The article is attached as
Reference 7.
71. Another article finds that, following the introduction of the duty to disclose the
components compensation of chief executive officers separately in the United States
in 1992, the relation of company profits and stock returns to compensation strength-
ened: Nikos Vafeas & Zaharoulla Afxentiou, The Association between the SEC’s 1992
Compensation Disclosure Rule and Executive Compensation Policy Changes, 17 Journal
of Accounting and Public Policy 17 (1998). The article is attached as Reference 8.
72. Finally, two articles show that, with the transition of Canada’s Ontario Province
(home of the Toronto Stock Exchange, the largest in the country) to a duty to disclose
executive compensation on an individual basis in 1993, the relation between executive
compensation and company performance increased significantly: Yun W. Park, Toni
Nelson & Mark R. Huson, Executive Pay and the Disclosure Environment: Canadian
Evidence, 24 Journal of Financial Research 347 (2001); Jane Craighead, Michel
Magnan & Linda Thorne, The Impact of Mandated Disclosure on Performance-Based
CEO Compensation, 21 Contemporary Accounting Research 369 (2004). The articles
are attached as References 9 and 10, respectively.
73. An indication of the importance of disclosing the compensation of Teva’s senior
managers on an individual basis can be seen in the harsh criticism Teva received when it
sought to increase directors’ compensation at the general meeting held on September 12,
2012. The proposal was approved but was widely criticized by significant shareholders,
who argued that Teva’s performance in the preceding year did not justify the extravagant
compensation. Had Teva not sought to increase the directors’ compensation, the share-
holders would not have been exposed to the high compensation paid to directors in 2012,
the reason being that Teva is careful not to disclose it on an individual basis in periodic
reports. One can only guess how shareholders would have responded to hearing the
compensation Teva pays its Chief Executive Officer and other members of management.
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74. Correcting Teva’s improper practice of not disclosing the compensation of directors
on an individual basis in annual reports is particularly important because, in the future,
Teva will be required to bring the Chief Executive Officer’s compensation for share-
holder approval as well. This is the requirement of Section 6(3) of the Companies Law
(Amendment No. 20), 2012, enacted recently. Once this amendment takes effect, the Chief
Executive Officer’s compensation, which until today had to be disclosed on an individual
basis according to the first clause of Item 6.B of Form 20–F, will have to be disclosed on
an individual basis according to the second clause as well. However, while the amendment
reinforces this Motion, it is not a substitute for it because it will force Teva to reveal only
the Chief Executive Officer’s compensation, and even this only when modifying the
compensation or replacing the Chief Executive Officer. Since Teva has appointed a new
Chief Executive Officer just recently, in May 2012, a long time is expected to pass before
the compensation of the Chief Executive Officer is disclosed, and even then the disclosure
will not be given annually. It is also clear that the new law will not cure the breach of the
disclosure duty until today.
B.7 Companies That Report Under the Dual Listing Law and Disclose Executive
Compensation on an Individual Basis
75. To the best knowledge of the Movants, Teva is the first company that chose to
conceal the breakdown of the compensation of its senior managers in the wake of the
Dual Listing Law. It started this practice in its periodic report for 2000 (attached as
Appendix 16), which it filed in Israel on March 31, 2001. Almost all Israeli companies
reporting under the Dual Listing Law on Form 20–F followed Teva. A significant group
of companies was thus formed, which adopted reporting practices inferior to the Israeli
ones and inferior to the U.S. ones.
76. However, not all companies reporting under the Dual Listing Law violate the duty
to disclose the compensation of senior managers on an individual basis in their periodic
reports on Form 20–F. For example, the periodic report of Ituran Location and Control
Ltd. for 2011, attached as Appendix 17, discloses the compensation of the five most senior
managers of the company on an individual basis. Moreover, 10 dual-listing companies
traded in Israel report under the Dual Listing Law on other forms (the U.S. Form 10–K
or the U.K. Annual Report), which disclose the compensation of senior managers and
directors on an individual basis.
B.8 Teva’s Interpretation of the Duties to Disclose Executives’ Compensation

Contradicts Its Interpretation of the Duties to Disclose Their Age
77. An examination of the periodic reports that Teva files annually in Israel and the
United States shows that Teva is inconsistent in its interpretation of the provisions on the
disclosure of senior managers’ compensation. This can be learned from Teva’s disclosure
policy regarding their age. The disclosure duty in U.S. law regarding the age of senior
managers is lenient in comparison to the disclosure duty regarding their compensation in
that the default regarding age is exemption from disclosure. Instruction 3 to Item 6.A of
Form 20–F (Appendix 4) provides as follows:
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The Teva case 405
The following information shall be disclosed with respect to the company’s directors and senior
management . . . (3) Date of birth or age (if required to be reported in the home country or
otherwise publicly disclosed by the company).
That is, reporting the birth date or age of senior managers is required only if it is
required in Israel or is otherwise disclosed by the company.
78. Israeli law in this regard is similar to the law regarding disclosure of executive
compensation. Companies filing periodic reports under Chapter VI of the Securities Law
are required to disclose in them the birth dates of senior managers under Section 26A(2)
of the Periodic and Immediate Reports Regulations. Companies reporting under the Dual
Listing Law are required, as noted above, to file in Israel the reports they are required
to file abroad. However, while Teva does not provide a breakdown of the compensation
of its senior managers, it discloses their age routinely. Examples can be found in Teva’s
periodic reports (Appendix 8 (report for 2011), page 84, Appendix 12 (report for 2007),
pages 76–77, and Appendix 13 (report for 2002), pages 41–42).
79. U.S. law has no default regarding the disclosure of age, rather it relies directly
on Israeli law. Nevertheless, Teva complies with the disclosure requirement. Since Teva
lists the ages of its senior managers, it certainly must also provide a breakdown of the
compensation of its senior managers, a breakdown which is required by default in the
United States (whereas the exception to this requirement is when Israeli law exempts from
providing a breakdown). Even if Teva claims that the disclosure of age is made voluntar-
ily, it is based on the understanding that it is inappropriate to conceal directors’ age when
both countries in which it is traded require that their age be revealed. Unfortunately, Teva
does not act this way when it comes to executive compensation, a far more sensitive and
significant matter.
B.9 An Israeli Court as the Only Forum for Hearing the Suit
80. An Israeli court is not only the appropriate forum for hearing this suit, but indeed
the only forum for hearing it.
81. The class on whose behalf it is requested to bring this suit includes all Teva
shareholders. Teva is a company incorporated in Israel and listed for trade on a stock
exchange in Israel; therefore, clarification of the reporting requirements underlying this
suit requires a thorough understanding of the Israeli law. As noted above, Israeli law
requires the filing of reports that are to be filed under U.S. law. With respect to reporting
on executive compensation, U.S. law requires disclosure on an individual basis by default,
and refers back to Israeli law as a possible source of exemption from the duty to provide
individual disclosure. The reference to Israeli law in U.S. law by itself is not the exemption
Teva is hoping for. An understanding of both U.S. and Israeli law is therefore needed. An
Israeli court is the appropriate forum to interpret the Israeli law.
82. Hearing the case in an Israeli court is dictated by the U.S. Supreme Court’s ruling
in Morrison v. National Australia Bank Ltd., 130 S.Ct. 2869, 177 L.Ed.2d 535 (2010)
(“Morrison”), attached as Reference 11. Morrison held that the securities laws of the United
States shall not apply to persons who purchased securities outside the United States, and
remedy to such purchasers shall not be granted in the United States. Morrison was applied
in numerous decisions, such as In re Alstom SA Securities Litigation, 741 F.Supp.2d 469
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(S.D.N.Y. 2010); Stackhouse v. Toyota Motor Co., 2010 U.S. Dist. LEXIS 79837 (C.D.
Cal. July 16, 2010); In re Royal Bank of Scotland Group PLC Securities Litigation, 765
F.Supp.2d 327 (S.D.N.Y. 2011); In re Vivendi Universal, SA Securities Litigation, 765
F.Supp.2d 512 (S.D.N.Y. 2011); In re UBS Securities Litigation, U.S. Dist. LEXIS 106274
(S.D.N.Y. Sept. 13, 2011); In re BP plc Securities Litigation, 843 F.Supp.2d 712 (S.D. Tex.
2012) (attached as Reference 12 to 17, respectively). Morrison was upheld also with regard
to persons who purchased shares in Israel. Thus, a U.S. court removed plaintiffs who
purchased in Israel shares of a dual-listing company incorporated in the United States
from a class action filed against the company in the United States in Clal Finance Batucha
Investment Management, Ltd. v. Perrigo Co., 2011 U.S. Dist. LEXIS 110607; Fed. Sec. L.
Rep. (CCH) P96, 551 (S.D.N.Y. Sep. 21, 2011) (attached as Reference 18).
83. The issue of the forum for hearing securities law claims against dual-listing companies
reporting under the Dual Listing Law has been discussed so far only in VeriFone. In Class
Action (Central District) 3912–01–08, Stern v. VeriFone Holdings, Inc., Dinim District,
2008 (57) 248, the District Court ruled that U.S. law applied to a violation of reporting
duties by VeriFone, a company incorporated in the United States and listed in the United
States and Israel, and in passing noted that the appropriate forum for the suit is a U.S.
court. After Morrison, the District Court revisited its ruling and held that the proceeding
would take place in Israel under U.S. law. See Class Action (Central District) 3912–01–08,
Stern v. VeriFone Holdings, Inc., Dinim District, 2011 (114) 708. The decision that U.S. law
would decide the suit is pending an appeal before the Supreme Court, filed by the person
seeking class representation (who is represented by the counsel for the Movants).
84. In any event, since the Movants purchased their shares on the Tel Aviv Stock
Exchange, they cannot seek relief from a U.S. court. An Israeli court is the only forum
that would hear their claim and grant them remedy. This conclusion is not expected to be
affected by the outcome of the VeriFone appeal. Moreover, an Israeli court is the appropri-
ate forum to hear this case because it involves the rights of Israeli investors who purchased
on an Israeli stock exchange shares of a company incorporated in Israel.
Part C – About the Movants
C.1 The Movants
85. The Movants are Teva shareholders. Movant 1 holds 66 Teva shares which he pur-
chased on November 14, 2011. An ownership certificate is attached as Appendix 18. The
shares were purchased on the Tel Aviv Stock Exchange for investment purposes and with
no connection to this suit. Movant 1 is a Professor of Law at Tel Aviv University (formerly
Vice Dean of the Faculty of Law) and an expert in corporate law. Movant 1 is the head
of the Joint Graduate Program of the Tel Aviv University and University of California at
Berkeley, and is the academic director of the Cegla Center for Interdisciplinary Research
in Law. Movant 1 has taught corporate law at Columbia University and Northwestern
University as well. He holds an LL.B. and a B.A. in Accounting from Tel Aviv University,
an LL.M. in corporate law from New York University (Hauser Program), and an S.J.D.
from Harvard University. His publications include, among others, articles in the law
reviews of the Universities of California, Michigan, and Northwestern. His articles deal
with corporate governance and executive compensation in particular.
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The Teva case 407
86. Movant 2 holds 130 Teva shares, which his investment portfolio manager acquired
for him on several occasions: on August 8, 2010, 153 shares were purchased; on September
28, 2010, 48 shares were purchased; on March 23, 2011, 56 shares were purchased; and on
January 5, 2012, 127 shares were sold. An ownership certificate is attached as Appendix
19. The shares were acquired on the Tel Aviv Stock Exchange for investment purposes
and with no connection to this suit. Movant 2 is a Professor of Law and Director of the
Business Law Program at the University of Southern California, and an Affiliate Professor
of Law at Tel Aviv University and Co-Director of the Batya and Issachar Fischer Center
for Corporate Governance and Capital Market Regulation at Tel Aviv University. Movant
2 is an expert in corporate law, mergers and acquisitions, securities law, and empirical
research methods. Movant 2 has taught corporate law at Harvard University as well as
at New York University. He holds an LL.B. and an LL.M. from the Hebrew University
and an LL.M. and a J.S.D. from Columbia University. His publications include, among
others, articles in the law reviews of the Universities Columbia, Cornell, Georgetown,
Harvard, and Stanford. His research includes, among other things, empirical study of
executive compensation.
87. The Movants are most appropriate to serve as class representatives. They resorted to
this procedure to promote the proper disclosure to which Teva shareholders are entitled.
Apart from the fact that the Movants are qualified to serve as class representatives being
Teva shareholders, it is very important that experts and academics participate in activities
for the establishment of proper corporate governance. The capital market suffers from
under-enforcement and such individuals ought to be encouraged to participate in this
undertaking.
C.2 Turning to the Court as Last Resort
88. The Movants turn to the Court after giving up hope that they can convince Teva
to fulfill its obligations.
89. On February 5, 2012, the Movants wrote as shareholders to Mr. Eyal Desheh, Teva’s
Chief Financial Officer, and required disclosure as set forth in this Motion (Appendix
10). To make it easier for Teva to prepare itself for the disclosure, the Movants demanded
that Teva disclose the compensation of its Chief Executive Officer in 2011 in the periodic
report it was about to file that month, and complete the disclosure of the compensation
of other managers and directors for the years 2007 to 2011 at the same time or shortly
thereafter. On February 15, 2012, Mr. Desheh contacted the Movants by telephone and
informed them that Teva did not accept their demands because, in the opinion of its
lawyers, it did not have to disclose executive compensation individually. When asked
whether Teva had sought approval for its position from the U.S. Securities and Exchange
Commission, Mr. Desheh answered that Teva had not seen a need for this. He added that
Teva’s lawyers would reply to the Movants in writing in the following week. In fact, such
a letter was sent to the Movants a month and a half later, on March 25, 2012 (Exhibit
11), as described below.
90. On February 19, 2012, Teva filed its periodic report for 2011in Israel (Appendix
8). As before, the report did not disclose the compensation of any of the managers or
directors on an individual basis.
91. On March 25, 2012, Uri Landau, an attorney with Teva’s legal department, wrote to
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the Movants that he was replying to them at the behest of Mr. Desheh (Appendix 11). Mr.
Landau’s letter stated that Teva was required to file in Israel reports in accordance with
the reporting requirements applying to it in the United States. In the opinion of its legal
advisers in the United States, as a foreign issuer in the United States it was not required
to provide individual disclosure of executive compensation. Before closing, Mr. Landau
added that “[t]he compensation of directors is brought for approval at the general meeting
of shareholders of the company, and therefore these compensation figures are listed in
notices on convening general meetings of the company which include director compensa-
tion on the agenda. That is, compensation figures of the directors of the company are
reported to the public.”
92. As explained in detail above, Mr. Landau’s reply is inconsistent with the law. First,
Teva must individually disclose both the compensation of its directors and the compen-
sation of its senior managers in periodic reports regardless of its disclosure elsewhere.
Second, the disclosure of director compensation on an individual basis in general meeting
notices, which Teva must provide in Israel and does in fact provide, gives rise to a separate
duty to disclose this information in periodic reports.
93. On May 6, 2012, the Movants wrote to Mr. Landau that his letter did not explain
Teva’s failure to disclose executive compensation on an individual basis, and that it was
not sufficient that its legal advisers thought it was not obligated to provide disclosure.
The Movants further wrote that in view of the fundamental importance of the issue, they
decided to file a suit against Teva on behalf of themselves and all shareholders harmed
by its conduct (the Movants’ letter is attached as Appendix 20). Teva did not reply to this
letter.
Part D – The Causes of Action
94. Section 1 of the Class Actions Law defines the purpose of the Law as follows:
The purpose of this Law is to establish uniform rules relating to the filing and management
of class actions, in order to improve the protection of rights, thus promoting in particular the
following:
(1) The exercise of the right of access to court, including for types of population that find it
difficult to go to court as individuals;
(2) Enforcement of the law and deterrence of its violation;
(3) Providing adequate remedy to victims of violation of the law;
(4) Effective, fair, and thorough handling of claims.
95. The suitability of this claim to be handled as a class action is particularly clear in
light of the purpose of the law to promote enforcement of the law and deterrence of its
violation. The claim deals with an important legal question common to a large class of
shareholders. Since each Teva shareholder holds only a fraction of the company, without
the class action mechanism there will be no incentive for a single member of the class to
assert his rights.
96. Many dual-listing companies followed Teva and do not disclose executive com-
pensation on an individual basis. According to the Tel Aviv Stock Exchange’s data, 43
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The Teva case 409
companies reporting under the Dual Listing Law are listed on this exchange, 42 of which
are companies listed for trade in Israel and the United States (the remaining company is
listed in Israel and United Kingdom). According to an examination by the Movants, 9
of these companies (8 of which are companies incorporated under the laws of one of the
states of the United States) file annually periodic reports on Form 10–K, which includes
disclosure of executive compensation on an individual basis. The remaining 33 companies
file annually periodic reports on Form 20–F, and the vast majority of them do not disclose
executive compensation on an individual basis. Thus, there is significant value in this class
action in order to enforce the law and deter its violation.
97. Section 3(a) of the Class Actions Law, which defines the grounds for filing a class
action, refers to the Second Supplement of that Law, which provides that a class action
may be filed based on a cause of action arising from an interest in a security. A security
is defined, for this purpose, as it is defined in the Companies Law and in Section 52 of
the Securities Law. An interest is defined as ownership, holding, purchase, or sale. Since
the Movants are Teva shareholders, they may bring an action against Teva based on any
cause of action arising from their ownership of the shares or the purchase of the shares.
98. The principal remedies sought in this suit are a declaratory court order according
to which Teva is required to disclose the compensation of senior managers and the com-
pensation of directors on an individual basis in periodic reports. An order for Teva to do
so in the future and an order for Teva to disclose the compensation of senior managers
and directors on an individual basis since 2000.
99. With respect to the declaratory order, “for the Movant to have a right of action it is
not necessary that he is harmed by the Respondent’s conduct . . . It seems that granting a
declaratory remedy, which has no element of damage, can protect the right of members of
the class which the Movant seeks to represent and deter the Respondent from continuing
to mislead its policyholders . . .” (Miscellaneous Motions (District of Tel Aviv) 60298/99,
Schwartz v. Hamagen Insurance Company Ltd., Piskey Din, 2001(2) 27, 37 (2001)).
100. As we have shown, Teva violates both Israeli and U.S. law by failing to disclose the
compensation of senior managers and directors on an individual basis in annual reports.
Part E—The Motion to Certify the Suit as a Class Action
E.1 Class Definition and Conditions for Class Action Certification
101. The issue in this suit is important to a class of tens of thousands of Teva sharehold-
ers. The class definition is: all Teva shareholders.
102. There is an identical legal question common to all members of the class. In addi-
tion, the entire factual basis is common to all class members.
103. The suitability of this suit for handling as a class action is clear. The conditions
for its certification as class action and their satisfaction in this case are analyzed below.
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E.2 Burden on the Movants, Existence of a Class
(A) Burden on the Movants

104. The extensive detail of the elements of the cause of action that the Movants have
and that were cited above show the existence of a cause of action that can be asserted in
a class action.
105. A class representative needs to show his cause of action and his compliance with
the prerequisites to filing a class action only by a test of reasonable likelihood in order not
to overburden the proceeding and not to deter class representatives. Thus, for example, the
Supreme Court held in Civil Appeal 2967/95, Maggen VeKeshet v. Tempo Beer Industries
Ltd., Piskey Din 51(2) 312, 329–330 (1997).
106. The Class Actions Law adopted this approach and requires only a reasonable
likelihood that material questions of fact or law common to the members of the class
will be decided in their favor. Recently, in Petition for Civil Appeal 2128/09, Amossi v.
Israel Phoenix Insurance Company Ltd., Nevo (2012), the Supreme Court addressed this
requirement and held:
The restriction in the Law with respect to unproven and unfounded class actions while demand-
ing higher standards than those required of a plaintiff who files a standard claim is not obvious.
The chances of the claim are not examined at the stage of certifying the class action in most
legal systems that are part of the common law. (Paragraph 12 of the opinion of Justice Eliezer
Rivlin)
107. The Supreme Court noted that the basis for this requirement is the burden and
the risk imposed on the defendant in such proceedings. After analyzing the requirement,
the Supreme Court concluded that:
The purpose of the Law is to instruct the court to conduct a preliminary examination of the
prospects of the action for the sake of a proportional protection on the rights of defendants. In
this regard, it is enough for a court to follow closely the words of the legislator and see if there
is a “reasonable likelihood” of a decision in favor of the plaintiff class. That is all. Tightening
the conditions for approval of a class action and examining most of the action already at the
stage of certifying the claim as class action oversteps the balance struck by the legislature, and
therefore it is inappropriate. (Id. at paragraph 15)
108. Implementation of this approach in our case leaves no doubt regarding the
justification for certifying the class action. This certification will not impose any special
burden or risk on Teva because the legal proceeding will focus on a single question, which
is the scope of the duty of disclosure that applies to it. The Movants meet the requirement
of showing a reasonable likelihood that the common questions will be decided in favor
of the class.
(B) Existence of a Class

109. Section 4(a)(1) of the Class Actions Law provides that “a person who has a cause
of action for a claim or a matter under Section 3(a)” may submit a motion for certification
of a class action. In the present case, the violation of disclosure duties regarding executive
compensation establishes a cause of action for the Movants as Teva shareholders and for
the remaining Teva shareholders.
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The Teva case 411
E.3 Satisfaction of the Conditions for Class Action Certification
110. Section 8(a) of the Class Actions Law lists the following conditions for certifica-
tion of a class action:
(A) The court may certify a class action, if it found all of the following:
(1) The claim raises significant questions of fact or law common to all members of the class,
and there is a reasonable likelihood that they will be decided in favor of the class;
(2) A class action is the most efficient and fairest way of deciding the dispute under the
circumstances;
(3) There are reasonable grounds to believe that the interests of all members of the class will
be represented and managed in an appropriate way; the defendant may not appeal or petition to
appeal the decision in this matter;
(4) There are reasonable grounds to believe that the interests of all members of the class will
be represented and managed in good faith.
111. All of the elements are present in this case. We have shown that the suit raises
significant questions of fact or law common to all members of the class and that there is
reasonable likelihood — indeed, much more than reasonable likelihood — that they will
be decided in favor of the class.
112. In this case, a class action is the most efficient and fair way of deciding the dispute.
The rights of tens of thousands of shareholders are involved. It will be effective in every
way possible if the matter is decided in a proceeding that binds all shareholders. This will
prevent the possibility of inconsistent rulings or settlements with individual plaintiffs that
do not serve the interests of the class. As shown above, there are reasonable grounds to
believe that the interests of all members of the class will be represented and managed in
an appropriate way and in good faith.
Part VI – Remedies and Summary
113. We have presented the existence of personal causes of action for the Movants, the
existence of a class, and the violation of law.
114. In this case, all prerequisites for certification of the claim as a class action are
present:
A. An act in violation of the law is involved;
B. The prospects of the suit are high;
C. There are questions of fact and law common to a large class;
D. There is no need to examine the personal circumstances of each member of the
class, and
E. The suit is filed in good faith after the facts supporting it and the law it involves have
been thoroughly checked.
115. As regards the reward to the class representatives and the legal fees, the Honorable
Court is requested to determine appropriate amounts in light of the scope of violation of
the disclosure duty, its duration, and the benefit to the capital market in general and to the
members of the class in particular from this proceeding. In addition, in determining the
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rewards and fees it is necessary to take into account the considerations set forth in Sections
22 and 23 of the Class Actions Law. Under the circumstances of this case, it would not be
right to quote proposed fees at this early stage of the proceeding.
116. Attached to this Motion are Affidavits of the Movants to substantiate the facts
in the Motion. A written opinion of Professor Jesse Fried of the Harvard Law School
regarding the foreign law is attached as well. The written opinion was signed outside of
Israel. In the coming weeks, a copy of it will be signed in Israel and submitted to the
Honorable Court. Some Appendices to this Motion include many pages. Therefore,
only the pages to which the Motion refers are attached. The complete Appendices and
References cited in the Motion are in the optical disk attached to this Motion.
117. The Honorable Court is therefore requested as follows:
A. To certify the filing of a class action by the Movants against Teva under to the Class
Actions Law; the suit to be filed shall be the one attached to this Motion (Appendix 1);
B. To rule, in accordance with Sections 10, 14(a)(1) and 26(b) of the Class Actions Law,
that the suit shall be filed on behalf of all Teva shareholders;
C. To rule, in accordance with Sections 4(a)(3) and 14(a)(2) of the Class Actions Law,
that the Movants shall be the class representatives and that their attorneys undersigned
on this Motion shall be counsel for the plaintiffs;
D. To rule, in accordance with Section 14(a)(3) of the Class Actions Law, that the cause
of action shall be violation of the reporting duties in Section 35EE(c) of the Securities
Law and Regulation 4 of the Regulations on Periodic and Immediate Reports of a
Foreign Company;
E. To rule, in accordance with Section 14(a)(4) of the Class Actions Law, that the
remedies in the class action shall be the following:
(1) A declaratory order, according to which Teva is required to disclose the compen-
sation it pays senior managers and directors on an individual basis in periodic reports;
(2) An order to Teva to disclose the compensation it paid senior managers and direc-
tors since 2000 on an individual basis;
(3) An order to Teva to disclose the compensation it pays senior managers and direc-
tors on an individual basis in periodic reports it will file in the future;
(4) The following provisions shall apply to the compensation disclosure noted above
(all in accordance with the instructions to Item 6.B of Form 20–F, Appendix 4 to the
Motion):
(a) Senior managers are the members of Teva’s administrative, supervisory, and
managerial bodies;
(b) Disclosure shall also cover contingent or deferred compensation accrued for
the year, even if the compensation is payable at a later date;
(c) If any portion of the compensation was paid pursuant to a bonus or profit-
sharing plan, a brief description of the plan and the basis upon which such persons
participate in the plan shall be provided;
(d) If any portion of the compensation was paid in the form of stock options, the
title and amount of securities covered by the options, the exercise price, the purchase
price (if any), and the expiration date of the options shall be provided;
F. To order, in accordance with Section 25 of the Class Actions Law, that the decision
in this Motion shall be published in the manner prescribed by the Court;
G. To certify the suit, in accordance with Section 13 of the Class Actions Law, as a class
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The Teva case 413
action subject to any change that the Court decides regarding the Motion to ensure the
fair and efficient administration of the class action, and
H. To order Teva to pay expenses.
118. Law and justice warrant the granting of the Motion.
Gil Ron, Adv.

Eyal Keinan, Adv.
Aharon Rabinovitz, Adv.
Gil Ron, Keinan & Co.
Jacob Aviad, Adv.
Aviad, Seren & Co.
Attorneys for the Movants
Tel Aviv, November 11, 2012.
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Section B
Comparative Shareholder Litigation
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24. A transatlantic perspective on shareholder
litigation in public takeovers
Dan Awrey and Blanaid Clarke*
1. INTRODUCTION
The majority of this handbook examines the dynamics of shareholder litigation in the
United States. As described in previous chapters, one of the most high profile and conten-
tious areas of litigation in the US revolves around disputes between bidders, shareholders,
and target boards of directors in the context of public takeover contests. This chapter
offers a comparative perspective on litigation as a process for resolving these disputes.
The bases for this comparison are the regulatory regimes governing public takeovers in the
United Kingdom and Republic of Ireland, where litigation has been largely supplanted
by detailed takeover codes interpreted and enforced by expert panels: the UK Panel on
Takeovers and Mergers, and the Irish Takeover Panel. Whereas the UK Panel enforces
its takeover code primarily through the threat of informal reputational sanctions and
restrictions on market access, the Irish Panel enforces its code through statutory rulings
and directions.
The legal and institutional environments in the US, UK, and Ireland share a number of
important similarities. First, all three jurisdictions have highly developed stock markets
within which ownership of publicly traded companies is relatively dispersed and, thus,
broadly characterized by the separation of ownership and control (LaPorta et al 1999).
Second, consistent with this pattern of investor ownership, each jurisdiction has adopted
a “market-oriented” (Armour and Skeel 2007: 1751) approach to corporate governance
that views takeovers as a mechanism for disciplining underperforming managers and,
thereby, maximizing value for shareholders.1 As a corollary, the volume of takeover bid
activity in the US and UK has historically been relatively high in comparison with many
other developed countries.2 Finally, and in part reflecting the volume of takeover activity,
* The views expressed in this chapter reflect the views of the authors alone and do not purport
to represent the views of any other person or body. Portions of this chapter were first published in
Dan Awrey, Blanaid Clarke, and Sean J. Griffith, Resolving the Crisis in U.S. Merger Regulation:
A Transatlantic Alternative to the Perpetual Litigation Machine, 35 Yale Journal on Regulation
1 (2018).
1
Whether this view is entirely accurate has been the subject of heated academic debate. For
what is likely the first articulation of this view, see Manne (1965). For other important contribu-
tions to this debate, see also Easterbrook and Fischel (1996); Franks and Mayer (1996); Coffee
(1984); Gilson (1981); and Lipton (1979). This view has also played an important role in framing
the objective of takeover law and regulation as being to ameliorate the information, agency,
and coordination problems faced by dispersed shareholders vis-à-vis delegated managers; see
Kraakman et al. (2009) and Gullifer and Payne (2015: 711).
2
Of the 23,123 historical completed public takeovers reported in the ZEPHYR corporate
415
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courts in the US and UK have developed a body of jurisprudence defining the role and
duties of target boards in responding to takeover bids.3
Despite these important similarities, the regulatory regimes governing public takeovers
in the UK and Ireland have evolved in a remarkably different direction to those on the
other side of the Atlantic (Kraakman et al 2009; Armour and Skeel 2007). In the US,
the resolution of disputes between bidders, shareholders, and target boards has been left
largely to common law courts applying basic fiduciary principles on a case-by-case basis.4
In the UK and Ireland, these disputes are instead resolved through the realtime application
of detailed takeover codes written, interpreted, and enforced by expert panels of market
professionals. Whereas the majority of takeover regulation in the US has been developed
by judges responding to the idiosyncratic facts of each case, the equivalent regimes in the
UK and Ireland have thus evolved in a more proactive and coordinated fashion as a result
of the industry, initiative, and expertise of investment banks, institutional investors, and
other repeat players in the public takeover market.
This crucial difference in the prevailing mode of takeover regulation has had an
important impact on its substance (Armour and Skeel 2007; Gelter 2009; Kraakman
et al 2009). In the US, Delaware courts have granted target boards and management
considerable discretion in how they respond to takeover bids. Provided that their
actions are consistent with their fiduciary duties, target boards are thus, for example,
permitted to adopt a range of defensive tactics designed to protect companies against
acquisition by unsavory bidders (Armour and Skeel 2007).5 For this reason, Delaware
jurisprudence is often viewed as strongly weighted toward the interests of incumbent
boards and managers (Armour and Skeel 2007; Bebchuk and Ferrell 1999; Gelter
2009; Roe 1994). In the UK and Ireland, meanwhile, the takeover codes are primarily
designed to safeguard the interests of shareholders. This shareholder-friendly stance
is reflected in the prescriptive timetables for the completion of bids, along with the
detailed disclosure regimes imposed on bidders and targets. It is also reflected in the
equivalent treatment and mandatory bid rules designed to prevent coercive bids, and
the strict prohibition against the use of defensive tactics by target boards without
prior shareholder approval.6 As a result, both bidders and target boards in the UK and
Ireland enjoy considerably less freedom of action in the cut and thrust of a takeover
contest.
This chapter proceeds as follows. Section 2 describes the emergence of public takeovers
in the UK and Ireland, the early jurisprudence arising from takeover disputes, and the
information database as of July 18, 2016, 6,675 (28.86 per cent) took place in the US and
2,911(12.58 per cent) took place in the UK.
3
Although, as we shall see, the introduction of takeover codes and panels in both the UK and
Ireland have largely stymied the development of this jurisprudence and, in the process, dramatically
reduced the role of target boards in responding to takeover bids.
4
Albeit against the backdrop of the disclosure and procedural rules governing tender offers
under the Securities Exchange Act of 1934, Pub. L. No 73-291, 48 Stat. 881 (1934), codified at 15
U.S.C. § 78a et seq. These rules were introduced under the Williams Act; see Williams Act, Pub. L.
No 90-439, 82 Stat. 454 (1968) (codified as amended in various sections of 15 U.S.C.).
5
Possible defensive tactics include nonvoting shares, poison pills, staggered boards, break fees,
lockup agreements, and tactical litigation.
6
These rules are discussed in greater detail in section 4.
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A transatlantic perspective 417
rationales behind the adoption of takeover codes and panels. Sections 3 and 4 introduce
the City Code governing public takeovers in the UK and the corresponding Takeover
Rules in Ireland. The distinctions between the UK’s flexible regulatory approach and the
more rigid statutory-based approach applied in Ireland is also explored in this context.
Section 5 provides an overview of the key provisions common to the takeover codes in both
jurisdictions relating to the timeframe for the completion of bids, disclosure requirements,
equal treatment and mandatory bids, and the general prohibition against defensive tactics.
Sections 6 and 7 describe the role of the UK and Irish Panels in writing, interpreting,
updating, and enforcing compliance with these and other provisions. They also describe
the mechanisms available for appealing against the decisions of the panels. Section 8
concludes by identifying some of the potential process advantages of these models relative
to more litigation-based models of takeover regulation. These comparative advantages
stem from the coordinated and proactive nature of the rulemaking process; the flexibility,
speed, and certainty of the adjudication process; and the cost savings derived from the
almost complete absence of litigation.
2. THE EMERGENCE OF PUBLIC TAKEOVER BIDS IN THE

UNITED KINGDOM
Public takeover bids appeared in the UK in the early 1950s. These first bids reflected
the confluence of several different factors, including postwar inflation on real estate
and other fixed assets, the imposition of dividend restrictions on public companies, and
improvements in financial reporting (Armour et al 2011; Johnston 2007; Hannah 1974).
Historically, a lack of hard financial information had forced investors to rely on measures
such as dividends as an indirect signal of a firm’s value (Cheffins 2006). Accordingly,
while the inflation of the early 1950s was rapidly increasing the value of companies’ fixed
assets, restrictions on dividends were actually depressing share prices. This created a fertile
environment for asset arbitrage, enabling investors to identify and acquire undervalued
targets (Armour et al. 2011). These arbitrage opportunities, combined with the divestment
of many family-owned firms and the emergence and growth of pension funds and other
institutional investors (Johnston 2007), resulted in a significant level of takeover activity
during the 1950s and 1960s.
The emergence of public takeover bids posed a threat to the security of tenure of directors
and management of target companies, who responded by adopting a range of defensive
tactics. High profile examples include the takeover contests for Savoy Hotel Ltd and British
Aluminium Ltd (Roberts 1992). In the case of the former, the bidder sought to acquire the
target in order to convert one of its flagship properties, the Berkeley Hotel, into commercial
offices (Gower 1955). The target board responded with a classic “lockup” defense: transfer-
ring ownership of the hotel to a shell company whose voting shares were then allotted to
the trustees of the Savoy’s employee pension fund, one of whom was the chairman of the
target board. The UK Board of Trade held that the target board’s actions were invalid,7 on
7
The Board of Trade was the predecessor to the current Department for Business, Energy and
Industrial Strategy.
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the basis that they had the effect of irrevocably denying any future controlling owner of the
ability to sell or alter the use of the hotel.8
In the contest for British Aluminium, the target board was approached privately by
two prospective bidders: one a partnership between Tube Investments and Reynolds
Metal Company (TI-Reynolds), the other the Aluminum Company of America (Alcoa).
Without publicly disclosing either of these approaches, the board rejected the TI-Reynolds
bid and agreed to a deal that involved the issuance of a significant number of new shares
to Alcoa.9 When it became clear that TI-Reynolds planned to make a direct offer to
shareholders, the target board then disclosed the earlier approaches and sought to secure
shareholder approval for the Alcoa deal by increasing the company’s dividend.10 The
revelation of the board’s decision to issue a large block of new and undervalued shares
to Alcoa attracted significant opprobrium from shareholders, many of whom quickly
sold out to TI-Reynolds.11 Indeed, shareholder reaction to the board’s conduct was so
powerful that a number of other public companies made the commitment not to issue
new shares without prior shareholder approval.12
The controversies surrounding the takeover contests for the Savoy and British
Aluminium provoked widespread calls for regulation limiting the range of actions that
target boards would be permitted to take in response to takeover bids (Armour et al 2011;
Armour and Skeel 2007). In July 1959, the Bank of England responded by convening
a committee representing large commercial banks, merchant banks, and institutional
investors, along with the London Stock Exchange, to draft a set of rules governing
takeover bids (Armour et al 2011; Gullifer and Payne 2015). The result was the Notes on
Amalgamation of British Businesses (“Notes”), a series of principles and procedural rules
“concerned primarily to safeguard the interests of shareholders.”13
The Notes are widely credited with articulating the basic principle of shareholder
primacy that survives in the UK to this day (Armour et al 2011). Ultimately, however, the
Notes proved less than successful in constraining abuse within the burgeoning takeover
market. As a preliminary matter, the principles themselves were often extremely vague.14
8
See E. Milner Holland, The Savoy Hotel Limited and The Berkeley Hotel Company
Limited: Investigation under Section 165(b) of the Companies Act, 1948: Report of Mr.
E. Milner Holland Q.C. 26 (1954). Ultimately, however, Holland’s report lacked the binding
force of judicial precedent.
9
See Battle for British Aluminium, The Economist, Dec. 6, 1958.
10
See Statement of the British Aluminium Board, Times (London), Dec. 6, 1958 and British
Aluminium Reveals Contract with Alcoa, Times (London), Nov. 29, 1958.
11
See British Aluminium: A Reply Under Pressure, The Economist, Dec. 27, 1958; Letters to
the Editor, Times (London), Dec. 11, 1958, and Letters to the Editor, Times (London), Jan. 9, 1959,
cited in Armour and Skeel (2007).
12
British Aluminium Reply, The Times (London), Dec. 20, 1958, cited in Armour et al. (2011:
235).
13
Editorial, Take-Over Ethics, Times (London), Oct. 31, 1959, cited in Armour and Skeel
(2007: 1759). For a description of the principles, see Johnston (2007).
14
They suggested for example, that “every effort” should be made to avoid market disturbance,
that shareholders should be given “adequate time (say three weeks)” for accepting an offer, and
that it was “desirable” that the offer be made for all of the target’s outstanding shares (Kershaw
2015: 13).
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Perhaps more importantly, there was no body with the responsibility for enforcing them
(Armour and Skeel 2007).
By the late 1960s, the use of defensive tactics—combined with the relative impotence
of the Notes—was also beginning to provoke litigation. The leading case from this
period is Hogg v. Cramphorn.15 Citing a long line of precedents,16 the court held that the
defensive tactics were voidable on the basis that the board’s primary purpose in adopting
the tactics was to thwart a potential bid.17 Importantly, satisfying this test necessitated
a fact-driven investigation into the board’s motives for adopting the tactics in question.
From the perspective of bidders and target shareholders, therefore, applying to a court for
relief was likely to be a time-consuming, costly, and uncertain process (Johnston 2007). In
the end, however, the influence of Hogg as a precedent for future cases would be largely
forestalled by the introduction of the City Code on Takeovers and Mergers (the “City
Code”) (Johnston 2007).18
3. THE CITY CODE ON TAKEOVERS AND MERGERS
The introduction of the City Code is generally viewed as a response to two threats to the
City of London’s shareholder-friendly reputation. The first was the threat of government
intervention following a spate of high profile takeover disputes in the late 1960s. These
disputes reinforced the perception that the Notes were an ineffective mechanism for
constraining abusive conduct and practices (Armour and Skeel 2007; Kershaw 2016).19
The second was the delay and uncertainty associated with the common law approach
to resolving these disputes, as embodied by the decision in Hogg (Johnston 2007). For
the second time in less than a decade, the Bank of England responded by convening a
committee of bankers, institutional investors, and other market participants. On March
28, 1968, the committee unveiled the new City Code: a collection of ten general principles
supplemented by 35 detailed rules governing the UK public takeover market. Like its
predecessor, the City Code was drafted by market participants concerned primarily
with protecting the interests of target shareholders. The key difference in terms of the
effectiveness of the City Code relative to the Notes was the creation of the UK Panel on
Takeovers and Mergers.
Between 1968 and 2006, the UK Takeover Panel operated as a self-regulatory body.
Spurred by the introduction of the EU Takeover Directive,20 the UK Companies Act
15
[1967] Ch. 254 [hereinafter “Hogg”].
16
These precedents included Piercy v. Mills [1920] 1 Ch. 77 and Fraser v. Whalley (1864)
2 H & M 10.
17
[1967] Ch. 254 at 266–7.
18
This is not to suggest that the introduction of the Code completely forestalled the develop-
ment of subsequent case law in this area; see e.g., Criterion Properties plc v. Stratford Properties
UK plc [2004] UKHL 28 and Howard Smith v. Ampol Petroleum [1974] A.C. 821, (P.C.).
19
This threat was notably framed in terms of the creation of a British Securities and Exchange
Commission; see, The Case for a British SEC, The Economist, Jan. 7, 1967. See also Back to the
Jungle, The Economist, July 22, 1967.
20
Directive 2004/25, 2004 O.J. (L142) 12 (EC) [hereinafter the “Takeover Directive”]. The
Takeover Directive was introduced with the objective of protecting the interests of shareholders
M4633-GRIFFITH_t.indd 419 30/10/2018 08:16

2006 put the City Code on statutory footing and provided the UK Panel with a range of
statutory powers and sanctions, including the power to make compensation rulings,21 and
the power to seek court orders to enforce rule-based requirements.22 While the Takeover
Directive imposed obligations on the UK Panel to introduce rules in certain areas, it also
permitted the Panel and other national authorities to lay down additional provisions for
the regulation of takeovers.23
Today, the City Code is organized around six General Principles, 38 Rules, and notes
providing guidance on each Rule. The notes are of considerable importance and in many
cases are treated as prescriptive by the Panel.24 The City Code applies to all offers made for
UK registered companies whose securities have been admitted for trading on a regulated
market or multilateral trading facility in the UK.25 It also applies to companies supervised
by the UK Panel by virtue of the Takeover Directive.26 The purpose of the City Code is
primarily to ensure that target shareholders are treated fairly, afforded equivalent treatment,
and not denied an opportunity to decide on the merits of a bid. The City Code also provides
‘an orderly framework within which takeovers are conducted.’27 Ultimately, however,
neither the Code nor the UK Panel is concerned with value judgments on the relative merits
of a bid.
4. THE IRISH TAKEOVER RULES
Until 1997, takeovers of Irish registered companies were regulated by the UK Panel.
However, in response to incoming EU legislation, the Irish Stock Exchange withdrew
from the International Stock Exchange of the United Kingdom and Republic of Ireland
in 1995. As a result, continued oversight of Irish listed companies by the UK Panel was
considered to be no longer appropriate. As the Irish experience with the UK Panel had
been very positive, the Irish government preferred to retain a self-regulatory model. Yet
and creating a level playing field across the European Union (Clarke 2007, 2009). While it
was initially hoped that the UK would be able to retain its self-regulatory model, there was
uncertainty around whether this would be consistent with full implementation of the Directive.
The UK government thus decided to provide the UK Panel with a statutory underpinning,
while also seeking to give it considerable scope to decide its internal structures and operational
framework; DTI, Company Law Implementation of the European Directive on Takeover Bids,
Government Response and Summary of Responses to the Consultative Document (November
2005) at 3.
21
Companies Act, 2006, s. 954.
22
Companies Act, 2006, s. 955.
23
Takeover Directive, art. 3(2)(b).
24
The Appendices contain more detailed guidance notes on specific issues such as mandatory
bid waivers and auction procedures. Also appended to the Code are 32 Practice Statements on
controversial issues such as shareholder activism and irrevocable undertakings.
25
City Code, Introduction, section 3(a)(i). The Code also applies to certain offers where: (1)
the takeover panel considers the target firm as having its central management and control in the
UK (section 3(a)(ii)) or (2) the UK shares jurisdiction with another jurisdiction in the European
Economic Area (section 3(a)(iii)).
26
Takeover Directive, art. 4.
27
City Code, Introduction, s. 2(a).
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it was also felt that statutory powers were required in order to ensure the effectiveness of
the new regime. The Irish Panel was thus established as a statutory body pursuant to the
Irish Takeover Panel Act, 1997.28
The Irish Panel regulates the conduct of takeovers of Irish registered companies listed
on the Irish Stock Exchange, London Stock Exchange, New York Stock Exchange, and
Nasdaq.29 The Takeover Act sets out seven General Principles, the first six of which are
identical to those set out in the City Code.30 The Irish Panel has supplemented these
principles with its own code of 41 rules contained in the Irish Takeover Panel Act, 1997
(Takeover) Rules, 2013. While not a self-regulatory body, the Takeover Act imbues the
Irish Panel with significant flexibility—allowing it, for example, to amend these rules and
to waive or derogate from them in exceptional circumstances.31 While most of the initial
differences with the City Code could be attributed to the statutory nature of the Irish
Rules, a small number of disparities have since arisen in the regulation of various issues.
These issues will be addressed in the next section. Ultimately, however, the objectives of
the Irish Rules are the same as those of the City Code.
5. KEY SUBSTANTIVE REQUIREMENTS OF THE CITY CODE

AND IRISH TAKEOVER RULES
The City Code and Irish Rules prescribe the timetable and procedures for each public
takeover bid. In the UK, once a possible offer has been announced, the bidder generally
has 28 days to announce either a ‘firm intention to make an offer’ or that it does not intend
to make an offer.32 In Ireland, no set period is prescribed, although the Irish Panel may
impose a deadline.33 Once a bidder has announced a “firm intention” to make an offer,34 it
will normally be required to proceed with the bid and post a formal offer to shareholders
within 28 days.35 After the formal offering documents have been posted, the bid must be
kept open for acceptance for at least 21 days.36 Any revised offer must be kept open for a
further period of at least 14 days,37 with any shareholders who accepted the earlier offer
entitled to receive any revised consideration.38
The City Code and Irish Rules also prescribe the financial and other information that
28
5/1997 [hereinafter the “Takeover Act”].
29
The Irish Panel may also be responsible for supervising certain other EU companies by virtue
of art. 4(2) of the Takeover Directive.
30
The seventh regulates substantial acquisitions of securities which are no longer regulated by
the UK Panel.
31
Takeover Act, s. 8(7).
32
City Code, Rule 2.6. This period may be extended where the UK Panel consents to an exten-
sion of the deadline.
33
Irish Rules, Rule 2.4(b).
34
See City Code, Rules 2.2 and 2.6 and Irish Rules, Rule 2.2 for the circumstances in which a
bidder is required to make an announcement.
35
City Code, Rule 24.1 and Irish Rules, Rule 30.2(a).
36
City Code and Irish Rules, Rule 31.1.
37
City Code, Rule 32.1(c) and Irish Rules 32.1(a).
38
M4633-GRIFFITH_t.indd 421 30/10/2018 08:16

must be provided to target shareholders. General Principle 2 states that “[t]he holders of
the securities of an offeree company must have sufficient time and information to enable
them to reach a properly informed decision on the bid.”39 This principle is then fleshed
out by a series of more detailed rules. For example, Rules 24 and 25 deal with the contents
of the offer document and the target’s response document. All information tendered by
a bidder or target must be made equally available to all shareholders as close as possible
to the same time and in the same manner.40 Equality of information to offerors is also
required.41 These detailed information requirements are then augmented by a more
general duty on bidders, target boards, and their advisers to ensure that each document,
announcement, statement, or other information released during the course of a bid is
prepared with the highest standards of care and accuracy.42
The City Code and Irish Rules also impose a number of constraints on the structure of
public takeover bids. These constraints include the equivalent treatment rule and manda-
tory bid rule. General Principle 1, the equivalent treatment rule, dictates that “[a]ll holders
of the securities of an offeree company of the same class must be afforded equivalent
treatment.”43 This rule is then extended to ensure equality between different classes of
equity securities,44 and between shareholders tendering to the offer and those selling their
securities on the open market.45 The principle of equivalent treatment is also reflected in
Rule 9, the mandatory bid rule. The mandatory bid rule requires any person who acquires
or consolidates control of a company to make an offer for all of the outstanding shares
of the company.46 Both the equivalent treatment and mandatory bid rules are designed to
39
City Code and Irish Rules, General Principle 2. See also City Code and Irish Rules, Rule 23.
40
City Code, Rule 20.1 and Irish Rules, Rule 20.1(a).
41
City Code Rule 21.3 and Irish Rules, Rule 20.2.
42
City Code and Irish Rules, Rule 19.1. This latter requirement helps to avoid acrimonious
disputes between the parties as only where a statement is expressly stated to be an opinion may it
be included without verification and a statement of source. Rule 19.2 provides that all documents
and advertisements published in connection with the offer by the bidder or target must contain
statements to the effect that the directors of the bidder or (as the case may be) the target accept
responsibility that the information contained therein is, to the best of their knowledge, accurate
and complete.
43
City Code and Irish Rules, General Principle 1.
44
City Code and Irish Rules, Rule 14 (mandating that, where an offer is made of any class of
equity share capital conferring voting rights, a “comparable” offer be made for each class regardless
of whether the class carries voting rights).
45
City Code, Rule 6.2 and Irish Rules 11.1(a). This is achieved by requiring the bidder to
increase their offer price to reflect any acquisition of the target’s securities on the open market at a
price that exceeded the previous offer price.
46
City Code and Irish Rules, Rule 9. The Takeover Directive requires all Member States to
apply a mandatory bid rule to the acquisition of control, although the definition of “control”
is left to the discretion of each Member State. In the UK, a mandatory bid is triggered when a
person, or “persons acting in concert” with that person, acquires an “interest in shares” carrying
30 percent or more of the voting rights or who, owning between 30 and 50 percent of such
rights, increases their holding. An “interest in shares” arises when a person has a long economic
exposure, whether conditional or absolute, to changes in the price of securities. In Ireland, a
mandatory bid is triggered when a person, or a person acting in concert with that person, acquires
securities conferring 30 percent or more of the voting rights, or, if they already hold between 30
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promote undistorted shareholder choice and ensure that all shareholders are able to reap the
benefits of any control premium (Bebchuk 1985; Schuster, 2013; Gullifer and Payne 2015).
The most important constraint imposed by the City Code and Irish Rules on the target
board—especially in comparison with the position in the US—is the “no frustration”
principle. General Principle 3 states that “[t]he board of an offeree company must act in
the interests of the company as a whole and must not deny the holders of securities the
opportunity to decide on the merits of the bid.”47 Rule 21 gives effect to this principle by
prohibiting target boards from taking any action that may result in the frustration of a
bid, or deprive shareholders of the opportunity to decide on the merits of a (possible) bid,
without first obtaining shareholder approval.48 This prohibition encompasses (but is not
limited to): the creation or issuance of shares, options, or other rights in connection with
the target’s shares; the acquisition or disposal of material assets; and the entering into of
any contract otherwise than in the ordinary course of business.49
Following Kraft’s successful takeover bid for Cadbury plc in 2011, the scope of the City
Code’s prohibition against frustrating action was expanded to include, subject to very
narrow exceptions, break fees, inducement fees, and other deal protection measures.50 In
Ireland, such measures are still permitted subject to Panel consent.51 In marked contrast
with the US, the role of target boards in defending against an unwelcome takeover bid
is thus limited to the identification of potential “white knights,” and to persuading
shareholders that the bid does not fully reflect the value of the firm. Perhaps most impor-
tantly for present purposes, the no frustration principle also replaces the fact-driven and
“nebulous” common law test articulated in Hogg for determining whether a target board
has engaged in impermissible defensive tactics (Johnston 2007).52
The City Code’s prohibition against frustrating action is also reflected in the UK Panel’s
approach toward tactical litigation. The UK Panel has described tactical litigation for the
purposes of preventing a bid from being considered on its merits as “highly undesirable
and potentially gravely damaging to the orderly conduct of bids.”53 It is presently not
clear whether the Irish Panel would apply Rule 21 in the same way. On the one hand,
and 50 percent of the voting shares, they increase their holding by more than 0.05 percent within
any 12-month period.
47
City Code and Irish Rules, General Principle 3.
48
City Code and Irish Rules, Rule 21.1(a).
49
City Code and Irish Rules, Rule 21.1(a). The Panel may consent to an otherwise restricted
action in certain circumstances including if it relates to a preexisting obligation, or if a decision to
take the proposed action was taken before the offer was imminent and that decision has either been
partly or fully implemented, or is in the ordinary course of business; see City Code Rule 21.1(c) and
Irish Rules, Rule 21.1(a) and also Takeover Directive, art. 9(3).
50
City Code, Rule 21.2.
51
Irish Rules, 21.2 and the related note. Consent normally relates only to arrangements in
respect of specific quantifiable third party costs subject to an upper limit of 1 percent of the value
of the offer and confirmation from the target’s financial adviser that the arrangement is in the
shareholders’ best interests.
52
See also Consolidated Gold Fields plc (Panel notice 1989/7, 2 May 1989) (acknowledging and
disapproving of the use of tactical litigation itself as a defensive tactic).
53
UK Panel Statement of May 9 1989 in relation to a bid by Minorco plc for Consolidated
Gold Fields plc. See Weinberg and Blank on Takeovers and Mergers, Part 4—Aspects of the
Takeover Process.
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preventing a board from taking legal action might be viewed as a breach of the company’s
constitutional right of access to the courts.54 On the other, Rule 21 does not represent an
outright prohibition against frustrating action, but rather a requirement that shareholder
approval be obtained before any action is taken.
Importantly, the prohibition against frustrating action is only triggered during the
course of an offer, or if the board has reason to believe that a bona fide offer may be
imminent.55 However, even where no bid is imminent, target boards in the UK and
Ireland still face a number of significant constraints on their ability to implement
defensive measures. Under both the UK Companies Act 2006 and the Irish Companies
Act 2014, for example, the issuance of new shares necessary to implement a poison pill
would require shareholder authorization.56 Shareholders also possess the mandatory
right to remove directors by ordinary resolution, thereby rendering staggered boards an
ineffective entrenchment mechanism.57 In theory, defensive action might also constitute
a breach of the directors’ duties to act in the interests of the company,58 and to exercise
their powers for proper purpose.59
6. THE UK PANEL ON TAKEOVERS AND MERGERS
Introduced alongside the City Code, the UK Panel serves two key functions. The first is
broadly legislative: writing, periodically reviewing, and updating the City Code.60 The
second is essentially judicial: giving guidance and rulings on the interpretation, applica-
tion, and effect of the City Code’s principles, rules, and notices.61 The UK Panel also
monitors compliance with the City Code and investigates and enforces potential breaches.
In furtherance of its rulemaking, investigatory, and enforcement functions, the UK Panel
is empowered by statute to “do anything that it considers necessary or prudent.”62 This
includes the power to compel disclosure of information, impose sanctions, and apply to
a court for the purposes of enforcing compliance with the City Code.63
Responsibility for reviewing and updating the City Code rests with the Panel’s Code
Committee.64 The Code Committee is composed of representatives drawn from the
Panel’s membership of institutional shareholders, corporate executives, legal and financial
54
This right was recognized by the Irish courts in Mccauley v. Minister for Posts and
Telegraphs [1966] I.R. 345 (Ir). In the Irish Supreme Court, Finlay C.J. stated “The right of access
to the courts, stated in its broadest fashion, is the right to initiate litigation in the courts”: State
(McCormack) v. Curran [1987] I.L.R.M. 225 (S.C.)(Ir.).
55
56
Companies Act 2006, ss. 549–51 and Companies Act 2014, s. 1021.
57
Companies Act 2006, s. 168 and Companies Act 2014, s. 146.
58
Companies Act 2006, s. 172(1) and Companies Act 2014, s. 228(1)(a)
59
Companies Act 2006, s. 171 and Companies Act 2014, s. 228(1)(c).
60
Companies Act 2006, ss. 943–4.
61
Companies Act 2006, s. 945.
62
Companies Act 2006, s. 942(2).
63
Companies Act 2006, ss. 947, 952, and 955.
64
City Code, Introduction, s. 4(b).
M4633-GRIFFITH_t.indd 424 30/10/2018 08:16

advisers, and other stakeholder groups.65 The Committee meets several times a year to
discuss market developments and emerging best practices, and determine whether any
amendments to the City Code are necessary.66
Frontline responsibility for providing guidance and rulings on the interpretation and
application of the City Code rests with the Panel’s Executive. The Executive is staffed
by a mix of fulltime Panel employees and professionals on secondment from law firms,
accountancy firms, brokerage houses, investment banks, and other City institutions.67
For each takeover bid, the Panel will assign a member of the Executive to oversee the bid
process. The parties to the bid will then be required to liaise with the Executive member
on a regular basis. Where one of the parties has a question about the interpretation or
application of the City Code, or a complaint about the conduct of another party, it will
approach the Executive for guidance or a ruling. Thus, for example, a bidder might lodge
a complaint that the target’s board has failed to provide it with sufficient disclosure or
engaged in impermissible defensive tactics. Where warranted, the Panel will then direct
the target board to provide the requisite information or cease and desist from any action
contravening the ‘no frustration’ principle.
Importantly, the City Code expressly contemplates that the Executive will interpret
and apply the General Principles and rules on the basis of both their technical letter
and their underlying spirit.68 The Executive also seeks to respond to any questions or
complaints in real time, with most decisions communicated to the parties by telephone
within 24 hours. While parties are often asked to provide information, there are no
formal rules of evidence, and most interactions with the Panel consist of oral commu-
nications. Moreover, while the parties are often represented in these communications,
it is typically by their financial—as opposed to legal—advisers (Armson 2005). As
John Armour and David Skeel have observed, the Panel’s adjudication process is thus
“untrammeled by the procedural and precedential niceties of the courtroom” (Armour
and Skeel 2007: 1729). This procedural informality, combined with the Executive’s
expert staff and close involvement throughout the bid process, enables the Panel to
interpret and apply the City Code on a dynamic basis in response to the unique facts
of each bid.
Residing in the background of this informal adjudication process is the threat that the
Panel will impose a wide range of sanctions in response to violations of the City Code.
At the more informal end of the spectrum, these sanctions include a private reprimand
or public censure.69 In response to more egregious conduct or repeat offences, the Panel
can also issue what is known as a “cold shoulder” statement. The effect of such a state-
ment is to require any person or firm authorized by the Financial Conduct Authority
(FCA) to cease working with the party identified in the statement in connection with
any takeover bid for a specified period of time.70 Where any authorized person or firm
65
Ibid.
66
Between 2015 and 2018, the Code Committee met 4 times per year on average; see Takeover
Panel Annual Reports, 2015–2018, available at www.thetakeoverpanel.org.uk/statements/reports.
67
City Code, Introduction, s. 5.
68
69
City Code, Introduction, s. 11(b)(i)–(ii).
70
City Code, Introduction, s. 11(b)(v).
M4633-GRIFFITH_t.indd 425 30/10/2018 08:16

fails to comply with a cold shoulder statement, they will themselves face sanctions from
the FCA including, in extremis, loss of authorization.71 This is considered by the UK
Panel to be the most serious disciplinary power exercisable by it and it has only been
utilized three times in its 50 year history.72 At the more formal end of the spectrum,
meanwhile, the Panel is empowered to require individuals violating certain provisions
of the City Code to pay compensation to affected shareholders.73 The Panel can also
report potential misconduct to the FCA,74 or seek a court order to enforce compliance
with the City Code.75 In 2017, the Panel had cause for the first time to seek such an order
when an individual ignored a ruling to make a mandatory bid for Rangers International
Football Club plc.76 While the Outer House of the Scottish Court of Session noted that
it had discretion under the Companies Act 2006 to either make or to refuse to make an
order enforcing the ruling, after analysing the circumstances it made the order in the
terms sought by the Panel.77 While there have been relatively few instances where any of
the formal sanctions have been imposed, the UK Panel’s enforcement regime is widely
viewed as an effective deterrent against violations of the City Code (Armour and Skeel
2007; Kershaw 2015).
Decisions of the Panel’s Executive are subject to both internal and external review.
Where a party to a bid or any other affected person with sufficient interest wishes to
contest a decision of the Executive, the party is entitled to request that the matter be
reviewed by the Panel’s Hearings Committee.78 Any party to a hearing before the Hearings
Committee (or any person denied such a hearing) may then appeal against the decision to
the Takeover Appeal Board, an independent body.79 Consistent with the Panel’s general
approach, hearings before both the Hearings Committee and Takeover Appeal Board are
largely informal—typically taking place in person and in private, and without formal rules
of evidence or the involvement of legal counsel.80 Decisions of the Hearings Committee
and Takeover Appeal Board are communicated to the parties in writing as soon as
practicable and then usually published on the Panel’s website.81
71
Ibid.
72
Takeover Panel Hearings Committee Statement 2017/1, p.21.
73
City Code, Introduction, s. 10(c). For example, the Panel required Guinness plc to pay
approximately £85 million in compensation for failing to make a cash alternative available to
shareholders in connection with its bid for Distillers Company plc; see Panel Statement 1989/13
(The Distillers Company plc, 14 July 1989).
74
City Code, Introduction, s. 11(b)(iv).
75
Companies Act 2006, s. 955.
76
Takeover Appeal Board Statement 2017/1 and Takeover Panel Statement 2017/8. A disagree-
ment existed between the parties as to the existence of a concert party. Coincidentally, one of the
three cold-shouldering sanctions also related to a mandatory bid issue involving a Scottish football
club namely Dundee Football Club Plc.
77
Panel on Takeovers and Mergers v King [2017] CSOH 156. This decision was upheld on appeal
([2018] CSIH 30).
78
City Code, Introduction, s. 4(c) and Appendix 9.1.
79
City Code, Introduction, s. 8 and Appendix 9.7. The chairman and deputy chairman of the
Takeover Appeal Board will usually have held high judicial office and its members will have experi-
ence in takeovers and the application of the City Code.
80
City Code, Introduction, Appendix 9.5.
81
Ibid.
M4633-GRIFFITH_t.indd 426 30/10/2018 08:16

The decisions of the Panel are also technically subject to judicial review. In practice,
however, judicial review is relatively uncommon for two reasons. First, English courts
have carefully limited the scope of any review of the Panel’s decisions. In R v. Panel on
Takeovers and Mergers ex p Datafin,82 the Court of Appeal determined that the Panel must
be given “considerable latitude”83 in the performance of its functions.84 Consistent with
this approach, the Panel was advised by the Court to ignore applications for leave to apply
since to do otherwise would enable applications to be used as “a mere ploy” in takeover
contests.85 Second, the strategy of seeking judicial review is unlikely to pay tactical divi-
dends in the context of an ongoing bid. As a preliminary matter, parties will be required to
comply with the Panel’s decisions whilst in the process of seeking judicial review.86 Perhaps
more importantly, the Companies Act 2006 provides that contravention of the City Code
will not affect the validity or enforceability of the transaction or give rise to any right of
action for breach of statutory duty.87 Reflecting this restrictive approach, the parties have
avoided involving the courts and as a result, decisions of the Panel are typically the final
word on the interpretation, application, and enforcement of the City Code.
7. THE IRISH TAKEOVER PANEL
The Irish Panel has been a statutory body since its inception. As with the UK Panel, the
members of the panel—who each nominate one director—are drawn from the financial,
business, and legal communities.88 The Governor of the Central Bank of Ireland nomi-
nates two further directors who serve as the deputy chairperson and chairperson to the
Board.89 Once appointed, all directors carry out their functions independently of their
82
[1987] QB 815 [hereinafter “Datafin”]. It should be noted however that this decision predated
the Takeover Directive and the introduction of the statutory functions for the Panel.
83
Ibid at 841.
84
Donaldson MR suggested that the Court should grant certiorari and mandamus only where
there had been a breach of natural justice and that in all other cases contemporary decisions of
the Panel should take their course and the relationship of the Court and Panel should be “historic
rather than contemporaneous”: ibid at 842.
85
Ibid at 840.
86
Ibid.
87
Companies Act 2006, s. 956. The Panel itself is also exempt from any liability save for acts
committed in bad faith or which contravene the United Kingdom’s Human Rights Act: Companies
Act 2006, s. 961.
88
Its members are the Law Society of Ireland, the Irish Association of Investment Managers,
the Irish Banking Federation, the Irish Stock Exchange, and the Consultative Committee of
Accountancy Bodies—Ireland. In some cases, the members are the corporate or personal nominees
of these bodies.
89
Provision is also made for the appointment by the members and governor of alternate direc-
tors ensuring that a quorum will be available even if some of the directors are unavailable or have a
conflict of interest in relation to a particular case: Takeover Act, s. 6(e). The Takeover Act also allows
for directors to be coopted by existing directors: Takeover Act, s. 6(d). While this has only been done
once to date, it provides a valuable resource where the expertise available to the Panel is considered
deficient in the circumstances of any particular takeover; See 470 Dáil Deb. col. 1604 (Oct. 31, 1996)
(Ir.), available at http://oireachtasdebates.oireachtas.ie/debates%20authoring/DebatesWebPack.nsf/
takes/dail1996103100005?opendocument&highlight=co-opt%20Pat%20Rabbitte.
M4633-GRIFFITH_t.indd 427 30/10/2018 08:16

nominators. The members of the Panel are expressly prohibited from instructing directors
regarding the conduct of their statutory duties.90 In order to ensure that the Panel’s direc-
tors remain totally independent, the provisions of the Companies Act 2014 allowing for
the removal of directors by ordinary resolution are also disapplied to the Panel.91
The statutory duties of the Irish Panel are twofold. First, it monitors and supervises
takeovers and other relevant transactions,92 in order to ensure compliance with the
provisions of the Takeover Act and the Irish Rules.93 Second, it makes rules in relation
to matters within its jurisdiction.94 The Takeover Act and Takeover Directive set out a
number of issues that must be regulated, but the Panel has considerable discretion to
design and implement rules. For example, the Panel is entitled to introduce rules for the
purpose of “ensuring that takeovers and other relevant transactions comply with the
[General Principles] and the other provisions of this Act.”95 The Irish Panel reviews its
rules from time to time, often following changes made to the City Code, and generally
consults with the public on any proposed changes.96
The functions of the Panel are divided between its Board and permanent Executive.
The Board is responsible for making formal decisions on the application, interpretation,
and enforcement of the General Principles and Irish Rules. The Board may, either on its
own initiative or upon the application of an interested party, make “rulings” on whether
any (proposed) activity complies with the General Principles and the Irish Rules.97 The
vast majority of applications are made by the legal or financial advisers to the target or
bidder on behalf of their clients. Often these applications request the Panel to give specific
directions to remedy alleged breaches. The usual process for dealing with these applications
involves the Executive informing the party alleged to be in breach of the nature of the
complaint against it, sending it the original complaint, and enquiring whether it wishes to
provide a written response to the Panel. Any response is sent to the complainant, who is
then permitted to respond. Save where the Panel deems a hearing necessary, only written
representations are accepted. In order to ensure compliance with the General Principles
and Irish Rules, the Panel may also give a “direction” to any party to do or to refrain from
doing anything that the Panel specifies in its direction.98 These directions may require
parties to, for example, acquire or dispose of securities, refrain from exercising voting
rights attached to securities, make an offer on specified terms, or disclose any information.
The day to day work of the Panel is carried out by its Executive. Although, like its UK
counterpart, the Executive bears frontline responsibility for providing guidance on the
interpretation and application of the Irish Rules, it does not make rulings or directions on
90
91
92
Takeover Act, ss. 5(1)(a) and 7(1).
93
Takeover Act, ss. 5(1)(a) and 7(1).
94
Takeover Act, ss. 5(1)(b) and 8.
95
Takeover Act, s. 8(1)(b).
96
In addition, ss. 8(5) and (6) of the Takeover Act require the approval of the Minister for
Jobs, Enterprise and Innovation before changes may be made to the rules relating to competition
legislation and the Substantial Acquisition Rules.
97
98
Takeover Act, s. 9(2)(a).
M4633-GRIFFITH_t.indd 428 30/10/2018 08:16

its own authority.99 The Executive is available to respond to queries from the parties and
the general public by telephone or email. It provides guidance to parties contemplating
a takeover before a bid is announced and during the course of a bid. The Executive is
also responsible for monitoring dealings in the securities of relevant companies to ensure
compliance with the General Principles and Irish Rules.
Where it has reasonable grounds to believe that a contravention of the General
Principles or Irish Rules has or may have occurred, the Panel may initiate a statutory
enquiry into the conduct of any person.100 Following an enquiry, the Panel may in public
or in private “advise, admonish or censure” such a person.101 These sanctions are generally
considered to increase in severity, with advice being the most lenient and censure the most
severe. Notably, not every ruling by the Panel involving a breach results in the provision of
advice, admonishment, or censure. While these sanctions have been used increasingly in
recent years, they still tend to be used sparingly in relation to the total number of breaches
and are generally levied only in response to particularly egregious or continuing breaches.
The Panel may also hold a statutory hearing.102 A hearing may be held, for example,
where there is conflicting evidence that needs to be resolved in order to make a ruling.
For the purposes of a hearing, the Panel has the same powers, rights, and privileges as
are vested in the High Court in relation to compelling attendance, examination on oath,
and ordering the production of documents. A witness before the Panel is also entitled
to the same privileges and immunities. At the hearing, arguments may be presented by
the parties themselves or their advisers and parties may call and question witnesses. The
Board may also question or invite statements from the attendees and call additional wit-
nesses. Parties and their advisers are entitled to be present throughout the hearing and to
see papers submitted to the Panel in connection with the hearing. To date, there has only
been one such statutory hearing.103
Despite the statutory nature of the Irish model, “efforts were made to ensure that this
would not give rise to increased litigation, particularly tactical litigation.”104 Although
there is nothing to stop a party inviting the Panel to review a ruling or direction, the
Takeover Act provides that the only method of questioning the validity of a rule, ruling,
or direction (or any derogation or waiver thereof)105 is by means of judicial review.106 The
purpose of this restriction is to provide “a balanced approach to ensure that parties can
99
Although it may exercise certain functions delegated to it by the Board: Takeover Act,
s. 6(2).
100
Takeover Act, s. 10. It may do this on its own initiative, at the request of a party to a take
over, or at the request of the Stock Exchange.
101
102
Takeover Act, s. 11.
103
This hearing arose in connection with a complaint that certain directors in a target company
had conflicts of interest in relation to a particular takeover and thus should have been excluded
from participating in the formulation and communication of advice to shareholders. Following a
two-day hearing, the Panel ruled that the parties were not conflicted within the meaning of the Irish
Rules: see http://irishtakeoverpanel.ie/1998/07/fitzwilton-plc/.
104
Irish Takeover Panel Annual Report 1998, Chairperson’s Statement at 8.
105
Section 13(2) of the Takeover Act provides that a rule may only be challenged where the
Panel has made a ruling or given a direction based on that particular rule.
106
Takeover Act, s. 13.
M4633-GRIFFITH_t.indd 429 30/10/2018 08:16

protect their interests while at the same time ensuring that takeover activity is not unduly
impeded.”107 The decision of the High Court is final and leave to appeal to the Supreme
Court will only be granted where the Court certifies that its decision involves a point of
law of “exceptional public importance” and that it is desirable in the public interest that
an appeal should be taken.108
Importantly, an applicant must seek leave from the High Court to apply for judicial
review. This application must generally be made within seven days of the relevant ruling
or direction.109 The strict time limit demonstrates the commitment of the legislature
to the swift settlement of disputes. It is consistent with the acknowledgement by the
English Court of Appeal, in Datafin, of the imperative of speed in the resolution of dis-
putes within financial markets.110 The Takeover Act provides that leave to apply for judicial
review is not to be granted unless the Court is satisfied that there are substantial grounds
for contending that the rule, derogation, waiver, ruling, or direction is invalid or ought to be
quashed.111 In the past, the Court, with the agreement of the parties, has been p repared to
hear the leave and judicial review applications together. The Takeover Act does not restrict
the choice of remedies available to the Court in judicial review p roceedings and, contrary
to the statement in Datafin that remedies would be only declaratory and prospective, there
is no indication that the Irish High Court considers itself limited in this regard. However,
section 15 of the Takeover Act ensures that where transactions have been completed, the
provisions of the Act cannot be used to have them unwound.112
In its 21 years of operation, the Irish Panel has only been the subject of three
judicial review applications—all involving hostile offers. The first two applications for
leave were withdrawn,113 leaving only one case in which the Court has actually made a
determination.114 In that case, the Court determined that the applicant had not established
substantial grounds to challenge the Panel’s interpretation of a rule because it had not
107
149 Seanad Deb. col. 1692 (Feb. 6, 1997), available at http://oireachtasdebates.oireachtas.ie/
debates%20authoring/DebatesWebPack.nsf/takes/seanad1997020600006?opendocument&highligh
t=co-opt%20Pat%20Rabbitte.
108
Takeover Act, s 13(6). This would not prevent a party challenging the constitutionality of
the law pursuant to s. 13(7).
109
Takeover Act, s. 13(3)(a). Section 13(3)(5) provides that this period may only be extended
where the delay was not caused by the default or neglect of the applicant or any person acting for
them and where an extension would not cause injustice to any other concerned party. Section 13(8)
provides that while an application for leave to apply for judicial review or for such judicial review is
pending, or during the seven-day period within which such an application may be made, the Panel
may apply to the Court for an order providing for appropriate interim or interlocutory relief.
110
Datafin at 840.
111
Takeover Act, s. 13(3)(b).
112
The only circumstances in which a transaction could potentially be unwound would be on
the basis of an application by the Panel itself to the Court to annul a transaction that had been
carried out contrary to a ruling or direction or where a ruling or direction was made on the basis of
false or misleading information provided by a party to the takeover: Takeover Act, s. 12.
113
These involved an application made by Ryanair Holdings plc in respect of a bid for Aer
Lingus Group plc in 2009 and an application by Echo Pharma Acquisition Ltd in respect of a bid
for Elan Corporation plc in 2013.
114
This case concerned an application made by Aer Lingus Group plc in respect of another
hostile bid by Ryanair Holdings plc.
M4633-GRIFFITH_t.indd 430 30/10/2018 08:16

shown that the interpretation was wrong or even questionable.115 An order for costs was
made by the High Court in favor of the Panel.116
It is highly unusual for any litigation to be initiated in the Irish courts in connection
with the takeover of an Irish company. However, in 2013, a target firm sought a High
Court injunction prohibiting a bidder from distributing a proxy statement filed in the
US on the basis that it did not comply with the Irish Rules. The parties ultimately agreed
in court that the matter should be resolved by the Panel pursuant to the Irish Rules.117
Notably, the Chairperson of the Irish Panel in its 2013 Annual Report expressed the
Panel’s hope that it was not witnessing a trend toward a more litigious approach to Irish
takeovers. He stated:
If parties do resort to the courts more frequently to resolve issues arising in connection with
takeovers, such actions may introduce legal uncertainty into the takeover process and may run
the risk of prolonging the bid timetable all of which is unlikely to be in the best interests of
shareholders and the market in general. The Panel is an expert group with significant experience
in applying its own rules and in dealing with issues arising during the course of a takeover. Since
its establishment the Panel has sought to ensure that matters arising during the course of a
takeover are dealt with expeditiously.118
This statement underscores the value of the Panel to all parties as the arbiter of disputes
that might arise in the context of a takeover.
8. PROCESS ADVANTAGES OF THE TAKEOVER REGIMES IN

THE UNITED KINGDOM AND IRELAND
The regulatory regimes governing public takeovers in both the UK and Ireland hold
out a number of potential process advantages in comparison with more litigation-based
regimes. These advantages stem from: the coordinated and proactive nature of the
rulemaking process; the flexibility, speed, and certainty of the adjudication process; and
the lower deadweight costs associated with the real-time interpretation, application, and
enforcement of detailed takeover codes by expert panels, as opposed to more amorphous
and fact-dependent fiduciary duties by common law courts. Importantly, these advan-
tages are largely independent of the longstanding debate over how far takeover regimes
should go to protect target shareholders against potential managerial agency costs.119 This
section takes a closer look at each of these potential advantages.
Fundamentally, rulemaking within common law systems involves an incremental and
largely uncoordinated process of articulating, refining, and distinguishing precedents
(Armour and Skeel 2007). This process is highly dependent on the incentives and capacity
of the parties to pursue litigation as a strategy for resolving disputes (Macey and Miller
115
Aer Lingus Group PLC v Irish Takeover Panel [2013] IEHC 428.
116
In Ireland, the unsuccessful party generally pays the costs.
117
Irish Takeover Panel Annual Report 2013, Chairperson’s Statement at 5.
118
Ibid at 6.
119
The notable exception being the absence of tactical litigation itself, which can be viewed as
enhancing speed and certainty for target shareholders.
M4633-GRIFFITH_t.indd 431 30/10/2018 08:16

1987; Zywicki 2003; Rubin 2005). It is also dependent on the idiosyncratic facts of each
case. The production of rules within common law systems is thus often viewed as a slow,
evolutionary, and in many respects unpredictable process.
The reactive nature of common law rulemaking stands in sharp contrast with the rule-
making process within code and panel-based takeover regimes (Armour and Skeel 2007).
In the UK and Ireland, the Panels are responsible for continuously monitoring market
developments and evaluating whether these developments warrant refinements to the City
Code and Irish Rules.120 The Panels thus proactively intervene to ensure that the rules evolve
to reflect changes in the marketplace. As one court has put it, the Panels act “as a sort of fire
brigade to extinguish quickly the flames of unacceptable and unfair practice.”121
Complementing the Panels’ proactive approach to rulemaking is the approach of
their executives to the interpretation, application, and enforcement of these rules.
First, by interpreting and applying the City Code on the basis of its underlying spirit,122
the Executive of the UK Panel is able to adopt a flexible approach that reflects new
developments and the idiosyncratic facts of each case without creating binding

precedent that might limit its scope for action in connection with future takeover bids.
Because of the statutory nature of the Irish Rules, the Irish Panel understandably has
less flexibility in this regard. Nevertheless, the grounding of the Irish Rules in a set
of General Principles still gives the Panel a considerable degree of latitude. General
Principle 6, for example, which provides that a target company must not be hindered in
the conduct of its affairs for longer than is reasonable by a bid, may be used to justify
many requirements, or conversely to support a ruling that any number of different
actions are unacceptable.
A second advantage of the adjudication process is its speed. While Delaware courts are
doubtlessly some of the fastest in the world, most cases still take several weeks from filing
to judgment—and in some cases significantly longer (Armour and Skeel 2007). Parties to
a takeover bid in the UK or Ireland, meanwhile, need only contact the Executives for guid-
ance or to seek a panel ruling. Typically, Executive advice will be available immediately
and Panel rulings may be obtained within a matter of days.123 This speed is a significant
advantage in the context of an ongoing takeover bid subject to a relatively strict and short
timetable for completion.
The speed of the adjudication process is closely related to a third advantage: certainty.
Echoing the approach taken by the High Court in Hogg, Delaware courts have stressed
the importance of adopting a flexible, fact-driven approach toward potential breaches
of a board’s fiduciary duties.124 Inevitably, however, such fact-driven investigations take
time when conducted in accordance with the rules of civil procedure, thereby increasing
120
As noted above, the Takeover Directive allows the Panels to lay down additional conditions
and provisions for the regulation of bids.
121
R v. Panel on Takeovers and Mergers, Ex parte Guinness plc (1988) 4 BCC 325 at 338.
122
123
Where investigations are required to determine the relevant facts prior to a ruling, the
Rangers case referred to above demonstrates that the process may be extended.
124
See, e.g., Paramount Communications, Inc. v. Time Inc., 571 A.2d 1140 (Del. 1989), in
which the Delaware court argues that the Unocal test should be applied flexibly and not on the basis
of a ‘mechanistic procedure’; ibid at 1153.
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Table 24.1 Average lawyer fee awards in US takeover litigation settlements (2005–2015)
Year Number of awards Mean award Median award

2015 4 $371,000 $405,000
2014 50 $731,000 $433,000
2013 49 $1,004,000 $450,000
2012 68 $1,427,000 $495,000
2011 55 $1,430,000 $580,000
2010 82 $1,263,000 $583,000
2009 44 $1,704,000 $638,000
2008 33 $865,000 $588,000
2007 53 $994,000 $550,000
2006 64 $1,835,000 $528,000
2005 34 $1,766,000 $450,000
Average 48.7 $1,306,285 n/a
Source: Cain and Davidoff Solomon (2016).
uncertainty for shareholders and other parties. By providing guidance and rulings more
or less in real time, the Panels largely remove this uncertainty—along with the potential
distortions it generates in the takeover process.
Finally, the takeover regimes in the UK and Ireland hold out potentially significant
advantages in terms of the deadweight costs of the dispute resolution process from the
perspective of bidders, targets, and their shareholders. Empirical evidence examining the
costs of takeover litigation in the US suggests that resort to litigation is fairly common.
Between 2005 and 2015, the percentage of completed public takeover bids worth more
than $100 million that resulted in litigation increased from 39.3 percent to 87.7 percent
(Cain and Davidoff Solomon 2016).125 Over the same period, the average number of suits
filed per takeover increased from 2.2 to 3.6 (Cain and Davidoff Solomon 2016). Empirical
evidence also suggests that lawyers’ fees in connection with this litigation are often sizable.
Table 24.1 reproduces data collected by Steven Davidoff Solomon and Matthew Cain on
the fees awarded to plaintiffs’ lawyers in connection with takeover litigation settlements.126
As Cain and Davidoff Solomon (2016) observe, the size of these fee awards has recently
been on a downward trajectory, due in part to the Delaware judiciary’s increasing reluc-
tance to approve “disclosure only” settlement agreements (Fisch et al 2015). By the same
125
Cain and Davidoff Solomon’s sample includes all completed transactions listed in the
FactSet MergerMetrics database and announced from 2005 to 2015 where the target was a US firm
publicly traded on the NYSE, AMEX, or NASDAQ stock exchanges, with a transaction size of at
least $100 million, and the offer price was at least $5 per share (2016: 2).
126
This data on the mean and median size of fee awards obscures a wide variance: with awards
ranging from $100,000 in the case of In re Gen-Probe Inc., No 7495-VCL, 2013 WL 1465619 (Del.
Ch. Apr. 10, 2013), to over $22.7 million in the case of In re Del Monte Foods Co. S’holders Litig.,
25 A.3d 813 (Del. Ch. 2011); see also Transcript of Settlement Hearing at 57–8, Del Monte Foods,
25 A.3d 813 (No 6027–VCL). For a more detailed discussion, see Fisch et al. (2015) and Cain and
Davidoff Solomon (2016).
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Table 24.2 Total annual expenditures of UK takeover panel per announced offer

(2006–2016)
Year Offer period Panel’s total annual Annual expenditure/offer

announced expenditure period announced*
2015–16 74 £11,780,069 £159,190.12
($208,539.06)
2014–15 89 £12,123,055 £136,214.10
($178,440.47)
2013–14 61 £11,369,738 £186,389.15
($244,169.78)
2012–13 81 £9,909,893 £122,344.36
($160,271.11)
2011–12 103 £9,201,159 £89,331.64
($117,024.45)
2010–11 134 £9,709,844 £72,461.52
($94,924.59)
2009–10 162 £11,174,568 £68,978.81
($90,362.25)
2008–9 211 £11,028,904 £52,269.69
($68,473.29)
2007–8 220 £11,841.372 £53,824.42
($70,509.99)
2006–7 230 £9,429,943 £40,999.65
($53,709.68)
Average 136.5 £10,756,854.50 £78,804.79
($103,234.28)
Note: *USD conversion as of July 25, 2016.

Source: UK Takeover Panel Annual Reports.
token, insofar as it does not include legal fees paid to lawyers for the defendants, this data
is likely to underestimate the total costs of the dispute resolution process.
In sharp contrast, one of the most striking features of the takeover regimes in the UK
and Ireland is the relative absence of both lawyers and litigation.127 This shifts the primary
source of the costs of dispute resolution, from the perspective of bidders, targets, and
their shareholders, from legal fees to the operating costs of the Panel itself. These opera-
tions are funded in the UK by way of small “document charges” levied in connection
with formal offers exceeding £1 million, fees on block transactions in shares listed on the
London Stock Exchange, sales of the City Code, and other minor charges.128 Table 24.2
127
Moreover, insofar as the advisers responsible for liaising with the Panel are investment
bankers and other financial professionals, the fees they charge to bidders and targets (if not
necessarily shareholders) in connection with these services are likely to already be embedded in the
relevant transaction fees.
128
See City Code, Doc. 1 and Takeover Panel Annual Statement—Income Statement (2016),
available at www.thetakeoverpanel.org.uk/statements/reports.
M4633-GRIFFITH_t.indd 434 30/10/2018 08:16

sets out the Panel’s total annual expenditures for the reporting years 2006–7 through
2015–16, along with the Panel’s average expenditure per announced offer period.129
This data provides us with some useful—if indirect—insight into the average cost of
dispute resolution under the UK’s takeover regime.130 At the same time, this data is likely
to significantly overestimate these costs, for two reasons. First, the denominator in the
equation—the number of announced offer periods—does not capture the significant
volume of work undertaken by the Executive in providing guidance and rulings in connec-
tion with contemplated (but ultimately unannounced) offers, whitewashes, waivers, and
general enquiries from interested parties.131 Second, the Panel’s total annual expenditures
include the costs incurred by the Panel as part of its rulemaking process, such as the
work of the Code Committee in monitoring market developments and updating the City
Code.132
Despite the statutory basis of the Irish Rules, as noted above, shareholder litigation
in connection with takeover bids in Ireland is also extremely rare. That there have been
three applications for judicial review in 21 years, supervising more than 100 takeover
offers, reflects the finality with which rulings and directions of the Irish Panel are gener-
ally viewed. Interestingly, advisers approaching the Irish Panel for guidance or rulings,
waivers, or derogations are more likely to be legal as opposed to financial advisers,
although this probably reflects the regime’s statutory grounding.133
Like its UK counterpart, the Irish Panel is self-financing. It imposes charges on relevant
companies on an annual basis, on bidders in connection with each offer, and on dealings
in the securities of relevant companies.134 Table 24.3 sets out the Irish Panel’s total annual
expenditures for the reporting years 2006–7 through 2015–16.
While data limitations make apples to apples comparisons difficult, it is revealing that
the average size of plaintiffs’ legal fee awards in the US over the past ten years ($1,306,285)
is 12.6 times higher than the UK Panel’s average expenditure per announced offer
($103,234), and almost four times higher than those of the Irish Panel ($343,705), over
129
The count for “offer periods announced” includes announcements of both firm and pos-
sible offers by offerors and announcements of formal sale processes by offerees.
130
Another potential proxy for these costs would of course be the income the Panel generates
from the various fees and charges imposed on parties to takeover bids. Historically, the Panel’s
income has on average slightly exceeded its expenditures owing to its commitment to maintaining
a surplus approximately equal to two years’ expenditures.
131
See Takeover Panel Annual Reports (n 66) at 18. See also Armour et al (2009).
132
Regrettably, the Panel’s Annual Statements do not provide a detailed breakdown of these
costs.
133
The Panel indicated in 2011 that it was considering introducing a new rule that would
impose specific responsibilities on advisers to bidders and targets, including a duty to act honestly
and professionally: see Consultation Paper 2 (2011) at 40–1. To date, no such rule has been
introduced.
134
The annual company charge varies from €1,250 to €18,750 depending on market capitaliza-
tion. The document charges for takeovers vary from €2,500 to €81,250 depending on the size of
the offer and €1.25 is charged on each contract note in respect of transactions valued at more than
€12,500.
M4633-GRIFFITH_t.indd 435 30/10/2018 08:16

Table 24.3 Total annual expenditures of Irish takeover panel per takeovers supervised
(2006–2016)135
Year Takeovers supervised Panel’s total annual Annual expenditure/takeovers

expenditure supervised*
2015–16 3 €870,241 €290,080
($318,276)
2014–15 4 €822,655 €205,663
($231,202)
2013–14 2 €717,496 €358,748
($403,296)
2012–13 4 €1,002,482 €250,621
($281,742)
2011–12 4 €908,003 €227,001
($225,189)
2010–11 4 €947,538 €236,885
($266,301)
2009–10 8 €917,701 €114,713
($128,958)
2008–9 1 €1,171,533 €1,171,533
($1,317,010)
2007–8 7 €1,107,480 €158,211
($177,857)
2006–7 8 €952,913 €119,114
($133,905)
Average 5 €941,804 €313,257
($343,705)
Note: *USD conversion as of 1 October 2016.

Source: Irish Takeover Panel Statements Annual Reports.
roughly the same period.136 This considerable difference, together with the other process
135
advantages described above, suggests that code and panel-based takeover regimes may
represent a cost effective substitute for more litigation-based regimes—or, at the very
least, for the current US regime.
135
The figures for Takeovers Supervised reflect the number of takeovers supervised, but not the
number of companies that might have been “in play” at that point in time. In addition to the two
caveats noted above in relation to the UK Panel, it is relevant to note that the time and resources
spent regulating a hostile bid are likely to exceed those spent regulating an uncontested bid. The
former is likely to give rise to more complaints, more requests for rulings and directions, and an
increased likelihood of judicial review. The three judicial review applications referred to above all
involved hostile bids. It is for this reason that 2008–9 involved the highest expenditure in the ten
years under review despite the fact that only one takeover was being supervised.
136
While this gap has narrowed in recent years, this largely reflects the reduction in the number
of announced offer periods in the United Kingdom (which are then divided against the largely
fixed costs of operating the Panel).
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9. CONCLUSION
The regulatory regimes governing public takeover bids have evolved in remarkably dif-
ferent directions on opposite sides of the Atlantic. In the US, the takeover bid process
is overseen largely by common law courts applying basic fiduciary principles. In the UK
and Ireland, the process is overseen by expert panels of market professionals applying
detailed takeover codes. These differences in the prevailing mode of takeover regulation
have important implications in terms of the coordination and responsiveness of the
rulemaking process; the flexibility, speed, and certainty of the adjudication process;
and the costs of dispute resolution from the perspective of bidders, targets, and their
shareholders.
Despite the potential process advantages of code and panel-based takeover regimes, the
purpose of this chapter is not to suggest that switching from a litigation-based regime is
necessarily feasible or, in the end, desirable. The effectiveness of the UK takeover regime
relies in part on the geographical and cultural cohesion of the City of London, along with
substantial buy-in from the relevant stakeholders, in order to generate the credible threat
of informal reputational sanctions. This unique environment would likely be difficult to
replicate in the US. At the same time, the success of the Irish takeover regime demon-
strates that it is possible to transplant a code and panel-based regime into a jurisdiction
that does not enjoy these geographical, cultural, or institutional advantages. In the end,
even if there is no immediate interest in transplanting a similar regime in the US, this
chapter provides a window into the relative costs of the current regime compared with the
UK and Ireland, along with a possible alternative for future consideration.
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M4633-GRIFFITH_t.indd 438 30/10/2018 08:16

25. Private ordering of shareholder litigation in the
EU and the US
Matteo Gargantini and Verity Winship* 137
?
1. INTRODUCTION
As shareholder litigation expands globally and increases in economic significance, so does
the interest of parties in fighting over the rules that govern it and determine its scope.
Sometimes this fight is over legislative or regulatory limits, but it can also occur in the
context of private ordering. To what extent can the players in shareholder litigation—
companies, management, shareholders, and other investors—set the rules for litigation
through private agreement? These agreements may be negotiated and involve explicit
consent, in a clear analog to sophisticated commercial contracts. But at other times the
locus of this private ordering is itself contested. In particular, the question arises whether
provisions in charters and bylaws or in prospectuses may shape litigation.
Shareholder litigation is an umbrella term for various forms of suit and a range of
claims brought by shareholders against the company in which they hold shares or against
its directors and officers. To determine when private ordering of these suits and claims is
viable requires a nuanced look at the types of actions and legal theories that make up this
larger category. In both the EU and US contexts, this chapter tracks distinct consequences
for corporate governance suits, which this chapter also terms “intracorporate” suits, and
for securities suits in which investors contend that there have been material misstatements
or omissions, accounting or prospectus fraud, or other securities law violations.
The chapter takes a comparative approach to private ordering of shareholder litiga-
tion. It begins with the US example, in which dispute resolution provisions emerged in
the constituent documents of US companies as a response to pressures from litigation.
The contours of permissible provisions have not been exhaustively drawn, but dispute
resolution bylaws have been tested in US state courts and were the subject of subnational
legislation. The chapter then examines how private ordering of shareholder litigation—
both intracorporate and securities suits—might function (or not) in the context of the EU
and some of its constituent countries.
2. DISPUTE RESOLUTION PROVISIONS IN US CORPORATIONS
The US has a history of first enabling representative litigation by shareholders and then,
as some of the disadvantages became pressing, limiting such suits legislatively or through
* The opinions expressed are exclusively the authors’ and do not necessarily coincide with
those of the organizations they belong to. Although the chapter is the result of shared reflections,
Section 2 shall be attributed to Verity Winship and Section 3 to Matteo Gargantini.
439
M4633-GRIFFITH_t.indd 439 30/10/2018 08:16

judicially created doctrines. Some of these limitations on shareholder litigation take the
form of procedural hurdles written into the US securities laws or rules of civil procedure.1
Continuing concerns about the efficacy of shareholder litigation, particularly on the
part of defendant corporations, created an appetite for a private ordering alternative that
could be implemented without enacting legislation or relying on judicial development. In
the US, this took the form of treating the organizational documents of corporations—
their charters and bylaws—as in some ways analogous to sophisticated commercial
contracts. These documents could then contain dispute resolution provisions more typical
of commercial contracts, such as exclusive forum, feeshifting, and mandatory arbitration
clauses. These dispute resolution provisions set the rules for litigation between corporate
actors. This section provides a brief history of the emergence of these provisions in
corporate organizational documents. It then highlights aspects of the US legal context
that prompted their development and which shape their use.
2.1 Emergence of Dispute Resolution Charter and Bylaw Provisions
Dispute resolution provisions in corporate charters and bylaws first emerged as a solution
to a particular problem (Winship 2016).2 Beginning in the early 2000s, litigation followed
most corporate deals in the US (Cain & Davidoff 2012). These shareholder suits took
the form of class actions in state court challenging a merger, usually alleging that officers
and directors had violated their fiduciary duties to shareholders. Plaintiffs’ attorneys
competed to represent the same class of shareholders and to be allocated a percentage of
their legal fees. Some attorneys brought suit outside of the state of incorporation to put
pressure on the other plaintiffs’ attorneys to give them a share of the fee in exchange for
consolidation (Thomas & Thompson 2012).
This recurring litigation pattern also prompted interest, particularly from defendant
corporations, in consolidating litigation in one state’s courts, often those of Delaware.3
Ultimately the prevalent solution to multiforum deal litigation was for corporations to
include an exclusive forum (choice of court) clause in the charter or bylaws. A Delaware
court approved the facial validity of exclusive forum bylaws, prompting widespread
adoption by Delaware public companies (Romano & Sanga 2017).4 This development
also gave rise to speculation about the types of other dispute resolution provisions that
might be permissible.
A year later, another Delaware court decision allowed corporations to amend their
1
See, e.g., Private Securities Litigation Reform Act of 1995, Pub. L. No 104-67, 109 Stat. 737,
747 (1995) (codified at 15 U.S.C. § 78u-4(b) (2012)) (imposing heightened pleading requirements,
stays of discovery, and mandatory Rule 11 reviews for securities litigation); Fed. R. Civ. Pro. 23.1
(requiring shareholders suing in a derivative suit to first “demand” that the board of directors bring
suit); NY Bus. Corp. L. § 627 (requiring shareholders bringing a derivative action to post a security
for litigation expenses if they own less than the specified percentage of shares).
2
A full history can be found in Verity Winship, Shareholder Litigation by Contract, 96 B.U.
Law Rev. 481 (2016).
3
However, as Sean Griffith has noted, changes in Delaware law may affect which forum
defendant corporations prefer (Griffith 2018).
4
Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 956 (Del. Ch. 2013)
(approving an exclusive forum bylaw as facially valid).
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Private ordering of shareholder litigation 441
bylaws to impose feeshifting on losing shareholders, altering the background American

rule on who bears the costs of litigation.5 The particular feeshifting bylaw at issue was
quite aggressively drafted,6 prompting Delaware legislation prohibiting their adoption by
stock corporations organized in the state.7 Although lawyers and other commentators had
predicted a trend of mandatory arbitration charter provisions and bylaws (Allen 2015),
this same legislation curtailed their use by prohibiting Delaware stock corporations from
adopting mandatory arbitration provisions in their organizational documents.8 Though it
imposed these limits, the legislation left untouched corporations organized elsewhere, as
well as all other forms of business organization and types of dispute resolution provisions.
These three types of clauses—choice of court, feeshifting, and mandatory arbitration—
have received the most attention, but the range of possible dispute resolution clauses is
quite broad, as suggested by the analogy to commercial contracting. One example is the
requirement adopted by several companies that restricts representative shareholder suits
to owners of a minimum percentage of shares.9 These provisions mimic the restrictions
in place in some US state statutes.10 A study of LLC operating agreements suggests that
a variety of dispute resolution provisions has already been imported into noncorporate
business forms, including jury waivers, service of process provisions, and various feeshift-
ing provisions, as well as clauses selecting the forum for disputes (Molk & Winship 2016).
2.2 Default Jurisdiction in US Intracorporate and Securities Litigation
As reflected in the brief history just provided, companies were motivated to experi-
ment with dispute resolution provisions in part because of the ubiquity (and financial
significance) of private shareholder litigation in the US. Generally applicable procedural
rules contribute to the extensive use of private litigation to enforce shareholders’ rights.
For example, contingency fees are permissible; each party must bear its own legal costs
under the “American rule” for fees; and information may be obtained through discovery
(Warren III 2013).11
Companies were also motivated to opt out of the background procedural rules that
5
ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014). Although ATP Tour
involved a nonstock corporation, the concern was that its reasoning would apply to stock corpora-
tions as well.
6
The clause required plaintiffs to cover fees if the claimant “does not obtain a judgment on
the merits that substantially achieves, in substance and amount, the full remedy sought.” Deutscher
Tennis Bund v. ATP Tour Inc., 480 F. App’x 124, 126 (3d Cir. 2012) (quoting Article 23 of the
Amended and Restated Bylaws of ATP Tour, Inc.). This clause would trigger feeshifting in most
shareholder litigation because the outcome is often settlement, and the full remedy requested is
rarely (possibly never) obtained.
7
See Del. Code Ann. tit. 8, §§ 102(f), 109(b) (2015).
8
Del. Code Ann. tit. 8, § 115 (prohibiting clauses that excluded Delaware courts in favor of
another forum, including an arbitral forum).
9
See, e.g., Hemispherx Biopharma, Inc., Current Report (Form 8-K), Item 5.03 (July 10,
2014), at 3 (including a bylaw that required plaintiff shareholders to post a “surety for the reason-
able expenses” if they held less than 5 percent of the company’s common stock).
10
See, e.g., N.Y. Bus. Corp. Law § 627 (McKinney 2003).
11
These apply regardless of whether the suit takes the form of a derivative suit or a shareholder
class action.
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determined where a suit would take place. In the absence of private agreement, the same
group of litigants may sue the same defendant(s) for the same violation in several jurisdic-
tions’ courts. In many circumstances, no mechanism exists to consolidate this litigation in
a single forum. The default rule is that multiple courts are available for the adjudication of
a corporate claim, whether for corporate governance (or “intracorporate”) claims or for
securities claims. Generally applicable jurisdictional rules allow suit where the defendant
has constitutionally sufficient contacts.12 For corporations, this ordinarily includes at least
the state where the legal entity is organized and the principal place of business (usually
the headquarters).
Corporate governance and securities suits have different default rules, but both offer
multiple potential locations for plaintiffs to file a lawsuit. Unlike the rules governing
voidance or nullification suits in Europe, no rule limits corporate governance suits to the
company seat or place of organization.13 Moreover, where the suit may be brought does
not depend on how the claim is characterized. In particular, it does not matter whether
the claim is characterized as contractual or tortious—a distinction that is sometimes
important in non-US litigation. Securities litigation may also be brought in several loca-
tions, although some of the most widespread securities fraud claims are limited to federal
rather than state courts.14
Not only may suits be brought in multiple alternative locations, but in some circum-
stances, they may be brought simultaneously in different courts. This issue is particularly
acute for representative suits brought in state court, such as the multiforum deal litigation
that triggered the debate over private ordering. No mechanism exists for state to state
consolidation of litigation. Although a constitutional provision (the Full Faith and Credit
clause) requires US states to respect the judgments of other states, no transfer system
exists among state courts. States instead rely on forum non conveniens, notions of comity,
and judicial application of such guiding principles as “first in time” to figure out which
litigation should go forward (Winship 2012). Choice of court provisions emerged to
address this lack of consolidation. In this sense, the use of choice of court clauses—which
opened the door to other dispute resolution charter and bylaw provisions—derives from
aspects of US federalism.
Finally, within that federal system, different states may have their own procedural rules.
Dispute resolution provisions also emerged in part because of entrepreneurial states
willing to accept new clauses. Delaware was one of these entrepreneurs—before exclusive
forum provisions became more widespread, the Delaware Chancery Court invited them,
suggesting that corporations that favored a particular forum were “free to respond with
charter provisions selecting an exclusive forum for intra-entity disputes.”15
12
U.S. Const. amends. V, XIV; Int’l Shoe Co. v. Washington, 326 U.S. 310 (1945).
13
The internal affairs doctrine once had this function, but evolved into a choice-of-law rule
only.
14
15 U.S.C. § 78aa(b) (2012) (providing that 1934 Securities Exchange Act claims must be
brought in federal rather than state court).
15
In re Revlon Inc. S’holders’ Litig., 990 A.2d 940 (Del. Ch. 2010); see also Boilermakers, 73
A.3d at 953 (noting that the fact that “a board’s action might involve a new use of plain statutory
authority does not make it invalid” and that “the boards of Delaware corporations have the flex-
ibility to respond to changing dynamics in ways that are authorized by our statutory law”).
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2.3 The US Approach to Private Ordering of Shareholder Litigation
Several key features of US corporate and contract law determine parties’ ability to alter
the background rules about where and how shareholder litigation takes place. These
include the subnational regulation of corporate governance and its relationship to federal
securities regulation, the prevalence of default rules in US corporate law, and the more
general legal enforceability of adhesion contracts.
First, the content of corporate charters and bylaws is predominantly governed at
the subnational, US state level. The law of the US differentiates between securities law,
which is promulgated centrally at the federal level, and corporate governance, which is
traditionally subnational and decentralized, with the applicable law generally determined
by the state of incorporation. This bifurcation has consequences for private ordering of
shareholder litigation in charters and bylaws. State corporate codes dictate required provi-
sions, explicitly allow other clauses, and then often give corporations broad permission
to adopt other provisions that are not contrary to state or federal law. Challenges to these
provisions are governed by state law and often arise before state courts.
Federal regulators’ policing of these corporate organizational documents is quite
limited. For example, the US Securities and Exchange Commission (SEC) has on a
few occasions refused to approve or accelerate registration statements that included a
mandatory arbitration clause in the corporate charter (Weiss et al 2012). The SEC also
oversees shareholders’ ability to amend bylaws, including dispute resolution bylaws,
through its policing of proxy statements. In 2012, for instance, a shareholder wanted to
include a proposal to repeal a board-adopted exclusive forum bylaw in the company’s
proxy statement.16 The SEC sided with the shareholder, rejecting the company’s attempt
to exclude this proposal.17
The bifurcation between state corporate governance and federal securities laws has
consequences for the permissible scope of dispute resolution provisions. The most
defensible case for including dispute resolution provisions in corporate charters and
bylaws is when they cover corporate governance disputes with claims based in US state
corporate law (Winship 2015). It is not clear, however, whether corporate organizational
documents can modify shareholder litigation beyond that core category. In particular,
there has been no resolution of whether they can modify disputes involving prospectus
liability, accounting fraud, or material misstatements or omissions (securities litigation).18
Existing clauses suggest that corporate defendants have an appetite for limiting this type
of shareholder suit, in part because of its economic significance. Some existing feeshifting
clauses were drafted to reach claims under the US federal securities laws; indeed, to reach
all shareholder claims against the company.19
Some limitations on whether charters and bylaws can govern federal securities law suits
are straightforward. Certain securities claims must be brought in federal rather than state
16
See Roper Indust., Inc., SEC No-Action Letter, 2012 WL 417665, at 2 (Mar. 29, 2012).
17
Ibid (refusing to issue a “no-action” letter).
18
See section 3.2 infra for a discussion of this category in the EU context.
19
See, e.g., Alibaba Grp. Holding Ltd., Amendment No 6 to Registration Statement (Form
F-1), Exhibit 3.2: Amended and Restated Memorandum and Articles of Association § 173 (Sept. 5,
2014), www.sec.gov/Archives/edgar/data/1577552/000119312514333674/d709111dex32.htm.
M4633-GRIFFITH_t.indd 443 30/10/2018 08:16

court, limiting the reach of choice of court clauses, which cannot divest US federal courts
of this exclusive jurisdiction.20 Moreover, an argument that charters and bylaws can alter
the rules of securities litigation must contend with the explicit nonwaiver provision in
the securities laws.21 At some point, the absence of any way to enforce a right may be
equivalent to a waiver of that right. However, the extent to which US courts will limit the
scope of dispute resolution provisions in corporate charters and bylaws remains an open
question.
Up to this point, this section has focused on private ordering through corporate
charters or bylaws, but that is not the only potential locus for provisions governing share-
holder litigation. Although the US debate has been focused on corporate organizational
documents, prospectuses may also include provisions that shape shareholder securities
litigation. This possibility is explored more fully below, with a focus on the EU.22 Some
of the same general questions obtain for both types of agreements: are these provisions
enforceable and, if so, whom do they bind?
The second aspect of US law with implications for the adoption of dispute resolution
bylaws and charter provisions is the prevalence of default rules in corporate governance.
Though the balance between mandatory and default rules in corporate law is debated
(Coffee 1989), US corporate law includes many examples of explicitly default contents
that give management and shareholders the ability to shape the contents of the charter
and bylaws.23 The concern that procedural limits indirectly curtail shareholder rights
may be lessened in a context of default substantive rules, where shareholders are aware
that the organizational documents may tailor many aspects of their relationship to the
corporation.
Finally, a main concern about corporate charters and bylaws is the nature of shareholder
consent to their terms and the degree to which organizational documents can be treated as
contracts (Cox 2015; Hamermesh 2014; Lipton 2016). Consent is not explicit. Management
ordinarily has the power to introduce new bylaws unilaterally and, even where shareholders
vote on a change, the minority is bound by the majority.24 The Delaware courts have treated
shareholders as having consented to bylaws unilaterally adopted by management on the
theory that shareholders have consented to a corporate governance system that permits
such adoption. Although some commentators have argued persuasively against treating
corporate bylaws as analogous to robust commercial contracts between sophisticated and
informed parties (Lipton 2016; Lipton 2018), many types of contracts and contract laws
have abandoned this classical consent model. For better or for worse, the treatment of the
corporate charter and bylaws as contractual, despite the lack of actual express consent
to their terms, should be compared to the US enforcement of adhesion contracts in the
20
15 U.S.C. § 78aa(b) (2012).
21
15 U.S.C. §§ 78cc(a), 77n.
22
See Section 3.2 infra.
23
Both the Delaware corporate code and the Model Business Corporation Act often state
that a provision applies “[u]nless otherwise restricted by the certificate of incorporation” or allow
corporations to opt out of certain provisions. See, e.g., Del. Code Ann. tit. 8, §§ 141(b), (d), (f)–(i),
223(a), 228(a) (2011); Model Bus. Corp. Act §§ 7.28(a), 8.06, 8.24(a), 8.25 (Am. Bar Ass’n 2010).
24
Boilermakers, 73 A.3d at 938–39.
M4633-GRIFFITH_t.indd 444 30/10/2018 08:16

consumer context.25 These too deviate from an idealized notion of consent and are broadly
enforced in the US system. Note that, in contrast to the EU, here the degree of protection
does not turn on whether the investor qualifies as a consumer.
These features of US litigation and corporate law have enabled the adoption of certain
dispute resolution clauses and have left the door open for the use of private ordering to
shape representative shareholder litigation more generally in the US.
3. CONTRACTUAL AGREEMENTS ON SHAREHOLDER

LITIGATION IN THE EU
Just as in the US, the EU legal framework for contractual agreements on shareholder
litigation inevitably reflects both the typical setting for corporate disputes and the inter-
state coordination systems concerning jurisdiction. However, the EU displays remarkable
differences from the US on both elements. As for corporate disputes, derivative suits and
securities class actions are less common in Europe than in the US. While other forms of
collective and individual actions work as a partial substitute, the drawbacks of excessive
representative litigations are less of a concern. As for the binding authority of foreign
judicial decisions, the EU is competent to adopt measures aimed at ensuring the mutual
recognition and enforcement of judicial and non-judicial decisions in the Union, and to
harmonize Member States’ rules on conflicts of jurisdictions (as per Articles 67(4) and
81(2)(a) and (c) of the Treaty on the Functioning of the European Union).
This section analyses the impact of the EU legal framework on the possibility of
adopting customized rules of procedure for litigation involving investors and their
companies (or one of their internal bodies). A straightforward way to determine the
applicable procedure is of course forum choice, but other techniques are also available to
tailor procedural rules to issuers’ and investors’ needs, including arbitration agreements.
Furthermore, forum choices and arbitration agreements can address either intracorporate
disputes or other forms of securities litigation, a distinction that is particularly relevant
in the EU context. This section will consider jurisdiction agreements, addressing first
intracorporate disputes, including derivative suits (§ 3.1), and then securities litigation
(§ 3.2). The analysis will then move on to arbitration in both intracorporate and securities
litigation, with some reference to other forms of contract procedure (§ 3.3).
3.1 Default Jurisdiction and Forum Choice Agreements in Intracorporate Litigation and

Derivative Suits
Derivative suits are notoriously less common in the EU than in the US. Legal scholars
explain these differences with a combination of factors, although not all of the differences
seem to play an equivalent role (Gelter 2012). Among the reasons why derivative actions
25
See ibid at 957–58 (comparing favorably the rights of stockholders subject to bylaws to those
of consumers subject to adhesion contracts and noting that “[u]nlike cruise ship passengers, who
have no mechanism by which to change their tickets’ terms and conditions, stockholders retain the
right to modify the corporation’s bylaws”).
M4633-GRIFFITH_t.indd 445 30/10/2018 08:16

are more costly in Europe is the “loser pays” rule, together with bans on contingency fees,
the lack of a discovery system, and share ownership requirements. Consequently, the bulk
of litigation between shareholders and their investee companies is triggered by claims
that typically challenge the validity of corporate bodies’ decisions. Requests for redress
typically accompany such voidance (or nullification) suits. National—and, increasingly,
EU26—company law provisions mandating a shareholder vote on a number of corporate
decisions can only add to this trend.
This litigation practice enjoys—unlike derivative suits—an ad hoc legal framework on
jurisdiction and jurisdiction agreements. Disputes concerning the validity of delibera-
tions adopted by internal bodies of a company are, in the EU,27 subject to the exclusive
jurisdiction of the country where that company has its seat (Article 24 No 2 Reg. (EU)
No 1215/2012 – Brussels Ia).28 This rule has two main implications.29
The first implication is that jurisdiction over intracorporate disputes is concentrated
in one, and only one, EU member state, to be identified according to the private
international law rules of the lex fori. Although Article 24 No 2 raises some complex
jurisdictional issues (Lehmann 2015), the risk that different judges will take conflicting
decisions because of divergent rules of private international law seems negligible.30 The
second implication of the rule on exclusive jurisdiction is that choice of court agreements
cannot move jurisdiction to a state other than that where the company has its seat (Article
25(4) Brussels Ia).
The ECJ has limited the scope of Article 24 No 2 to litigation that directly concerns the
validity of corporate decisions, while disputes where those decisions only have an indirect
relevance fall outside exclusive jurisdiction. This is the case, for instance, where the
26
EU provisions on mandatory shareholder voting date back to the origin of EU company law,
see, e.g., Art. 25 Directive 77/91/EEC (now Art. 29 Directive 2012/30/EU, mandating shareholder
approval for increases in capital). More recently, see § 4 Recommendation 2004/913/EC, and § 6
Recommendation 2009/385/EC (on say on pay, applicable to listed companies). See also the new
directive on shareholder rights, which introduces, for listed companies, a mandatory vote on the
directors’ remuneration policy and on the remuneration report (Arts 9a and 9b of the text adopted
by the EU Parliament on 14 March 2017).
27
Whether the claimant is looking for nullity of the decision, for redress of the ensuing dam-
ages, or for both. This also includes actions challenging general meeting resolutions that determine
the price offered as consideration for shares in the context of squeeze-outs (see ECJ, C-560/16,
E.ON vs Dědouch, 7 March 2018; the dispute did not involve Art. 15 Directive 2004/25/EC on
takeover bids, which does not mandate a general meeting resolution).
28
The same connecting factor and the same limitations to choice-of-court agreements apply to
disputes concerning the validity of the company.
29
While Article 24 no 2 Brussels Ia does not address how each Member State should allocate
jurisdiction among its courts, national procedural rules normally refer to the company’s seat as
well, because this helps reduce the risk of multiple suits within a single State.
30
For companies incorporated in countries adopting the real seat doctrine, registered office
and central administration will both be in that country. When the legal seat (or incorpora-
tion) doctrine applies, the registered office will determine the applicable private international
law also in the country where the company has its central administration (see ECJ Case
C-208/00, Überseering BV v. Nordic Constr. Co. Baumanagement GmbH, E.C.R. I-9919
(5 Nov. 2002)).
M4633-GRIFFITH_t.indd 446 30/10/2018 08:16

plaintiff challenges the validity of a contract by alleging the voidability of the deliberation
that authorized a director to enter that contract.31
For matters outside exclusive jurisdiction, the general principle will apply that jurisdic-
tion is established in the state where the defendant has its domicile (Article 4 Brussels Ia),
unless other special rules state otherwise on the basis of the specific disputed matter. This
general principle enables some concentration of litigation within the company’s state, as
in intracorporate (as well as in securities) litigation the company is very likely to play, with
some limited exceptions,32 the role of the defendant. However, for the purposes of Article
4 a company can alternatively be sued in the country where it has either its registered
office, or its central administration, or its principal place of business (Article 63 Brussels
Ia), so that some residual room for plaintiff’s freedom of choice partially undermines the
unifying role of the defendant’s domicile. While for most issuers these three connecting
factors will be located in the same country, companies located in countries that apply
the incorporation doctrine might split the legal and the real seat between two different
countries.33 This will ultimately give claimants the opportunity to select the applicable
procedural rules among the available alternatives,34 but the decision whether to allow
such an optional choice (and that on the available choices) will lie with managers and,
ultimately, with shareholders (as a consequence of the decision to separate the legal and
the administrative seats).
In any event, the general principle that the defendant’s domicile is the relevant connecting
factor applies in a limited set of cases, because other bases of jurisdiction normally apply to
intracorporate disputes and derivative suits. For instance, investors will often invoke issuers’
tortious liability because this gives the claimant the opportunity to bring the action before
the courts “where the harmful event occurred” (Article 7 No 2 Brussels Ia). For establish-
ing jurisdiction, this can be the place where either the wrongful conduct (Handlungsort)
or the damage itself (Erfolgsort) has occurred, at the plaintiff’s choice.35 The ECJ has
conveniently curtailed the possibility that jurisdiction be established in places where only
indirect damages are suffered (Schadensort), such as the domicile of the claimant.36 By
and large, investors can normally rely on the place of the securities account,37 where the
31
See ECJ Case C-144/10, Berliner Verkehrsbetriebe (BVG) v. J.P. Morgan Chase Bank N.A.,
E.C.R. I-03961 (12 May 2011).
32
Claims concerning consideration for shares not paid in full are a notable exception (see ECJ
Case 34/82, Martin Peters Bauunternehmung GmbH v. Zuid Nederlandse Aannemers Vereniging,
E.C.R. 00987 (22 March 1983); ECJ Case C-214/89, Powell Duffryn Ple v. Wolfgang Petereit,
E.C.R. 1745 (10 March 1992)). See also infra 46.
33
Supra note 29.
34
The court first seized has jurisdiction (Art. 31 Brussels Ia).
35
ECJ Case C-21/76, Handelskwekerij G. J. Bier BV v. Mines de Potasse d’Alsace SA, E.C.R.
I-01735, §§ 17 ff (30 Nov. 1976).
36
ECJ Case C-364/93, Marinari v. Lloyds Bank plc, E.C.R. I-02719 (19 Sept. 1995), C-168/02,
ECJ Case C-168/02, Kronhofer v. Maier, E.C.R. I-6022 (10 June 2004) (excluding that the domicile
can establish jurisdiction on the basis of tortious liability even when the investor’s financial assets
are concentrated there). See also ECJ Case C-220/88, Dumez France v. Hessische Landesbank
(Helaba), E.C.R. I-0049 (11 Jan. 1990).
37
See, e.g., Article 9(2) Dir. 98/26/EC (on settlement finality) and Art. 9(1) Dir. 2002/47/
EC (on financial collaterals). The place of the securities account might be difficult to determine
as securities are usually held in an immobilized or dematerialized form. Normally, such place is
M4633-GRIFFITH_t.indd 447 30/10/2018 08:16

relevant securities are held in book-entry form.38 As we shall see, other connecting factors
may come into play in securities litigation, but for the time being these do not seem to affect
intracorporate disputes.
Besides the place(s) of the harmful event, the place of performance of the issuer’s
obligations—or the directors’, for derivative suits—may also come into play as a substitute
for the defendant’s domicile. This is because, absent a tort cause of action, the claim for
damages is normally deemed to qualify, for the purposes of establishing jurisdiction, as
a contractual violation (tertium non datur (Pfeiffer 2007)).39 This will normally be the
appropriate legal setting for derivative suits, so that jurisdiction for claims alleging breach
of director duties will in principle lie with the courts of the state where the directors carried
out their activities for the most part, as per Article 7 No 1(b), second hyphen, Brussels Ia.40
Intracorporate disputes falling outside the scope of exclusive jurisdiction under Article
24 No 2 can in principle be the object of choice of court agreements. Under Brussels
Ia, these agreements are, however, subject to some stringent limits. For consumers, the
contractual determination of jurisdiction (“prorogation,” in the Brussels Ia parlance)
may deviate from the special protection regime only by way of an agreement entered into
after the dispute has arisen (Article 19). This limitation curbs the capacity of choice of
court agreements to prevent plaintiff from instrumentally filing suits with the sole aim of
slowing down dispute resolution (torpedo actions) (Article 31(4)).41 For other investors,
jurisdiction agreements can predate litigation, but they must be either in writing (or
evidenced in writing, including in electronic form through a durable medium) or in a form
which complies with international trade usages (Article 25(1)(a) and (c)).42 Whether inves-
tors qualify as consumers vis-à-vis issuing companies remains to some extent debated
and interpretations diverge as to what “written form” precisely means for the purpose of
jurisdiction agreements, partially because the requirement is often understood as a legal
device aimed at ensuring an actual and genuine consent of the parties (Hausmann &
Queirolo 2012; Magnus 2012).43
While these questions reduce legal certainty for securities litigation, choice of court
considered to be the place where the first intermediary from the point of view of the investor is
located, a criterion known as Place of the Relevant Intermediary Approach (PRIMA) or, with
some slight variations, Place of the Relevant Account Approach (PRACA) (Haentjens 2007;
Paech 2013).
38
See Kronhofer, ECJ Case C-168/02.
39
See also ECJ Case C-189/87, Kalfelis v Bankhaus Schröder, Münchmeyer, Hengst and Co.,
E.C.R. 05565, § 17 (27 Sept. 1988); ECJ Case C-548/12, Brogsitter v. Fabrication de Montres
Normandes, ECLI:EU:C:2014:148, § 20 (13 March 2014).
40
ECJ Case C-47/14, Holterman Ferho Exploitatie BV v. F.L.F. Spies von Büllesheim,
ECLI:EU:C:2015:574, § 64 (10 Sept. 2015). However, if the directors qualify as employees, their
domiciles will establish jurisdiction, unless their position in the company (for instance because of
their capacity not only as directors but as shareholders, too) enables them to influence the will of
the company’s administrative body (ibid § 47).
41
Torpedo actions are brought before a court lacking jurisdiction with the mere purpose of
preventing other courts from establishing a procedure until the court first seized declines jurisdic-
tion, on the basis of lis pendens rules.
42
Less relevant for this analysis is the possibility for the parties to set, by way of a framework
contract, the form for future jurisdiction agreements (Art. 25(1)(b)).
43
ECJ Case C-150/80, Elefanten Schuh v. Jacqmain, E.C.R. 01671 (24 June 1981).
M4633-GRIFFITH_t.indd 448 30/10/2018 08:16

agreements addressing intracorporate shareholder litigation seem to enjoy a relatively

safer legal environment. First, scholars reject the argument that shareholders qualify
as consumers, due to the unique features of a company’s membership (Mülbert 2005;
Hausmann & Queirolo 2012)—and some nonbinding precedents seem to confirm this
opinion.44 Consequently, the protective regime laid down in Article 19 for consumers
does not apply. Second, the ECJ qualifies corporate charters and bylaws as contracts,45
and deems the jurisdiction clauses they contain as binding for shareholders.46 This
interpretation relies on the consideration that, by becoming shareholders, investors agree
to be subject to corporate charters and bylaws (and to the decisions lawfully adopted by
the organs of the company), even when no such consent covers each provision in such
charters and bylaws (or some of the organs’ decisions).
Besides setting clauses that are openly framed as jurisdiction agreements, corporate
charters and bylaws may also determine jurisdiction on derivative suits by specifying the
place of performance of directors’ duties, as this will attract jurisdiction irrespective of
the place where directors actually carried out those duties.47
3.2 Default Jurisdiction and Forum Choice Agreements in Securities Litigation
Securities litigation suits typically invoke issuer liability for dissemination of misleading
information. This can either take the form of prospectus liability—also on the basis of the
violation of precontractual duties of care and information—or of liability for accounting
fraud or for misstatements in the publication of inside information (or the lack thereof).
Less often, claimants also invoke a breach of the securities’ terms and conditions, either to
enforce such terms and conditions or to seek annulment of the contract and restitution of
the sums paid.48
Prospectus liability and other forms of liability for false or misleading information
qualify as tortious for the purpose of jurisdiction (Lehmann 2016), so that the power to
adjudicate lies with the courts of the states where the harmful event occurred. As shown
in § 3.1, this means either the place of the event giving rise to damage or, at the plaintiff’s
choice, the place where the damage occurred. The ECJ is somehow still struggling to
44
ECJ Case C‑366/13, Profit Investment SIM SpA v. Stefano Ossi, Advocate General’s
Opinion, ECLI:EU:C:2015:274, § 48 (23 April 2015).
45
Martin Peters, ECJ Case 34/82, § 13; Powell Duffryn, EJC Case C-214/89, §§ 16 and 19. In
Martin, the Court qualified as contractual the shareholders’ obligation toward the company for
contributions still due (Gaudemet-Tallon 2010), but the reasoning is however extended by some
scholars to the reciprocal positions of the company toward its shareholders (Mankowski 2012).
In Powell Duffryn, EJC Case C-214/89, the Court stated that a clause inserted in the company’s
statutes that confers jurisdiction also binds those who became shareholders after the clause was
adopted, as the mere fact of becoming a member showed an agreement to be subject to all the
provisions in the statutes.
46
Powell Duffryn, EJC Case C-214/89, § 17 ff.
47
Holterman, ECJ Case C-47/14, § 60. However, when the directors qualify as employees and
they have no power to influence the decisions of the company’s board, jurisdiction is established in
the State where they have their domiciles (Art. 22 Brussels Ia).
48
This chapter does not address disputes between investors and intermediaries (such as bank
and investment firms including brokers and dealers) for violation of conduct of business rules or
of fiduciary and fiduciary-style duties.
M4633-GRIFFITH_t.indd 449 30/10/2018 08:16

identify the place where the damage occurred in securities litigation. Besides the place of
the securities account, the place of the bank account where the money spent to buy such
securities came from also have some relevance in establishing jurisdiction for disputes
concerning false prospectuses, but only if other factors also point in the same direction.49
More recently, the place where the investor entered into a legally binding obligation to
invest has also been considered in pending case law concerning prospectus liability.50
All in all, issuers face the risk of being sued for a fraud on the secondary market in
any EU country, irrespective of whether they addressed investors by publishing a listing
or an offering prospectus in that country,51 and even when issuers explicitly excluded
investors residing in that country from their original offer (Article 6(3) Regulation
(EU) 2016/301).52 On the flipside of the coin, litigation costs for investors are reduced,
ceteris paribus, although increased issuer litigation costs may partially offset the benefits
investors have as potential disputants. While this is hardly a zero-sum game because
of different investor preferences and because the efficiency of courts across the EU
is far from homogeneous, it is very difficult to tell in advance whether leaning on the
side of facilitating investor litigation is the most efficient solution in all circumstances
(Gargantini 2016).53
When securities are offered without a prospectus and do not trade on any regulated
markets,54 plaintiffs are likely to invoke a breach of the securities terms and conditions
or to ask for the voidance of the purchase contract. These actions are likely to qualify
as contractual,55 so that jurisdiction is established in the place of performance of the
obligation (Article 7 No 1(a)). To what extent this links jurisdiction to the issuer’s domicile
for securities litigation remains uncertain, absent clear precedents in ECJ case law clarify-
ing how to locate the place of performance of the obligations underlying a financial
instrument.
As a consequence of the doubts concerning the place of performance of a financial
obligation and of the risk of multiforum litigation for liability based on misleading
information, jurisdiction agreements play a crucial role in ensuring legal certainty and
in shaping the balance between issuer and investor litigation costs. However, the EU
49
Compare ECJ Case C-375/13, Kolassa v Barclays Bank plc, ECLI:EU:C:2015:37, § 55
(28 Jan. 2015) with ECJ Case C-12/15, Universal Music Int’l Holding BV v. Michael Tétreault
Schilling, ECLI:EU:C:2016:449, §§ 36–37 (16 June 2016).
50
See Advocate General Opinion in Löber, ECJ Case C-304/17.
51
This makes the inquiry on whether investors qualify as consumers more trivial in this respect
(securities holders that qualify as consumers may sue the issuer in the country where they have their
domiciles, provided that the issuer directed its activity in the State of the consumer’s domicile, see
Art. 17 Brussels Ia).
52
The EU framework for offering and listing prospectuses enables issuers and offerors to
passport their prospectuses in the countries where they are requiring admission to listing or where
they are seeking to offer securities (see Arts 17 and 18 Directive 2003/71/EC). Passporting requires
a mere administrative communication from the securities supervisor competent in the issuer or the
offeror home country to that operating in the country of destination.
53
For further reflections see M. Gargantini, Capital Markets and the Market for Judicial
Decisions: In Search of Consistency, MPI Luxembourg WP Series 1, January 2016, www.mpi.lu.
54
For instance, no duty to publish a prospectus exists for offerings addressed to professional
investors alone (Art. 3(2)(a) Directive 2003/71/EC).
55
Profit SIM, ECJ Case C‑366/13, § 56.
M4633-GRIFFITH_t.indd 450 30/10/2018 08:16

regulatory framework for jurisdiction agreements in securities litigation leaves room for
uncertainty, too.
These concerns are particularly acute for bondholders, whose experience provides
a useful comparison to shareholders and shareholder litigation, in part because it
illustrates the complexities of a legal framework where the enforceability of jurisdic-
tion agreements remains uncertain. While shareholders involved in securities litiga-
tion are not consumers and are bound by jurisdiction agreements that are part of
corporate charters and bylaws just as in intracorporate disputes (see § 3.1), individual
bondholders often invoke a consumer capacity—incidentally acknowledged by the
ECJ56—because this attracts jurisdiction to their domiciles (Articles 17 and 18 Brussels
Ia).57 A bondholder’s qualification as consumer also prevents jurisdiction agreements
from binding some bondholders, unless such agreements are entered into after the
dispute has arisen.
For bondholders that do not qualify as consumers, jurisdiction clauses within securities
terms and conditions are binding to the extent that they meet the formal requirements of
a written agreement (or of an agreement evidenced in writing), a proxy for the genuine
investor consent.58 To this end, the ECJ case law distinguishes between primary and
secondary market transactions. As for primary market transactions, a jurisdictional
clause written in a prospectus is binding if the contract between the issuer (or the offeror)
and the underwriter (or the original buyer) “expressly mentions the acceptance of that
clause or contains an express reference to that prospectus.”59 As for the secondary market,
such a clause is binding for subsequent buyers only if all the three following conditions
are met: (1) the clause was valid between the issuer and its counterparty on the primary
market (underwriter or first buyer); (2) the subsequent buyers succeeded to the primary
market counterparty’s position under the applicable law, thereby acquiring the rights and
obligations of that party; (3) the subsequent buyers had “the opportunity to acquaint”
themselves with the prospectus containing the jurisdiction clause, “which implies that the
prospectus is readily accessible.”60
A thorough analysis of this dictum would be out of the scope of this chapter. Suffice
it to say that each of the requirements for the validity of jurisdiction agreements on the
secondary markets raises some complex questions. Condition (1) increases legal risk, as
one does not see why bondholders’ rights and obligations should depend on the validity
56
See Kolassa, ECJ Case, C-375/13, §§ 23–24.
57
Clauses limiting the effect of jurisdiction agreements to professional investors are wide-
spread in bond prospectuses. See e.g. for Germany Commerzbank, Base Prospectus Relating to
Italian Certificates (filed with BaFin) (23 July 2014) 230 (Frankfurt am Main court has exclusive
jurisdiction, but only for professionals and public law entities); for Italy Banca IMI, Prospetto di
Base Relativo al Programma di Offerta e/o Quotazione di Obbligazioni (filed with Consob) (2 April
2015) 67 f (Milan court has exclusive jurisdiction, but consumer’s domicile prevails); Unicredit,
Prospetto di Base 2015-2016 Relativo al Programma di Offerta e/o Quotazione di Prestiti
Obbligazionari, (filed with Consob) (10 July 2014) 46 f (same).
58
The written form is not necessary, though, to the extent that the clause is in a form that
accords with an international trade usage the parties should be aware of, which is for national
courts to determine (Art. 25(1)(c) Brussels Ia).
59
Profit SIM, ECJ Case C‑366/13, § 29.
60
Ibid §§ 36–37.
M4633-GRIFFITH_t.indd 451 30/10/2018 08:16

of a clause they are not able to ascertain (Gargantini 2016).61 As for (2), the ECJ position
has the merit of getting rid of previous interpretations that excluded enforceability of
choice of courts clauses on the secondary market.62 However, referring to national laws
in order to ascertain whether the initial bondholders’ rights and obligations pass on to
subsequent buyers may be problematic.63 Finally, in the light of condition (3), issuers are
better advised to maintain their prospectuses published on their websites until the relevant
securities come to maturity, even in the absence of such an obligation (Article 14 Directive
2003/71/EC).
3.3 Arbitration and Contract Procedure in Intracorporate and Securities Litigation
Arbitration is not subject to any specific EU legal framework, and this leads to some
uncertainties that affect the possibility of using national and foreign arbitral awards to
devise a private ordering of shareholder litigation. Brussels Ia Regulation does not always
provide clear guidance in this respect, either, because it sometimes falls short of clarifying
the interaction between arbitration and jurisdiction of national courts; for instance, as
regards the recognition and enforcement of courts’ decisions barring a party of an arbitral
agreement from initiating or continuing litigation before courts of another Member State
(antisuit injunction).
At the national level, Member States retain the power to determine the features of
arbitration, although the EU law sets some limitations in specific areas (such as consumer
protection). This freedom includes the possibility of establishing whether courts can
ascertain the jurisdiction of arbitral tribunals (negative effects of the competence-
competence principle) and whether corporate and securities litigation can be the object
of an arbitration clause.
National rules and case law diverge on the arbitrability of disputes involving corporate
and securities law. Some countries have no special provisions on corporate and security
arbitration, while others have adopted a rather detailed framework, although these dif-
ferences do not necessarily correspond to different levels of legal certainty. Germany and
Italy provide good examples.
In Germany, absent an ad hoc legal framework, the general rule applies that all claims
involving an economic interest are arbitrable (§ 1030(1) Zivilprozessordnung—ZPO).
61
Nothing prevents issuers from establishing jurisdiction in a country other than that where
they are based, for instance to take advantage of a more efficient adjudication system that is more
able to ensure swift and effective enforcement of securities terms and conditions (which is reflected
in the securities price).
62
See Advocate General Opinion in Profit SIM, ECJ Case C‑366/13. For a critique, see
M. Gargantini, Jurisdictional Issues in the Circulation and Holding of (Intermediated) Securities:
The Advocate General’s Opinion in Kolassa v. Barclays, 50 Riv. Dir. Int. Priv. Proc. 1095 (2014)
(Gargantini 2014).
63
In some jurisdictions, rights on securities arise when such securities are registered on the
purchaser’s account rather than derived from the previous owner; even in the same jurisdiction,
whether the one or the other form of transfer applies may depend on the circumstances (European
Commission, EU Clearing and Settlement. Legal Certainty Group—Questionnaire. Horizontal
answers, Brussels, 2006, 165–71). There is no evident reason, however, not to enforce jurisdiction
agreements against new bondholders whichever is the case.
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However, some limitations to the general principle of arbitrability apply. From the point
of view of derivative suits, the general ban on arbitrations for employment matters is of
little concern, because the limitation does not apply to board members and key manag-
ers, irrespective of whether they are also bound by an employment contract (§§ 101(3)
and 5(1) Arbeitsgerichtsgesetz—ArbGG). Substantial constraints to arbitrability rather
come from public policy limitations, which may sit uneasily with the possibility that the
arbitral award be binding for nonparticipating parties such as other shareholders.64 The
Federal Supreme Court has acknowledged that disputes over shareholder resolutions
are arbitrable, if the statutes set forth some procedural requirements aimed at ensuring
open participation in favour of all shareholders.65 However, this decision has a clear prec-
edential value only for limited liability companies (GmbH), while public policy reasons
may prevail over the freedom to defer dispute to arbitrators for other legal entities (Roth
2015). As a consequence, arbitration is normally excluded for listed joint-stock companies
(AG), while the framework for closely held joint-stock companies remains uncertain. It
is unclear, in fact, whether an arbitration clause would infringe the general rule that AG
corporate charters may deviate from the law on joint-stock companies only when this is
expressly allowed (§ 23(5) Aktiengesetz—AktG).66
Under Italian law a specific regulatory framework instead exists for corporate arbitra-
tion. All disputes concerning disposable rights stemming from the corporate contract
and arising between a company and its shareholders—or among shareholders—may be
deferred to arbitration, including derivative suits (Article 34 legislative decree No 5/2003).
Ad hoc procedural rules ensure adequate dissemination of information concerning pend-
ing claims, and explicitly allow shareholder and third party intervention. Arbitrability
does not apply, however, to listed companies, so that disputes must be deferred to courts
in this case. Similarly, the requirement that rights subject to arbitration shall be disposable
prevents arbitration for claims concerning consideration for shares not paid in full,67 as
opposed to what happens in Germany, where such disputes are arbitrable.68
On top of national limitations, the EU consumer protection regime restricts arbitrabil-
ity as it establishes a (rebuttable) presumption of unfairness for predefined clauses hinder-
ing consumers’ right to take legal action, particularly when these provide for mandatory
arbitration outside legal provisions (Article 3 and Annex 1(q) Directive 93/13/EEC).
When the presumption is not rebutted, arbitral clauses in bond terms and conditions do
not bind consumers (Article 6). This hinders the effects of arbitral clauses for securities
litigation involving individual bondholders.69
The EU consumer protection regime also curbs other deviations from standard
64
This is for instance the reason why the Dutch Supreme Court has held that claims for void-
ance of shareholder decisions cannot be decided by an arbitrator (Hoge Raad (HR), Groenselect,
NJ 2007, 561) (10 November 2006).
65
German Federal Supreme Court (BGH), II ZR 255/08 (6 April 2009), or a set of model
clauses see Deutsche Institution für Schiedsgerichtsbarkeit (DIS), Supplementary Rules for
Corporate Law Disputes (2009), www.dis-arb.de (DIS 2009).
66
DIS Supplementary Rules, supra note 65, comment to the Introduction (DIS 2009).
67
See supra note 44.
68
Federal Court of Justice (BGH), Judgment of 19 July 2004 (Neue Zeitschrift für
Gesellschaftsrecht—NZG, 2004, 905).
69
See supra note 56.
M4633-GRIFFITH_t.indd 453 30/10/2018 08:16

procedural law besides arbitration. The rebuttable presumption of unfairness includes

contractual provisions restricting the evidence available to consumers or reversing the
default burden of proof to their detriment (Article 3 and Annex 1(q) Directive 93/13/
EEC). Moreover, national laws of the EU Member States may provide for additional limi-
tations to consensual procedural rules. Most, if not all, of the procedural systems in EU
member states explicitly allow agreements on specific matters, including in a tacit form
when some legal consequences are attached to litigants’ inactivity. However, the extent to
which special agreements can opt out of the default procedure remains uncertain, and
answers are not uniform even in the same country (Fabbi 2015).
Member States’ power to set the conditions for making recourse to arbitrators also
influences the possibility of resorting to foreign arbitral awards with a view to tailoring
procedural rules. Absent an EU framework addressing the crossborder validity of arbitral
awards, the 1958 New York Arbitration Convention regulates recognition and enforce-
ment of foreign arbitral awards by EU Member States in their capacity as contracting
States of the Convention.70 This ensures that arbitral awards have effect in Member States
other than that of the arbitration seat, but only as far as the Convention mandates recog-
nition and enforcement. Among the grounds for refusing recognition and enforcement,
the Convention includes matters that are “not capable of settlement by arbitration under
the law” of the country where recognition and enforcement are sought (Article V(2)(a)).
Similarly, the contracting states may refuse recognition and enforcement when “the award
would be contrary to the public policy” of the same country (Article V(2)(b)).
4. IMPLICATIONS AND CONCLUSION
The general context for representative litigation drives both the availability and the
appetite for private ordering restrictions on shareholder litigation. Unsurprisingly, for
instance, interest in adopting exclusive forum clauses increases when issuers could be sued
in any EU member state or when shareholders can pursue parallel actions for the same
conduct in multiple US states.
Apart from the conditions that promote adoption of dispute resolution provisions,
three aspects of this chapter’s comparison are particularly noteworthy. First, in both the
US and the EU, the availability of private ordering depends on the type of disputed claim
(Gelter 2018). This chapter’s analysis reflects the division between intracorporate (or
corporate governance) claims and securities claims such as prospectus fraud or material
omissions or misstatements. Both of these categories are identifiable in both the EU and
US systems.
In the US, the most defensible reach of dispute resolution charter and bylaw provisions
is to the category of state law corporate governance claims, with breach of fiduciary duty
a typical claim. In contrast, the availability of choice of court clauses in the EU depends in
part on whether the shareholder suit directly concerns the validity of corporate decisions.
Within that context, private ordering is quite limited. Other types of intracorporate claims
70
Convention on the Recognition and Enforcement of Foreign Arbitral Awards, done at New
York on June 10, 1958. See Recital 12 and Art. 73(2) Regulation Brussels Ia.
M4633-GRIFFITH_t.indd 454 30/10/2018 08:16

by investors can, in theory, be subject to private ordering. The availability is limited,

however, by other noteworthy aspects of this comparison: the importance of determin-
ing whether the investor qualifies as a consumer under EU law and possible limitations
to the circulation of jurisdiction clauses along with securities. These aspects trigger
limitations that may prevent the enforcement of jurisdictional agreements or arbitration
clauses altogether or as to specific litigants, and may curtail other deviations from default
procedural law.
A third implication of this comparison concerns the divide between shareholders and
investors more generally. Whereas the US debate has focused primarily on the corporate
organizational documents, the examples of the bond prospectus and private ordering of
securities regulation in the EU highlight an important additional locus of private ordering
of shareholder and other investor litigation. Taken together, they may push courts and
parties to distinguish between the rights of shareholders as part of the corporate body,
and those as an investor.
BIBLIOGRAPHY
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751 (2015), 751–818.
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Brussels (2014), 13-5.
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(2015), 257–92.
Fabbi, A., New “Sources” of Civil Procedure Law: First Notes for a Study, in L. Cadiet, B. Hess, M. Requejo
Isidro (eds), Procedural Science at the Crossroads of Different Generations, Nomos, Baden-Baden, 2015, 73.
Gargantini, M., Jurisdictional Issues in the Circulation and Holding of (Intermediated) Securities: The Advocate
General’s Opinion in Kolassa v. Barclays, 50 Rivista di diritto internazionale privato e processuale 1095
(2014), 1095–1108.
Gargantini, M., Capital Markets and the Market for Judicial Decisions: In Search of Consistency, MPI
Luxembourg WP Series 1, January 2016, www.mpi.lu.
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Shareholder Litigation (2018), Sean Griffith et al., eds.
Gelter, M., Why Do Shareholder Derivative Suits Remain Rare in Continental Europe? 37 Brooklyn Journal
of International Law (2012), 843–92.
Griffith, S. & Rickey, A, Who Collects the Deal Tax, Where, and What Delaware Can Do About It, Research
Handbook on Representative Shareholder Litigation (2018), Sean Griffith, et al., eds.
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Hamermesh, L.A., Consent in Corporate Law, 70 Business Law 161 (2014), 161–74.
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Verlag, Munich (2012), 480–1.
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Oxford (2015), 268–9.
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Kolassa Ruling (Case C-375/13), 12 Journal of Private International Law 318 (2016), 318–43.
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Representative Shareholder Litigation (2018), Sean Griffith, et al., eds.
Lipton, A.M., Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws,
104 Georgetown Law Journal 583 (2016), 584–641.
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Mankowski, P., Art. 5, in U. Magnus & P. Mankowski, Brussels I Regulation, Sellier, Munich (2012), 133.
Molk, P. & Winship, V., LLCs and the Private Ordering of Dispute Resolution, 41 Journal of Corporation
Law 795 (2016), 796–815.
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(2005), 332–4.
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M4633-GRIFFITH_t.indd 456 30/10/2018 08:16

APPENDIX: SUMMARY CHARTS
M4633-GRIFFITH_t.indd 457
Table 25A.1 Intracorporate/corporate governance claims
Claim Type Default Jurisdictional Rules Contractual Deviation Allowed

Intracorporate/Corporate Governance
US EU US EU
Voidance/Nullification N/A Company seat (Art. 24, No N/A No
(Art. 24, No 2, 2, Brussels Ia)
(Art. 25(4), Brussels Ia)
Brussels Ia)
Tort Location of harmful event Probably
(wrongful conduct or
Choice of court: If permitted,
damage) must be in writing or a
(Art. 7, No 2, Brussels Ia) form that complies with
Contract Place of performance international trade usages
(e.g., claims alleging (Art. 7, No 1(a), Brussels Ia) ((Art. 25(1)(a) & (c), Brussels
breach of directors’ Ia)
duties) If the shareholder qualifies as
Other Ordinarily state of Defendant’s Domicile Mixed a consumer (unlikely), only
Intracorporate Claims organization or corporate
(location of registered
Choice of court charter & agreements entered into
headquarters office; central bylaw provisions generally after the dispute has arisen
(US Const. 5th & 14th Ams administration, or allowed. are allowed
principal place of (e.g., DGCL 115) (Art. 19, Brussels Ia)
& state-level jurisdictional
rules) business) Mandatory arbitration and Arbitration: regulated
(Arts 4 & 63, Brussels Ia)
fee-shifting charter & nationally, with some EU

bylaw provisions may be consumer protection limits
disallowed (e.g., DGCL §§
102(f), 109(b) & 115)
Other dispute resolution
charter and bylaw
provisions may be allowed
30/10/2018 08:16
Table 25A.2 Securities claims
M4633-GRIFFITH_t.indd 458
Claim Type Default Jurisdictional Rules Contractual Deviation Allowed
Securities
US EU US EU
Tort N/A Location of harmful event N/A Uncertain
(e.g., prospectus liability and other (wrongful conduct or Choice of court:
liability for false and misleading damage) If permitted, must be in
statements) (Art. 7, No 2, Brussels Ia) writing or a form that
complies with international
Contract Place of performance
trade usages.
(e.g., OTC and no prospectus) (Art. 7, No 1(a), Brussels
(Art. 25(1)(a) & (c), Brussels
Ia)
Ia)
Other securities claims Ordinarily state of N/A Uncertain If the investor qualifies as a
(i.e., other legal bases for suits against organization or consumer, only agreements
issuers for dissemination of misleading corporate headquarters entered into after the
information) (U.S. Const. 5th & dispute has arisen are
14th Ams. & state-level allowed.
jurisdictional rules) (Art. 19, Brussels Ia)
Securities fraud (1934 Act) Unlikely that shareholders
restricted to federal qualify as consumers, but
court. (15 U.S.C. § likely for some individual
78aa(b)). bondholders.
Arbitration: regulated
nationally, with some EU
consumer protection limits
30/10/2018 08:16
26. Mapping types of shareholder lawsuits across
jurisdictions
Martin Gelter* 71
*
1. INTRODUCTION
When corporate law scholars trained in the United States explore shareholder litigation
abroad, they often start by looking for types of shareholder litigation familiar from
the US legal landscape. In particular, scholarship often explores derivative litigation in
various jurisdictions, often from a somewhat US-centric perspective (for example, West,
1994; Baum and Puchniak, 2012; Gelter, 2012). To be sure, derivative litigation can
potentially serve an important function in disciplining directors and other fiduciaries,
even if it constitutes only a minority of shareholder actions. When we look at the totality
of shareholder litigation from a functional perspective, even in the US we have to take
a broader perspective and take direct actions, securities class actions, and appraisal into
account, as well as the oppression remedy when we look at small firms and outside of
Delaware. In comparative analysis, we may have to look even further.
In this vein, this chapter attempts to create a functional (but likely incomplete) taxon-
omy of shareholder lawsuits across jurisdictions. While the distinction between derivative
suits and direct class actions in the US is largely familiar, many other jurisdictions employ
different types of shareholder lawsuits. While the buzzword of “legal origins” almost
sounds like a broken record, we can identify patterns where the lasting influence of either
legal traditions or transplants can be felt. The derivative suit, while it exists in common
law jurisdictions in general, has risen to prominence in the United States as a frequently
used mechanism, from where it has spread to a number of Asian civil law jurisdictions.
In the UK and other “Commonwealth” jurisdictions, it is often eclipsed by the “unfair
prejudice” or “oppression” remedy. In the civil law world, derivative litigation and close
equivalents exist, but often another form of shareholder litigation takes a more prominent
role, namely litigation regarding the validity of shareholder resolutions.
This chapter proceeds as follows. Section 2 briefly describes the types of harm which
shareholder lawsuits seek to address. Based on this, section 3 develops a taxonomy of
shareholder litigation. Section 4 looks at common policy issues across jurisdictions that
determine which types of suits will likely be used and identifies the most common factors.
It takes a deeper look at German rescission litigation and how German law addressed
the frequently discussed problem of abusive litigation by repeat plaintiffs. Section 5
concludes.
* For helpful comments and discussion, I thank Sean Griffith, Nemika Jha, Vera Korzun,
Neshat Safari, and participants of the 2016 Corporate & Securities Litigation Workshop at the
University of Illinois at Urbana-Champaign’s Illini Center in Chicago.
459
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2. CONFLICTS OF INTEREST AND SHAREHOLDER

LITIGATION
Corporate law gives rise to a number of different conflicts of interest between directors,
managers, and shareholders, as well as among shareholders. The types of conflict of
interest are of course to some extent contingent on the type and ownership structure of the
corporation. These types are typically linked to different types of harm.
First, harm may be inflicted upon the corporation, either through the careless business
decisions, or because of a transaction benefiting the fiduciary (for example, self-dealing).
In this case, other shareholders are harmed reflectively because of the loss in value of
their shares. This is a pattern that we often see in the classical “Berle-Means corporation,”
which continues to animate most policy discussions in the US. It is characterized by a
powerful management and dispersed shareholders, who suffer from collective action
problems and are therefore rarely in the position to coordinate and influence management
(e.g., Berle and Means, 1932; Roe, 1994). Comparative corporate governance scholarship
has often emphasized how dispersed ownership prevails in the US and the UK, setting
these jurisdictions apart from other large economies. The US and the UK differ in the
dominant type of dispersed ownership, since in the US retail investors historically took
a large proportion, whereas in the UK share ownership was typically dispersed among
institutional investors (e.g., Armour, 2009, pp.109–10). The typical conflict of interest
is between managers and shareholders as a class. Managers may, for example, self-deal,
take corporate opportunities, or act carelessly in making decisions, thus harming the
corporation.
Harm to the corporation may also arise from the presence of a controlling shareholder.
Corporations with concentrated ownership have traditionally prevailed in public corpora-
tions dominating in most other developed jurisdictions besides the US and UK. Managers
are thought to be largely held in check by large shareholders, but besides the occasional
squabble within the controlling coalition, conflicts of interest typically erupt between
outside investors on the one hand, and controlling shareholders (another firm or financial
institution, a family, or the government) on the other (e.g., Becht & Roëll, 1999; La Porta
et al., 1999; Ringe, 2015, pp. 496-498). Harm to the corporation often results from self-
dealing transactions between the corporation and a major shareholder.
Second, shareholders may get harmed directly without any corresponding loss to
the corporation, typically by diluting their ownership stake for the benefit of majority
shareholders. This typically happens when new shares are issued (for example, to a
majority shareholder at a low price), when shares are repurchased, and in the course of
a merger where shareholders received inadequate compensation (e.g., Conac et al, 2007,
p.496). One of the most salient scenarios is the freezeout merger (internationally often
known as “squeezeout”;1 see, for instance, Khanna and Varottil, 2015, p.1012). These
types of problems are particularly salient in firms (and jurisdictions) with concentrated
ownership, given that the majority typically benefits from diluting the minority.
1
In the US, the term “squeezeout” tends to refer to situations where minority shareholders are
put under significant pressure by the majority in closed corporations. See O’Neal & Thompson
(2016), § 9:2.
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Mapping types of shareholder lawsuits across jurisdictions 461
Third, shareholders may sometimes be formally treated equally, but a particular con-
duct, or the absence of such conduct, has a more significant impact on some shareholders
than on others, resulting in particular harm to the former. This is typical of closely held
firms, where conflicts of interest typically arise between a majority shareholder (or a
controlling coalition) and minority shareholders, although the impact on whoever ends
up in the minority is often more severe. Shares in closely held corporations are typically
an illiquid investment without a market allowing a sale, and often a legal arrangement
locking minority shareholders into a position where they can expect neither profits nor
capital gains (Bachmann et al, 2014, pp.9–11). For example, shareholders in control might
withhold dividends from the minority and remove them from management functions
in order to coerce them to sell at a low price (e.g., Moll, 2005, pp.890–1; O’Neal and
Thompson, 2016, § 9:2). In closely held firms, patterns of oppression often combine harm
to the corporation and to minority shareholders.
Fourth, shareholders in publicly traded firms may be harmed by false and misleading
information being publicized by the company. Oddly, in this situation the harm incurred
by plaintiffs is actually compensated by the gains of other market participants. The social
cost is actually the reduced functioning of the market, and in part results from inefficient
decisions being made based on distorted information (Velikonja, 2013). The taxonomy in
the following section omits the fourth type of harm, which is typically within the purview
of securities law.
3. A TAXONOMY OF SHAREHOLDER LAWSUITS
3.1 Lawsuits Addressing Harm to the Corporation
Seeking redress for harm to a corporation is usually a task assigned to a corporation’s

directors or officers. In two-tier board systems such as the German one, litigation might
be a responsibility of the supervisory board if the defendant is a member of the manage-
ment board. In many jurisdictions, however, shareholders have some form of remedy if a
claim is not pursued, at least under circumstances that raise suspicions that the decision
to sue was not disinterested.
US law is comparatively liberal in permitting shareholder litigation of this type,
allowing a derivative suit in principle for any claim “in the right of the corporation,”
meaning the derivative suits are not limited to claims against directors or managers.2 A
major hurdle is the “demand requirement,” which gives the board the opportunity to
pursue the claim itself, and which is only waived if the board is conflicted in a way that
would render demand futile.3 Many jurisdictions limit derivative suits to claims against
directors for violations of their duties as such, which is in principle true even for the UK,
2
See, e.g., Federal Rules of Civil Procedure, Rule 23.1(a) (“This rule applies when one or
more shareholders or members of a corporation or an unincorporated association bring a deriva-
tive action to enforce a right that the corporation or association may properly assert but has failed
to enforce”).
3
Federal Rules of Civil Procedure, Rule 23.1(b)(3).
M4633-GRIFFITH_t.indd 461 30/10/2018 08:16

where a derivative claim must arise from a violation of directors’ duties.4 Others, such as
controlling shareholders, may be sued under this provision only if they were involved in
the director’s breach (see Davies and Worthington, 2016, ¶ 17-14).5 In the UK, the rule
of Foss v. Harbottle historically made derivative suits difficult by limiting them mainly
to cases of “fraud on the minority”6 where the majority shareholder is conflicted and it
would not be appropriate for shareholders to decide collectively whether to bring a suit
(Baum and Puchniak, 2012, pp.68–9). While the rule has been superseded by the some-
what more lawsuit-friendly Companies Act 2006, it continues to influence other common
law jurisdictions, including those in Asia (see Puchniak, 2012, pp.114–24).
Continental European and other civil law countries have historically been divided as
to whether they even provided for a derivative suit in the narrow sense. While France
and Switzerland provided for an individual right to enforce directors’ liability claims, in
Germany, Austria, Belgium, Italy, and Spain suing directors was historically a collective
right of shareholders that could be initiated in the shareholder meeting (Gelter, 2012,
pp.853–4; Siems, 2012, pp.98–100; Baum and Puchniak, 2012, pp.82–4). Under the latter
system, only if the majority decided against a lawsuit can a minority exceeding a speci-
fied percentage petition a court to appoint a special representative to enforce the claim on
behalf of the corporation. As this instrument was widely considered ineffective, Germany
enacted a reform in 2004, which enabled what can be considered an actual derivative suit,
but still requires plaintiff shareholders to hold at least 1 per cent of the corporation’s
shares (e.g., Saenger, 2015, pp.20–4). Most Continental European countries provide for
a form of minority enforcement mechanism, although often it is similarly limited to
a qualified minority, and to claims against directors but not, for example, controlling
shareholders.7 The Asian civil law jurisdictions of Japan, South Korea, and Taiwan
adopted the US-style derivative suit during the second half of the twentieth century,
and at least the first two have seen a fair number of lawsuits (Puchniak, 2012, pp.100–11;
Osugi, 2016, p.50, reporting 121 derivative suits in Japan between 1991 and 2011).
Overall, derivative suits are not a necessary element of corporate law systems across
jurisdictions. For example, under Chinese law, only a 2005 reform that came into force
in 2006 made it clear that a derivative suit is possible, even if there was previously some
debate about the issue (Huang, 2012, p.621). But maybe more to the point, Dutch law does
not offer a derivative suit or similar mechanism (Schuit et al., 2002, p.155; Gerner-Beuerle
and Schuster, 2014, p.216).
Jurisdictions are sometimes more liberal with respect to suits seeking to police the
4
Companies Act s. 260(3) (UK) (permitting derivative suits “only in respect of a cause of
action arising from an actual or proposed act or omission involving negligence, default, breach of
duty or breach of trust by a director of the company”). A derivative suit in the UK may also be
used to enjoin a director’s action that would violate their duties (De Dier, 2013, p. 471).
5
Moreover, UK law includes “shadow directors.” Companies Act s. 260(5)(b) (UK).
6
Foss v. Harbottle, [1843] 67 E.R. 89. (Ch.).
7
Note that this describes only the situation in the Aktiengesellschaft (public limited company).
In the Gesellschaft mit beschränkter Haftung (private limited company), under German law the
action pro socio is generally accepted by the courts as a mechanism for the corporation to enforce
claims against members provided that managers do not adequately pursue the claim. E.g., Cabrelli
(2013), pp.307–8. The same is true in private limited companies in other European jurisdictions.
Bachmann et al. (2014), pp.65–6.
M4633-GRIFFITH_t.indd 462 30/10/2018 08:16

boundaries of directors’ powers. For example, in the UK individual shareholders can

enforce the “proper purpose” rule codified in s. 171 of the Companies Act. Directors
must act in accordance with the company’s constitution and only exercise powers for the
purpose for which they are conferred. Since these are understood to be individual rights
of shareholders under the corporate charter, individuals can bring a suit (de Dier, 2013,
p.473), even if strictly speaking the corporation is harmed. Similarly, under German
law, the individual shareholders may bring a suit when directors take actions which they
would have been required to submit to shareholders, for example, under the Holzmüller
doctrine (Saenger, 2015, p. 18).8 Both the UK and the German suit are not understood as
individual suits and thus are not subject to particular procedural requirements.
3.2 Lawsuits Addressing Harm to Shareholders
In the US, direct suits are distinguished from derivative suits in that the harm they address
is a personal injury of a shareholder, or an entire class of shareholders. Consequently,
Delaware’s Tooley test looks at whether the corporation or the shareholders were harmed,
and whether consequently the corporation or the shareholders should receive the remedy.9
Such a suit might be brought if a right to obtain information or a right to vote is infringed
upon, or in the case of a stock issue or merger with disadvantageous effects for (some)
shareholders. From the plaintiff lawyer’s perspective, direct actions have the advantage
that they do not have to pass the demand requirement and thus can go into discovery
without facing this additional hurdle; however, when brought as class actions, they have
to meet class certification requirements. Often direct suits are brought when a merger
transaction is announced. Because of the time critical nature of mergers, firms are under
strong pressure to settle, which often arguably result in disclosure-only settlements that
produce few benefits for shareholders (Fisch et al, 2014, pp.563–8).
In comparative perspective, similar suits exist for such situations in other jurisdictions.10
In countries such as France and Germany, the distinction between derivative and other
suits is rather obvious, given that the relief sought is different (Baum and Puchniak, 2012,
p.11). However, as a general characteristic of civil procedure, class actions are often not
available in many jurisdictions outside the US; typically, it is necessary to “opt in,” which
strongly reduces the bargaining power of a plaintiff lawyer acting as a “private attorney
general” (for the “group litigation order” in the UK, see, for example, Armour et al, 2009,
p.693; Cheffins and Black, 2006, pp.1411–12; generally for European civil procedure, see
Issacharoff and Miller, 2009, p.202).
Especially in civil law jurisdictions, the functional equivalent to the American direct
class action suit is often a lawsuit seeking to rescind or nullify decisions taken in the share-
holder meeting (for Germany, see Vermeulen and Zetzsche, 2010, p.23; for Spain, Sáez
8
The Holzmüller case BGH II ZR 174/80, BGHZ 83, 122 and subsequent case law concern
the question under what circumstances shareholders must be asked to approve a spinoff of the
company’s main operations into a subsidiary. See Rock et al. (2017), pp.199–200.
9
Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004).
10
See, for instance, the French action individuelle, which is thought to be based on C. Com. art.
L.225-253 (Fr.) in the SA. See De Wulf (2010), p.1558. In the SARL, the suit is based on C. Com.
art. L.223-22 (Fr.).
M4633-GRIFFITH_t.indd 463 30/10/2018 08:16

and Riaño 2013, p.366, who report 188 suits against shareholder decisions between 2000
and 2011).11 Corporate laws often include statutes governing these types of suit, which
automatically have a classwide effect as a rescission stops transactions for all shareholders.
In some jurisdictions, these provisions also address lawsuits seeking to invalidate formal
board resolutions.12 These lawsuits tend to be fairly common across jurisdictions, and
their prevalence seems to be linked to the fact that a larger number of decisions require a
shareholder vote in European countries than in the United States.13 Besides the election
of directors, on one hand,14 and changes to corporate articles, on the other,15 European
shareholders typically vote on the approval of financial statements,16 and virtually
always on the issuance of dividends.17 Most importantly, they vote on capital increases,18
capital reductions,19 mergers,20 and divisions.21 This means that an issuance of new shares
and any change to the corporation’s financial structure require a vote. Some jurisdic-
tions, notably France, go even further and require shareholder votes for related party
transactions with directors and certain significant shareholders.22 The EU Shareholder
11
AktG §§ 241–57 (Ger.); C. Com. art. L. 235-1 (Fr.); C.c. arts. 2377–9 (It.); Ley de Sociedades
de Capital (LSC) art. 204 (Spain); Burgerlijk Wetboek [BW] arts 2:13–2:16 (Neth.). On the
technical level, there is a typically distinction between resolutions that need to be rescinded and
those that are null and void. This may make a difference, among other things, for standing require-
ments and limitation periods.
12
E.g., C. com. art. 235–1(2) (Fr.); LSC art. 251 (Spain); C.c. art. 2388 (It.) (shareholders can
challenge the validity of board decisions if they infringe upon their rights). See also De Dier (2013),
pp.481–7, pp.488–90, pp.491–3 (discussing Belgian, French, and Dutch law).
13
E.g., Hellgardt and Hoger (2011), p.48 (pointing out that lawsuits under DGCL § 225(b),
which permits stockholders to challenge the validity of the result of any stockholder vote, likely
have remained rare because shareholders have smaller decision-making powers in the US, in par-
ticular as regards increases in and reduction of the number of outstanding shares, which typically
can be decided by directors); see also Gelter (2012), p.883.
14
AktG § 101(1) (Ger.); C. Com. art. L. 225-18 (Fr.); LSC art. 214 (Spain); C.c. art. 2364(2)
(It.); BW arts. 2:132 (Neth.).
15
AktG § 179(1) (Ger.); C. Com. art. L. 225-96 (Fr.); LSC art. 285.1 (Spain); C.c. art. 2365
(It.); BW art. 2:121 (Neth.).
16
C. Com. art. L. 225-100 (Fr.); LSC arts. 160(a), 272.1 (Spain); C.c. art. 2364(1) (It.); BW arts.
2:117(5), 2:362(6) (Neth.). In Germany, shareholders vote on financial statements only in cases of
disagreements between the management and supervisory boards. AktG § 173 (Ger.).
17
AktG § 58 (Ger.); C. Com. art. L. 232-11 (Fr.); LSC art. 273.1 (Spain); C.c. art. 2364bis(4)
(It.).
18
See AktG §§ 182, 192, 202 (Ger.); C. Com. arts. L. 225-129, L. 225-130 (Fr.); LSC art. 296.1
(Spain); BW art. 2:96 (Neth.).
19
AktG §§ 222, 229, 237 (Ger.); C. Com. art. L. 225-204 (Fr.); LSC art. 318.1 (Spain); BW art.
2:99 (Neth.).
20
Umwandlungsgesetz [UmwG] [Reorganization Act], §§ 13, 65 (Ger.); C. Com. art. L. 236-2
(Fr.); Ley 3/2009 de 3 de abril sobre modificaciones estructurales de las sociedades mercan-
tiles [LSME], arts. 8, 40 (Spain); C.c. art. 2365 (It.); BW art. 2:317 (Neth.).
21
E.g. UmwG § 125 (Ger.); LSME art. 73 (Spain) (both referring to the sections governing
mergers); BW art. 2:234m (Neth.).
22
C. Com. art. L. 225-38, 225-40 (Fr.). The ownership threshold for shareholders triggering a
vote is 10 per cent. See, e.g., Conac et al. (2007), p.498. The EU Shareholder Rights Directive, as
amended in 2017, states that Member States must require approval either by the general meeting or
the administrative or supervisory board. Shareholder Rights Directive 2007/36/EC as amended by
Directive 2017/828/EU, art. 9c(4).
M4633-GRIFFITH_t.indd 464 30/10/2018 08:16

Rights Directive, as amended in 2017, requires a shareholder vote on remuneration

policy.23
While in concentrated ownership systems corporations are de facto controlled by a
shareholder or a shareholder coalition, rescission lawsuits that are formally brought
against the corporation de facto constitute a way for minority shareholders to put the
brakes on the majority’s actions. Based on allegations of legal impropriety of the decision,
minority shareholders can bring a lawsuit, usually without having to meet a minimum
ownership threshold.24 Depending on the applicable substantive law, this may allow a
court to review whether, in exercising his voting power, a majority shareholder violated
the duty of loyalty or engaged in conduct considered abusive (Conac et al, 2007, pp.501–2;
Sáez and Riaño, 2013, p.363; Enriques et al, 2017, pp.161–2), even if in practice it is
typically easier to bring a suit based on violations of procedural and information rules.
Given the hurdles that derivative suits sometimes face in these jurisdictions, this type of
lawsuit is often the main mechanism keeping controlling shareholders in check (for Spain,
see Sáez and Riaño, 2013, pp.364–5; for the annulment of decisions to retain profits in a
French company, see Conac, 2013, pp.228–9).25
Lawsuits challenging the validity of shareholder resolutions are also fairly common
in East Asia, particularly South Korea. Japan adopted the framework for rescission and
“nullity”26 lawsuits from Germany in various corporate law reforms starting in 1899, and
South Korea followed the Japanese influence in reforms in 1962 and 1984 (Kim and Choi,
2016, p.223). Between 1998 and 2013, the Seoul Central District Court recorded between
10 and 23 lawsuits against shareholder meeting decisions every year, and never more than
seven derivative suits per year (in some years none or only one or two) (Kim and Choi,
2016, pp.229–30).
An advantage of rescission suits is that generally, other than in derivative suits, share-
holders have standing without having to pass a minimum ownership threshold. There
are some exceptions such as Italy, where only shareholders holding 0.1 percent or more
of voting rights may seek the nullification of a decision of the shareholder meeting of a
publicly traded firm.27 The 2003 reform introducing these thresholds has arguably made it
harder to police self-dealing transactions and facilitated exploitative conduct by control-
ling shareholders (Enriques, 2009, p.498). While rescission suits do not provide complete
deterrence, they remain a major enforcement mechanism for those transactions subject
to a shareholder vote. Thus, the possibility of rescission suits in combination with voting
23
Shareholder Rights Directive, art. 9a.
24
AktG § 245(1) (Ger.) (providing that a shareholder who submitted a written objection in the
shareholder meeting has standing); BW art. 2:15(3)(a) (Neth.) (providing that a person with a legal
interest can sue); see Germain (2002), p.412 (explaining that in France, the party the law intends to
protect can sue).
25
For the UK, see Ringe (2017), pp.266, 272 (pointing out that shareholders in the UK are not
subject to fiduciary duties, but merely a limited obligation to “act bona fide for the benefit of the
company as a whole” when voting, which generally permits them to vote in their own interest); see
also Conac (2013), p.246.
26
This means a lawsuit declaring that a resolution is void, as opposed to one that is merely
voidable.
27
C.c. art. 2377 (It.). These thresholds were introduced in 2003, apparently because of con-
cerns about excessive lawsuits. In privately held firms, the threshold is 5 per cent.
M4633-GRIFFITH_t.indd 465 30/10/2018 08:16

requirements constitutes a major mechanism to hold controlling shareholders account-

able in concentrated ownership systems (Sáez and Riaño, 2013, pp.378, 390). Similarly,
since a 2014 amendment, Spanish corporate law has also limited standing to shareholders
individually or jointly holding at least 1 per cent (0.1 per cent in publicly traded firms),
except in those cases where the decision violates public policy.28
3.3 Appraisal Rights and Similar Mechanisms
In addition, jurisdictions sometimes provide remedies for the dilution of share value in
mergers and related transactions, which often do not require a showing a violation of a
law or charter, but merely a mispricing of the compensation received by shareholders.
Moreover, invalidating a merger that has already been consummated creates practical
problems, which is why many jurisdictions attempt to limit redress to a repricing (e.g.,
Ventoruzzo, 2010, p.883; Conac, 2013, pp.229–30). Appraisal rights in the US provide the
prime example. In Delaware, specifically, they are available for statutory mergers, whereas
some states add sales of all assets or de facto mergers to their scope of applicability. The
usefulness of appraisal rights in Delaware is limited by a number of factors. First, the
scope of applicability of the provision—which depends in part on the compensation given
to shareholders—appears to follow no consistent theory.29 Second, the provision requires
that dissenting shareholders submit a written demand for appraisal to the corporation
before voting against it.30 Consequently, only a limited set of shareholders will typically
be able to petition for appraisal, which stands in contrast to a fiduciary duty class action
against a merger, where plaintiff counsel will represent the entire class consisting of all
(minority shareholders), thus vastly increasing bargaining power vis-à-vis the defendant
(for a summary of the critique, see Korsmo and Myers, 2015, pp.1560–6).
European law, in harmonizing merger procedures, does not require appraisal or
similar procedures. In contrast to US law, the Merger Directive provides for an ex ante
appointment of an independent expert (appointed by a court or administrative author-
ity) to review the valuation in the merger agreement,31 as well as liability both of the
members of company management and administrative bodies and the expert in cases
of “misconduct”32 (see Ventoruzzo, 2010, pp.878–9). Member States are free to back up
this ex ante mechanism with an ex post revaluation of shares, but they do not necessarily
follow the US appraisal model. For example, Italian corporate law establishes withdrawal
rights for shareholders under certain enumerated circumstances (such as changes to the
articles or going private)33 that do not necessarily apply in a merger (Ventoruzzo, 2010,
p.884). Under French law, a minority shareholder might either seek to have the merger
28
LSC arts 206.1, 206.2, 495.2(b) (Spain).
29
DGCL § 262(b).
30
DGCL § 262(d)(1).
31
Directive 2011/35/EU of the European Parliament and of the Council of 5 April 2011
concerning mergers of public limited liability companies (codification), 2011 O.J. L 110/1, art. 10
[hereinafter Merger Directive].
32
Merger Directive, art. 20, 21.
33
C.c. art. 2437, 2437quater (It.).
M4633-GRIFFITH_t.indd 466 30/10/2018 08:16

voided by a court upon showing that it constitute an “abuse of majority,” or by suing the
majority shareholder or auditor for damages (Conac, 2013, pp.230–1).
An example closer to the US appraisal model is the German Spruchverfahren, which
applies to various types of structural changes under German company law, includes
group restructurings, mergers, and freeze-out transactions (known as squeeze-outs in
German).34 Interestingly, dissident shareholders only need to submit a formal objection
in the shareholder meeting and vote against the merger if they intend to challenge the
amount of cash compensation they are to receive.35 If they seek to challenge the share
exchange ratio in a stock for stock merger, any shareholder can ask for a judicial reas-
sessment.36 This includes even shareholders who voted in favor of the transaction. This
policy choice is intended to avoid incentives for shareholders to vote against a merger only
because they seek a revaluation of the exchange ratio (Kubis, 2015, ¶ 6).37
The German procedure has an erga omnes effect, that is, all shareholders participate
from better compensation awarded to them by the court, regardless of whether they asked
for a revaluation or not.38 Arguably, it thus has effects comparable to a class action in the
US (Krebs, 2012, p.967).39 However, the comparison to appraisal rights as such seems
more adequate, as the procedure does not permit plaintiffs to “block” a transaction with
an injunction. A reform enacted in 2005 removed the possibility for shareholders to seek
the rescission of a merger based on an incorrect valuation,40 if the appraisal procedure
is instead available (Vermeulen and Zetzsche, 2010, p.27; Ringe, 2015, p.531 n.133).41
“Entrepreneurial” plaintiff lawyers do not appear to be as great an issue as elsewhere in
the proceedings. The court is required to appoint a common representative for sharehold-
ers who were entitled to object but failed to do so.42 Typically, the appointee will be an
investor protection organization (Krebs, 2012, p. 967). Nevertheless, due to their low cost
and wide availability they are a frequently sought remedy for shareholders.
3.4 Oppression and Unfair Prejudice Claims
Finally, some jurisdictions provide for mechanisms of litigation that address “oppressive”
conduct that may not explicitly violate the law, but may violate the spirit of the law or the
contract underlying the corporation. Delaware does not provide for a statutory oppres-
sion remedy, but many other US states do.43 In these jurisdictions, courts typically have
the discretion to dissolve the corporation if “those in control of the corporation” (that is,
34
§ 1 SpruchG (Ger.).
35
§§ 29, 207 UmwG (Ger.).
36
§§ 15, 196 UmwG (Ger.).
37
Shareholders have three months to submit a petition for revaluation. § 4 SpruchG (Ger.).
38
39
The court has wide discretion to award litigation cost to the firm or to petitioners. § 15
SpruchG (Ger.).
40
Gesetz zur Unternehmensintegrität und Modernisierung des Anfechtungsrechts
[UMAG], September 22, 2005, BGBl. I at 2802.
41
§ 243(4) AktG (Ger.).
42
43
But see DGCL § 273 (dissolution following a deadlock between two shareholders owning 50
per cent each).
M4633-GRIFFITH_t.indd 467 30/10/2018 08:16

directors or controlling shareholders) have acted “in a manner that is illegal, oppressive,
or fraudulent.”44 Often the right to petition for an involuntary dissolution on grounds
of oppression is limited to shareholders holding a relatively high percentage of shares
(for example, 20 per cent in New York and one third in California45), thus rendering the
mechanism useful basically only in deadlocked closely held corporations. The default
remedy envisioned in US statutes is typically dissolution. While this is a drastic measure
that could conceivably enhance a minority shareholder’s bargaining power, its actual
imposition is in the hands of a court that will likely hesitate to actually impose it except
in the most unusual of circumstances. However, in recent decades a number of states have
amended their oppression statutes to permit alternative remedies, particularly buyout of
the minority, and some courts have asserted to equitable power to fashion appropriate
remedies, including buyout (Moll, 2005, pp.892–5; O’Neal and Thompson, 2016, §§ 9.36,
9.37).
In jurisdictions whose corporate law is derived from the English common law, includ-
ing the UK, Australia, Canada, and India, what is called the “unfair prejudice remedy”
(historically also called “oppression”46) is often thought to be much more important than
the derivative suit (for Canada, see, for instance, Dine and Cheffins, 1992, pp.89–92; for
the UK, see Ringe, 2017, p.278). In part, the reason is likely that English company law has
historically limited derivative suits to a small set of circumstances.47 Minority sharehold-
ers could not normally bring a derivative suit against a board that had violated its duties
without conferring an advantage to a controlling shareholder, given that majority rule
would apply absent a conflict (Armour, 2009, p.80). Derivative suits were therefore of rela-
tively little use in public companies without a controlling shareholder (ibid). The unfair
prejudice remedy appears to have been used somewhat more than the derivative suit even
in public companies in the past, although none of the reported suits were successful (ibid,
p.83). In any event, while the limitations on derivative suits were somewhat liberalized in
the Companies Act 2006,48 the unfair prejudice remedy has generally remained the more
popular mechanism.49 This remedy benefits from its wide scope of application,50 which
44
RMBCA § 14.30(a)(2)(ii). See, e.g. NYBCL § 1104-a(a)(1); Cal. Corp. C. § 1800(b)(4).
45
NYBCL § 1104-a(a); Cal. Corp. C. § 1800(a)(2).
46
Companies Act 1948, s. 210 (UK).
47
Foss v. Harbottle, [1843] 67 E.R. 89. (Ch.).
48
Companies Act (2006), ss. 260–4 (UK).
49
Companies Act (2006), ss. 994–9 (UK). According to s. 994(1), “[a] member of a company
may apply to the court by petition for an order under this Part on the ground (a) that the company’s
affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of
members generally or of some part of its members (including at least himself), or (b) that an actual
or proposed act or omission of the company (including an act or omission on its behalf) is or would
be so prejudicial.”
50
Companies Act (2006), s. 994(1) (UK) provides that only a member of a company may bring
an unfair prejudice petition. However, the standing to sue has been broadened by extending the
concept of “membership” to include: (1) those to whom shares have been transferred but whose
names have not been registered in the register of members (Re Quickdrome Ltd (1988) BCLC
370); (2) those to whom shares have been transmitted by operation of law and whose names have
not been registered in the register of members (s. 112); and (3) a person who is only a nominee
shareholder (Re Brightview Ltd (2004) BCC 542). Although the petitioner must be a member of
the company when the petition is presented, he may rely in support of the petition on events which
M4633-GRIFFITH_t.indd 468 30/10/2018 08:16

encompasses any action by those controlling the firm that is unfair to those not in control.
The language of the 2006 Companies Act clarified that an unfair prejudice can result from
a single act or omission and does not necessarily require a sustained conduct or scheme.51
English courts have applied an objective test as to what is considered unfair, holding
that “it is not necessary for the petitioner to show that the persons who have de facto
control of the company have acted as they did in the conscious knowledge that this was
unfair to the petitioner or that they were acting in bad faith; the test, I think, is whether
a reasonable bystander observing the consequences of their conduct, would regard it as
having unfairly prejudiced the petitioner’s interests.”52 The test is typically whether the
“legitimate expectations” of the minority shareholder have been disappointed.53 This
could be because of an informal agreement by the parties outside the company’s articles.
Unlike the oppression remedy in a few US states,54 in the UK the unfair prejudice
remedy does not require plaintiffs to surpass an ownership threshold, and even a
majority shareholder can bring it if the firm is controlled by a minority.55 The courts
have permitted unfair prejudice actions even where, in principle, derivative suits would
have been available (Davies and Worthington, 2016, ¶ 20-14). Another advantage is the
court’s wide discretion regarding remedies; it has been held that an appropriate remedy
is one that would “put right and cure for the future the unfair prejudice which the
petitioner has suffered at the hands of the other shareholders of the company,”56 and
the Companies Act 2006 now provides that the court may make “such order as it thinks
fit for giving relief in respect of the matters complained of.” 57 In particular, the court’s
order may also (1) regulate the conduct of the company’s affairs in the future, (2) require
the company to refrain from doing or continuing an act complained of, or to do an act
that the petitioner has complained it has omitted to do, (3) authorize civil proceedings
to be brought in the name and on behalf of the company by such person or persons and
on such terms as the court may direct, (4) require the company not to make any, or any
specified, alterations in its articles without the leave of the court, or (5) provide for the
purchase of the shares of any members of the company by other members or by the
company itself and, in the case of a purchase by the company itself, the reduction of the
occurred before he became a member. It has also been held that while the petitioner needs to be
a member at the time of bringing the unfair prejudice petition, the petitioner may rely on events
that occurred before such petitioner became a member (Lloyd v Casey (2002) 1 BCLC 454). There
is also no requirement to be a minority shareholder in order to bring an unfair prejudice petition.
51
Companies Act (2006), s. 994(1)(b) (UK).
52
See Re Bovey Hotel Ventures Ltd unreported but quoted and followed in RA Noble & Sons
Clothing Ltd (1983) BCLC 273 at 290.
53
E.g., O’Neill v. Philipps [1999] 2 BCLC 1; see also Davies and Worthington (2016), ¶ 20-8.
54
E.g., NYBCL § 1104-a(a) (requiring a 20 per cent minority).
55
Re Ravenhart Service (Holdings) Ltd (2004) 2 BCLC 376. However, the court will not grant
a majority shareholder any remedy if the unfair prejudice can be avoided by exercising other rights
available to such majority shareholder (Re Baltic Real Estate (1993) BCLC 503). Further, the
prejudicial conduct need not affect the interests of the petitioners in their capacity as members. An
unfair prejudice petition may be brought so long as the prejudicial conduct is sufficiently connected
with membership. Accordingly, exclusion of a member from the board of directors was held to
amount to an unfair prejudice (Re a Company (1986) BCLC 376).
56
Re Bird Precision Bellows Ltd (1986) Ch 658 at 669.
57
Companies Act (2006), s. 996(1) (UK).
M4633-GRIFFITH_t.indd 469 30/10/2018 08:16

company’s capital accordingly.58 Moreover, the court’s wide discretion sometimes may
include monetary payments as well as mandatory buyouts of the aggrieved shareholder,
which are used most frequently in practice (Davies and Worthington, 2016, ¶ 20-19; for
Australia, see Koh, 2016, p.388). Maybe most importantly, bringing an unfair prejudice
claim allows a plaintiff shareholder to avoid the procedural requirements for a derivative
claim (Keay, 2016, p.60). Since the remedy can be either direct or derivative, the unfair
prejudice mechanism appears to have left little space for the derivative actions in the
UK. In practice, unfair prejudice have become an all-purpose instrument in privately
held firms, whereas courts have not traditionally been receptive to admitting them in
publicly traded companies (Armour et al, 2009, pp.695–6; see also Cheffins and Black
2006, pp.1409–10).
Some scholars claim an influence of the UK model on Chinese company law in this
respect (see Hawes et al, 2015, pp.560–3). Article 20.2 of the Chinese Companies Law
laconically provides that shareholders abusing their rights shall be liable to the company
or other shareholders in accordance with the law. An empirical analysis of the cases under
this “oppression” remedy has revealed that the courts use it as a catchall mechanism and
as the basis for a variety of remedies (Hawes et al, 2015, pp.569–70). In contrast to the
usual structure of the unfair prejudice mechanism under English and similar laws, a suit
can be brought both by the minority shareholder and by the company itself (if it has
been harmed). However, the harm must have been caused by a shareholder (and not, for
instance, by a director) (Hawes et al, 2015, pp.581–4).
Another mechanism that shares some features with oppression remedies is the
“inquiry proceeding” in the Netherlands, although it might also be characterized as
a judicial supervision mechanism. Under Dutch law—which does not provide for a
derivative suit—minority shareholders can petition the enterprise chamber (onderne-
mingskamer), a division of the Amsterdam Court of Appeals, to launch an investigation
into the company’s management or financial statements.59 Shareholders must hold at
least €225,000 or a 10 percent share, but the advocate general or a labor union can also
bring a petition (see generally Schuit et al, 2002, p.157; Vermeulen and Zetzsche, 2010,
p.16; de Dier, 2013, pp.493–5).60 The enterprise chamber will then determine whether
any misconduct occurred. One major feature shared with the unfair prejudice remedy
is the flexibility of remedies: the court can decide to dismiss board members or appoint
temporary ones, rescind shareholder resolutions, or even dissolve the company (see
Schuit et al., 2002, p. 159).61 In spite of the high ownership threshold for sharehold-
ers, the mechanism is understood to be effective and widely used (see Vermeulen and
Zetzsche, 2010, p. 17).
58
Companies Act (2006), s. 996(2) (UK).
59
BW art. 2:345(1), art. 2:447 (Neth.).
60
BW art. 2:345(2), 2:346(b), 2:347 (Neth.).
61
BW art. 2:356 (Neth.).
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4. COMMON POLICY ISSUES
4.1 Institutional Preconditions for Effective Shareholder Litigation
Across jurisdictions, we can observe a tradeoff between litigation as an effective

enforcement mechanism for corporate law, and the potential for rent-seeking conduct by
entrepreneurial plaintiffs and their even more entrepreneurial lawyers. There are a number
of preconditions for a particular type of lawsuit to become a frequently used enforcement
mechanism, which can be put into three categories. First, shareholders must have standing
to sue or must be able to obtain standing to sue collectively, or use a form of lawsuit that
has collective effects, without facing significant hurdles, against a defendant to whom the
suit matters. Second, the allocation of cost and litigation risk—both at the ex ante and ex
post stages—must not set strong incentives against shareholder litigation. Third, share-
holders must be able to obtain the information needed to bring a suit in order to surmount
the applicable evidentiary standard (which may vary by issue or form of litigation).62
4.1.1 Standing to sue

Where shareholder derivative litigation and similar mechanisms to enforce directors’
liability are concerned, US law is notable in that it is very liberal with respect to standing.63
In public limited companies, many civil law jurisdictions require a minimum percentage
of share ownership on the part of those bringing or otherwise initiating the lawsuit (typi-
cally ranging between 1 per cent and 10 per cent).64 The intuition behind these thresholds
seems sound at first glance, since a shareholder holding only a minute stake in the firm
likely only has an incentive to sue if his interest in the suit is a personal rather than a
collective one (for example, because it enables him to “blackmail” a firm into a lucrative
settlement). Contrary to this view, Grechenig and Sekyra (2011) show in a mathematical
model that with an ownership threshold, potential defendant managers only need to
discourage large shareholders above the threshold from suing, which is considerably easier
and may mean that corporate law is not enforced even if a suit would be socially desirable.
While in some cases it may be desirable to disallow likely non-meritorious litigation by
small shareholders, in other cases only large or controlling shareholders complicit in
wrongdoing will have standing to sue because of the minimum threshold. Notably, in the
62
Gelter (2012) describes these factors as jointly constituting the “Anna Karenina Principle”
of shareholder litigation: all of these factors are necessary conditions for shareholder litigation to
emerge, but none of them by itself appears to be sufficient.
63
In some states, the plaintiff may be required to post a bond, which can be a severe limitation.
E.g., Cal. Corp. Code § 800(c).
64
Gerner-Beuerle & Schuster (2014), p.217 provide a recent overview of the EU member
states, and report that Belgium, the Czech Republic, Germany, Italy, and Portugal require an
ownership stake of more than one share but less than 5 per cent. Bulgaria, Hungary, Latvia,
Romania, Slovakia, and Spain range from 5 per cent to less than 10 per cent, whereas Austria,
Croatia, Denmark, Finland, Greece, Slovakia, and Sweden require 10 per cent or more. Estonia,
Luxembourg, and the Netherlands do not have a derivative suit, whereas in Cyprus, France,
Ireland, Lithuania, Poland, and the UK a single share suffice to bring a suit. China establishes no
threshold in the LLC, but requires that plaintiffs have held 1 per cent for more than 180 days in a
Joint Stock Limited Company (Huang, 2012, p. 623).
M4633-GRIFFITH_t.indd 471 30/10/2018 08:16

UK, France, Switzerland, and Japan there is no ownership threshold for derivative suits,
but in the first three countries these remain uncommon. Korea has a very low threshold
of 0.01 percent in publicly traded firms, but this is still considered a major impediment
to derivative litigation (Kim and Choi, 2016, p.241). In China, the 1 per cent threshold is
seen as a reason why, as of 2011, only one derivative suit had been filed against a publicly
traded firm (Zhang, 2011, p.193).
Another aspect of standing is having standing against the right kind of plaintiff. With
the exception of the US, where a derivative suit can be brought to enforce any “right of
the corporation,”65 other jurisdictions (including the UK) tend to be more restrictive.
Typically, derivative suits and similar mechanisms are established in the respective
corporate law to enforce liability claims against directors only.66 This means, first, that
only liability claims are possible—injunctions usually are not. Second, derivative suits
sometimes cannot be used as a mechanism to discipline controlling shareholders (for
China, see Huang, 2010, p.253; but see Huang, 2012, p. 623, regarding “any other person”;
for Japan, see Oda, 2011, p.342; for European jurisdictions, see Gelter, 2012, pp.875–80).
There are exceptions, such as holding controlling shareholders accountable for violations
of directors’ duties they were involved in; qualifying controlling shareholders as de facto
or shadow directors (for Italy, see Galgano and Genghini, 2006, p.483; for France, see
Cozian et al, 2009, ¶ 262; for the UK, see Companies Act § 260(5)(b)); and the German
law of corporate groups, which explicitly permits a derivative suit against the “controlling
undertaking.”67 However, there are no known cases where such a suit has been brought (in
spite of the absence of a percentage standing threshold in this special case) (Ulmer, 1999,
p.300; Hirt, 2005, pp.191–2).
In the US, the main hurdle for a potential plaintiff to overcome to establish standing in
a derivative suit is the demand requirement, which seeks to ensure that directors are given
the opportunity to pursue the claim before the ability to sue devolves to shareholders. This
mechanism has become a model for other jurisdictions. Under the UK Companies Act of
2006, a shareholder must seek the court’s leave to pursue a derivative claim.68 Interestingly,
the court must consider, among other things, whether a person seeking to promote the
best interests of the company would bring the suit,69 and whether the plaintiff is acting
in good faith;70 in other words, to some extent the court must evaluate whether the suit
is in the interest of the company (Paul, 2010, p.89). Similarly, when Germany reformed
its derivative suit mechanism in 2005, it created a “lawsuit admission procedure” that
65
Fed. R. Civ. P. 23.1(a).
66
See, e.g., Companies Act (2006), s. 260(3) (UK): “A derivative claim under this Chapter may
be brought only in respect of a cause of action arising from an actual or proposed act or omission
involving negligence, default, breach of duty or breach of trust by a director of the company. The
cause of action may be against the director or another person (or both).”
The second sentence may permit impleading another person (for example, a third party who
improperly received funds because of the directors’ wrongdoing, but does not include cases where
a controlling shareholder’s fiduciary duty is at issue). Civil law jurisdictions often do not permit
this extension.
67
AktG §§ 317(4), 309(4) (Ger.).
68
Companies Act s. 261 (UK).
69
Companies Act s. 263(2)(a) (UK).
70
Companies Act s. 263(3)(a) (UK).
M4633-GRIFFITH_t.indd 472 30/10/2018 08:16

requires plaintiffs to show that they took steps to induce directors to bring the suit.71 A
major problem under German law is that the plaintiff has to establish a “gross violation
of the law or the charter,” requiring the court would have to determine whether the suit
is in the best interests of the corporation (Saenger, 2015, p. 26). In China, plaintiffs must
either permit the board 30 days to consider the suit, or establish that the delay would result
in irreparable harm to the company (Huang, 2012, pp.624, 638). Similarly, in Japan, 60
days after filing a request with a company, shareholders can bring a suit without having
to ask for the court’s leave to do so (Oda, 2011, p.343). By contrast, French law does not
have a demand requirement for its derivative suit (De Wulf, 2010, p.1558).
Note that these standing requirements seem to be an issue mainly in derivative suits
and similar mechanisms, not in other forms of shareholder litigation. The most likely
reason is the particular salience of the suspicion raised by a shareholder’s suit on behalf
of a corporation from which she will only draw a minute proportionate benefit. There are
typically fewer limitations on standing for direct suits and for rescission suits challenging
the validity of decisions of the shareholder meeting, given that these tend to remedy harm
inflicted on shareholders directly.
4.1.2 Allocation of cost and risk

For shareholder litigation to be viable, the allocation of cost and litigation risk must set
the right incentives, both at the ex ante and ex post stages. At the ex ante stage, upfront
court fees may deter shareholder litigation, in particular if these amounts are measured as
percentages of the amount in dispute. This can be a strong deterrent factor, especially if
it is measured as a percentage of the harm to the company (for China, see Huang, 2012,
p.651). Arguably, a court decision that reduced the filing fee for derivative suits from a
percentage to a modest flat fee opened the floodgates for derivative litigation in Japan in
1993 (West, 1994, pp.1463–5; West, 2001, p.353; Osugi, 2016, p.53; contra Puchniak and
Nakahigashi, 2012, pp.48–50, 54–6).
A “security for expense statute,” which permits the corporation or other defendants
to request that plaintiffs that do not exceed a minimum ownership threshold (usually 5
percent) post security for litigation expenses, has a similar effect. At present, nine states
in the US have such a requirement for derivative suits (DeMott, 2016, ¶ 3.02).72 Japanese
law pursues similar objectives when it gives the court the discretion to require derivative
plaintiffs to provide a significant deposit to cover the defendant’s cost, provided that
it believes that the plaintiff acted in bad faith (Oda, 2011, p.344; Osugi, 2016, p.53).
However, ex ante fees cannot alone explain the pervasiveness of a particular type of litiga-
tion. For example, in Germany ex ante fees for derivative suits and rescission lawsuits are
similar (several thousand euros), and yet these two types of suits differ vastly in prevalence
(Gelter, 2012, pp.869, 887).
The ex post stage of litigation also plays a significant role, in particular with regard
to whether the “loser pays” or “English” rule creates a deterrent against lawsuits with
71
AktG § 148(1) Nr. 2 (Ger.).
72
These states are Alaska, Arkansas, California, Colorado, Nevada, New Jersey, New York,
North Dakota, and Pennsylvania. Many states also have general “security for costs statutes”
applicable to all suits, but limited to only certain classes of expenses, such as nonresidents (DeMott,
2016, ¶ 3.03).
M4633-GRIFFITH_t.indd 473 30/10/2018 08:16

uncertain prospects,73 as well as the availability of some form of contingency payment for
lawyers (e.g., Keay, 2016, p.44). Both UK and German law, however, allow the court to
shift the plaintiff’s expenses in a derivative suit to the corporation in an unsuccessful suit
under certain circumstances (Paul, 2010, pp.96, 101–2, 110). In any event, the incentive
effects of the “English rule” should not be overestimated, since in many jurisdictions
the reimbursement of the plaintiff is limited to court fees or to attorney fees according
to the bar association’s official rate (see Gelter, 2012, pp.862–6; for the UK, see Huang,
2010, p.254, reporting “between two-thirds and four-fifth of the actual rate”). In some
jurisdictions only court fees, not lawyers’ fees, are typically reimbursed (for France, see
Gelter, 2012, p.864; for China, see Huang, 2012, p.641). Some form of contingency fee
or conditional fee system likely plays a role in incentivizing some lawsuits; apparently
conditional fee arrangements contributed to the rise of derivative litigation in Japan in
the 1990s (West, 2001, pp.369–70). In the UK, conditional fees are limited to 100 percent
of hourly fees, which greatly attenuates the effectiveness of the mechanism in creating
incentives; it is thus not a strong substitute for contingency fees (Cheffins and Black, 2006,
p.1405). However, as the example of German rescission lawsuits shows, contingency or
conditional fees are clearly not a necessary condition for lawsuits to arise, even if they may
be a strong contributing factor.
The allocation of cost and risk also entails the necessity of collective effect. To have an
incentive to sue, shareholders would normally need a strong personal benefit from success-
ful litigation that outweighs the cost. This is normally the case in any type of suit in closely
held firms, but often not in publicly traded firms. US law overcomes this obstacle both in
the derivative suit and in the direct (class action) suit by providing powerful incentives for
plaintiff lawyers. Thus, the collective benefits of the suit are achieved by concentrating
high-powered incentives in a single party. By contrast, appraisal rights were traditionally
thought not to be particularly effective because the collective effect was absent, as share-
holders had to opt into them. Incentives only came into being with appraisal arbitrage
(Korsmo and Myers, 2015). Rescission lawsuits in Continental European jurisdictions
automatically have a collective effect as to their results; the cost-sharing problem is
mitigated by the fact that the cost for the plaintiffs are relatively limited.
4.1.3 Access to information

Another necessary element of an effective litigation system is a solution for the informa-
tion asymmetry between the parties. However, this is a much more significant issue for
some types of suit than for others. For example, it is highly significant for derivative
actions based on allegations of violations of fiduciary duties, where plaintiffs might have
to establish wrongdoing by directors. It is far less important for lawsuits challenging the
validity of shareholder decisions, since much litigation of this type revolves around viola-
tions of procedural and information requirements.
In suits alleging wrongdoing by managers or directors, the company will typically have
records that might substantiate the suit to which plaintiffs usually will not have access.
US law addresses this issue by providing pretrial discovery, which requires that the parties
73
On the use of the “American rule” in China, see Clarke (2009), pp.253–5.
M4633-GRIFFITH_t.indd 474 30/10/2018 08:16

disclose pertinent information to each other74—for a comparison, see generally Stürner,

2001.75 Moreover, the nuisance value of a suit is greater if discovery is available (Osugi,
2016, p.55). Thus, in the US the struggle between the parties often takes place before
discovery in the form of motions to dismiss, particularly in the context of the demand
requirement for derivative suits (on the significance in the context of corporate govern-
ance, see Gorga and Halberstam, 2014). In theory, a possible functional equivalent in
several European jurisdictions is the “special audit,” which a minority of shareholders
exceeding a particular percentage may be able to initiate (see Paul, 2010, pp.103–5; Gelter,
2012, pp.873–5). It is generally not thought to be widely used or effective. A more realistic
functional equivalent could be a shift in the burden of proof on directors in a number
of jurisdictions, specifically Germany, Austria, the Czech Republic, Italy, Slovenia, and
Portugal (Gerner-Beuerle and Schuster, 2014, p.203). In this case, the defendant director
or manager has to show that she acted with due care. Note that this shift does not extend
to issues of whether a decision was subject to a conflict of interest. Moreover, in Germany,
for example, the effect of this is mitigated by the primary hurdle in the “lawsuit admission
procedure” for the plaintiff to establish facts indicating dishonesty or serious violations of
the law or the corporate charter.76 Paradoxically, plaintiffs must first surpass this higher
hurdle to obtain standing before they may benefit from the shift in the burden of proof.
In some other jurisdictions, the lack of discovery procedures may be circumvented by
plaintiffs making use of information brought to light in public enforcement actions. West
(2001, pp.380–1) reports that this is a significant factor in Japan, and it may also play a
role in jurisdictions such as France, where minority shareholders can initiate criminal
enforcement actions to obtain damages (Conac et al, 2007, p.518). Another example in
this category is likely securities lawsuits in China, which have an administrative or criminal
sanction as a prerequisite (Huang, 2013, p.764).
4.2 German Rescission Lawsuits as an Example
Germany provides an example of a homegrown style of shareholder litigation that

in some ways resembles, but in other ways differs, from litigation in the US. While
shareholder derivative suits have remained relatively uncommon in spite of the 2005
liberalization, shareholder litigation has focused on the area of rescission lawsuits, which
are discussed frequently both in legal scholarship and in the business press. It is frequently
claimed that these types of lawsuit are dominated by a group often described as “profes-
sional plaintiffs” (Berufskläger) or “predatory shareholders” (räuberische Aktionäre) that
bring lawsuits for personal gain. The number of lawsuits is considerable. Vermeulen and
Zetzsche (2010, pp.24–5) report that 135, 164, and 163 suits were brought in the years 2006
through 2008, respectively. Given that 752 companies were traded in regulated markets
at that time, and about 450 in nonregulated markets, this implies that about 12 per cent
of publicly traded firms were hit with a suit each year. Baums and colleagues (2011,
p.2331) estimate that there were 580 suits in publicly traded firms between 1 July 2007
74
Fed. R. Civ. P. 26.
75
Regarding more limited pre-action disclosure in the UK, see Paul (2010), pp.94–6.
76
AktG § 148(1) Nr. 3 (Ger.).
M4633-GRIFFITH_t.indd 475 30/10/2018 08:16

Table 26.1 Types of shareholders resolution challenged (only showing types with 10 or

more lawsuits)
Type of resolution challenged Lawsuits

Discharge of supervisory board or its members 83
Discharge of management board or its members 73
Amendment of articles 44
Election of supervisory board members 40
Repurchase of own shares 33
Election of the auditor 30
Use of profits (dividend or retention) 29
Authorized capital 28
Squeeze out 27
Approval of group integration 25
Capital increase 25
Issuance of (certain) financial instruments 14
Confirmation of prior shareholder decisions 12
Capital reduction 12
Creation or elimination of conditional capital 12
Mergers, transformations, divisions 12
Source: Baums et al., 2011, p.2337.
and 30 July 2011. Most suits were brought by a small circle of repeat plaintiffs. The most
active individual, Klaus Zapf, brought 32 suits in 27 companies. The most litigious legal
entity, Pomoschnik Rabotajet GmbH, which brought 42 suits against 37 firms, was also
controlled by Mr Zapf (Baums et al, 2011, p.2334). Baums et al (2011) reviewed the types
of shareholder decisions challenged by the plaintiffs, as shown in Table 26.1.
A number of the top positions in the table are taken by lawsuits against routine resolu-
tions, such as elections and discharge resolutions, where suits are mainly an unwelcome
distraction that may inflict reputational harm on the company. However, as with merger
litigation in the US, there was considerable concern that pending lawsuits would impede
important transactions (such as a merger or issuance of new shares). This may create
allegations regarding shareholders bringing badly founded suits in order to coerce a
corporation into a financially lucrative settlement in order to allow a transaction to
proceed. Lawsuits against capital increases and reductions and related changes to the
company’s capital structure are obviously more bothersome, as they can in principle
delay or disrupt important transactions, thus creating bargaining power for plaintiffs. The
same may apply to mergers and similar transactions, which also figure on the list. Most
academic commentators believe that much of this litigation, which became common in
the late 1970s (Hopt, 1997, p.267), was not meritorious (e.g., Vermeulen and Zetzsche,
2010, p.60). Baums and colleagues’ empirical study appears to confirm that this is indeed
a significant problem, arguably because many cases settle. In the 2007–11 time window,
45 per cent of cases settled, but this rose to 72 per cent when one of the known repeat
plaintiffs was involved (Baums et al, 2011, p.2343). This appears to be the case particularly
often when the suit is brought against an important transaction such as a capital increase
M4633-GRIFFITH_t.indd 476 30/10/2018 08:16

or merger (Baums et al, 2011, p.2344). The provisions of the settlements vary, but in
addition to, for instance, increased information disclosures or improved compensation for
shareholders in a freezeout transaction, settlements appear often to include agreements
about compensation of the plaintiffs’ expenses. The authors suggest there are strong hints
that not only lawyers, but plaintiffs themselves, received significant payments (Baums et
al, 2011, p.2347).
Given that a delay to a significant transaction can inflict harm on the company, in a
few cases plaintiffs have been held liable for damages to the company. In the Nanoinvests
case,77 Mr Zapf was held liable for damages caused by frivolous litigation. Allegedly,
he had used the threat to bring a suit to coerce the company to assign to him (and to a
handful of other shareholders that joined his suit) a vastly disproportionate number of
preemptive rights in the company’s shares.
Given that the plaintiff’s actions are rarely as blatantly abusive and easy to prove
as they were in this case, liability lawsuits were not considered a solution for the
“predatory shareholders” problem. To reduce plaintiffs’ ability to coerce the com-
pany into a settlement, a reform enacted in 2005 created a “clearance procedure”
(Freigabeverfahren)78 for the increase and reduction of capital and group integration
agreements. In these cases, the corporation may ask the court to permit the registration
of the transaction while the suit is pending, thus relegating the plaintiff to damages in
the case of success. The 2005 law permitted a “clearance” only where the suit appeared
to be “obviously without foundation” and the advantages of letting the transaction go
forward outweighed the disadvantages (e.g., Naruisch and Liepe, 2007, pp.231–2). A
2009 reform expanded the procedure further and permits a clearance even if the suit
was not “obviously without foundation”79 where the plaintiff holds less than €1000 of
the nominal value of the firm’s stock, but also in cases where the court finds that harm
from the delay outweighs disadvantages to the shareholder (see Krebs, 2012, pp.966–7;
Ringe, 2015, p.506). In Baums et al’s (2011, p.2349) study, 48 out of 61 clearance
requests were approved by the courts. According to Bayer and Hoffmann (2013), the
2009 reform helped to reduce the number of defendant firms considerably (down to
55 in 2012), and had a particularly strong impact on the activities of repeat plaintiffs,
even if the fundamental problem has not been completely resolved (see also Bayer and
Hoffmann, 2014).
For the objective of this chapter, there are three key takeaways. First, even if rescission
lawsuits are not formally equivalent to (direct) shareholder class actions in the United
States, they often perform a similar function in policing controlling shareholders’ deci-
sions that might dilute the minority’s stake. At the same time, they raise similar problems
77
OLG Frankfurt, January 13, 2009, 5 U 183/07, review denied by BGH, August 10, 2010, VI
ZR 47/09; but see OLG Hamburg, October 20, 2010, 11 U 127/09 (denying liability of a plaintiff
in an allegedly abusive suit to an individual who was expected to become a shareholder of the
corporation as a result of the transaction).
78
AktG § 246a (Ger.), introduced by Gesetz zur Unternehmensintegrität und
Modernisierung des Anfechtungsrechts [UMAG], September 22, 2005, BGBl. I at 2802.
79
AktG § 246a (Ger.), as amended by Gesetz zur Umsetzung der Aktionärsrechterichtlinie
[ARUG], July 30, 2009, BGBl. I at 2479.
M4633-GRIFFITH_t.indd 477 30/10/2018 08:16

by permitting non-meritorious suits to go forward and creating the possibility for

plaintiffs to coerce the corporation into a settlement.
Second, we can see that rescission lawsuits are widespread because the preconditions
for shareholder litigation outlined in section 4.1. are met (whereas they are not for deriva-
tive suits in Germany). Rescission lawsuits have liberal standing rules and do not require
a minimum ownership threshold. Moreover, the allocation of cost and risk is favorable
for plaintiff shareholders. The amount in dispute used to measure court fees is normally
limited to the lower of 10 per cent of the corporation’s nominal capital and €500,000,80
which keeps the risk for plaintiffs within bounds.81 Finally, suits of this type tend to be
easier to bring because they often are based on allegations of inadequate information of
shareholders rather than violations of fiduciary duties. Hence, plaintiffs do not need to
be privy to internal information of the company to establish a colorable claim (for Spain
compare Sáez and Riaño, 2013, p.367).82
Third, it is difficult to set up a legal regime that maintains incentives for meritorious
suits while eliminating those for abusive ones. Arguably, the discretion granted to the
court in the 2009 reform to weigh the interests affected by the suit against each other
does just that, especially because the clearance procedure permits suits to go forward
but eliminates plaintiffs’ leverage over the company. In general, it is hard to determine to
what extent high-powered incentives to bring suits that are potentially not meritorious are
generally necessary to maintain incentives to sue at all, which in turn will create incentives
to comply with the law. In the German case, however, most rescission suits relate mainly
to procedural and disclosure requirements and therefore likely do little to police firms’
and controlling shareholders’ conduct.
5. CONCLUSION
The chapter has surveyed shareholder litigation mechanisms functionally equivalent to

the derivative and direct suits familiar from US corporate law. Overall, we can see that in
the UK, and to some extent in other jurisdictions influenced by the UK, the unfair preju-
dice remedy is used as an all-purpose mechanism for shareholder grievances, especially
in privately held firms. In some civil law jurisdictions, lawsuits challenging the validity
of shareholder resolutions are particularly important, given the types of issue that are
subject to a shareholder vote. At least in those areas, it is safe to say that, for example,
German corporate law is certainly not underenforced, even if these lawsuits have given
rise to a problematic group of “entrepreneurial” plaintiff shareholders that arguably often
attempt to coax corporations into settlements when planning significant transactions. As
in the United States, it has proven difficult to find the right balance between ensuring the
appropriate level of enforcement and preventing nuisance litigation that distracts from
gainful economic activity and sometimes entails costly buyouts of litigants.
80
AktG § 247(1) (Ger.).
81
Baums (2000), p.296 therefore suggests that only “occasional,” not “professional,” plaintiffs
will be deterred by cost risk.
82
In fact, it is sometimes alleged that plaintiffs deliberately overuse shareholder rights in the
annual meeting in order to provoke violations of formal requirements (Bayer, 2013, pp.92–3).
M4633-GRIFFITH_t.indd 478 30/10/2018 08:16

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27. Securities class actions in Canada: ten years later
Poonam Puri*
1. INTRODUCTION
Securities class actions for secondary market misrepresentations were virtually nonexist-
ent in Canada before 2005. The introduction of a statutory civil liability framework for
secondary market misrepresentations changed that. The province of Ontario was the first
to introduce this framework in December 2005, followed by other provinces.1 Until then,
only primary market misrepresentations could be addressed through a statutory scheme.
And, until then, secondary market investors could only seek recourse through common
law remedies for losses incurred as a result of misrepresentations made by public compa-
nies. But the common law required, and continues to require, proof of actual detrimental
reliance on the alleged misrepresentation.2 This typically means that each investor must
prove his/her individual reliance, which makes it difficult to seek certification and to suc-
cessfully bring a class action due to the lack of a “common issue” among investors. As a
result, Canadian investors lacked adequate recourse in the secondary market, even though
approximately 94 percent of capital market trading in Canada occurs in the secondary
market.3
Some would say that the process of getting to a statutory scheme started with the
formation of the Toronto Stock Exchange (“TSX”) Committee on Corporate Disclosure
(the “Allen Committee”) in June 1994.4 It took more than ten years of reports, proposals,
and notice and comment periods to put the 2005 statutory liability provisions in place.
* The author is grateful to Aarushi Puri, Beverly Cheung, Bilal Manji, Ekin Ober, Jory Binder,
and Jessica Hassett for excellent research assistance. The support of the Social Sciences and
Humanities Research Council (SSHRC Insight Grant 435-2013-2169) is gratefully acknowledged.
Note that all figures in the chapter are denominated in Canadian dollars unless explicitly indicated
otherwise. This chapter is current as of June 2017.
1
Securities Act, RSO 1990, c S-5, Part XXIII.1 (1995). Ontario was followed by other provinces
and territories, including: Alberta in 2006; Quebec, Manitoba, New Brunswick, Newfoundland
and Labrador, and Nova Scotia in 2007; and British Columbia, Northwest Territories, PEI, and
Saskatchewan in 2008.
2
In the province of Quebec, a civil law jurisdiction, investors could only seek recourse through
the Civil Code. Investors were similarly required to provide proof of a causal link between the
alleged misrepresentation and the harm suffered.
3
Canadian Securities Administrators, 2000. “CSA Notice 53-302 Proposal for a Statutory
Civil Remedy for Investors in the Secondary Market and Response to the Proposed Change to the
Definitions of ‘Material Fact’ and ‘Material Change’,” 23 OSCB 7383 at 7385 [hereinafter CSA
Notice].
4
This was preceded by a study initiated in May 1973 on the regulation of the Canadian
securities market. It concluded that, among other things, a statutory civil liability scheme should
be introduced for continuous disclosure violations (Anisman et al. 1979). The Allen Committee
comprised 12 members: Thomas I.A. Allen, Philip Anisman (made the dissenting statement),
482
M4633-GRIFFITH_t.indd 482 30/10/2018 08:16

Securities class actions in Canada 483
The debate surrounding the regime was animated by constant attempts to achieve the
appropriate balance between the dual objectives of deterrence and compensation. Other
questions that were raised included: How do we avoid opening the floodgates of litiga-
tion? What can we learn from the US experience? Would introducing the civil liability
scheme open the doors to strike suits? Should there be a cap on liability for damages?
The primary objective of private securities litigation could reasonably be to compensate
harmed investors. Deterring public companies from violating their continuous disclosure
obligations is, or arguably should be, a higher priority for public enforcement rather
than private enforcement. However, the 1997 Final Report by the Allen Committee
(the “Allen Report”), which propelled the 2005 regime, concluded that “the majority of
the Committee favoured a deterrence model” for the civil statutory scheme.5 The Allen
Committee justified this conclusion on the basis that “effective deterrence [would] logi-
cally reduce the need for investor compensation.”6
This chapter critically analyzes how Canada’s private securities enforcement landscape
has changed since 2005, with the introduction of statutory secondary market liability.
Specifically, this chapter examines ten years of data on secondary market securities class
actions from January 1, 2006 (the first secondary market statutory case was filed in 2006)
to December 31, 2015.7 A total of 74 secondary market claims were commenced during
the sample period, involving 47 companies.8 Of the 74 cases, more than twice as many
claims were commenced in the second half of the sample period (2011 to 2015) than in
the first half (2006 to 2010). The relatively small number of claims overall in part reflects
the relative size and maturity of the Canadian market.9
This chapter provides the first academic study of secondary market securities class
Robert Bertram, Andrew Fleming, John Howard, David L. Knight, Peter McCarter, Lise Pratte,
Terry Reid, Ken Shields, Robert Sillcox, and Alain Tuchmaier.
5
Toronto Stock Exchange, 1997. “The Toronto Stock Exchange Committee on Corporate
Disclosure, Final Report: Responsible Corporate Disclosure: A Search for Balance” at 41 [herein-
after Allen Report]. See Philip Anisman’s dissenting statement in the Allen Report.
6
Allen Report, supra note 5, at vii.
7
Ontario’s regime came into effect on December 31, 2005, and the first case (i.e. Silver v Imax
Corp, 167 A.C.W.S. (3d) 881, [2008] O.J. No 1844) was filed in 2006.
8
For the purposes of this study, a claim was considered to have commenced when the initial
statement of claim was issued. All data collected during the sample period is based on publicly
available information and is current as of June 2017. The cases were collected from the Canadian
Bar Association’s National Class Action Database (http://cbaapp.org/ClassAction/Search.aspx)
and commercial databases, such as Westlaw and Quicklaw, and were cross-referenced against each
another. We identified and obtained information on variables such as the identity of plaintiff(s),
defendant(s), and counsel, the type of claim, and the progression of the claim.
9
To put the number of claims into context, over the same sample period, there were more
than 1,700 securities class actions filed in the US. Securities Class Action Clearinghouse, http://
securities.stanford.edu/charts.html%22. This database includes all securities class actions filed
in the US, which typically are secondary market claims. However, the US capital markets are
more than 13 times larger than Canada’s capital markets (Puri 2012). Similarly, the US gross
domestic product (“GDP”) and population are nearly nine times greater than Canada’s GDP
and population. World Bank data on GDP http://data.worldbank.org/indicator/NY.GDP.MKTP.
KD?year_high_desc=true; World Bank data on total population http://data.worldbank.org/indica
tor/SP.POP.TOTL?year_high_desc=true.
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actions in Canada. Using comprehensive data, this chapter examines and analyzes key
findings, including the following:10
● Judicial interpretation of the leave requirement: To commence a secondary market

statutory liability action, a plaintiff must obtain leave of the court. Canadian courts
are playing a key role in interpreting such procedural aspects of the legislation.
Specifically, courts have gradually raised the bar for plaintiffs to obtain leave by
making the “reasonable possibility” of success threshold more onerous. Courts have
also introduced uncertainty in the application of limitation period provisions.11
● Defendant companies: The legislative cap on damages (5 percent of a company’s
market capitalization) suggests that plaintiffs and their lawyers would pursue the
largest public companies to maximize potential recovery. However, the data shows
that plaintiffs and their lawyers tend to pursue relatively large, but not the largest,
companies, with a median market capitalization of $1.2 billion. As a benchmark
for Canadian capital markets, the S&P/TSX Composite Index includes public
companies with a median market capitalization of $3 billion. This may suggest
that the largest public companies have, or are perceived to have, stronger internal
controls. In terms of industry sector, the data shows that a disproportionately high
percentage of mining companies were subject to securities class actions, while
financial institutions were disproportionately less likely to be named as a defendant.
Does this indicate anything about companies in the mining industry as compared
to those in financial services?
● Other defendants: Surprisingly, the data shows that gatekeepers, such as auditors,
underwriters, and lawyers, were rarely, if ever, named as defendants. Could this be
attributable to the legislation, which only holds experts liable in certain circum-
stances? Only 13 of the 74 cases (18 percent) involved the companies’ auditors,
suggesting that the arguments often made by auditors regarding liability floodgates
may be overblown.
● Plaintiffs: Retail investors were more likely to commence actions as compared to
institutional investors. Plaintiffs’ counsel typically play a pivotal role in commencing
class actions and actively look for representative plaintiffs to lead actions. Retail
investors may be more willing to take up the role of the representative plaintiff.
Additionally, institutional investors often face conflicts of interest in acting as
representative plaintiffs due to their commercial relationships with the potential
defendants. Institutional investors were representative plaintiffs in only 11 percent
of the 74 cases and were not substantially more likely to obtain a settlement than
retail investors. However, when institutional investor-led cases settled, they resulted
in settlements on average nearly three times higher than the settlements obtained
by retail investors (approximately $29 million versus $10 million). What is it about
10
NERA Economic Consulting has been publishing annual studies on trends in Canadian
securities class actions since 2009, but the author is not aware of any other academic studies that
have been published.
11
In Alberta, Manitoba, New Brunswick, Nova Scotia, and Ontario, the legislatures have
amended the limitation period provisions, and thus the courts’ interpretations do not apply. For
more information, see section 2 of the chapter.
M4633-GRIFFITH_t.indd 484 30/10/2018 08:16

institutional investors that makes them much less likely to be a representative

plaintiff, but more likely to obtain a significantly higher settlement amount when
they are involved?
● Plaintiffs’ counsel: Across the 74 cases in the dataset, one law firm was involved in
66 percent of the cases, suggesting that a small handful of plaintiffs’ law firms have
developed an expertise in securities class actions. Representation on the defendants’
side was significantly more diverse.
● Progression of cases: Not a single case has been heard on the merits to date. Of the
total cases, 58 percent have settled, been dismissed, or become time-barred. Based
on the sample data, the average time in which a class action was settled, dismissed,
or time-barred was three years. The shortest time was about 11 months for a case
filed in 2008. The longest was slightly over nine years, in the first case filed under
the statutory civil liability scheme in 2006. Settlement amounts have ranged from
$105,000 to $166 million, with a median of $12 million. Of the cases that settled,
68 percent had not actually been certified, but were certified for the purpose of
settlement, indicating that it is common for an action to reach settlement without
being certified.12 Do the facts that no case has been heard on the merits and that
46 percent of the cases settled indicate that the certification and leave requirements
build an early barrier?
● Public and private enforcement: First, does a public regulatory investigation or
proceeding prompt private class actions? Surprisingly, there seems to be little direct
overlap between the cases pursued by public regulatory action and private enforce-
ment. Out of the 47 companies subject to class actions, 85 percent were not subject
to public enforcement proceedings. But, where overlap did exist, public regulatory
action almost always preceded private class actions. Second, what impact will the
new no-contest settlement regime have on private class actions? And finally, has
the private regime’s focus on deterrence sent a signal to securities regulators to
shift their focus away from disclosure violations? While the number of proceedings
commenced by securities regulators for disclosure violations was low to begin with
(about 5 percent of their caseload), not a single public enforcement proceeding
relating to disclosure violations was commenced in 2016.
Section 2 of this chapter provides a brief overview of Canadian securities law and
Canadian class actions. Section 3 reviews Canadian courts’ evolving interpretations of
key procedural aspects of the new secondary market statutory regime, specifically, the
leave requirement and issues around limitation periods. Section 4 discusses the implica-
tions of the caps on damages and the types of defendants that have been named in
secondary market class actions. Section 5 discusses who can bring an action and the types
12
Class proceedings in Canada need to be certified. In Ontario, plaintiffs need to seek certifica-
tion under the Class Proceedings Act, S.O. 1992, c. 6. In general, the following five criteria need
to be met for certification: (1) the pleadings must disclose a cause of action; (2) there must be an
identifiable class of persons that would be represented by the representative plaintiff or defendant;
(3) the proposed representative must be appropriate; (4) there must be common issues among the
class members; and (5) a class procedure would be the preferable procedure for the resolution of
the common issues (Branch (2000) at 4.40–4.1080).
M4633-GRIFFITH_t.indd 485 30/10/2018 08:16

of plaintiffs that actually commence secondary market suits. Section 6 examines the status
of cases that have been brought over the past ten years. Section 7 analyzes the relationship
between the public and private securities enforcement regimes, including an assessment of
the impact of the recently introduced no-contest settlements of public actions on private
actions. Finally, section 8 concludes and discusses considerations for potential reform to
the secondary market civil liability class actions framework.
2. OVERVIEW OF CANADIAN SECURITIES LAW AND CLASS

ACTIONS
2.1 Canada’s Continuous Disclosure Regime
The mandate of securities regulation in Canada is to protect investors, encourage fair and
efficient capital markets, and promote confidence in the capital markets.13 Mandatory
disclosure is a key pillar of this mandate. Its underlying rationale is to ensure equal access
to information about publicly traded companies, whether in the primary or secondary
markets. The primary market attempts to accomplish this mandate by requiring the “full,
true and plain disclosure” of material facts in prospectus offerings;14 in the secondary
market, it is done through continuous disclosure obligations (Condon et al 2005).
Canada’s continuous disclosure regime comprises periodic and timely disclosure.
Periodic disclosure requires public companies to disclose quarterly and annual financial
statements, together with management’s discussion and analysis (“MD&A”), and addi-
tional documents, such as annual information forms and information circulars.15 Timely
disclosure requires public companies to make timely and accurate disclosure of any
material changes as they occur in real time.16
Deficient disclosure in some high-profile corporate scandals in the 1990s raised con-
cerns about the robustness of Canada’s continuous disclosure regime and failing investor
confidence in the capital markets.17 Both the public and private enforcement regimes
in Canada address continuous disclosure violations. However, the Allen Committee
concluded that the pre-2005 public sanctions provided “inadequate” deterrence.18 They
also found that the available private remedies were “so difficult to pursue that they [were],
as a practical matter, largely hypothetical,” because individual reliance could act as “a bar-
13
See, e.g., Ontario Securities Act, R.S.O. 1990, c. S-5 § 1.1.
14
See, e.g., R.S.O. 1990, c. S-5, § 56(1).
15
NI 51-102 Continuous Disclosure Obligations, 27 OSCB 3439 (2004). The term “issuer” is
used in the legislation and includes public companies.
16
See, e.g., R.S.O. 1990, c. S-5 § 75(1). NI 51-102 Continuous Disclosure Obligations defines
a “material change” as a change in the business, operations, or capital of the reporting issuer that
would reasonably be expected to have a significant effect on the market price or value of any of the
securities of the issuer. It includes a decision to implement such a change made by the board of
directors of the issuer or by senior management of the issuer who believe that confirmation of the
decision by the board of directors is probable.
17
Allen Report, supra note 5, at vi. For example, the Bre-X scandal involving misleading or
untrue resource calculations.
18
Ibid at 5.
M4633-GRIFFITH_t.indd 486 30/10/2018 08:16

rier to maintenance of a class action.”19 The private enforcement landscape has evolved
significantly since 2005 with the introduction of secondary market statutory liability.
2.2 Secondary Market Statutory Liability in Canada
In response to the increased number of continuous disclosure violations in the early 1990s,
the Allen Committee was formed in June 1994. In 1997, the Allen Committee issued the
Allen Report, recommending a statutory scheme for secondary market liability. After a
decade-long debate, the statutory civil liability scheme was first introduced in Canada.
The new statutory civil liability scheme has made it easier for investors to pursue second-
ary market liability claims; previously, they could only rely on the common law (Puri
2012). Removing the reliance requirement means finding a common legal issue to seek
certification for class actions is no longer a significant hurdle. For example, the Ontario
Securities Act now expressly provides that investors have a right of action “without regard
to whether [they] relied on the misrepresentation” (emphasis added).20 The Canadian
Securities Administrators (the “CSA”) generally supported the Allen Committee’s
recommendations, but made some significant changes along the way, including the leave
requirement, as discussed in section 3.21
Faced with the competing objectives of strengthening deterrence and providing inves-
tors with meaningful compensation, the Allen Committee “adopted improved deterrence
as its goal in the belief that effective deterrence will logically reduce the need for investor
compensation.”22 Additionally, the Allen Committee wanted to avoid imposing more
onerous liability standards than the United States, which would discourage companies
from raising capital in Canada.23 The proposal in the Allen Report also lowered the
burden of proof for plaintiffs to establish the liability of companies and their officers or
directors for certain misrepresentations. For example, companies, their officers and direc-
tors, influential persons, and experts are now strictly liable for misrepresentations in core
documents, such as annual financial statements, MD&A, and material change reports.24
A lower burden of proof combined with no actual detrimental reliance requirement
19
Ibid at 5, 34.
20
R.S.O. 1990, c. S-5 § 138.3(1), (2), (3), (4).
21
CSA Notice 53-302. To discourage strike suits, the CSA proposed that the new legislation
should include a screening mechanism requiring plaintiffs to seek leave of the court to proceed with
an action and to obtain court approval of any settlement. The CSA proposed this notwithstanding
the Allen Committee’s view that it was unnecessary to have a gatekeeper to restrict plaintiffs in their
use of the civil liability remedy. For more information, see section 2 of the chapter.
22
Allen Report, supra note 5, at vii.
23
Ibid at iii.
24
With respect to noncore documents, public oral statements, and omissions to make timely
disclosure of material changes, plaintiffs are required to prove that the defendant knew of the
misrepresentation or omission, deliberately avoided acquiring knowledge, or was guilty of gross
misconduct in relation to the misrepresentation or omission. However, a person or company may
not be liable for any part of a noncore document or public oral statement that summarizes or
is quoted from an expert report, opinion, or statement, and where the expert provided written
consent for the information to be relied on. Experts, however, may still be held liable in such cases.
See, e.g., R.S.O. 1990, c. S-5, § s 138.4.
M4633-GRIFFITH_t.indd 487 30/10/2018 08:16

18 24 claims 50 claims
16
14
Number of Claims Filed
12
10
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Imax decision Year Theratechnologies
decision
Figure 27.1 Secondary market claims filed by year
makes it easier for harmed investors to recover.25 As stated, a total of 74 secondary market
claims were commenced during the sample period, involving 47 companies. Of the 74
cases, more than twice as many claims were commenced in the second half of the sample
period (2011–15) than in the first half (2006–10), as illustrated in Figure 27.1. There was
a visible decrease in the number of claims filed in 2009 and 2015. The year 2009 marked
the Ontario Superior Court’s (the “ONSC”) decision in Silver v. Imax Corp (“Imax”)
and 2015 marked the Supreme Court of Canada’s (the “Supreme Court”) decision in
Theratechnologies Inc. v. 121851 Canada Inc. (“Theratechnologies”). However, the statu-
tory regime also imposes certain limits on investor claims, including the leave requirement
and caps on damages, as discussed in the following sections, which counterbalance inves-
tors’ ability to recover.
3. JUDICIAL INTERPRETATION OF KEY PROCEDURAL

MATTERS
3.1 The Gatekeeper Role of the Courts
The new legislation includes certain checks to discourage strike suits. First, plaintiffs are
required to obtain leave of the court to commence secondary market statutory liability
25
Section 4 of the chapter discusses the types of plaintiffs bringing class actions.
M4633-GRIFFITH_t.indd 488 30/10/2018 08:16

actions,26 which acts as an initial screening mechanism. Second, any proposed settlement
of an action requires court approval,27 which provides a final check by the court to ensure
that a proposed settlement is in the best interest of the class. Both these checks were
adopted in the 2005 regime on the recommendation of the CSA, even though neither
was proposed by the Allen Committee.28 The CSA recommended these measures due
to pressure from public companies and some instances of “entrepreneurial litigation.”29
The CSA disagreed with the Allen Committee’s assessment that the current framework
could adequately discourage strike suits. The Allen Committee considered the US experi-
ence with strike suits and was concerned that the introduction of the statutory liability
regime, together with the class action legislation, may open the floodgates to strike suits
in Canada.30 However, they concluded that this was unlikely in Canada, given the less
litigious, more conservative litigation culture and loser-pays costs rules, all of which
would deter unmeritorious claims.31
The leave requirement is a key factor that distinguishes Canada’s secondary market
statutory liability scheme from the American regime. Specifically, a plaintiff in Canada
is required to establish that the “action is being brought in good faith” and that there is a
“reasonable possibility that the action will be resolved at trial in favour of the plaintiff.”32
The case law has focused less on what “good faith” means and much more on what
“reasonable possibility” of success means. Is it a speed bump? Is it a mini-trial? Or is it a
full-blown trial? And what implications does that have for the dynamics between plaintiffs
and defendants? Initially, Canadian courts set a relatively low bar for the leave require-
ment. However, they have gradually raised the threshold for “reasonable possibility” of
success over the sample period, making it more onerous for plaintiffs to obtain leave.
In 2009, the ONSC in Imax established that the threshold is “relatively low,” requiring
“more than a de minimis possibility” of success.33 Additionally, the court held that a
“reasonable possibility” of success requires “a reasoned consideration of the evidence.”34
Imax marked the first case filed in Canada under the statutory civil liability scheme. It
was also the first case to address the leave requirement and the first to obtain leave. While
26
See, e.g., R.S.O. 1990, c. S-5, § 138.8(1).
27
See, e.g., R.S.O. 1990, c. S-5, § 138.10.
28
CSA Notice, supra note 3, at 7389.
29
Ibid at 7389.
30
Allen Report, supra note 5, at 14.
31
Ibid at 14; R.S.O. 1990, c. S-5, § s 138.11.
32
R.S.O. 1990, c. S-5, §138.8(1).
33
Silver v. Imax Corp, 184 A.C.W.S. (3d) 259 at para 324, [2009] O.J. No 5585 [hereafter Imax].
The plaintiffs alleged that Imax, a proprietary movie theatre system producer, and a few of its
officers and directors misled investors through misrepresentations overstating the company’s 2005
revenue and net income, resulting in a 40 percent decrease in the company’s share price. In 2006,
the plaintiffs brought claims under both the common law tort of negligent misrepresentation and
the statutory cause of action under the Ontario Securities Act. As Imax was dual-listed on the
TSX and NASDAQ at the time of the misrepresentations, parallel proceedings were commenced
in the United States by investors who purchased the company’s shares on NASDAQ. In 2012, the
American proceedings were settled for US$12 million.
34
Ibid at para 324.
M4633-GRIFFITH_t.indd 489 30/10/2018 08:16

the case did not proceed to a judgment on the merits, it was eventually settled in 2016 for
$3.75 million.35
Toward the end of the sample period (April 2015), in Theratechnologies, the Supreme
Court raised the bar for plaintiffs to obtain leave.36 The court stated that the threshold
for reasonable probability of success “should be more than a ‘speed bump’.”37 It held that
the threshold requires plaintiffs to provide a reasonable analysis of the relevant legislation
and some credible evidence supporting the claim, but does not entail a “mini-trial.”38
Applying this threshold to the case, the court allowed the defendant’s appeal from the
lower court’s decision granting leave to the plaintiff as the evidence failed to “credibly
point to a material change that could have triggered timely disclosure obligations.”39
Theratechnologies only dealt with the leave requirement in the legislation for the province
of Quebec, but the Supreme Court has subsequently confirmed that the same threshold
applies in Ontario.40
Turning to the evidentiary requirements for a leave application, the legislation states
that “the plaintiff and each defendant shall serve and file one or more affidavits” setting
out the material facts on which they intend to rely.41 This provision was first interpreted
by the ONSC in Ainslie v. CV Technologies Inc. (“CV Technologies”), where one defend-
ant failed to file any affidavits and the other defendants only filed affidavits of expert
witnesses.42 The court dismissed the plaintiffs’ motion for an order compelling each
35
Silver v. Imax Corp, 2016 ONSC 403 at para 15, 262 A.C.W.S. (3d) 856.
36
Theratechnologies Inc. v. 121851 Canada Inc., 2015 SCC 18, [2015] 2 S.C.R. 106 [hereinafter
Theratechnologies]. The plaintiff claimed that Theratechnologies, a TSX-listed pharmaceutical
research and development company, failed to make timely disclosure of a material change to its
investors in relation to a drug application filed with the US Food and Drug Administration (the
“FDA”). Specifically, the plaintiffs alleged that Theratechnologies failed to make timely disclosure
of the FDA’s questions on the drug’s side effects, which amounted to a material change. The public-
ity of the questions by stock quotation enterprises led to a 58 percent decrease in the company’s
share price. However, the Court found that the plaintiff failed to point to any evidence that could
qualify as a material change in the defendant’s operations, capital or business, triggering timely
disclosure obligations. The defendant had disclosed the results of the clinical trials, and there was
no new information about the side effects of the drug in the FDA questions.
37
Ibid at para 38.
38
Ibid at para 39.
39
Ibid at para 56.
40
Canadian Imperial Bank of Commerce v. Green, 2015 SCC 60 at para 122 [2015] 3 S.C.R.
801 [hereinafter CIBC (SCC)]. CIBC (SCC) was a trilogy of cases that raised similar issues
relating to the leave requirement. The three defendant companies were Canadian Imperial Bank of
Commerce, Imax Corporation, and Celestica Inc.
41
See e.g., R.S.O. 1990, c. S-5, §138.8(2). There are similar provisions in the other provinces’
legislation, excluding the province of Quebec. Section 225.4 of the Quebec Securities Act, CQLR,
c. V-1.1 only requires that the request for authorization “state the facts giving rise to the action”
and “be filed together with the projected statement of claim” to be served on the defendant(s).
42
Ainslie v. CV Technologies Inc. (2008), 93 OR (3d) 200, 304 DLR (4th) 713 [hereinafter CV
Technologies]. The plaintiffs brought an action against the TSX-listed company, three of its former
or present officers and directors, and its former auditors (Grant Thornton LLP). The plaintiffs
alleged that CV Technologies misrepresented its financial results and that the individual officers
and directors and the auditors participated in the misrepresentation, which resulted in an artificial
inflation of the issuer’s share price followed by a sharp decline after the public correction of the
misrepresentation. This led to the plaintiff investors incurring a loss. A parallel class action was
M4633-GRIFFITH_t.indd 490 30/10/2018 08:16

defendant to file and serve an affidavit sworn in their name. It stated that the legislative
purpose of the leave requirement was “to protect defendants from coercive litigation and
to reduce their exposure to costly proceedings.”43 Therefore, the court held that the leave
requirement does not place any burden on defendants; rather, the onus remains with the
plaintiffs to show that the required threshold is met.44 The court reached this conclusion
despite the clear statement in the legislation that requires each defendant to file one or
more affidavits.
As it stands now, defendants can choose either to do nothing or to take a proactive
approach by providing evidence to the court at the leave stage. To illustrate, in contrast
to the defendants in CV Technologies, the defendants in Coffin v. Atlantic Power Corp
(“Atlantic Power”) chose to “battle from the outset” by submitting a substantial volume
of evidence.45 The defendants produced more than 14,000 electronic records and filled
nearly 10 banker boxes with evidence such as fact affidavits, expert reports, and hundreds
of corporate documents, emails, and board meeting minutes.46
Has the courts’ interpretation of the legislation gone too far in advancing the objective
of discouraging strike suits? The current interpretation of the “reasonable possibility”
standard and the affidavit evidence requirement may make it difficult for investors to
pursue even meritorious claims. Typically, information and evidence about alleged mis-
conduct is asymmetrically distributed between investors and companies, with companies
having the upper hand, suggesting that the procedural threshold for investors to com-
mence an action should not be set too high. Moving forward, will more secondary market
class actions be filtered out at an early stage due to the higher threshold for obtaining
leave set out in Theratechnologies?
Atlantic Power, the first case to apply the Theratechnologies threshold, may be telling in
this regard. The plaintiffs were denied leave to proceed.47 In light of the evidentiary record
produced by the defendants, the ONSC concluded that none of the plaintiffs’ allegations
had a “reasonable possibility of success at trial.”48 While the plaintiffs’ appeal of the
ONSC decision was pending, the parties reached a settlement to dismiss the action “with
prejudice and without any payment,” including costs.49 In the settlement, the plaintiffs
also abandoned their appeal.50 The more onerous leave requirement, as interpreted in
commenced in Alberta, but that was eventually dismissed as part of the settlement reached in
Ontario for $7.1 million in 2010.
43
Ibid at para 15.
44
Ibid at para 20.
45
Coffin v. Atlantic Power Corp, 2015 ONSC 3686 at para 23, O.J. No 3927 [hereinafter Atlantic
Power]. The plaintiffs alleged that the company—a power generation company dual-listed on the
TSX and the New York Stock Exchange—its CEO, and its CFO misrepresented the company’s abil-
ity to maintain its dividend. It was claimed that this led to certain shareholders and debenture holders
incurring losses when the dividend was cut and the share price declined. The plaintiffs also alleged
that the defendants failed to make timely disclosure of a material change in the company’s business.
46
Ibid at para 24.
47
The court also denied certification of the proposed class action.
48
Ibid at para 123. The plaintiffs’ motion for certification of the proposed class action was also
dismissed.
49
ONSC Settlement Approval and Dismissal Order, Coffin v. Atlantic Power. Exhibit A
(Minutes of Settlement) at para 1 (December 2, 2015).
50
Ibid at para 2.
M4633-GRIFFITH_t.indd 491 30/10/2018 08:16

Theratechnologies, and the loser-pays cost implications of losing the appeal may have
contributed to this unique settlement, including no payment and an agreement that the
plaintiffs would not cover the defendants’ costs.
3.2 Limitation Period
Actions under the statutory civil liability scheme must be commenced within three years
after the misrepresentation was made or after the requisite disclosure should have been
made.51 If leave has been obtained, the action must be commenced within six months after
the issuance of a news release disclosing that leave has been granted.52 On the one hand,
a long limitation period is desirable to facilitate access to justice for harmed investors. On
the other hand, the period during which an investor can make a claim needs to be cut off at
a reasonable point to provide public companies and other potential defendants with some
predictability and certainty. Further, the Supreme Court has recognized that the purpose
of the limitation period is “to impose an additional mechanism designed to screen out
strike suits as early as possible in the litigation process.”53 However, until December 2015,
judicial interpretation of the application of the relevant limitation period was in flux.
This is because under the Ontario Class Proceedings Act, the commencement of a class
action tolls the limitation period that applies to a securities cause of action “asserted” in
the class proceeding.54 In other words, commencing a class action suspends the relevant
limitation period. Tolling is important because it determines whether a plaintiff’s claim
will be brought within the relevant limitation period. Judges have debated whether the
Ontario Class Proceedings Act tolls the limitation period when a plaintiff pleads in the
statement of claim an intention to seek leave under the statutory civil liability scheme, or
whether the plaintiff must actually obtain leave, at which point the tolling begins.55
The issue is what “assert” means in the context of a secondary market statutory action
and also the policy implications of tying the suspension of the limitation period to actu-
ally obtaining leave. Canadian courts have gone back and forth on this multiple times. The
concern is that obtaining leave within the three year period may be challenging.56 This is
because, first, as the limitation period is not tied to the discovery of the misrepresentation
or omission, a plaintiff needs to obtain leave and commence an action within three years
from the date of the misrepresentation or omission.57 Second, a plaintiff does not have
the power to unilaterally control whether leave is granted within the relevant limitation
period, as delays in obtaining leave may be caused by defendants’ and court availability
or resources.58
51
See, e.g., R.S.O. 1990, c. S-5, § 138.14(1). In Ontario, the basic limitation period is two years
from the date on which the claim was discovered (Limitations Act, 2002, S.O. 2002, c. 24, Sched.
B, § 4).
52
See, e.g., R.S.O. 1990, c. S-5, § 138.14(1).
53
CIBC (SCC), supra note 40, at para 47.
54
S.O. 1992, c. 6 § 28(1).
55
Ibid.
56
Green v. Canadian Imperial Bank of Commerce, 2014 ONCA 90 at para 25, 118 O.R. (3d) 641
[hereinafter CIBC (ONCA)].
57
Ibid.
58
Ibid at paras 26, 27.
M4633-GRIFFITH_t.indd 492 30/10/2018 08:16

In Sharma v. Timminco Ltd. (2012) (“Timminco”), a three-member panel of the Ontario

Court of Appeal (the “ONCA”) held that leave must actually be obtained before a statu-
tory civil liability claim can be “asserted,” so that the Ontario Class Proceedings Act tolls
the limitation period in the Ontario Securities Act.59 Two years later in Green v. Canadian
Imperial Bank of Commerce (“CIBC (ONCA)”), a five-member panel of the ONCA
overruled its own three-member decision in Timminco.60 The panel concluded that the
original decision in Timminco did not allow for “procedural simplicity and reconciliation
of the respective purposes of the [Ontario Class Proceedings Act] and the Securities
Act.”61 Rarely does a court overrule its own decision within a two-year span. The court
found that the Ontario Class Proceedings Act tolls the limitation period once an intention
to seek leave is pleaded under the statutory civil liability scheme.
Shortly after, in 2015, a very divided Supreme Court in Canadian Imperial Bank of
Commerce v. Green (“CIBC (SCC)”) reversed the CIBC (ONCA) decision and restored
the original Timminco decision. A 4–3 majority concluded that section 28 of the Ontario
Class Proceedings Act does not suspend the limitation period before leave has been
obtained. However, the majority held that courts have the discretion to issue orders nunc
pro tunc (that is, to backdate their leave orders to a date before the expiry of the limitation
period), as long as a motion for leave is filed before the expiry of the limitation period.
Courts can occasionally exercise this discretion in certain circumstances, including where
“the delay has been caused by an act of the court” and “the order would facilitate access
to justice.”62
The Supreme Court in CIBC (SCC) recognized that “[t]he decision in Timminco
seems to have taken the Ontario Bar by surprise,” leading to the limitation period being
contested in three subsequent cases.63 Until Timminco, both plaintiffs’ and defendants’
lawyers assumed that filing a motion for leave was enough to toll the limitation period.64
59
Sharma v. Timminco Ltd., 2012 ONCA 107 at para 28, 109 O.R. (3d) 569 [hereinafter
Timminco]. The plaintiffs alleged that the company made misrepresentations between March and
November 2008, resulting in a decline in the value of its shares in the secondary market. The plain-
tiffs filed a statement of claim in May 2009, pleading a common law cause of action and an inten-
tion to obtain leave for a statutory action, but leave was not obtained before the limitation period
expired in 2011. In March 2011, as the expiry of the three-year limitation period approached, the
plaintiffs sought and obtained a declaration that the limitation period is suspended, which was
reversed on appeal. The three judges on the panel were Justice Stephen Goudge, Justice Robert P.
Armstrong, and Justice Susan E. Lang.
60
CIBC (ONCA), supra note 56, at para 78. The five judges on the panel were Justice David
H. Doherty, Justice Kathryn N. Feldman, Justice Eleanore A. Cronk, Justice Robert A. Blair, and
Justice Russel Juriansz. The ONCA spent a major part of the decision considering whether it could
overrule its 2012 decision in Timminco.
61
Ibid at para 62.
62
CIBC (SCC), supra note 40, at para 90. The minority found that none of the trilogy actions
were statute-barred. This was on the basis that once a “plaintiff properly commences a class
proceeding for a common law cause of action and pleads the statutory cause of action and its
constituent elements in the statement of claim,” the limitation period is suspended. The minority
did not discuss the availability of the nunc pro tunc doctrine.
63
Ibid at para 22.
64
Trustees of the Millwright Regional Council of Ontario Pension Trust Fund v. Celestica Inc.,
2012 ONSC 6083 at para 3, 113 O.R. (3d) 264.
M4633-GRIFFITH_t.indd 493 30/10/2018 08:16

Post-Timminco, it appears that defense lawyers saw an opportunity to leverage the

uncertainty created by the court’s interpretation of the limitation period. Defense lawyers
filed three motions within a short eight-month span, dismissing the plaintiffs’ respective
actions in CIBC (SCC) as being statute-barred.
Following the ONCA’s decision in February 2014, the Ontario legislature passed an
omnibus bill in July 2014, which included amendments to the Ontario Securities Act’s
limitation period provision. Specifically, filing a notice of motion for leave now explicitly
suspends the limitation period in Ontario.65 Four other provinces, namely, Alberta,
Manitoba, New Brunswick, and Nova Scotia, have amended their securities legislation to
suspend the limitation period from the day on which the application for leave is filed.66 It
seems that these legislatures felt the need to intervene and introduce certainty for plaintiffs
with respect to the events that toll the limitation period. The latest 2016 Annual Progress
Report by the Provincial-Territorial Council of Ministers of Securities Regulation states
that “[j]urisdictions remain committed to bring forward amendments to address the
limitation period” provision.67 This suggests that other provinces may follow suit.
Until then, the Supreme Court’s decision in CIBC governs for other provinces. Tying
the suspension of the limitation period to actually obtaining leave has made it more
onerous for civil liability actions to proceed past the procedural stage. Even with the
courts’ power to backdate leave orders for statute-barred claims, it is uncertain when a
court will actually exercise such discretion. Even the Supreme Court majority was split in
its application of the nunc pro tunc doctrine in two of the three cases. The entire majority
held that filing for leave before the expiry of the limitation period was necessary to grant
nunc pro tunc.68 However, part of the majority also considered the fact that the plaintiffs
did not seek leave expeditiously.69 Thus, even if leave is filed on time, courts may consider
additional factors against issuing a backdated leave order. This makes it difficult for
plaintiffs to predict whether they will be allowed to proceed.70
Plaintiffs will likely be incentivized to commence actions in the five provinces that have
amended the limitation period provision or to rush their leave applications to obtain leave
and avoid a situation that requires a judicial assessment of whether nunc pro tunc applies.
In more complex cases, where it may be more onerous and costly to gather evidence at
65
R.S.O. 1990, c. S-5, § 138.14(2).
66
Manitoba was the first province to make this amendment in June 2012, even before Ontario,
followed by New Brunswick in May 2014, Alberta in December 2014, and Nova Scotia in
December 2015.
67
Provincial-Territorial Council of Ministers of Securities Regulation, 2016. “Annual Progress
Report” at 5, www.securitiescanada.org/2017-0419-progress-report-english.pdf.
68
CIBC (SCC), supra note 40, at paras 93, 130.
69
Ibid at para 100.
70
In Pennyfeather v. Timminico Limited, 2017 ONCA 369, the plaintiffs filed a motion for
“conditional leave” three days before the expiry of the limitation period. The ONCA upheld the
lower court’s decision to refuse nunc pro tunc relief to the plaintiffs on the basis that required dis-
cretionary factors were not met. On the criteria of filing for leave before the expiry of the limitation
period, the lower court ruled that a motion for “conditional leave” did not meet the criteria. While
the ONCA judge did not decide on the issue of “conditional leave,” he stated in obiter that “con-
ditional leave” could in fact meet the criteria. Given that the ONCA’s views in obiter conflict with
the lower court’s decision, it remains unclear as to how courts may rule on this issue in future cases.
M4633-GRIFFITH_t.indd 494 30/10/2018 08:16

the leave stage, plaintiffs may be discouraged from bringing statutory civil liability actions
in the first place.
Canadian courts have gone back and forth on issues relating to the leave requirement
and the limitation period, suggesting that they are grappling with these provisions. Each
decision has implications for plaintiffs’ incentives to commence actions and the likelihood
of success (be it a settlement or a judgment on the merits). The procedural aspects of the
legislation are complex and there are no perfect answers.
4. CAPS ON SECONDARY MARKET STATUTORY LIABILITY

AND THE TYPES OF DEFENDANTS
Another key feature of Canada’s secondary market statutory civil liability regime that
distinguishes it from the United States is the cap on liability against companies, their
management, and experts. Damages against companies and influential persons who
are not individuals are capped at the greater of $1 million or 5 percent of their market
capitalization.71 Influential persons, and companies’ or influential persons’ officers or
directors are liable up to the greater of $25,000 or 50 percent of their aggregate compensa-
tion from the company or the influential person.72 Finally, experts are liable for the greater
of $1 million or the revenue earned from the company in the 12 months preceding the
misrepresentation.73 However, the caps on liability for influential persons, officers, direc-
tors, and experts do not apply if the plaintiff can establish that the defendant knowingly
permitted or influenced the making of the misrepresentation or the failure to make timely
disclosure.74
The above caps are the same as the limits proposed in the Allen Report. The Allen
Committee’s rationale for imposing limits on secondary market liability for companies
was largely premised on balancing the conflicting interests of harmed investors and exist-
ing shareholders.75 With respect to harmed investors, they recognized that companies and
their management should be liable for harm caused by continuous disclosure violations.76
However, the Allen Committee also recognized the potentially crippling economic
impact of unlimited damages for secondary market liability on innocent shareholders.77
Ultimately, the shareholders “indirectly and often inequitably” bear the cost of securities
class actions, including settlements (Coffee 2006). This was not an unfounded concern.
The American experience illustrated the upward trend for secondary market actions to
71
See, e.g., R.S.O. 1990, c. S-5, § 138.1. An influential person is defined as a control person, a
promoter, an insider who is not a director or officer of the responsible issuer, or an investment fund
manager, if the issuer is an investment fund.
72
See, e.g., ibid.
73
See, e.g., ibid.
74
See, e.g., R.S.O. 1990, c. S-5, § 138.7(1).
75
Allen Report, supra note 5, at 41–2.
76
Ibid.
77
Ibid at 42. In contrast, unlimited primary market liability can be justified because harmed
investors are entirely compensated from the proceeds of the primary offering and the company’s
treasury is left intact. Philip Anisman’s dissenting statement noted that the proposed cap on
companies’ liability is “a reasonable compromise from a compensatory perspective.”
M4633-GRIFFITH_t.indd 495 30/10/2018 08:16

lead to “pocket shifting” of the damages from the company, or its insurers, to the share-
holders (Puri 2012). As a result, current shareholders who bring an action against the
company are funding their own settlement. The Allen Committee’s rationale for imposing
limits on liability for individuals, such as officers or directors of public companies, was to
avoid a chilling effect on responsible individuals taking up these roles.78
Given that the caps on damages are relatively low, the ability to obtain a high settlement
under the statutory framework for secondary market liability depends in large part on the
company’s size (Puri 2012). More specifically, plaintiffs and their lawyers would look for
companies with a certain minimum market capitalization to make the case “worth their
while” to litigate. Plaintiffs’ lawyers would also consider other factors such as the absolute
quantum of potential damages and the extent of the company’s insurance, as well as the
risk that the company might go insolvent.
The caps on damages create incentives for harmed investors and plaintiffs’ lawyers
to pursue larger companies. It would make strategic sense for plaintiffs to bring actions
against public companies that have a relatively large market cap to obtain higher set-
tlement amounts and to cover the cost of properly litigating a class action. During the
sample period, claims were brought against public companies with market caps ranging
from $12 million to $137 billion, with an average of $12 billion and a median of $1.2
billion.79 Excluding two public companies not listed on the TSX, market caps ranged from
$12 million to $81 billion, with an average of $9 billion and a median of $1.1 billion.80
As expected, plaintiffs do not appear to be pursuing very small public companies.
Among the factors considered by plaintiffs and their lawyers, it is perceived that smaller
companies typically have a higher insolvency risk, and they would generally want to avoid
litigating companies that are likely to become insolvent. As a comparison to the data, the
S&P/TSX Venture Composite Index includes issuers with market caps ranging from $7
million to $492 million, with an average of $49 million and a median of $25 million.81
78
Allen Report, supra note 5, at 59. Philip Anisman’s dissenting statement concluded that the
proposed cap on directors’ and officers’ liability is “too low” and “the alternative ceiling based on
director’s or officer’s total compensation is too solicitous of directors and officers and gives insuf-
ficient weight to compensation of injured investors.” He also found that the cap “should reflect
any profits obtained by the director or officer through trading in securities of the issuer during the
period of the disclosure violation.”
79
Market capitalization values are based on data from a Bloomberg terminal for 62 of the 74
defendants or 39 of the 47 public companies, where data was available. The market capitalization
was measured on the last trading day one month prior to the class action filing date. Where a
public company was subject to more than one class action, the company’s market capitalization was
measured on the last trading day one month prior to each class action filing date. This data did not
differ significantly from the data based on each company’s market capitalization measured only on
the last trading day one month prior to the earliest class action filing date, where companies were
subject to more than one class action.
80
The two public companies that are not listed on the TSX or the TSX Venture Exchange
are American International Group Inc. (listed on the New York Stock Exchange with a relevant
market capitalization of $10 billion) and BP plc (listed on the London Stock Exchange with a
relevant market capitalization of $137 billion).
81
TMX Indices. TSX real-time indices https://web.tmxmoney.com/indices.php?section=tsxv&i
ndex=^JX#indexInfo (accessed on June 2, 2017). These are the end of day values for June 2, 2017.
The S&P/TSX Venture Composite Index is a broad market capitalization-based index, designed to
M4633-GRIFFITH_t.indd 496 30/10/2018 08:16

> $20B
Market Capitalization
$10 – 20B
$5 – 10B
S&P/TSX
$1 – 5B Median: $3B
Dataset
$500M – 1B
Median: $1.2B
$225M – 500M
$0 – 225M
– 2 4 6 8 10 12 14 16 18
Number of Companies
Figure 27.2 Defendant companies by market capitalization
In addition to the median of the data being much greater than the S&P/TSX Venture
Composite Index median, only six of the 74 cases involved companies listed on the TSX
Venture Exchange. Of these six cases, two have settled as of June 2017, and the settlement
amounts in these two cases were among the lowest recorded during the sample period.
However, surprisingly, plaintiffs do not seem to be litigating the largest public com-
panies either, as illustrated in Figure 27.2.82 As a benchmark, the S&P/TSX Composite
Index includes issuers with market caps ranging from $355 million to $138 billion, with
an average of $8 billion and a median of $3 billion.83 The median of the data excluding
the non-TSX public companies is much lower than the S&P/TSX Composite Index
median. Is this because the largest public companies have, or are perceived to have,
stronger internal controls in place and do not tend to violate their continuous disclosure
measure the performance of securities listed on the TSX Venture Exchange, and included 425 issuers
as of June 2, 2017. The TSX Venture Exchange is the primary venture equity market in Canada, and
there were 2,000 companies listed on this stock exchange as of June 2, 2017.
82
As mentioned in the introduction to this chapter, Canada’s capital markets represent only
2–3 percent of global market capitalization, while the capital markets in the US are more than 13
times larger. Thus, large companies are defined differently in Canada. Further, Canadian capital
markets are characterized by a disproportionately large number of small companies and a small
number of very large companies (Puri 2012). Additionally, in Canada, there is no quantitative
materiality requirement. In contrast, the US disclosure regime includes quantitative percentage
thresholds, which may result in lower disclosure obligations for very large companies (Georgiev
2017).
83
TMX Indices. TSX real-time indices https://web.tmxmoney.com/indices.php?section=tsx
&index=^TSX#indexInfo (accessed on June 2, 2017). The S&P/TSX Composite Index provides
approximately 95 percent coverage of the Canadian equities market and included 250 issuers as of
June 2, 2017. It is the principal gauge for Canadian-based, TSX-listed companies. The TSX is the
primary stock exchange in Canada, and there were 3,000 companies listed on the TSX as of June
2, 2017.
M4633-GRIFFITH_t.indd 497 30/10/2018 08:16

40
Data Set
35 S&P/TSX
30
Percentage of Market
25
20
15
10
–
G mer
gy
ia /
re
ls
gy
es
er
ia
er g
ria
at nin
ca
iti
th
er
lo
nc
S
ls
su
til
O
&
lth
st
En
no
na
M Mi
du
U
on
ea
ch
Fi
In
s&
C
Te
al
et
M
Industry
Figure 27.3 Defendant companies by industry
obligations as often? It does not appear that plaintiffs and their lawyers are concerned
about the immense resources that may be available to such companies, which the plaintiffs’
side would then have to match. In fact, when there have been allegations of continuous
disclosure violations against some of Canada’s largest companies, a carriage fight
between plaintiff firms ensues, signalling a high level of interest in pursuing such com-
panies. For example, the class action proceedings involving Barrick Gold Corporation in
2014 and Valeant Pharmaceuticals International, Inc. in 2015 (market capitalizations of
approximately $23 billion and $81 billion, respectively) gave rise to carriage fights that
were ultimately resolved by the court.84
In terms of industry sector, 34 percent of the 47 companies named as defendants
were mining companies. As a comparison, the materials sector, which includes mining,
constitutes around 12 percent of the S&P/TSX Composite Index.85 Thus, a dispropor-
tionately high percentage of public companies from the mining industry were subject to
securities class actions for secondary market misrepresentations, as illustrated in Figure
27.3. In contrast, financial institutions were disproportionately less likely to be named as
defendants. Around 15 percent of the companies named as defendants in the dataset were
84
The market capitalization values correspond to one month prior to the earliest class action
filing dates. See Mancinelli v. Barrick Gold Corporation, 2016 ONCA 571, 131 O.R. (3d) 497;
Kowalyshyn v. Valeant Pharmaceuticals International, 2016 ONSC 3819, [2016] O.J. No 3043.
85
TMX Indices. TSX real-time indices available at https://web.tmxmoney.com/indices.php?sec
tion=tsx&index=^TSX#indexInfo (accessed on June 2, 2017). Note that the S&P/TSX Composite
Index does not provide a perfect comparison, given that the data only reflects approximately 95
percent of the Canadian equities market by market capitalization and included 250 issuers as of
June 2, 2017.
M4633-GRIFFITH_t.indd 498 30/10/2018 08:16

from the financial services sector, but the sector constitutes nearly 36 percent of the S&P/
TSX Composite Index.86 What does this indicate about companies in the mining industry
as compared to those in financial services?
Financial institutions are subject to both market conduct regulation through securities
laws as public companies and prudential regulation through regulators such as the Office
of the Superintendent of Financial Institutions and the Financial Services Commission
of Ontario, which may impose additional internal controls and processes. In contrast,
mining companies are only subject to market conduct regulation. The mining industry
is one of two industries for which the CSA has issued additional guidance and rules
consolidating and expanding on the disclosure and reporting obligations, including
technical reports.87 One reason for this may be that the mining sector constitutes a
relatively large part of the Canadian capital markets and, thus, any disclosure scandals
would have a greater economic impact. Despite the detailed rules, a 2013 review by the
Ontario Securities Commission (the “OSC”) of the technical reports filed by Ontario
mining issuers found “an unacceptable level of compliance” with the disclosure and
reporting requirements.88
Finally, gatekeepers, such as auditors, underwriters, and lawyers, were rarely, if ever,
named as defendants by plaintiffs and their lawyers. Could this be attributable to the
legislation, which provides that experts are only liable if an expert report, opinion, or
statement contains the misrepresentation, and it is quoted or summarized with the
expert’s written consent?89 Plaintiffs and their lawyers named public companies and/or
their officers and directors in 70 of the 74 cases (95 percent).90 None of the cases named
the companies’ lawyers as defendants. Only seven of the 74 cases (9 percent) named the
companies’ underwriters as defendants. In 2016, the ONSC held that underwriters are
not “experts” for the purposes of a statutory civil liability action and “are not intended
to be caught by the secondary market liability provisions.”91 The court reasoned that
underwriters are already subject to primary market liability under section 130 of the
Ontario Securities Act.92 This decision will likely further discourage claims against
underwriters.
Finally, 13 of the 74 cases (18 percent) named the companies’ auditors as defendants.
Canadian auditors have generally succeeded in narrowing the scope of their liability
through legislation and common law because of the perception of a “liability crisis” (Puri
& Ben-Ishai 2003). The low percentage of cases involving auditors in the dataset suggests
that liability floodgates arguments often made by auditors may be overblown.
86
TMX Indices. TSX real-time indices available at https://web.tmxmoney.com/indices.php?sec
tion=tsx&index=^TSX#indexInfo (accessed on June 2, 2017).
87
NI 43-101 Standards of Disclosure for Mineral Projects; Form 43-101F1 Technical Reports.
The other industry is oil and gas.
88
See OSC Staff Notice 43-705, 2013. “Report on Staff’s Review of Technical Reports by
Ontario Mining Issuers.”
89
See, e.g., R.S.O. 1990, c. S-5, § 138.3. The examples of “experts” included in the Ontario
Securities Act include auditors but not underwriters.
90
In the remaining four cases, only auditors or underwriters were named as defendants.
91
LBP Holdings v. Allied Nevada Gold Corp., 2016 ONSC 1629 at para 47, 130 O.R. (3d) 401.
92
Ibid at para 62.
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5. STANDING AND TYPES OF PLAINTIFFS
Who has standing to pursue a statutory secondary market claim in Canada? If a misrep-
resentation is made in a document or statement, any person or company who transacts
in a company’s securities has a right of action.93 What are the dynamics at play? What
types of investors pursue secondary market statutory liability actions? Does the type of
investor—retail or institutional—have an impact on settlements or settlement amounts?
Retail investors generally do not have the resources or expertise to pursue litigation
when harmed. Given the cost of litigation and the high threshold to obtain leave under
the 2005 civil statutory scheme, one would expect that retail investors would commence
few actions unless brought as class proceedings. However, for statutory claims pursued
as a class action, the new civil liability regime has made it easier for plaintiffs to seek
certification and for a class to go forward by removing the reliance requirement that
continues to exist in the common law. In addition, the 1992 legalization of contingency
fee arrangements for class actions has been an impetus for class actions, along with third
party litigation financing (Puri 1998).
By comparison, institutional investors are more sophisticated, better informed, and
have more resources. On this basis, one would expect institutional investors to pursue
more statutory liability actions. But the story for institutional investors is slightly more
complicated. They often face conflicts of interest in acting as representative plaintiffs
due to their commercial relationships with the very companies that might be potential
defendants (Cox & Thomas 2006; Cox & Thomas 2005). Additionally, institutional inves-
tors may not be inclined to divert their resources to litigation efforts, away from their core
business of investing.
Based on our data, retail investors were more likely to commence actions as compared
to institutional investors. Of the 74 cases, 60 (81 percent) were commenced by retail inves-
tors, six (8 percent) were commenced by both institutional and retail investors, and only
eight cases (11 percent) were commenced by institutional investors alone.94 This may be
because plaintiffs’ counsel typically play a pivotal role in commencing class actions and
will actively look for representative plaintiffs to lead actions.95 Further, it may be relatively
easier to find a retail investor willing to take up the role of a representative plaintiff than
an institutional investor for the reasons mentioned above.
In terms of plaintiffs’ counsel, one law firm was involved in 66 percent of the cases in
the sample.96 This suggests that plaintiffs’ lawyers have developed an expertise in securities
class actions, attracting plaintiffs to the few law firms with this expertise. Representation
on the defendants’ side was significantly more fragmented.
Despite the relatively few cases commenced by institutional investors, research shows
93
See, e.g., R.S.O. 1990, c. S-5, § 138.3.
94
In the US, there may be more cases commenced by institutional investors because of the
rebuttable presumption under the Private Securities Litigation Reform Act of 1995 that the lead
plaintiff should have “the largest financial interest in the relief sought by the class.”
95
Some plaintiffs’ counsel reportedly hire lobbyists to persuade institutional investors to
assume the representative plaintiff position (Cox & Thomas 2006).
96
Siskinds LLP was involved in 66 percent of the cases. Other firms included Sutts, Strosberg
LLP, and Koskie Minsky LLP.
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that the type of investor may have an impact on the settlement value obtained. In the
United States, institutional lead plaintiffs are associated with improved settlements and
larger recoveries (Cox & Thomas 2006). In Canada, the data shows that claims com-
menced by institutional investors were not necessarily more likely to obtain a settlement
than claims commenced by retail investors. To illustrate, as of June 2017, five of the eight
cases (63 percent) commenced by institutional investors were completed (that is, settled,
dismissed, or time-barred), of which four (80 percent) have settled. Similarly, 34 of the 60
cases (57 percent) led by retail investors have been completed, of which 27 (79 percent)
have settled. However, the data shows that as of June 2017, in cases led by institutional
investors, the average settlement is approximately $29 million, while in cases led by retail
investors it is only $10 million.
The low number of suits brought by institutional plaintiffs makes it difficult to draw
definitive conclusions. However, the relationship between settlements and retail and insti-
tutional investor-led cases in the dataset is consistent with the finding that institutional
investors are often associated with higher settlements (Cox & Thomas 2006). Therefore,
while the type of investor does not necessarily influence whether a settlement is obtained,
the data suggests that cases led by institutional investors resulted in higher settlements.
One reason for this may be that institutional investors tend to own a larger proportion of
shares than retail investors, and therefore incur greater damages (Cox & Thomas 2006).
Institutional investors also tend to reject early settlements that would fail to adequately
compensate their losses (Cox & Thomas 2006). Overall, the four settled cases involving
institutional plaintiffs, along with findings from other studies, seem to suggest that it may
be preferable from the investor recovery perspective to have an institutional investor as
the representative plaintiff. However, it might be more difficult for plaintiffs’ counsel to
get institutional investors on board.
6. STATUS OF SECONDARY MARKET SECURITIES CLASS

ACTIONS IN CANADA
6.1 Progression of Cases
As mentioned previously, plaintiffs are required to obtain leave of the court to commence
secondary market statutory liability actions. Additionally, plaintiffs are required to seek
certification under the respective province’s Class Proceedings Act.97 The certification
process is an additional screening mechanism to filter out frivolous class actions. All
secondary market statutory liability actions originate in the province’s trial courts, where
the court decides whether to grant leave and to certify a class proceeding. As illustrated in
Figure 27.4, both representative plaintiffs and defendants have the right to appeal the trial
court’s decision on leave and certification in the divisional court or the province’s court
of appeal. If either party wants to appeal the appellate court’s decision in the Supreme
Court, they must seek permission to appeal. Once plaintiffs obtain leave and certification
to commence an action as a class, the case proceeds to judgment on the merits in the trial
97
See, e.g., S.O. c. 6 § 5(1); Class Proceedings Act, R.S.B.C. 1996, c. 50, § 4(1).
M4633-GRIFFITH_t.indd 501 30/10/2018 08:16

Either party has the right to appeal the

decision by the trial court at the
Pre-certification, defendants divisional court and/or the appellate
can bring a motion to strike court level. To appeal the appellate
and/or a motion for court’s decision at the Supreme Court,
summary judgment. either party must seek permission.
Certification & Judgment on the

Claim Commenced Case Concluded
Leave Merits*
Certification requires a plan

that sets out a workable
method for advancing *None of the 74 cases have proceeded to a
the action. judgment on the merits
Average time to settlement or case dismissal ~3 years
Figure 27.4 Progression of an action
court. Again, either party has a right to appeal the trial court’s judgment in the court
of appeal, but there is no appeal as of right at the Supreme Court level. Parties require
permission to appeal.
Certification in Canada requires a representative to prepare a plan that sets out a
workable method for advancing the action on behalf of the class.98 The onerous certifica-
tion and leave requirements build an early barrier to entry for securities class actions in
Canada (Puri 2012). None of the 74 cases have proceeded to a judgment on the merits,
although many cases have settled (46 percent). Of the 74 cases in the dataset, 43 (58
percent) have settled, been dismissed, or become time-barred as of June 2017. Of these
43 cases, 34 (79 percent) were settled, seven were dismissed, and two were time-barred
(including Timminco). Settlement amounts have ranged from as low as $105,000 to $166
million, with an average of $18 million and a median of $12 million.99 In all, 31 of the 74
cases (42 percent) were still ongoing as of June 2017. Based on the sample data, the aver-
age time until a class action was settled, dismissed, or time-barred was three years. The
shortest time was about 11 months for a case filed in 2008. The longest was slightly over
nine years, which was for the first case filed in Canada under the statutory civil liability
scheme in 2006. This data suggests that the procedural hurdles before a class action can
even get under way may be slowing down the progress of the cases.
98
See, e.g., S.O. c. 6 § 5(1)(e)(ii); R.S.B.C. 1996, c. 50, § 4(1)(e)(ii).
99
Most of the cases in the dataset involved more than one settlement with multiple defendants.
In some instances, all settlements occurred at the same time, while in others, different defendants
settled separately. For the purposes of this chapter, all settlements corresponding to the same claim
have been aggregated. The settlements in the dataset also included a unique settlement involving
no payment to the plaintiffs and an agreement for both parties to cover their own costs, which has
been excluded from the figures above as an outlier.
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Aside from the merits, there are different pressures for both parties to settle. As men-
tioned previously, the new regime has made it easier for plaintiffs to seek certification in
a class action by removing the reliance requirement and thus providing a common legal
issue. Therefore, it would be pragmatic for public companies to avoid prolonged litiga-
tion and to reach an early settlement. This would help mitigate the reputational risk and
damage to the company, including the impact on stock prices. Of the cases that settled,
68 percent had not actually been certified but were certified for the purpose of settlement,
indicating that it is common for an action to reach a settlement without certification. This
suggests that both defendants and plaintiffs may be conducting a cost–benefit analysis.
Defendants may be willing to settle to minimize the nuisance value, to avoid diverting
management’s time from the business to litigation, and to preserve their market reputation.
Defendants may also be incentivized to settle earlier rather than risk certification, which is
more likely to happen now because it is easier to find a common issue under the statutory
scheme than the common law. Further, the higher threshold for obtaining leave may now
push plaintiffs to accept early settlement offers even before leave is obtained. Are plaintiffs
also incentivized to settle for less than they might get post certification, so as to obtain an
earlier settlement with less effort and fewer resources used? Plaintiffs’ counsel, who tend
to play a more leading role in obtaining settlements than do plaintiffs, may be willing to
accept a lower amount earlier rather than a higher amount later, given the significant
resources that are required to carry a class action and the risk discount involved.100
7. RELATIONSHIP BETWEEN PUBLIC AND PRIVATE

SECURITIES ENFORCEMENT
Public and private securities enforcement regimes should not operate in silos but, rather,
should complement each other.101 Striking the right balance between the two is key to
fostering investor confidence and efficient capital markets. In Canada, both public and
private enforcement operate concurrently, promoting the robustness of its capital markets
(Puri 2012). While this chapter focuses on the private enforcement regime, it would be dif-
ficult to ignore the coinciding public regulatory developments for the companies subject
to securities class actions in the dataset. Further, the focus of the statutory civil liability
scheme on deterrence (largely the role of public enforcement) over compensation may
have had an impact on the level of public enforcement. Is there an overlap in the cases
pursued by public regulatory action and private enforcement? Very few companies were
subject to both public enforcement proceedings and private class actions. Out of the 47
100
Plaintiffs’ counsel may be willing to take the risk discount by securing a lower amount
earlier in exchange for less risk (there is a possibility that plaintiffs may get an even lower settlement
amount later, as the cost of litigation increases and the value of the settlement decreases after
taking into account the time value of money).
101
There has been considerable debate on whether public or private enforcement is more
important for promoting investor confidence and fostering efficient capital markets (La Porta et
al. 2006; Jackson & Roe 2009). Some scholars conclude that private enforcement is more valuable
than public enforcement (La Porta et al. 2006), while others consider public enforcement just as
important as private enforcement (Jackson & Roe 2009).
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companies subject to class actions, 77 percent were not subject to any public enforcement
activities, including informal investigations, while 85 percent were not subject to public
enforcement proceedings.
One argument that is often made is that plaintiffs’ counsel benefit from the efforts of
public enforcement staff, so that when an investigation is announced, it prompts plaintiffs’
counsel to commence class actions. In investigations, securities regulators have a number
of enforcement tools available to them that are not available to plaintiffs’ counsel. This
includes the ability to compel information and documents from public companies. Public
companies are granted a license to participate in the capital markets, and the securities
regulators’ access to these tools allows them to ensure that the capital markets function
smoothly. In private enforcement, plaintiffs must wait until the discovery stage to gather
information and documents, unless defendants file affidavit evidence at the leave stage.
Overall, there were few cases in the sample with an overlap between public regulatory
action and private class actions. But, where there was an overlap, public enforcement
activity almost always preceded private class actions. Of the companies in the sample
subject to both public enforcement proceedings and private class actions, none of the
class actions were preceded by the securities regulators’ statement of allegations. However,
nearly all of them were preceded by some indication of public enforcement activity.
This included public disclosure of a regulatory investigation made by the companies
themselves or cease-trade orders by securities regulators for the same reasons underlying
the class actions. One conclusion that can be drawn from this is that public regulatory
action does indeed signal to plaintiffs’ counsel that there are potential misrepresentation
or disclosure issues that would be ripe for class actions. That said, there were very few
companies that were subject to both public regulatory action and private class actions.
7.1 Public Regulatory Actions
A public regulatory action in Canada is preceded by an investigation. The OSC begins

with an informal investigation, which can be prompted by multiple avenues, including
investor complaints, market surveillance technology, and newspaper articles (Puri 2017).
If OSC staff decide to move to the next stage, they launch a formal regulatory investiga-
tion and serve the company under investigation with a summons forcing them to testify.
Typically, the OSC does not publicly disclose its investigations, although companies may
choose to do so if the investigation would be considered material.
Once the investigation is complete and if OSC staff find that the company under
investigation has violated securities laws, the next step is to issue a non-public enforce-
ment notice (the United States equivalent of a “Wells Notice”) to the company and/or
its officers and directors. If no settlement is reached at this point, OSC staff commence
public enforcement proceedings by issuing a Notice of Hearing and a Statement of
Allegations. Settlements reached with OSC staff require the Commission’s approval and
are eventually made public. The other provincial securities regulators in Canada have
adopted a similar approach.
Generally, public enforcement is driven by a host of factors, such as choosing cases
that send a message to deter companies from similar violations and are in the public
interest, but compensating harmed investors is not one of these. However, the decision
to bring a private action is largely a function of whether the defendants will be able to
M4633-GRIFFITH_t.indd 504 30/10/2018 08:16

adequately compensate investors and their lawyers. Even though the Allen Committee
and the CSA adopted deterrence as the primary objective of the statutory scheme, in
practice, securities class actions are largely driven by plaintiffs’ counsel. Thus, there would
not be much overlap between public and private enforcement. Out of the 47 companies
subject to class actions, there was some degree of public enforcement activity against 11
companies (23 percent), ranging from cease-trade orders and informal investigations to
public enforcement proceedings.
As expected, companies were generally not subject to both the public and private
enforcement regimes. Has the private regime’s focus on deterrence sent a signal to securi-
ties regulators to shift their focus from disclosure violations to other types of offenses?102
There has been a decreasing trend in the number of proceedings being commenced by
Canadian securities regulators for disclosure violations, from 5 percent in 2011 to no
proceedings in 2016.103 Is there a need for more public enforcement to tackle continuous
disclosure violations to achieve optimal deterrence? Additionally, given that the market
capitalization-based liability cap encourages plaintiffs and their lawyers to pursue larger
companies, smaller companies may effectively be immune from private enforcement (Puri
2012). Therefore, public enforcement is particularly important with respect to disclosure
by smaller companies, and initiatives such as the OSC’s recent Whistleblower Program
may need to be further tailored to close this gap.104
Public enforcement proceedings (which are separate from cease-trade orders) relating
to the same facts as the class actions were announced against seven of the 47 companies
(15 percent) and/or their senior executives and directors. Of these proceedings, two were
dropped: an OSC investigation into Imax Corporation’s accounting practices and a
“Wells Notice” that had been issued to Manulife Financial Corporation (“Manulife”).
Of the five proceedings that moved forward, two were brought by the OSC against
Sino-Forest Corporation (“Sino-Forest”) and Greenstar Agricultural Corporation, and
two were brought by the Alberta Securities Commission against Afexa Life Sciences Inc.
(formerly known as CV Technologies Inc.) and Poseidon Concepts Corp. (“Poseidon”).
The British Columbia Securities Commission brought the fifth proceeding against
Southwestern Resources Corp.
For 10 of the 11 companies that were subject to some degree of public enforcement
activity, some indication of public enforcement activities preceded some or all of the
corresponding class actions.105 Either the companies made the investigations or receipt
102
The OSC’s 2017–18 enforcement priorities include reducing regulatory burden in the public
markets by lowering ongoing disclosure requirements. See OSC Notice 11-777—Statement of
Priorities—Request for Comments Regarding Statement of Priorities for Financial Year to End
March 31, 2018, www.osc.gov.on.ca/en/SecuritiesLaw_sn_20170323_11-777_rfc-sop-end-2018.htm.
103
Canadian Securities Administrators, 2012. “2012 Enforcement Report,” www.securities-
administrators.ca/uploadedFiles/General/pdfs/CSA-2012-English-rev2014.pdf; Canadian Securities
Administrators, 2016. “2016 Enforcement Report,” www.csasanctions.ca/CSA_AnnualReport2016_
English_Final.pdf.
104
OSC Notice of Policy Adopted under Securities Act, 2016. “OSC Policy 15-601 Whistleblower
Program.”
105
Note: The only exception was Southwestern Resources Corp., which involved enforcement
proceedings against the company’s CEO alone. For Poseidon, the public disclosure of a cease-trade
order by the regulator preceded four out of the six class actions relating to the company.
M4633-GRIFFITH_t.indd 505 30/10/2018 08:16

of a “Wells Notice” public, or securities regulators issued cease-trade orders for the same
reasons underlying the class actions. One conclusion that can be drawn from this data is
that an indication of public enforcement activities, such as an investigation, can encour-
age class actions, even if they do not ultimately translate into public enforcement proceed-
ings by the securities regulator. An indication of public regulatory action may signal to
plaintiffs and their counsel that there are potential misrepresentation or disclosure issues
that would be ripe for class actions.
Imax, the first private action under the statutory civil liability scheme, is one example.
It was preceded by an informal inquiry by OSC staff in June 2006 into the company’s
“accounting policies and related matters.”106 Similar to the subject matter of the class
action, the “primary focus” of the OSC investigation was “the Company’s application
of multiple element arrangement accounting to its theatre installations and system
agreements.”107 Three months later, investors brought a class action. In June 2011,
Imax announced that OSC staff had ended their inquiry and “will be taking no further
action.”108 Even though the class action started after public regulatory action, it still took
nine years to settle. The class action was not resolved until December 2015, when the
ONSC approved the parties’ $3.75 million settlement.109
Manulife is another example of how public regulatory action may prompt private class
actions. The company was similarly subject to an OSC investigation before investors
brought two class actions in Ontario and Quebec.110 In June 2009, Manulife received
a “Wells Notice” from OSC staff regarding its “disclosure before March 2009 of risks
related to its variable annuity guarantee and segregated funds business.”111 The OSC
indicated in its preliminary conclusion that Manulife “failed to meet its continuous
disclosure obligations related to its exposure to market price risk in its segregated funds
and variable annuity guaranteed products”; Manulife responded to this.112 Just a month
later, investors brought class actions in Quebec and Ontario. Manulife announced two
years later that OSC staff would not be seeking “any orders from the OSC in connection
with the enforcement notice delivered by staff in June 2009.”113 However, the class actions
went on to be settled for $69 million almost eight years later, in 2017.114
106
Imax, 2010. Form 10-K at 23. The SEC initiated a formal investigation in parallel on or
about September 3, 2010.
107
Press Release, Imax Corp., 2007. “Imax Announces Delay in Filing of 2006 10-K,” March 29,
2007, http://investors.imax.com/phoenix.zhtml?c=118725&p=irol-newsArticle&ID=979259#top.
108
See Alastair Sharop, 2011. “Imax Says SEC Dropping Accounting Probes,” Reuters
Canada, http://ca.reuters.com/article/businessNews/idCATRE75S7VU20110629. The SEC inves-
tigation was also dropped at the same time.
109
Imax, 2015. Order Approving Settlement and Fees. “Marvin Neil Silver and Cliff Cohen
and Imax Corporation, Richard L. Gelfond, Bradley J. Wechsler, Francis T. Joyce, Neil S. Braun,
Kenneth G. Copland, Garth M. Girvan, David W. Leebron and Kathryn A. Gamble,” www.
siskinds.com/cmsfiles/PDF/Securities/Imax/ORDER_OF_JUSTICE_BALTMAN.pdf.
110
Dugal v. Manulife Financial Corporation, 2011 ONSC 1785, 105 O.R. (3d) 364; Comité
syndical national de retraite Bâtirente inc. c. Société financière Manuvie 2011 QCCS 3446, [2011]
J.Q. no 9021.
111
Manulife, 2010. Annual Information Form at 59.
112
Ibid.
113
Manulife, 2011. Annual Information Form at 56.
114
Settlement Agreement, 2017. “Settlement Agreement between Ironworkers Ontario Pension
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Sino-Forest is a unique example of how public regulatory action may prompt private
class actions. The company’s disclosure of an investigation by OSC staff preceded all
three class actions and a cease-trade order indicating an ongoing investigation preceded
the final class action. In addition, the OSC took the unusual step of disclosing its
investigation. The company announced on June 8, 2011 that OSC staff had “opened an
investigation.”115 Quebec investors commenced a class action the next day, followed by
investors in Ontario on July 20. In August 2011, OSC staff issued a cease-trade order
banning all trading in the securities of Sino-Forest, indicating that they were “conducting
an investigation into the activities and business of Sino-Forest and its subsidiaries and
their management.”116 The order also required the chairman and CEO, as well as some
senior executives, to “resign any and all positions” that they held in Sino-Forest or in “any
other registrant” and prohibited them from becoming or acting as director or officer of
any issuer. Investors in Saskatchewan commenced a class action three months later.117
Sino-Forest filed for bankruptcy protection under the Companies’ Creditors Arrangement
Act in March 2012.118 The OSC staff issued a Notice of Hearing and Statement of
Allegations against Sino-Forest, its former chairman and CEO, its former CFO, and four
other senior executives two months later. In December 2012, OSC staff separately com-
menced public enforcement proceedings against Ernst & Young LLP (“EY”), who had
been the auditors of Sino-Forest between 2007 and 2012. The allegations included that
EY “failed to undertake their audit work on the Sino-Forest engagement with a sufficient
level of professional skepticism.”119 OSC staff entered into settlement agreements with
the CFO in June 2014 and EY three months later.120 For the remaining respondents, the
Fund Leonard Schwartz Marc Lamoureux and Le Mouvement D’éducation et de Defense Des
Actionnaires (“Medac”) and Manulife Financial Corporation (“MFC”) Dominic D’Alessandro
and Peter Rubenovitch,” www.manulifesettlement.com/sa.
115
Press Release, Sino-Forest. 2011. Sino-Forest Confirms Ontario Securities Commission
Investigation, www.siskinds.com/cmsfiles/PDF/Securities/Sino/A100-149/A-126%20-%20Sino%20
Press%20Release%20-%20June%208,%202011%20-%20SF%20Confirms%20Ontario%20Securitie
s%20Commission%20Investigation.pdf.
116
OSC Temporary Order, 2011. “In the Matter of the Securities Act R.S.O. 1990, c. S.5, as
Amended and in the Matter of Sino-Forest Corporation, Allen Chan, Albert Ip, Alfred C.T. Hung,
George Ho and Simon Yeung Temporary Order (Section 127(1), 127(5)),” www.osc.gov.on.ca/en/
SecuritiesLaw_ord_20110902_221_sino-forest.htm.
117
The class actions were filed against Sino-Forest, its former chairman and CEO, its former
CFO, other senior officers and directors, auditors, and underwriters. The plaintiffs alleged that,
among other things, the defendants misrepresented that Sino-Forest’s financial statements had
been compiled in accordance with generally accepted accounting principles by materially mis-
stating the company’s assets and results of operations. As of June 2017, the court had approved
settlements with EY (approved on March 20, 2013); the former CFO (approved on July 24, 2014);
the underwriters (approved on October 30, 2015); Sino-Forest’s independent directors (approved
on March 29, 2016); and BDO Limited, as the former auditors, and certain Sino-Forest directors
(both approved on November 16, 2016).
118
Office of the Superintendent of Bankruptcy Canada, 2015. CCAA Records Sino-Forest
Corporation, www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/br02791.html.
119
OSC Statement of Allegations, 2012. “In the Matter of the Securities Act R.S.O. 1990, c. S.5
as Amended and In the Matter of Ernst & Young LLP,” at para 2.
120
Both these settlement agreements were approved by the Commission on July 21, 2014 and
October 3, 2014, respectively.
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hearing on the merits commenced in September 2014, and the proceedings were ongoing
as of June 2017.
7.2 Impact of No-Contest Settlements
The relationship between public and private securities enforcement may be impacted by
the terms on which public actions are settled, particularly whether they include an admis-
sion of liability. No-contest settlements of public actions (that is, settlements reached
without companies admitting liability or any facts) can be a double-edged sword. On the
one hand, no-contest settlements can be disadvantageous to plaintiffs because the admis-
sion of liability in public enforcement proceedings helps facilitate settlements of private
class actions. On the other hand, no-contest settlements may incentivize companies to
offer earlier and larger settlements to harmed investors, so that that they can go to the
OSC with “clean hands.” Unlike the United States, Canada did not have the concept of
no-contest settlements until 2014, when the OSC implemented its No-Contest Settlement
Program. This program was driven by companies’ concerns that an admission of liability
in enforcement proceedings could compromise their position in parallel private litigation,
which prevented the efficient resolution of public actions (Puri 2012).
Companies may qualify for no-contest settlements if they cooperate with OSC staff
during investigations or self-report, and if their conduct was not abusive, fraudulent, or
criminal (Puri 2017). Such settlements are particularly attractive to companies tackling
concurrent or potential class actions. However, for plaintiffs and their lawyers, no-contest
settlements are disadvantageous because the admission of liability in public enforce-
ment proceedings potentially facilitates the settlement of class actions—although, as
Philip Anisman has highlighted, even without admissions, settlement agreements in
public enforcement proceedings can assist plaintiffs and their lawyers in obtaining leave
(Anisman 2013).
The OSC has only approved seven no-contest settlements to date, all in the financial
services sector.121 Given that the companies in those cases significantly compensated
the harmed investors, the OSC seems to be carefully implementing the program in very
limited circumstances (Puri 2017). As noted in section 4, very few cases in the dataset
named financial institutions as defendants. Perhaps because financial institutions
proactively compensated harmed investors adequately, investors did not commence as
many class actions against them as they did against companies in other industries, such
as mining.
The EY settlement in 2014 with OSC staff was the first no-contest settlement to be
approved by the Commission. EY agreed to make a voluntary payment of $8 million “to
121
As of June 2017, the OSC has approved no-contest settlement agreements with the follow-
ing companies: (1) EY in September 2014; (2) TD Waterhouse Private Investment Counsel Inc.,
TD Waterhouse Canada Inc. and TD Investment Services Inc. in November 2014; (3) Quadrus
Investment Services Ltd in November 2015; (4) CI Investments Inc. in February 2016; (5) Scotia
Capital Inc., Scotia Securities Inc., and HollisWealth Advisory Services Inc. in July 2016; (6) CIBC
World Markets Inc., CIBC Investor Services Inc. and CIBC Securities Inc. in October 2016; and
(7) BMO Nesbitt Burns Inc., BMO Private Investment Counsel Inc., BMO Investments Inc., and
BMO InvestorLine Inc. in December 2016.
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advance the Commission’s mandate of protecting investors and fostering fair and efficient
capital markets.”122 Importantly, this was preceded by EY’s $117 million settlement in
November 2012 of the Sino-Forest class action in which it was involved (the highest to
date for statutory secondary market liability). This came shortly after OSC staff com-
menced public enforcement proceedings against Sino-Forest in May 2012.123 On the one
hand, no-contest settlements may make it more difficult for plaintiffs to pursue private
litigation, to the extent that plaintiffs’ counsel rely on liability admissions by defendants in
enforcement proceedings. On the other hand, no-contest settlements may not necessarily
be an obstacle for private enforcement. They may incentivize companies to offer earlier
and larger settlements to harmed investors, so that that they can go to the OSC with
“clean hands,” requesting a settlement where they do not have to admit liability or facts,
and other mitigating factors.
8. CONCLUSION
The introduction of the statutory civil liability scheme in 2005 has made it easier for
investors to pursue secondary market misrepresentation claims. Several key findings have
emerged in the past ten years. First, Canadian courts and provincial legislatures play a
key role in interpreting procedural aspects of the legislation. Courts have gradually raised
the bar for plaintiffs to obtain leave by making the “reasonable possibility” of success
threshold more onerous, and introduced uncertainty in the application of limitation
period provisions. The legislatures of five provinces have intervened and amended their
respective legislation to introduce certainty for plaintiffs with respect to the events that
toll the limitation period under the statutory civil liability scheme.
On the defendants’ side, despite the caps on damages (5 percent of market capitaliza-
tion), the data shows that plaintiffs and their lawyers tend to pursue relatively large, but
not the largest, companies. This may suggest that the largest public companies have, or are
perceived to have, stronger internal controls. In terms of industry sector, the data shows
that a disproportionately high percentage of mining companies were subject to securities
class actions. Finally, in addition to companies and their directors and officers, the data
shows that gatekeepers, such as auditors, underwriters, and lawyers, were rarely, if ever,
pursued by plaintiffs and their lawyers.
On the plaintiffs’ side, retail investors were more likely to commence actions and be
representative plaintiffs as compared to institutional investors. Plaintiffs’ counsel typically
play a pivotal role in commencing class actions and will actively look for representative
plaintiffs to lead actions. Additionally, institutional investors often face conflicts of
interest in acting as representative plaintiffs due to their commercial relationships with
the potential defendants. While not conclusive, the data also suggests that even though
institutional investors are seldom representative plaintiffs and are not necessarily more
122
Settlement Agreement, 2014. “In the Matter of the Securities Act, R.S.O. 1990 c. S.5, as
Amended and in the Matter of Ernst & Young LLP and in the Matter of Ernst & Young LLP
(Audits of Zungui Haixi Corporation) Settlement Agreement between Staff of the Commission
and Ernst & Young LLP,” www.osc.gov.on.ca/en/Proceedings_set_20140923_ernst-young.htm.
123
OSC staff commenced public enforcement proceedings against EY in December 2012.
M4633-GRIFFITH_t.indd 509 30/10/2018 08:16

likely to obtain settlements, their settlements are, on average, nearly three times greater
than those obtained by retail investors. Finally, across the 74 cases in the sample, one
law firm was involved in most of the cases, suggesting that a few plaintiff law firms have
developed an expertise in securities class actions.
In terms of the progression of cases, not a single case has been heard on the merits to
date, and many cases were still ongoing as of June 2017. Of the cases that settled, more
than half were certified at a later stage for the purpose of settlement, indicating that it is
quite common for an action to reach a settlement without certification. Finally, there does
not seem to be much direct overlap between the cases pursued by public regulatory action
and private class actions. The majority of companies subject to class actions were not
involved in public enforcement proceedings. It also appears that the number of proceed-
ings commenced by Canadian securities regulators that involve disclosure violations have
decreased, with no proceedings in 2016.
This chapter focuses on providing ten years of data, but it also raises many questions
that future studies should explore further. Overall, while the 2005 regime provides easier
access for investors to seek compensation, barriers such as the leave requirement and
caps on damages may counterbalance some of the effects of the regime. When the Allen
Committee decided to prioritize deterrence over compensation, they did so under the
presumption that deterrence would “reduce the need for investor compensation.” But
after a decade of secondary market claims under this regime, has the prioritization of
deterrence in fact translated into adequate compensation? Is there a need to strike a better
balance between deterrence and compensation to enhance market discipline?
With the current regime, there is a risk that companies may not even be effectively
deterred in view of the limits on investors’ compensation. On the one hand, caps may
provide companies with a framework to assess the costs and benefits of disclosure
violations, fueling their risk appetite. On the other hand, caps can potentially encourage
the settlement of class actions, since both parties have an expectation of the maximum
payout. Defendants know their potential loss to the business, while plaintiffs know
their potential maximum gain if the case goes to trial, providing a range that the
parties can negotiate within. But given that the $1 million cap was determined over a
decade ago, does it need to be adjusted to accurately reflect today’s market?124 Do the
caps need to strike a better balance between investor compensation and the potentially
crippling economic impact of unlimited damages on shareholders? Are there addi-
tional reforms that can better facilitate securities class actions for secondary market
misrepresentations?
Has the leave requirement gone too far? Should courts lower the bar for plaintiffs to
obtain leave of the court to commence secondary market statutory liability actions? Or
should the legislature amend the language in the statute to lower the threshold for obtain-
ing leave or remove the requirement altogether? This is unlikely to replicate the American
strike suits experience because Canada has a vastly different litigation atmosphere as well
124
For example, a chapter 13 bankruptcy under the US Bankruptcy Code has a debt eligibility
threshold, which is periodically adjusted to reflect changes in the consumer price index. A similar
approach could potentially be adopted to periodically adjust the caps on secondary market statu-
tory liability.
M4633-GRIFFITH_t.indd 510 30/10/2018 08:16

as cost rules that discourage frivolous litigation.125 The CSA proposed the leave require-
ment in the first place due to the significant pressure from the issuer community.126
Finally, would an increased overlap between the cases pursued by public regulatory
action and private class actions better facilitate class actions for secondary market
liability? Do no-contest settlements positively influence private enforcement in ways
other than the leave requirement? Further, while the lack of direct overlap between public
and private enforcement may indicate that private enforcement fills the gap for investor
protection where public enforcement falls short, private enforcement may not provide
adequate compensation on its own. Is there value in making securities investigations
against companies (not individuals) public if they meet a certain threshold?
The Canadian private securities enforcement landscape has certainly shifted over the
past ten years. Certain barriers to pursuing secondary market liability claims have been
removed, while others have arguably been added. The balance between deterrence and
compensation has also been a subject of continuous debate. With the many changes that
have occurred, there now exists a decade’s worth of litigation that can be used to evaluate
and further refine the current regime.
BIBLIOGRAPHY
Anisman, P., J. Howard, W. Grover, & J.P. Williamson, Proposals for a Securities Market Law for Canada
(Ottawa: Minister of Supply and Services, Canada, 1979).
Anisman, Philip, 2013. “No-Contest Settlements and the SEC’s Recent Experience: Implications for Ontario
(prepared at the request of Staff of the Ontario Securities Commission),” www.osc.gov.on.ca/en/SecuritiesLaw_
rpt_20130605_15-706_no-contest-settlements.htm.
Branch, Ward K., Class Actions in Canada (Aurora, Ontario: Canada Law Book).
Coffee, John C. Jr, 2006. “Reforming the Securities Class Action: An Essay on Deterrence and Its
Implementation,” 106(7) Columbia Law Review 1534.
Condon, Mary, Anita Anand, & Janis Sarra, Securities Law in Canada: Cases and Commentary (Toronto:
Emond Montgomery, 2005).
Cox, James D., & Randall S. Thomas, 2005. “Letting Billions Slip Through Your Fingers: Empirical Evidence
and Legal Implications of the Failure of Financial Institutions to Participate in Securities Class Action
Settlements,” 58 Stanford Law Review 411.
Cox, James D., & Randall S. Thomas, 2006. “Does the Plaintiff Matter? An Empirical Analysis of Lead
Plaintiffs in Securities Class Actions,” 100(2) Columbia Law Review 101.
Georgiev, George S., 2017. “Too Big to Disclose: Firm Size and Materiality Blindspots in Securities Regulation,”
64 UCLA Law Review 602.
Jackson, Howell E., & Mark J. Roe, 2009. “Public and Private Enforcement of Securities Laws: Resource-Based
Evidence,” 93 Journal of Financial Economics 207.
La Porta, Rafael, Florencio Lopez-De-Silanes, & Andrei Shleifer, 2006. “What Works in Securities Laws?” 61
The Journal of Finance 1.
Puri, Poonam, 1998. “Financing of Litigation by Third-Party Investors: A Share of Justice?” 36 Osgoode Hall
Law Journal 515.
Puri, Poonam, 2012. “Securities Litigation and Enforcement: The Canadian Perspective,” 27 Brooklyn Journal
of International Law 3.
Puri, Poonam, 2017. “When the OSC Comes Knocking,” Listed Magazine.
Puri, Poonam, & Stephanie Ben-Ishai, 2003. “Proportionate Liability Under the CBCA in the Context of
Recent Corporate Governance Reform: Canadian Auditors in the Wrong Place at the Wrong Time?” 39
Osgoode Hall Law Journal 36.
125
Puri 2017; see, e.g., R.S.O. 1990, c. S-5, § 138.11.
126
CSA Notice, supra note 3, at 7389.
M4633-GRIFFITH_t.indd 511 30/10/2018 08:16

Section C
Other Modes of Enforcement
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28. CSRC enforcement of securities laws: preliminary
empirical findings
Chao Xi
1. INTRODUCTION
At the center of the ongoing debate over comparative securities regulation is the relative
value of private and public enforcement for the development of securities markets around
the world. One line of theory—which has been characterized as the “private enforcement
primacy” thesis—argues that stronger private enforcement of investor protection, via
both disclosure requirements and private liability rules, correlates with larger and deeper
stock markets, and that public enforcement is much less relevant to financial outcomes
(La Porta et al, 2006; World Bank, 2006; Djankov et al, 2008). That thesis is matched
by a rival polar position holding that private enforcement is merely one of a number of
mechanisms that can contribute to robust securities markets (Black, 2001) and that it
has in fact played only a limited role in the development of some national markets, Italy
(Ferrarini & Giudici, 2005) and the UK (Armour, 2009; Armour et al, 2009) being notable
examples. Public enforcement, as measured by regulatory resources—it is argued from
this perspective—is significantly and robustly associated with the breadth and depth of
stock markets (Jackson, 2007; Jackson & Roe, 2009). In other words, public enforcement
does matter.
Most of the empirical evidence thus far put forward in the context of this debate
concentrates either on the formal characteristics of securities laws and enforcement
institutions (La Porta et al, 2006) or on such regulatory input as the staffing and budget
resources of regulators (Jackson & Roe, 2009). There have been few attempts at the
comparative measurement of enforcement outcomes, largely because of the considerable
data collection difficulties involved (Coffee, 2007). This chapter represents a modest
attempt to fill this important empirical gap by offering solid quantitative data on public
enforcement outcomes in China. It is hoped that the attempt will facilitate future large-
scale cross-country empirical research encompassing China.
By way of background, securities markets are a relatively recent market institution in the
People’s Republic of China (PRC). First appearing in the early 1990s, the Chinese securi-
ties markets have expanded phenomenally. The market capitalization of domestic Chinese
listed firms was in the tone of $512 billion in 2003. By the end of 2015, it had increased
almost sixteenfold to reach $8.188 trillion (World Federation of Exchanges database, n.d.),
making China’s securities markets the second largest in the world. The total number of
domestic listed firms also rose significantly over the period, increasing from 1,285 in 2003
to 2,827 in 2015 (ibid). China’s stock markets are also gaining increasing significance in the
country’s traditionally bank-dominated financial system (Allen & Qian, 2014; Pistor et al.,
2015). The size of its securities markets as a share of GDP rose from just over 30 percent
in 2003 to close to 75 percent in 2015 (World Federation of Exchanges database, ibid).
513
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The burgeoning Chinese securities markets have long been plagued by market mis-
conduct and securities law violations. Instances of fraud, abuse, and manipulation were
at one point so rampant that the Chinese stock markets were dubbed as “worse than a
casino” (Wu, 2001, cited in Green, 2004). Private enforcement of securities laws, by way
of aggrieved investors bringing civil actions against wrongdoers, has been weak, owing to
an array of legal and institutional constraints (Deng, 2005; Xi, 2006a; Guo & Ong, 2009;
Palmer & Xi, 2009), with public enforcement thus significantly greater in amount and
intensity.
This chapter draws on a unique, hand-collected dataset comprising all 466 sanction
decisions taken by the China Securities Regulatory Commission (CSRC), China’s pri-
mary securities regulator, during the period from 2006 through 2012. Its aim is to shed
empirical light on an important component of the public enforcement of securities laws
in China.1 The remainder of the chapter is structured as follows. Section 2 provides an
overview of the CSRC enforcement process, and sets the stage for the discussions that
follow. Section 3 presents the key statistical findings of the research, and discusses what
those findings tell us about the nature of CSRC enforcement actions. Section 4 offers
concluding remarks.
2. OVERVIEW OF CSRC ENFORCEMENT PROCESS
The CSRC is the Chinese equivalent of the US Securities and Exchange Commission
(SEC), and is China’s primary enforcer of the country’s securities laws. It is vested under
PRC law with the authority to investigate possible violations of securities laws and regula-
tions and to discipline culpable firms and individuals. Before we proceed to an overview of
the CSRC enforcement process,2 it is necessary to say a few words about the way in which
the CSRC enforcement apparatus is structured.
The CSRC carries out its enforcement efforts from both its headquarters in Beijing and
its local offices throughout the country. CSRC headquarters sets up two internal divisions
that share investigative authority: the Enforcement Bureau (jicha ju) and the Enforcement
Contingent (jicha zongdui). The former plays a largely coordination-oriented role; the
latter is tasked with carrying out investigations into alleged misconduct (Xi & Pan, 2017).
At the local level, the country is divided into nine regions for regulatory purposes, and
each of the CSRC’s nine regional offices houses an internal enforcement bureau. Further
down the organization’s administrative hierarchy, it operates a local office in each of the
country’s provinces, with each office typically having one or more divisions tasked with
1
The focus of this chapter is the enforcement actions taken by CSRC headquarters. The other
important components of China’s public enforcement of securities laws include the local offices
of the CSRC and the two official bourses, viz., the Shanghai Stock Exchange and Shenzhen Stock
Exchange. This research was supported by a General Research Fund grant (CUHK-452913) from
the Research Grants Council of the Hong Kong SAR.
2
The CSRC has developed a set of increasingly sophisticated rules to govern its enforcement
process, including the 2008 CSRC Implementing Measures on Case Investigation and 2013 CSRC
Opinions on Further Strengthening the Work of Inspection and Enforcement. Owing to space limi-
tations, this part of the chapter does not cite or refer to specific rules within the CSRC regulations.
M4633-GRIFFITH_t.indd 514 30/10/2018 08:16

CSRC enforcement of securities laws 515
securities enforcement. The CSRC’s Beijing headquarters focuses its efforts on the core
areas of regulatory concern: violations of disclosure laws, market manipulation, insider
trading, and so on. It also has jurisdiction over cases that are otherwise “complex, sensi-
tive, or of a unique character.” CSRC’s local offices, in contrast, pursue only matters
occurring within their respective territorial boundaries.
2.1 Filing, Investigation, and Review
The CSRC’s formal enforcement process typically starts with what is called a “filing order.”
The filing orders issued by CSRC headquarters or one of its local offices are generally
based on the outcomes of a preliminary, informal review of the facts and circumstances,
which determines whether further investigation is warranted. In other words, an informal
investigation typically precedes a filing order, although there is no requirement for a filing
to occur only after the completion of a preliminary investigation.3
A filing order can typically be initiated at CSRC headquarters in one of two ways: by
the CSRC divisions responsible for day to day surveillance of the securities markets or
by the two CSRC internal divisions tasked with the investigation. In both cases, the filing
order must be endorsed by a member of the CSRC’s top administration (presumably of
vice chairman rank or above). Filings can also be initiated and ordered directly by a top
CSRC official. Further, regional and local CSRC offices can also issue their own filing
orders on matters that fall within their territorial jurisdiction. Orders initiated at the
local level are, however, subject to review, and they may be overturned or modified by the
Enforcement Bureau at CSRC headquarters.
The next step in the enforcement process is formal investigation. There is no separate
order for a formal investigation, which, as noted, typically succeeds the issuance of a
filing order. National legislation grants the CSRC a wide range of powers in the conduct
of formal investigations:4 it can carry out visits to the sites of potential violative conduct
with a view to taking evidence, and it can compel firms and individuals under investigation
to answer queries and provide statements. The CSRC is also granted access to a variety
of records, registrations, and other documents related to the matters under investigation.
It is also vested with the authority to access trading accounts, bank accounts, and other
financial accounts pertaining to the investigation and, where necessary, freeze and/or seize
those accounts. Moreover, national securities laws also grant the CSRC the authority to
halt trading in any security that is involved in a potential case of market manipulation
or insider trading. When a listed firm learns that it has become the subject of a CSRC
investigation, it is required by CSRC regulations to disclose that investigation.
At the close of an investigation, the CSRC can take a number of actions in addition to,
or as an alternative to, instituting formal enforcement proceedings, which are discussed in
greater detail immediately below.5 The CSRC may refer cases which it considers particu-
larly egregious to the criminal authorities (the Ministry of Public Security in particular)
3
Interviews with CSRC officials.
4
2014 PRC Securities Law, Art. 180.
5
There is an additional case review process conducted by the Enforcement Bureau. The
manner in which an investigation is carried out, any factual findings, the determination of
violative conduct, and the recommendation that sanctions be imposed, if any, are all subject to a
M4633-GRIFFITH_t.indd 515 30/10/2018 08:16

and/or other authorities. It also has the discretion to conclude or terminate a formal investi-
gation if it determines that the gravity of the violative conduct is insufficient to warrant the
commencement of enforcement proceedings. In that case, the CSRC can refer the matter
to self-regulatory organizations (including the Shanghai Stock Exchange or the Shenzhen
Stock Exchange) and/or to its own divisions tasked with day to day market surveillance.
2.2 Proceedings
The CSRC can initiate formal enforcement proceedings against a regulated entity only
via its in-house Administrative Sanction Commission (ASC). The potential alternative,
bringing a civil action against the culpable firm or individual, is not available to the CSRC
under Chinese law.
The ASC acts on behalf of, and in the name of, the CSRC in enforcement proceedings.
It is composed of a number of CSRC-appointed member “judges,” and is separate both
organizationally and operationally from the CSRC divisions investigating possible securi-
ties violations. However, the ASC is not intended to serve as an adjudicator independent
of the CSRC; to the contrary, it is appointed by, and answerable to, the CSRC that creates
it. This stands in contrast with the notion of independence with regard to administrative
law judges (ALJs) operating at the SEC. AJLs are supposed to be independent, and are
largely insulated from SEC influence (Zaring, 2016). The underlying purpose of the
ASC, in contrast, is to check and balance the CSRC’s investigative powers from within.
In other words, the ASC’s role is to review the enforcement recommendations made by
the CSRC’s internal investigation divisions and to make enforcement decisions on behalf
of the CSRC. Accordingly, the ASC is not intended to be a neutral, third party arbiter;
rather, it is part of the CSRC enforcement apparatus.
ASC decisions are the outcomes of a trial-like procedure. Although it is beyond the
scope of this chapter to provide a full account of that procedure,6 it is worth highlight-
ing three important procedural rights afforded to defendants. First, regulated entities
are entitled to a hearing before a panel of ASC member judges in a manner similar to
courtroom hearings, and are entitled to representation. Second, regulated entities are also
entitled to a prehearing notice laying out the factual findings, legal determinations, and
sanctions, if any, to be imposed. Finally, an adverse decision by the ASC—in the name
of the CSRC—can be appealed to the CSRC itself, which will review the ASC decision
de novo, and an adverse determination by the CSRC can then further be appealed in the
courts. Alternatively, defendants can appeal an ASC decision in the courts.
2.3 Sanctions
China’s primary securities legislation empowers the CSRC to impose a wide variety of
sanctions on regulated entities.7 The available sanctions fall broadly into three categories:
“ substantive review.” In practice, this review process is often sidestepped to the extent that it now
takes place only in limited circumstances. Interviews with CSRC officials.
6
For a fuller treatment of the ASC, see Xi and Pan (2017).
7
2014 PRC Securities Law, Chapter 11.
M4633-GRIFFITH_t.indd 516 30/10/2018 08:16

warnings and orders to remedy misconduct; monetary sanctions, such as fines or dis-
gorgement orders; and orders suspending or barring regulated entities from the securities
industry or listed sector. These sanctions can be used singly or in combination.
Warnings are the least severe type of CSRC sanction, and are often used in combina-
tion with other sanctions. In addition to warnings, the CSRC can order regulated entities
to cease their violations of securities laws. It can also order defendants to take remedial
actions to rectify those violations, such as the disposal of illegally obtained securities or
the return of funds illegally raised from investors.
Monetary sanctions can take two forms. First, the CSRC may order defendants to
disgorge any ill-gotten profits or illicitly acquired revenues. Second, it may order defend-
ants to pay a fine, the amount of which should fall into the range prescribed by the PRC
Securities Law.
Finally, the CSRC may prohibit defendants from offering securities services on either
a temporary or permanent basis. Firms’ licenses and individuals’ qualifications may be
temporarily suspended or permanently revoked. For individuals who have committed the
more egregious violations, the Securities Law separately devises an even harsher form of
sanction, namely, an industry ban,8 which bars them from engaging in securities business,
or disqualifies them from serving as the directors, supervisors, or senior executives of
listed firms, for a fixed period of time or indefinitely.
3. DATA AND PRELIMINARY FINDINGS
3.1 The Data
The dataset comprises all 466 official sanction decisions taken by the CSRC from 2006 to
2012. CSRC sanction decisions offer a considerable amount of information concerning
enforcement actions, including the identities of violators, findings of fact, conclusions
of law, and sanctions imposed. The length of sanction decisions ranges widely, from just
a few hundred words to close to 20,000. Although some are little more than skeleton
statements, others elaborate at length on the underlying jurisprudential considerations.
The difference in length seems to depend on a number of factors, including the inher-
ent character of the violation (for example, the complexity of the case, the number of
violators involved) and other, more contingent factors (for example, the personal style
of the ASC “judges” involved). The data were hand-collected by two teams of research
assistants working independently of each other. The two teams checked each other’s work
for inconsistencies, and all data were then verified by the project’s principal investigator.
It is worth noting that CSRC sanction decisions come under two separate, and distinct,
rubrics: administrative sanctions (xingzheng chufa) and industry bans (shichang jinru).
This distinction is not to be confused with the three categories of sanction identified in
the foregoing section. Instead, their differences appear to be a matter of path dependence.
More specifically, CSRC decisions on administrative sanctions can be traced back to the
founding years of the CSRC. By way of these decisions, the CSRC is able to make use
8
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Table 28.1 Relationships among sanction types and sanction decisions
CSRC Decisions on CSRC Decisions on Industry

Administrative Sanctions Bans
Warnings and orders to remedy Yes No
misconduct
Monetary sanctions Yes No
Orders suspending or barring Yes, but not inclusive of Yes, but industry bans only
regulated entities from the industry bans
securities industry
Table 28.2 CSRC decisions on administrative sanctions and industry bans
Year CSRC Decisions on CSRC Decisions on

Administrative Sanctions Industry Bans
2006 38 19
2007 36 18
2008 52 27
2009 58 16
2010 53 16
2011 57 11
2012 57 8
Total 351 115
of almost all types of sanctions—with the exception of industry bans—against securities

violations, as deemed appropriate. The industry ban, in contrast, is a relatively new tool
in the CSRC’s regulatory toolkit. Rather than absorb it into the more established heading
of administrative sanctions, the industry ban has been given standalone status. CSRC
decisions on industry bans are considerably narrower in scope than other decisions,
making use of a single type of sanction, for example, the industry ban. Table 28.1 depicts
the relationships among the three categories of sanctions and the two rubrics of sanction
decisions.
During the period under investigation, the CSRC issued 351 decisions on administra-
tive sanctions and 115 on industry bans. The annual numbers of CSRC decisions on
administrative sanctions and industry bans, respectively, are reported in Table 28.2. It can
be seen that the annual number of the former has risen over the study period, whereas that
of the latter has declined sharply.
3.2 Violators: General
The CSRC is vested with the statutory authority to take enforcement actions against a
wide range of regulated entities and individuals. Regulated entities include issuers, listed
firms and their controlling corporations, broker-dealer firms, investment advisory firms,
financial advisory firms, credit rating institutions, and providers of securities services
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Table 28.3 Firms and individuals sanctioned by the CSRC
Year Sanctioned Firms Sanctioned Individuals

Administrative Sanction Industry Ban
2006 28 154 69
2007 30 199 59
2008 36 251 60
2009 33 219 53
2010 37 221 52
2011 43 197 16
2012 29 170 12
Total 236 1,411 321
(accounting firms, auditing firms, and law firms that engage in securities business).
Among the individuals regulated by the CSRC are the directors, supervisors, and senior
executives of listed firms; securities practitioners; and accounting, auditing, and legal
practitioners. The CSRC is also authorized to take enforcement actions against firms
and individuals engaging in insider trading, market manipulation, and other kinds of
misconduct.
Table 28.3 shows the annual number of firms and individuals sanctioned by the CSRC
between 2006 and 2012. In keeping with CSRC regulatory practice, as discussed previ-
ously, culpable individuals are divided into two separate subgroups: individuals subject
to administrative sanctions and individuals subject to industry bans. There are some
overlaps between the two, as some violations can result in an individual attracting both
an administrative sanction and industry ban. For example, a trader who violates insider
trading laws may be ordered to disgorge illicit profits and pay a fine, both of which are
imposed by a CSRC administrative sanction decision. At the same time, he or she may
also be barred from operating in the securities industry for a set period of time under a
separate industry ban. Such a trader is counted twice in Table 28.3. Our statistics reveal
144 individuals who were disciplined by administrative sanctions and an industry ban at
the same time.
There appears to be no clear pattern with respect to the annual number of firms and
individuals disciplined under the administrative sanctions rubric. The annual number of
individuals barred from the securities industry and/or from serving as a director or officer
of a public company exhibits a downward trend, however, declining sharply from 69 in
2006 to a mere 12 in 2012.
3.3 Violators: Firms
Here, we first assess the types and characteristics of the culpable firms that attract CSRC
sanctions. Table 28.4 offers a breakdown of the types of firms sanctioned by the CSRC
during the period under investigation.
It is clear from Table 28.4 that enforcing securities law violations perpetrated by listed
firms is the CSRC’s top priority, with those firms constituting the largest cohort in every
year from 2006 to 2012. Overall, listed firms account for close to half of all sanctioned
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Table 28.4 Types of firms sanctioned by the CSRC
Year Listed Broker-dealer Investment Accounting Others Annual

Companies Firms Advisory Firms Total
Firms
N % N % N % N % N %
2006 22 78.57 1 3.57 1 3.57 1 3.57 3 10.71 28
2007 22 73.33 0 0.00 0 0.00 4 13.33 4 13.33 30
2008 14 38.89 2 5.56 3 8.33 7 19.44 10 27.78 36
2009 11 33.33 0 0.00 6 18.18 5 15.15 11 33.33 33
2010 15 40.54 0 0.00 6 16.22 3 8.11 13 35.14 37
2011 14 32.56 0 0.00 10 23.26 2 4.65 17 39.53 43
2012 14 48.28 0 0.00 6 20.69 2 6.90 7 24.14 29
Grand 112 47.46 3 1.27 32 13.56 24 10.17 65 27.54 236
Total
firms in that period. The relative importance of such firms in CSRC enforcement efforts
has, however, declined significantly over the years, accounting for well over 75 percent of
the sample firms in 2006 but just over 30 percent in 2011.
Accounting firms are also frequent targets of security law enforcement for such viola-
tions as fraud or misrepresentation in their reports. Although they represent more than
10 percent of all targeted firms, they seem to have drawn considerably less enforcement
attention in recent years. The CSRC’s focus instead seems to have shifted to another group
of regulated entities, viz., investment advisory firms, which in recent years have consti-
tuted approximately 20 percent of the sanctioned firm population. Broker-dealer firms, in
contrast—which are frequent targets of securities enforcement action in the United States
(SEC, various years)—are not frequently targeted by the CSRC. Only three broker-dealer
firms in China were sanctioned during the period under investigation. The discrepancy
may well have to do with the comparatively small number of listed broker-dealer firms in
China—fewer than 20 in 2012.
Having identified the various types of sanctioned entities, we now take a closer look
at the sample listed firms. Our focus is on listed firms partly because public information
is more readily available on these firms than on private firms. Of particular interest
are two firm attributes, viz., firm size and ownership type, considered to be important
determinants of securities regulation.
Prior research in the US suggests that firm size is associated with enforcement action
outcomes, with larger firms and their employees tending to fare better in SEC enforce-
ment actions (Coffee, 2012; Gadinis, 2012). In light of such scholarship, we examine
whether larger Chinese listed firms fared better than their smaller counterparts in the
study period. We define larger firms as those included in the China Securities Index 300
(CSI 300) and its sub-index, the China Securities Index 100 (CSI 100). The CSI 300 is
roughly equivalent to the S&P 500, and consists of the 300 Chinese A-share stocks with
the largest market capitalization and greatest liquidity (China Securities Index Co Ltd,
2016a). Similarly, the CSI 100 comprises the 100 largest CSI 300 constituent companies,
as measured by market capitalization (China Securities Index Co Ltd, 2016b). Table 28.5
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Table 28.5 Sanctioned CSI 300 firms and CSI 100 firms
Year Sample Sanctioned CSI 300 Firms Sanctioned CSI 100 Firms
Listed
N % of Sample % of Chinese N % of Sample % of Chinese
Firms
Listed Firms Listed Firm Listed Firms Listed Firm
Population Population
2006 22 5 22.73 19.93 0 0.00 6.64
2007 22 4 18.18 18.79 1 4.55 6.26
2008 14 3 21.43 18.66 0 0.00 6.22
2009 11 1 9.09 17.01 0 0.00 5.67
2010 15 2 13.33 14.2 0 0.00 4.73
2011 14 2 14.29 12.78 1 7.14 4.26
2012 14 1 7.14 12.14 1 7.14 4.05
Total 112 18 16.07 3 2.68
presents the annual number of CSI 100 and CSI 300 firms sanctioned during the period
under investigation.
At first glance, CSI 300 and CSI 100 firms do not appear to have been frequently
targeted, with just 18 and 3 such firms, respectively, subjected to CSRC administrative
sanctions over the seven-year period. A closer look at the statistics, however, paints a
rather more mixed picture. Take the CSI 300 firms, for example. Table 28.5 shows their
share in the population of sanctioned firms, as compared to their share in the population
of A-share listed firms. In the seven years under investigation, CSI 300 firms were, pro-
portionately, underrepresented relative to smaller firms in four years (2007, 2009, 2010,
and 2012) and overrepresented in three (2006, 2008, and 2011). The statistics on CSI 100
firms are more difficult to interpret, as a single action against such a firm can decisively
swing the balance—as occurred, for example, in 2011 and 2012. However, it is perhaps fair
to say that the statistics are less conclusive than they might initially appear with respect to
whether large firms fare better than small firms.
Ownership type is another important consideration in terms of the manner in which
securities laws are implemented and enforced in economies with a strong state presence in
the corporate sector (Hou & Moore, 2010). Accordingly, we are interested in determining
whether state-owned firms fared better in CSRC enforcement actions during the study
period than their non-state-owned counterparts. In keeping with a prior study in this area
(Xi, 2015), we categorize the sample listed firms with reference to the identity of their
ultimate controlling shareholders: the PRC central government and its agencies; Chinese
local governments at various levels and their agencies; private individuals; or “miscellane-
ous,” such as a collective or firm without a single ultimate controlling shareholder. The
data on the ultimate controllers of the sample listed firms were hand-collected.
Table 28.6 provides a breakdown of the sample listed firms with respect to their
ultimate controllers. Table 28.7 presents two sets of comparisons: first, the annual shares
of state-owned firms in the sample listed firms, as compared to their annual shares in the
entire population of A-share Chinese listed firms; second, the annual shares of central
government-controlled firms in the sample listed firms relative to their annual shares in
the Chinese listed firm population. The patterns are very clear. With the exception of
M4633-GRIFFITH_t.indd 521 30/10/2018 08:16

Table 28.6 Ultimate owners of sanctioned listed firms
Year State-owned Non-state-owned Sample

Listed
Central Local Private Miscellaneous
Firms
Government Governments Individuals
N % N % N % N %
2006 2 9.09 7 31.82 12 54.55 1 4.55 22
2007 3 13.64 5 22.73 14 63.64 0 0.00 22
2008 2 14.29 7 50.00 5 35.71 0 0.00 14
2009 2 18.18 3 27.27 6 54.55 0 0.00 11
2010 1 6.67 2 13.33 12 80.00 0 0.00 15
2011 0 0.00 5 35.71 9 64.29 0 0.00 14
2012 1 7.14 3 21.43 10 71.43 0 0.00 14
Total 11 9.82 32 28.57 68 60.71 1 0.89 112
Table 28.7 State-owned sanctioned firms
Year State-Owned Firms* State-Owned Firms Controlled by

Central Government**
% of Sample % of Chinese % of Sample % of Chinese
Listed Firms Listed Firm Listed Firms Listed Firm
Population Population
2006 40.91 55.00 9.09 12.89
2007 36.36 63.00 13.64 10.33
2008 64.29 62.00 14.29 −
2009 45.45 60.00 18.18 −
2010 20.00 53.00 6.67 16.48
2011 35.71 47.00 0.00 7.54
2012 28.57 38.50 7.14 11.53
Total 38.39 9.82
Notes:
* Data on the annual numbers of state-owned listed firms are drawn from the Annals of State-owned
Assets Supervision and Administration in China (2007), the official website of the China Association of Listed
Companies (http://www.capco.org.cn/), and the China Securities Journal.
** Data on the annual numbers of state-owned listed firms controlled by the PRC Central Government are
drawn from the Annals of State-owned Assets Supervision and Administration in China (2007), the Securities
Herald, the Securities Daily, and other sources.
2008, state-owned firms fared significantly better, as a proportion, than their non state-
owned counterparts, and central government-controlled firms were underrepresented in
the five years for which official statistics are available.
A note of caution is in order concerning the foregoing statistical findings. Although
they are revealing, we must resist the temptation to infer a causal link between the
attributes of Chinese listed firms and the outcomes of CSRC enforcement actions, for
M4633-GRIFFITH_t.indd 522 30/10/2018 08:16

two main reasons. First, as presented, the statistics do not capture a number of other
important determinants, one of the most important of which is the underlying firm
misconduct, specifically whether there was any misconduct in the first place and, if so,
how severe it was. In the absence of this information, it is difficult to establish causality
between firm characteristics and enforcement outcomes. Second, the CSRC sanctions
examined in this research are but the tip of the iceberg. The CSRC takes a large number
of enforcement actions against regulated entities and individuals that are less formal (and
visible) in nature, and thus are not captured in our sample. Also missing from our dataset
is the vast body of enforcement actions taken by the local offices of the CSRC and the two
official stock exchanges, which are, in general, less severe than CSRC sanctions. Further
empirical research is necessary before any conclusions can be drawn on the determinants
of securities enforcement in China.
3.4 Violators: Individuals
Having dealt with the firms sanctioned by the CSRC, we now turn to culpable individuals.
Our focus is the directors, supervisors, and employees of listed firms, information on
whom is more readily available. By way of background, the corporate board structure
under Chinese law comprises two boards: the board of directors and the supervisory
board. However, that dual structure differs from the German two-tier system in an
important way: in China, both boards are appointed by the shareholders’ meeting and
are held accountable to it (Xi, 2006b; Gu, 2010; Wang, 2014). Directors, supervisors (that
is, members of the supervisory board), and senior executives owe a fiduciary duty to the
company, as well as a duty of loyalty (Howson, 2008, 2010). Under Chinese securities
law, listed firms are liable for their violations of securities laws. The individuals who are
directly responsible for those violations, be they directors, supervisors, senior executives,
midlevel managers, or frontline employees, may also be held personally liable.
Table 28.8 presents a breakdown of this cohort of culpable individuals, with non-
independent directors and members of senior management accounting for the lion’s share
(over 75 percent). Independent directors were also often the target of CSRC securities
enforcement during the study period, representing more than 15 percent of the culpable
cohort. This finding is in conformity with the well-established jurisprudence developed by
Table 28.8 Identities of culpable individuals
Year Non-Independent Independent Supervisors Others Total

Directors and Directors
Executives
2006 119 14 0 30 163
2007 160 34 0 14 208
2008 163 44 2 5 214
2009 116 24 5 16 161
2010 132 30 2 10 174
2011 116 25 8 3 152
2012 89 17 8 3 117
Total 895 188 25 81 1,189
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Table 28.9 Corporate liability and individual liability
Year Firms & Individuals Firms Only Cases Individuals Only Cases
Cases
Firms Individuals
Involved
2006 17 5 0 0
2007 21 1 3 22
2008 14 0 5 37
2009 11 0 4 25
2010 14 1 1 14
2011 13 1 3 20
2012 13 1 2 11
Total 103 9 18 129
the Chinese judiciary, and embraced enthusiastically by the CSRC, stipulating that inde-
pendent directors are not immune from directors’ liabilities (Clarke, 2006). Supervisors,
in contrast, are largely absent—and are certainly underrepresented relative to the “others”
category, which includes frontline employees and midlevel managers—offering some
evidence in support of the conventional view that the Chinese supervisory board is, in
practice, something of a figurehead, playing a minimal role in corporate governance (Xi,
2006b).
An interesting question that immediately arises is whether the CSRC places greater
emphasis on corporate than personal liability, displaying reluctance to hold liable the
specific individuals responsible for the firm’s misconduct.9 Table 28.9, which provides a
breakdown of CSRC actions against both firms and the individuals they employ, actions
against firms alone, and actions against individuals alone, provides evidence to the
contrary.10 In the overwhelming majority of cases (more than 90 percent), the CSRC took
enforcement actions reflecting both corporate and individual liability. In other words,
in very few cases (just 8 percent) did the CSRC take such actions against culpable firms
alone. Interestingly, our dataset captures 18 cases in which the CSRC targeted only the
individuals deemed responsible for the corporate wrongdoing in question, without also
holding the firms that employed them liable. Further research is warranted to determine
the explanation for these anomalies, that is, whether they can be explained by the underly-
ing facts of the cases or by considerations beyond the merits of the cases, such as the
ownership type and size of the firms concerned.
3.5 Violators: Barred Individuals
As explained previously, industry bans fall into a separate rubric of enforcement actions
within the CSRC enforcement program. Individuals targeted by industry ban orders
9
For the literature on corporate and individual liability in the U.S. context, see, e.g., Coffee
(1981), Kaplow (1990), Arlen and Kraakman (1997), and Baer (2008).
10
This typology is drawn from Gadinis (2012).
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Table 28.10 Length of industry bans
Year 2-Year Ban 3-Year Ban 5-Year Ban 7-Year Ban 10-Year Ban Lifetime Ban Total
N (%) N (%) N (%) N (%) N (%) N (%)
2006 0 0.00 5 7.25 24 34.78 0 0.00 18 26.09 22 31.88 69
2007 0 0.00 21 35.59 13 22.03 0 0.00 15 25.42 10 16.95 59
2008 0 0.00 10 16.67 13 21.67 1 1.67 16 26.67 20 33.33 60
2009 1 1.89 11 20.75 18 33.96 0 0.00 7 13.21 16 30.19 53
2010 0 0.00 15 28.85 18 34.62 2 3.85 9 17.31 8 15.38 52
2011 0 0.00 3 18.75 6 37.50 1 6.25 4 25.00 2 12.50 16
2012 0 0.00 3 25.00 4 33.33 0 0.00 3 25.00 2 16.67 12
Total 1 0.31 68 21.18 96 29.91 4 1.25 72 22.43 80 24.92 321
Table 28.11 Proportion of longer and shorter industry bans
Year % of Industry Bans of 5 years or less % of Industry Bans of 7 years or above

2006 42.03 57.97
2007 57.63 42.37
2008 38.33 61.67
2009 56.60 43.40
2010 63.46 36.54
2011 56.25 43.75
2012 58.33 41.67
Total 51.40 48.60
therefore constitute a subset of the data on culpable individuals in Table 28.2. Here, we
take a closer look at the nature of the industry bans in the dataset as they pertain to
individuals. As noted, individuals may be barred from operating in the securities industry
and/or serving as directors, supervisors, or senior managers for a fixed period of time or
indefinitely. In practice, the length of such bans ranges from two years to a lifetime. Table
28.10 provides a breakdown of industry bans by length, showing five-year (29.91 percent),
ten-year (22.43 percent), and three-year bans (21.18 percent) to be the most common.
However, permanent/lifetime bans are imposed by the CSRC surprisingly often (24.92
percent).
As can be seen from Table 28.3, the annual number of individuals receiving an
industry ban decreased dramatically over the period under investigation. Table 28.11
further documents the CSRC’s recent inclination to impose shorter, and presumably less
consequential, industry bans, with the share of bans of five years or less increasing over
time. This trend is puzzling. It seems not in congruence with the general upward trend
in enforcement intensity suggested in Tables 28.2 and 28.3. There also appears to be no
evidence showing that industry bans have been more frequently challenged in administra-
tive and court proceedings in recent years, causing the CSRC to become more cautious in
imposing them. Further empirical research is needed to determine the factors prompting
the reduced reliance on industry bans.
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Table 28.12 Violation types
Year Issuer’s Insider Misuse Market Acquirer’s Appropriation Others Total

Violation of Trading of Third Manipulation Failure to of Funds and
Disclosure Party’s Disclose Securities
Rules Trading Shareholdings
Account
N (%) N (%) N (%) N (%) N (%) N (%) N (%)
2006 23 45.10 0 0.00 3 5.88 6 11.76 1 1.96 9 17.65 9 17.65 51
2007 25 56.82 2 4.55 3 6.82 7 15.91 0 0.00 1 2.27 6 13.64 44
2008 21 31.34 3 4.48 6 8.96 4 5.97 1 1.49 8 11.94 24 35.82 67
2009 14 21.88 6 9.38 4 6.25 5 7.81 8 12.50 7 10.94 20 31.25 64
2010 16 26.67 10 16.67 8 13.33 2 3.33 5 8.33 4 6.67 15 25.00 60
2011 16 26.67 10 16.67 10 16.67 5 8.33 6 10.00 0 0.00 13 21.67 60
2012 17 26.98 14 22.22 4 6.35 8 12.70 11 17.46 0 0.00 9 14.29 63
Total 132 32.27 45 11.00 38 9.29 37 9.05 32 7.82 29 7.09 96 23.47 409
3.6 Violations: Types
Statistics on the types of violations sanctioned also shed light on the overall trend in
the CSRC’s enforcement focus. As Table 28.12 shows, the bulk of cases has consistently
involved disclosure issues, wherein an issuer has failed to disclose material information or
has disclosed false or misleading information, thereby violating securities disclosure rules.
However, the share of actions against such cases has declined dramatically over time,
falling from 60 percent of the CSRC caseload in 2007 to just over 20 percent in 2009. It
is an open question whether this declining trend reflects the effectiveness of the CSRC’s
clampdown on disclosure violations or simply a shift in focus to other types of violations.
Two areas in which case numbers have climbed appreciably since 2009 are insider trad-
ing and acquirers’ failure to disclose shareholdings in target firms. The number of insider
trading cases rose from none in 2006 to 14 in 2012, in keeping with the CSRC’s proclaimed
focus on enforcing insider trading laws (Howson, 2012). The CSRC has also intensified
its enforcement activities with respect to takeover laws. Chinese securities law contains
a Williams Act-type disclosure requirement stipulating that a firm that has acquired
5 percent of the shares in a target firm, or increased its shareholding in that firm by 5
percent, must disclose all pertinent information.11 Enforcement actions against takeover
disclosure violations increased from 1 in 2006 to 11 in 2012.
4. CONCLUDING REMARKS
Drawing on a dataset comprising all 447 CSRC sanction decisions taken from 2006 to
2012, this chapter presents preliminary empirical findings on an important component
of China’s public securities enforcement activities: CSRC administrative sanctions and
11
M4633-GRIFFITH_t.indd 526 30/10/2018 08:16

industry bans. In particular, it shows that the patterns of those efforts have shifted over
time, from an initial focus on violations of disclosure rules to targeting a much wider
spectrum of wrongdoing—insider trading and investment advisor violations, in particu-
lar. In enforcing China’s securities laws, the CSRC does not typically assume individual
or corporate liability alone but frequently holds both parties liable, that is, considers
both the culpable firms and the individuals responsible for the malfeasance in question.
Industry bans are less frequently invoked to discipline individual wrongdoers than other
types of sanctions, and when they are imposed they tend to be shorter in length and less
consequential than they were in the past.
Going forward, the fast-paced growth of the Chinese securities markets and increasing
complexity of securities violations will pose new and ever more complex challenges for
the CSRC. The changing patterns of CSRC enforcement activities during the period
under investigation suggest that the CSRC has emerged as an adaptive regulator that is
willing and able to develop new strategies and shift its enforcement priorities as market
conditions evolve. The post-2012 securities markets in China have been marked by a
significant period of market turbulence. Further examination of CSRC enforcement
efforts since 2013 will help offer additional insights into the nature of public security law
enforcement in China.
Interestingly, as noted, the findings of the research presented in this chapter do not
seem to offer conclusive evidence that CSRC securities enforcement is sensitive to any
considerations beyond the merits of the cases pursued, such as the ownership type or
size of the sanctioned firms. Further empirical research is thus warranted to explore the
determinants of the public enforcement of securities laws in China in greater depth.
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Index
accounting restatements 2, 29, 32–3, 35–6 appraisal actions 243–4, 267

increase in 34 consolidation of multiple suits 257–8
Qwest 34 control of proceedings 257–9
WorldCom 34 fair value in 245
Xerox 34 see also fair value
see also restatement framework /fiduciary duty class action differentiation
actionable losses 88–8 245
consequential losses 89 fiduciary nature of 256–7
as fundamental losses 88 judicial response to 243–4
market signaling 91–9 mitigating risk of opting in 255–6
reputational damage 88 modern 246–9
adequacy of representation 156, 172 multiple petitions 247
badges of inadequacy 156 number of 246–8
doctrinal standards 162–5 only mergers triggering in Delaware 244
adequate care 168–9 settlement
appellate review 169 costs sharing 262–5
fast-filer presumption of inadequacy 166 disputes 259–60
inadequate representation 162–3, 165 with non-petitioners 261–2
meaningful discovery 168–9 with petitioners 260–61
quality of the pleadings 168 recovery of fees and expenses 265–7
refining 166, 167 statutory framework of 259
totality of circumstances test 166–7 values of dissenting shares 247–8
as element of due process 158 arbitration 184
evaluating 162, 169–71
benefits conferred through settlement 171 backdating 60, 64–5, 127, 493, 494
choice of forum in 170 bad faith 133, 469
in original litigation 170 intentional illegal acts as 101
timing and investment 169 board of directors
requirement 157–9 centrality of 333
sources of law 161–2 power 334
ALI Principles of Corporate Governance 101 primacy of 343–4
American Rule 193, 194, 198, 353, 441 brightline rule 105, 135
amicus curiae 143 in Delaware 152, 153
appraisal 244–5 business judgment rule 128, 129
actions see appraisal actions in Delaware 98, 101
arbitrage 243, 245, 251 and dismissal recommendations 129–30
forfeiture of rights of 245 high presumption of propriety in 129–30
legal developments 249–52 not covering illegal business decisions 101,
disclosure-only settlements in fiduciary 106
duty class actions 249 qualified deference 129
in merits opinions 249, 250–51 and structural bias 75, 129
statutory amendments 249–50 business risk 92
longstanding remedy 244
as replacement protection 244 Canada 482, 485–6
as representative litigation 254–5 Canadian Securities Administrators 487
requirements 254 Class Proceedings Act (1996) 501
risk 248 Companies’ Creditors Arrangement Act
statutes 244–5 (1985) 507
529
M4633-GRIFFITH_t.indd 529 30/10/2018 08:16

continuous disclosure regime Sino-Forest class action 507, 509

deficient disclosure 486 TSX Committee on Corporate Disclosure
enforcement 486–7 (Allen Committee) 482–3
periodic disclosure 486 Final Report (1997) 483, 487
timely disclosure 486 formation 487
non-contest settlements 508–9 Wells Notice 504, 505, 506
Office of the Superintendent of Financial capitalization rate 84
Institutions 499 case law
Ontario Allapattah Services, Inc. v. Exxon Corp. 289,
Class Proceedings Act 492, 493 290
Financial Services Commission 499 ATP Tour, Inc. v. Deutscher Tennis Bund 75,
Securities Act 487, 493 179, 180, 184, 186
Securities Commission 499 Atzmon v. Bank Hapoalim Ltd. 231–2, 233,
Provincial-Territorial Council of Ministers 234, 237
of Securities Regulation Annual Barkan v. Amsted Indus., Inc. 205, 209, 214
Progress Report (2016) 494 Basic Inc. v. Levinson 12, 13, 14, 16
public enforcement 505–6 Blue Chip Stamps v. Manor Drug Stores 14,
/private enforcement relationship 503–4, 89
505 Boilermakers Local 154 Retirement Fund
public regulatory actions 504–8 v. Chevron Corp 178–9, 181, 182, 185,
enforcement, 504–505 195
investigations 504 C & J Energy Servs., Inc. v. Miami Gen.
non-public enforcement notices 504 Empls.’ & Sanitation Empls.’ Ret. Tr.
Notice of Hearing 504 215–16, 217, 218–19, 220, 221, 222–3
Statement of Allegations 504 Chiarella v. United States 21, 22, 23
secondary market class actions 483–4, 506 Copeland v. Fortis 355–60
certification requirement 502 Dirks v. SEC 21–2, 24–5
defendant companies 484 Eisen v. Carlisle & Jacquelin 122, 123, 126
judicial interpretation of leave Flanagan, Lieberman, Hoffman & Swaim
requirement 484 v. Ohio Public Employees Retirement
leave requirement 502 System 288, 298
other defendants 484 Foss v. Harbottle 462
plaintiffs 484–5 Goldstein v. Pinros Holdings Ltd. 233–4
plaintiffs’ counsel 485 Gorman v. Salamone 342, 343
private and public enforcement 485 Graham v. Olympus Corporation 362, 363,
progression of cases 485, 501–3 367
secondary market statutory liability 487–8, Halliburton Co. v. Erica P. John Fund Inc
506, 509–11 (Halliburton II) 12, 13–16
burden of proof 487–8 decision, 16–18
caps on 495–500 Hazout v. Tsang Mun Ting 321–2
case law see case law Hogg v. Cramphorn 419, 423, 432
defendants 499–500 In re Cendant Corp. Litigation 278, 294–5,
evidentiary requirements 490–91 298
gatekeeper role of courts 488–92 In re Appraisal of Dell Inc. 235, 248, 251,
leave requirement 488–9, 490, 491–2 258, 264, 266–7
limitation period 492–5 In re Enron Corp. Sec., Derivative & ERISA
no reliance requirement 487 Litig. 35, 288, 289, 293, 300
plaintiffs 500–501 In re EZCORP Inc. Consulting Agreement
pocket shifting of damages 496 Deriv. Litig. 73, 114, 173
reasonable possibility threshold 489–90, In re Revlon, Inc. Shareholders Litigation 5,
491 135, 178, 196, 202, 204, 205, 207, 210,
sectors involved 498–9 211, 213–14, 225
settlement 497 In re Riverbed 110, 113, 115, 119
standing 500 In re Royal Dutch/Shell Transport Sec. Litig.
securities class actions 482 358, 359, 368
M4633-GRIFFITH_t.indd 530 30/10/2018 08:16

Index 531
In re Synthroid Marketing Litigation 291, Securities Regulatory Commission see

296 CSRC
In re Trulia 4, 67, 110, 112, 113, 115, 119, stock markets 513–14
134, 136–7, 140–1, 142, 146, 150, 191–2 circularity 36, 37, 94
In re Wal-Mart Delaware Derivative in FOTM class actions 47–8
Litigation 156, 161, 164 of secondary market fraud gains and losses
Ironworkers District Council of Philadelphia 51
and Vicinity Retirement & Pension Plan of settlement payments 48, 86
v. Andreotti 132–3 class action
Kital Holdings & Int’l Dev. Ltd. v. Maman abuses of 192
231, 232, 234, 235, 236, 238, 240 covered 17
Mannix v. PlasmaNet, Inc. 261–2, 265–6 FOTM see FOTM class action
Mills Acq. Co. v. Macmillan, Inc. 208–9, 210, securities fraud see securities fraud class
211, 213, 221, 225 actions
Morrison v. National Australia Bank Ltd 8, class conflict 96
354, 363, 365, 405–6 Code of Federal Regulations
Omnicare, Inc. v. Laborers District Council 17 C.F.R.
Construction Industries Pension Fund § 240.10b5-1 23
124 § 10b5-2 23
Paramount Communications Inc. v. QVC § 240.14e-3 23
Network Inc. 204, 209–10, 211–13, § 243.100 (2015) 23
221 Rule 10b-5 (Private Right of Action) 2, 24
Pennoyer v. Neff 316–17 see also Rule 10b-5 private right of
R v. Panel on Takeovers and Mergers ex p action
Datafin 427, 430 collateral estoppel 156, 157, 164
Revlon, Inc. v. MacAndrews & Forbes collusion 164
Holdings, Inc. 196, 202 common fund doctrine 193
Rosenbloom v. Pyott 130–31 competing claims 82–3
Shaffer v. Heitner 318, 319, 323 buyer-holders 82
Sharma v. Timminco Ltd. 493–4, 502 prioritizing corporate claims 82–3
Silverman v. Motorola, Inc. 291, 295 prioritizing direct claims of buyers 82
Smith v. Van Gorkom 118, 202, 204–5, 337 conflict of interest 9, 163, 306, 367, 378, 389
Standard Iron Works v. Arcelormittal et al. in derivative suits 75
290–91 direct 166
Teva see Teva and shareholder litigation 460–61
Theratechnologies Inc. v. 121851 Canada Inc. corporate benefit doctrine 193
488, 490, 491–2 absence of 200
United States v. Newman 24, 25 /common fund doctrine distinction 5, 193
United States v. O’Hagan 22–3, 24 as exception to American Rule 193
Unocal Corp. v. Mesa Petroleum Co. 202, not widely recognized 193, 194, 196–7
203, 208, 213 corporate governance
Volkswagen litigation 360–61 ALI Principles of 101
Zapata Corp. v. Maldonado 101, 132 board’s centrality in 333
causation 85, 125 documents
cash outflow 85–6 as contractual 182
discount rate 86–7 limiting litigation through see limiting
expected return 87–8 litigation
causes of action 2, 408 market-oriented approach to 8–9, 415
common law fraud 39, 40 mechanisms 341
federal 71, 83 reforms 61, 63, 68, 73
misrepresentation 81 subnational regulation of 443
private 40, 44, 369 suits 442
securities fraud 12, 13–14, 35, 83 tools 43, 50
China corporate internal affairs see internal affairs
Companies Law Article 470, 20.2 doctrine
M4633-GRIFFITH_t.indd 531 30/10/2018 08:16

corporate law consequential 88, 90

underproduction of 119–20 crash 88
corrective justice 41–2 fundamental 94–95
FOTM 41–2, 48–9 measure of 80
cost of equity 84 reputational 88
costs 19, de minimis requirement 249, 250
agency 52, 61–2, 305, 306 deal price 234, 235, 250, 305
deadweight 50, 51, 433–4 Deepwater Horizon 93
direct 44 defenses
enforcement 42 lockup 417
English rule 473–4 meaningful cautionary language 12–14
FOTM class actions 52–3 puffery 123–4
litigation see litigation costs truth on the market defense 123
overdeterrence 44, 53 defining characteristic of corporate form
private Rule 10b-5 44 330
PSLRA not reducing 29 Delaware
reputational 42 appointment of lead plaintiffs 150–52
riskbearing 49, 52 bar 199
sharing 262–5 Code Title 10
social 42, 49 § 366 (sequestration) 317–18
counsel § 3104 (long arm) 316
bidders, 307 § 3114 (implied consent) 316, 319
dea, 307 see also implied consent; long arm statute
litigation 307 corporate charters 118
plaintiffs’ 308 debtors’ rights cases 318–19
crosslisting 8, 372 development of corporate law 119
failure of laws 378–9 disclosure settlements 140, 142–5
Israel regulation 374–5 external decisions 146–7
US regulation 374 distinction between equity and law courts
weak enforcement of laws 375–6 142
CSRC enhanced scrutiny 202–3
Administrative Sanction Commission 516 fairness hearings 142–3
administrative sanctions (xingzheng chufa) fiduciary obligations 203
517–18 General Corporate Law
Enforcement Bureau (jicha ju) 514 litigation limits 180
Enforcement Contingent (jicha zongdui) 514 § 142 342
enforcement process 514–15 § 109 342
conclusion 515–16 § 220 (inspection rights) 111, 114
filing orders 513 § 262 244
formal enforcement proceedings 516 implied consent statute 319
formal investigation 515 constitutionality 320, 322–3
industry bans (shichang jinru) 517, 518 enactment 319
regulated entities 518–19 extension 319, 321–2
regulated individuals 519 limitations 320, 322
sanctions 516–17, 519, 526–7 personal jurisdiction under 321, 322
barred individuals 524–6 two-part test 319–20
culpable firms 519–23 jurisdiction 316, 326, 328–9
culpable individuals 523–4 conspiracy theory of 327–8
monetary 517 implied consent statute see implied
remedy orders/warnings 517 consent statute above
suspension/barring of company 517 long arm statute see long arm statute
types of violations 526 below
over non-resident officers 337
damages landmark M&A decisions 202–3
collateral 91 see also mergers and acquisitions
M4633-GRIFFITH_t.indd 532 30/10/2018 08:16

Index 533
leading jurisdiction for corporate law 110, settlements 65

112 superiority of 96
potential loss of status 115–16 and varying procedural requirements 196–7
long arm statute deterrence 42–4
adoption 323 direct actions 89, 92, 197, 459
amenability to service of process 323, 324, advantage of 463
325, 326 demand requirement in 463
asserting jurisdiction under 326–7 /derivative claim distinction 197
current application 323–4 direct claims 81, 197
extension 326 buyers’ 82
limitations 324 precedence of derivative claims 82
not source of personal jurisdiction 325 stockholders’ 81
need to emphasize own decisions 152–3 directors
nuisance claims 141–2, 146–7, 150 board see board of directors
migration of from 152 duties see directors’ duties
public takeovers speed of adjudication 432 independence 130, 131
ratification of misconduct 137 legal obligations 186
slowing number of merger cases in 112 /officers
top destination for incorporations 112 distinction 332–4
demand requirement 3, 71, 76, 128–33, 461 overlap 337
demand-futility 130, 138 /shareholder power differential 185
in direct actions 463 as shareholder trustees 186
excused demand 128, 129 directors’ duties 449, 462, 472
screening via see screening fiduciary 100
special litigation committees 132 see also fiduciary duties
weakening 129 loyalty 101
derivative claims 58–9, 78, 81, 83, 89 obeying the law 99–102, 104–5
Allergan 130–31 stockholder wealth maximization 100
for backdating 64–5 directors’ liability 471
bond requirement in 71 net loss rule 100
collateral estoppel in 172–4 disclosure claims 159
escaping scrutiny 65 whether direct or derivative action 197
no perceived crisis 66–7 disclosure settlements 138, 140, 143–5, 191
forum shopping in, 74 attorney’s fees 194–5
geographically dispersed 68 and corporate benefit doctrine 197–8
/merger litigation distinction 66, 67 as deal tax 192
new approach to 72 and forum selection clauses 192
corporate self-help 74–6 judicial review of 191, 193
increased judicial oversight 73–4 applicable law 195
legislative 76–8 application of internal affairs doctrine
no judicial or legislative support for 67–8 195–6
no motivation for reform 68–9 authority to award attorneys’ fees 197–9
numbers of 64 reasonableness of fees 199
payment of expenses 71 only addressing disclosure claims 197
primarily filed under state law 58 opposing 200
problems with 59–60 supplemental disclosures 199–200
agency costs 61–2 Trulia materiality standard 145, 150, 191,
few financial recoveries 60–61 194, 200
lack of effectiveness 62–4 as substantive law 196
nonmonetary settlements 61 discount rate 80, 83, 84, 86–7, 92
procedural hurdles 69–72 Federal Reserve 245
control of suit 71–2 diversifying away loss 83, 87, 95
difficulty filing suit 70–71 doctrines of repose 156, 157
heightened procedural rules 70–71, 76 due process 161, 328
representative plaintiffs in 61–2 adequacy-of-representation 158, 174
M4633-GRIFFITH_t.indd 533 30/10/2018 08:16

clause 299, 322 derivative suits 445–6

federal 173 choice of forum 445
rights 114 default jurisdiction 445, 448
loser pays rule 446
earnings game 34 Directive 93/13/EEC
enforcement Article 3 and Annex 1(q) 453, 454
continuous disclosure 486–7 Article 6 453
costs 42 Directive 2003/71/EC
CRSC 514–15 Article 14 452
see also CRSC Directive 2004/25 (takeovers) 419, 420
modes of 10, 512 Directive 2007/36/EC (shareholder rights)
enhanced scrutiny 202–203, 204–6, 209, 214, 464–465
219 intracorporate litigation 445, 446
for illegality 100, 101, 104, 105 choice of court agreements 448–9
range-of-reasonableness test 223 exclusive jurisdiction rule 446
entrepreneurial litigation 351–4, 368–9 matters outside exclusive jurisdiction
in Asia 362 447–8
as controversial 352 relevant connecting factors in 447, 448
counterreaction 367–8 primary/secondary market transaction
definition 352 differentiation 451
in Europe 354–5 validity of jurisdiction agreements 451–2
by American law firms 357–8, 367 Regulation (EU) 2016/301
consolidation of claims 356–7 Article 6(3) 450
financing 357 representative litigation 454–5
Fortis litigation 355–60 securities litigation
opt-in principle 355 breach of the securities terms and
two-step strategy 360 conditions 450
using stichting as vehicle for 356–7, 358 choice of forum agreements 449, 450–51
Volkswagen litigation 360–61 default jurisdiction 449
future directions 368 fraud on the secondary market 450
globalization of 352, 353–4, 364–6 prospectus liability 449, 450
in Japan 362–4 tortious liability 449–50
in Korea 364 tortious liability 447
new players 366 Treaty on the Functioning of the European
potential for 365 Union 445
reverse auctions 367 /US differences on shareholder litigation
skepticism over 353 445, 454–5
third party funders 366–7 intracorporate claims 457
unequal distribution 367 securities claims 458
EU
arbitration 452–3 fair value 230, 241
arbitrability of derivative suits 453 burden of proof 245
arbitrability of securities disputes 452 calculation of 245
bondholder/shareholder comparison 451 DCF method of valuation 230
Brussels Ia and merger price 245
Article 4 447 objective anchors in 231
Article 7 No 1(b) 448 consent of most of minority 232–3
Article 7 No 2 447 consent of sophisticated offeree 237–9
Article 19 448 consent of sophisticated shareholder 235
Article 24 No 2 446–7 institutional/private shareholders 236
Article 25(1)(a) and (c) 448 market price 231–2
Article 31(4) 448 negotiations 236–7, 239
Article 63 447 prior deal 234–5
consumer protection regime 453–4 share price manipulation 233–4
rebuttable presumption of unfairness in 453 when lacking objective anchors 239–41
M4633-GRIFFITH_t.indd 534 30/10/2018 08:16

Index 535
Federal Civil Rules Advisory Committee 17, 77 first to file rule 196
Federal Rule of Evidence 706 200 foreseeability 322, 323, 328
Federal Rules of Civil Procedure forum
Rule 23 15, 122, 351 forum non-conveniens doctrine 147, 442
commonality requirement 16 shopping see forum selection
23.1 73 forum selection 156, 183–4
fee agreements parallel suits 63, 159
presumption of reasonableness 294–5 race to the bottom 159–60
overriding 295 FOTM class action 45–8, 53
fee awards 288–9 compensatory damages in 46
contingent 293 definition 45
regulating see regulating fee awards efficiency of 50
see also fees expanded liability in 46–7
feedback 86 incentives to settle in 47
fees no privity of dealing in 46
contingent 287 pre-trial dismissal 47
in securities class actions 300–2 reliance in 125
sliding scales 293–4 settlement 47
ex ante negotiations 299 circularity of 47–8
ex post negotiations 299 social function of
retainers 298–9 corrective justice 48–9
sliding scales 300 costs of 52–3
terms 287–8 deterrence 49, 53
establishing upfront 297–9 discouragement of victim precautions
see also fee awards 51–2
feeshifting 71, 179, 180, 184, 281 forced cost internalization 49–51
banning 187 reduction of riskbearing costs 52
bylaws 249, 441 fraud on the market 12–13, 14–15, 16, 36
limited 77, 362 class action see FOTM class action
loser pays 354, 355, 357 secondary market fraud 48
fiduciary doctrine social function of 48
divergence in 336–41 fraud tax 282
weakness of 331 frivolous litigation 110
see also fiduciary duties deterring 110–12, 113–14
fiduciary duties 187, 330–31, 334 adequate investigation requirement 114
care 335, 336, 337 Section 220 actions 114
directors’ 332, 335 limiting see limiting litigation
/officers’ distinction 331–2 merit thresholds 111, 112, 113
effectiveness 331 and merger suits 113
enforcing 331, 334–5 multijurisdictional litigation 111, 114–15
director preference in 339 private ordering solutions 176–7, 181
evolution of 335 arbitration clauses 176
holding managers to account 331 enforceability 177
loyalty 335, 336 fee shifting 177
officers’ 332, 335–6, 340–41, 344 forum selection clauses 176
absence of case law on 336–7, 339 limiting jurisdiction 176
and director preference 339 minimum stake requirements 177
/directors’ distinction 331–2 rationale for 177
procedural law preventing development and war chests 112
of 337–9
purposes in corporate law 344–5 Germany
as unyielding 334 Act on Model Procedures for Mass Claims
value of 345 in Capital Market Cases 360
see also directors; fiduciary doctrine; officers appraisal rights 467
fiduciary duty class actions 248–49, 251–2 arbitrability in 452–3
M4633-GRIFFITH_t.indd 535 30/10/2018 08:16

rescission suits in 475–8 litigation limits 181–3

Berufskläger 475 scope of 182–3
Freigabeverfahren 477 international shareholder litigation 8
number of 475–6 comparative 8–9
räuberische Aktionäre 475 globalization of 8
settlement 476–7 Ireland
similar function to shareholder class Companies Act (2014) 424
actions 477–8 public takeovers see public takeovers
types of shareholders resolution (Ireland)
challenged 476 Takeover Panel Act (1997) 421, 429
widespread 478 Israel
standing to sue in 472–3 appraisal rights 230
good faith 117, 129, 132, 179, 218, 335, 489 in complete tender offers 229
only for ‘going private’ tender offers 229
hindsight bias 129, 163 case law 241
Companies Law
illegality 98–9, 102–4 amendment of 232
and advancing technology 103 § 336 229
as breach of fiduciary duty 101 § 337 229–30
and corporate law 98–9, 106–7 § 337(a) 230
criminal and civil liability 98 § 338 230
director liability 99 /Delaware comparison 235
drivers of change 102–3 estimating fair value 230
greater scrutiny for 100, 101, 104, 105 see also fair value
no business judgment rule protection 104, Italy
106 appraisal rights 466
regulatory entrepreneurs see regulatory Article 34 legislative decree No 5/2003 453
entrepreneurialism corporate arbitration 453
and self-driving cars 106
stockholder suits as supplemental law judicial waiver 71
enforcement 105–6 jurisdiction
and ultra vires doctrine 105 asserting 326–7
as violation of duty of loyalty 101 choice of 308–9
insider trading default 441–2, 449
liability 22–3, 24 Delaware 316, 326, 328–9
predicate breach of fiduciary duty see also Delaware
requirement 2122 limiting 176
Insider Trading and Securities Fraud personal 316–17
Enforcement Act (1988) 22 extension of 322
§ 2 24 subject matter 355
Insider Trading Sanctions Act (1984) 22
institutional investors 274 law firm quality 304
effect of 276–8 defense firms 311–12
effectiveness of 276 gaps in knowledge 312–13
hedge funds 275 in M&A litigation 307
increase in 222–3, 226 choice of jurisdiction(s) 308–9
as lead plaintiffs 274 selection of counsel 307–8
see also lead plaintiffs measuring
as litigation gatekeepers 15 in class actions 305–7
pay to play 278–9 effect of agency costs 305, 306
public pension funds 274–5 by outcome 304–5
mutual funds not being 275 successful plaintiffs’ firms 310–11
union pension funds 275–6 lawmaking partnership 12–13, 16, 18, 26
internal affairs doctrine advantages of in private securities fraud
enforceability of forum selection clauses 181 litigation 19
M4633-GRIFFITH_t.indd 536 30/10/2018 08:16

Index 537
common objective 19 costs see litigation costs

common objectives 24 frivolous see frivolous litigation
conceptualizing 18–20 funding 116–18
developing financial regulation 24–5 contingency fees 121
dynamic processes of 20–21 income smoothing 117–18
exploiting institutional competencies 20 litigation finance companies 118
and insider trading regulation 21–3 limiting see limiting litigation
implications of 18, 24–6 limits see litigation limits
open-textured original statute 19, 24 merger see merger litigation
preventing agency capture 20 multijurisdictional 112, 159–60
responsiveness 25 see also forum selection
and the SEC 23–4 representative
sequential adjustments 19 appraisal as 254
lead plaintiffs 32, 121, 271, 273, 284–5 see also appraisal
authority 272 vexatious see vexatious litigation
Delaware appointment of 150–51 litigation costs 126–8
effect of 274–6 effect on volume of litigation 126–7
on attorney’s fees 277–8 procedural requirements raising 126
on settlement amounts 276–7 raising 126–8
figurehead plaintiffs 281, 282 substantive requirements raising 126
government-sponsored pension funds 272 litigation limits 186, 187–8
having largest financial interest 271–2 and contract & consent 185–7
individual investors 282 directors’ powers to enact 185
institutional investors 274 forum selection 183–4
effect of 276–8 unilaterally imposed 183
effectiveness of 276 whether appropriate subject for private
hedge funds 275 ordering 183–5
mutual funds not being 275 whether matter of corporate internal affairs
pay to play 278–9 181–3
public pension funds 274–5 loss 95–6
union pension funds 275–6 actionable 88–9
monitoring 273–4 see also actionable losses
reforms avoidable 83
campaign contributions 280 causation 85
fee arrangements 280–81 cash outflow 85–6
fee shifting 282, 284 discount rate 86–7
repeat plaintiffs 280 expected return 87–8
standing 281–3 component factors of 93–4
transparency 279 crash damages 88
success of 272 diversifying away 83
legal origins 459 fundamental 94–5
limiting litigation 176–7 reputational 92
arbitration clauses 177–8, 184
Delaware General Corporate Law 180 management buyouts 205, 209, 251, 306, 310
see also Delaware managers see directors; officers
fee shifting 179–80, 184 mapping shareholder lawsuits 459, 478
forum selection 178–9, 180–81 access to information 474–5
history 177–81 allocation of cost 473–4
ownership requirement 180 allocation of risk 473–4
whether corporate internal affair 181–3 appraisal rights
see also frivolous litigation; litigation limits EU 466
litigants and law firms 6 France 467
officers and directors 7 Germany 467
plaintiffs 6–7 Italy 466
litigation US 466
M4633-GRIFFITH_t.indd 537 30/10/2018 08:16

closely held corporations 461 mergers

conflicts of interest 460–61 cashout 232
direct harm to shareholders 460–61, 463–6 challenging 3, 66, 73, 178
in civil law jurisdictions 463–4 crackdown on 244
in concentrated ownership systems 465 deal tax on 73
France & Germany 463 freezeout 460
nullity suits 465 squeezeout 460
rescission suits 464–5 mergers and acquisitions 227
UK 463 case law see case law
US 463 current attitudes to 214–15
harm upon the corporation 460, 461–3 bidders’ contract rights 220
China 462 in Delaware Supreme Court 218–21
Continental Europe 462 management-led single-bidder process
UK 462, 463 215–16
US 461 in Delaware Court of Chancery 216–18
institutional preconditions 471 shareholder voting 221
oppression claims 467–8, 469 early attitudes to 204
/inquiry proceeding comparison 470 defensive measures in merger agreements
publicly traded firms 461 207–10
rescission suits in Germany 475–8 asset lockups 208–9
Berufskläger 475 no-shop clauses 207, 208, 209
Freigabeverfahren 477 termination fees 208
number of 475–6 enhanced scrutiny 204–6, 209, 214, 219
räuberische Aktionäre 475 connotation of multiple bidders 205,
settlement 476–7 206
similar function to shareholder class management-led single-bidder processes
actions 477–8 204–7, 209–10
types of shareholders resolution multiple bidders 205
challenged 476 judicial preference for 206–7
widespread 478 primacy of fiduciary duties 210–11
standing to sue 471–3 over third party contract rights 211–13
China 473 shareholder voting in 213–14
France 472 hostile bids 205
Germany 472–3 reasons for changing attitudes to 222–6
Japan 472 failure of stockholder-led M&A litigation
Switzerland 472 223–5, 226
UK 472 increase in institutional investors 222–3,
US 471 226
unfair prejudice claims 468–70 increased judicial comfort over defensive
merger litigation 3, 58 measures 225
appraisal actions 5–6 severability in 225–6
backlash against 66–7 targeted preliminary injunctions 210–11,
black hat 141 219–20
‘deal tax’ 66, 140–42 see also preliminary injunctions
Delaware courts’ authority in 67 misappropriation theory 22–3, 24
/derivative suits distinction 66 misrepresentation 81, 87, 487, 520
and forum selection 67 experts’ liability 495
In re Trulia see case law secondary market 482, 498, 500, 509
judicial perspectives 4–5 multijurisdictional litigation 3–4, 111, 114–15,
merger tax 118–19 159–60, 183
multijurisdictional 3–4
nuisance claims in 140, 141–2 negative value claims 354
post-Trulia 141 Netherlands
sorting of 141, 153–4 Act on Collective Settlement of Mass
white hat 141 Claims (the Netherlands) 8, 358
M4633-GRIFFITH_t.indd 538 30/10/2018 08:16

Index 539
New York Arbitration Convention (1958) 454 goals of 271

North Carolina Rules of Professional Conduct lead plaintiff provision 17
198 see also lead plaintiffs
Rule 1.5 199 pleading standard 17, 29, 124, 126
nuisance claims 106, 115, 140–141, 144, 147, response to abuses of securities class actions
283 273–4
and de minimis rule 249–50 screening effect 32
provable losses 284 § 21D(a) 17
nuisance settlements 146, 148, 282 procedural rules 70
fees 154 heightened 70–71, 76
migration outside Delaware 152 control of suits 70, 71–2
nunc pro tunc doctrine 494 cost sharing 77
creating difficulty filing suits 70–71
officers limited fee shifting 77
accountability 341–4 pleading standards 77
via directors 341–2 transsubstantive 70
proxy battles to remove 342–3 proximate cause 88, 89, 90, 91
via stockholders 342–4 pseudo-foreign corporations 317
/directors overlap 337 public character of corporate litigation 187
/directors distinction 332–4 public takeovers 415–17
fiduciary duties see fiduciary duties Ireland/UK/US differences 416, 437
malfeasance 340–41 Ireland/UK/US similarities 415–16
powers 333–4 see also public takeovers (Ireland); public
Oklahoma Code takeovers (UK)
§ 18-1126 71 public takeovers (Ireland)
overdeterrence 44, 53, 96 regulatory regime 416–17
certainty of 432–3
pay to play 278–9 deadweight costs 433–4
policy considerations 16 proactive approach to rulemaking 431–2
policy objectives 23–4 process advantages of 431
preclusion 165, 167 relative absence of litigation 434, 435
addressing 162 Takeover Panel 415, 427–31
claim 156, 161, 69 adjudicatory speed 432
issue 111, 114, 165, 169, 174 applying Rule 21 423–4
preclusive effect 4, 157, 158, 161, 167, 171 Board 428
preliminary injunctions 135–6 Executive 428–29 432
of future claims 282 expenditures 435–6
as powerful tools 221 independence of 427–8
targeted M&A 210–11, 219–20 judicial review of decisions 430–31
private ordering 439 powers 429
dispute resolution provisions 439–40 restrictions on 429–30
choice of forum 440, 442 self-financing 435
emergence of 440–41 statutory duties 428
fee shifting 441 statutory hearings 429
mandatory arbitration 441 Takeover Rules 417, 420–21
US approach 443–5 disclosure of information 421–2
default rules in corporate governance 444 equivalent treatment 422–3
governing of content of corporate mandatory bid 422–3
charters and bylaws 443–4 no frustration principle 423, 424
organizational documents can be treated substantive requirements 421–4
as documents 444–5 timescales 421
Private Securities Litigation Reform Act (1995) public takeovers (UK)
2, 13, 15, 47, 58, 117, 273 City Code on Takeovers and Mergers 417,
discovery bar 17, 126 419–20
effects of 127 disclosure of information 421–2
M4633-GRIFFITH_t.indd 539 30/10/2018 08:16

expanding scope of 423 in Third Circuit 288, 294–6

General Principle 1 422 judicial assessments 295–6
General Principle 2 422 presumption of reasonableness for ex ante
General Principle 3 423 fee agreements 294–5
no frustration principle 423, 424 securities-specific 294–6
substantive requirements 421–4 regulation
timescales 421 as revenue source 102–3
defensive tactics 417–18 circumventing 103
first appearance 417 securities 372–3
Notes on Amalgamation of British race to the bottom in see race to laxity
Businesses 418–19 regulatory entrepreneurialism 99, 102, 105
Panel on Takeovers and Mergers 415, 419, combating inefficient laws 103
424–7 potential of 106
adjudication process 425 reliance 125, 487
Code Committee 424–5 presumption of 16, 125
decisions subject to review 426–7 remedies
Executive 425, 432 aggregate litigation 354
expenditures 434–5 appraisal 243
judicial function 424 see also appraisal
legislative function 424 oppression 467–8, 469
monitoring compliance with City Code unfair prejudice 468–9
424 required rate of return 84
powers of 424, 425–6 res judicata 156, 157
proactive approach to rulemaking 431–2 respondeat superior liability 41–2, 43, 49
self-financing 435 restatement framework 156, 163, 165
on tactical litigation 423–4 applying 174
regulatory regime 416–17 interpreting 161, 171–172
certainty of 432–3 Restatement (Second) of Judgments 162
cost of dispute resolution under 435 restatement test 162
deadweight costs 433–4 risk
process advantages of 431 allocation 473–4
relative absence of litigation 434 appraisal 248
public takeovers -bearing 49, 92
regulatory regime 416, 417 business 92
materialization 93–4
race to laxity 373–4 Rule 10b-5 private right of action 39, 53
crosslisting legislation in Israel 374–5 early 39–41
crosslisting legislation in US 374 corrective justice in 41–2
as good thing 376–7 costs of 44
Teva case see Teva deterrence in 42–4
weak enforcement of crosslisting laws 375–6 evolution of 44
see also crosslisting doctrinal innovation 44–5
reasonableness 203 FOTM Class Actions 45–8
of fees 199 see also fraud on the market
presumption of 294–5
range-of-reasonableness test 223 Sarbanes–Oxley Act (2002) 15, 89
regulating fee awards 287–9 scienter requirement 14, 24, 31, 36, 88, 124, 126
establishing fee terms upfront 297–9 screening
in Fifth Circuit 296 via approval of settlement 133, 136–8
mimic-the-market method 287–9, 290, see also settlement
291–2, 302–3 causation 125
percentage-based fees 290–93 via demand requirement 128–33
in Ninth Circuit 296–7 see also demand requirement
setting terms 287 dismissal recommendations 130
in Seventh Circuit 287 for economic loss 125
M4633-GRIFFITH_t.indd 540 30/10/2018 08:16

Index 541
heightened pleading requirement 124–5 private class actions 17

materiality 123–4 RiteAid 33
motions to dismiss 134–5 screening in 122–6
preliminary hearings 122–3 see also screening
preliminary injunctions 135–6 and securities fraud 29–30
for reliance 125 severe fraud 33–5
Section 220 inspection rights 111 see also securities fraud
Securities & Exchange Commission 13 Sunbeam 33
adoption of Rule 14e-3 24 as system for redistributing stockholder
exercise of authority 20 wealth 91
increasing threat of scrutiny 34 Securities Litigation Uniform Standards Act
Securities Act (1933) 180 13, 15
Securities and Exchange Act (1934) adoption of 17
Rule 10b-5 13–14, 80 Securities-Related Class Action Law (Korea)
§ 10(b) 39 364
§ 10(b) 13, 14 Senate Committee on Banking, Housing, and
§ 10b-5 80 Urban Affairs 30
§ 14, 309 separation of control 334
§ 21D, 88 settlement 133–8
securities fraud 12 approval of 137–8
actionable causes of loss 80–81 disclosure 138, 140, 142–5
class actions see securities fraud class actions see also disclosure settlement
Enron, 33, 35 judicial preference for 192, 197
fraud on the market see fraud on the market preclusive 160
as lawyer-driven litigation, 15 weakness as screening process 136–7
limitations on scope, 14 severability 225–6
policy considerations in 14 shareholder
private 13–14 consent 185–6
importance of 15 derivative suits, 2–3
limiting litigation abuse 14 see also derivative claims
limiting vexatious litigation in 15 /director power differential 185
as political hot potato 19–20 not autonomous agents 186
protecting investors 14 power 185
statute of limitations 15 rights 187
severe 29–30, 33–5 suits see shareholder suits
increase in 34 shareholder suits
WorldCom 33, 35 class actions see class actions
securities fraud class actions 1–2, 12, 37 derivative see derivative claims
abuses of 273 externalities 121–2
by bondholders 34 individual 121
causation in 125 lawyer driven 121, 176
Cendant 33 representative 121
as Congress/Court lawmaking partnership screening 122–6
12–13, 16, 18 see also screening
as enforcement tool 17 as vexatious 176
and first internet stock bubble 33 side payments 273
as form of insurance 90–91 standing 89, 281–3, 471–3, 500
future implications 35–7 China 473
HealthSouth 33 France 472
impact of PSLRA 31–2, 37 Germany 472–3
accounting restatements 34, 35 Japan 472
lead plaintiffs in 32 Switzerland 472
lower fees in 300–302 UK 472
pre-PSLRA 30–31 US 471
pretrial evaluations in 123 stare decisis 16
M4633-GRIFFITH_t.indd 541 30/10/2018 08:16

stichting 8, 356 motion 385

Stop Trading on Congressional Knowledge to certify as class action 409–11
Act (2012) 23, 25 movants 406–7
strike suits 489 no regulation 378
not reporting individual executive pay
Teva 377 377–8
aftermath 381–2 remedies 411–13
Brodet Committee 393 US disclosure duties, expansion of 393–4
causes of action 408–9 US disclosure rules 395–7
class action 379–80 tramp corporations 317
corporate avoidance of duty 378 two-tier plaintiffs’ bar investigation 148–9
Court as last resort 392, 407–8 methodology 149
Decision 381 results 149–50
executive remuneration disclosure 397–400,
404 UK
failure of crosslisting laws 378–9 Companies Act (2006) 419–20, 424
importance of individual disclosure § 171 463
400–404 public takeovers see public takeovers
ISA reaction 380–81 (UK)
Israeli court as only forum 405–6 shareholder primacy 418
Israeli disclosure rules 394–5 ultra vires doctrine 99–100, 105
main arguments 386 Uniform Interstate and International
continuation of violation of law 391 Procedure Act (1986) 323
contradictory interpretation of duty to US
disclose 390, 404–5 Berle-Means corporation 460
disclosure obligations 387–8 /EU differences on contractual agreements
failure to disclose directors’ compensation on shareholder litigation 445
389–90 non-public enforcement notices 504
failure to disclose intent to stop individual public takeovers see public takeovers
reporting 390–91
general 386–7 valuation,
no self-created exemption from disclosure factors 84–5
391–2 vexatious litigation 14, 176
reports after Dual Listment Law 388–9 vicarious liability
reports before Dual Listing Law 387 overdeterrence costs 53
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Sean Griffith - Jessica Erickson - David H Webber - Verity Winship - Research Handbook On Representative Shareholder Litigation-Edward Elgar Publishing (2018)

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Sean Griffith - Jessica Erickson - David H Webber - Verity Winship - Research Handbook On Representative Shareholder Litigation-Edward Elgar Publishing (2018)

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RESEARCH HANDBOOK ON REPRESENTATIVE

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Research Handbook on Shareholder Power

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RESEARCH HANDBOOKS IN CORPORATE LAW AND GOVERNANCE

Cheltenham, UK • Northampton, MA, USA

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Edward Elgar Publishing, Inc.

A catalogue record for this book

Library of Congress Control Number: 2018945844

This book is available electronically in the

ISBN 978 1 78643 533 0 (cased)

Typeset by Servis Filmsetting Ltd, Stockport, Cheshire

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PART I SECURITIES CLASS ACTIONS

1 The development of securities litigation as a lawmaking partnership 12

PART II SHAREHOLDER DERIVATIVE SUITS

4 The (un)changing derivative suit 58

PART III MERGER LITIGATION

Section A Managing Multijurisdictional Litigation

7 Fighting frivolous litigation in a multijurisdictional world 110

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Section B Judicial Perspectives on Shareholder Litigation

12 Disclosure settlements in the state courts post-Trulia: practical

Section C Appraisal Actions

15 Recent developments in stockholder appraisal 243

PART IV LITIGANTS AND LAW FIRMS

Section A Plaintiffs and Law Firms

Section B Officers and Directors

20 Jurisdiction over directors and officers in Delaware 316

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PART V COMPARATIVE AND INTERNATIONAL SHAREHOLDER

Section A The Globalization of Shareholder Litigation

22 The globalization of entrepreneurial litigation: law, culture, and incentives 351

Section B Comparative Shareholder Litigation

24 A transatlantic perspective on shareholder litigation in public takeovers 415

Section C Other Modes of Enforcement

28 CSRC enforcement of securities laws: preliminary empirical findings 513

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Shareholder litigation—primarily representative litigation on behalf of all stockholders

1. SECURITIES CLASS ACTIONS

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2. SHAREHOLDER DERIVATIVE SUITS

Part II analyzes shareholder derivative suits and the characterization of representative

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3. MERGER LITIGATION

Representative stockholder litigation challenging corporate mergers and acquisitions is

A. Managing Multijurisdictional Litigation

In “Fighting Frivolous Litigation in a Multijurisdictional World”, Adam Badawi inter-

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B. Judicial Perspectives on Shareholder Litigation

In “Disclosure Settlements in the State Courts Post-Trulia: Practical Considerations,”

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C. Appraisal Actions

The discussion of appraisal actions continues with “Recent Developments in Stockholder

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as an investment strategy, coupled with sensible prophylactic measures against potential

4. LITIGANTS AND LAW FIRMS

Part IV examines the dynamics of representative shareholder litigation. It takes a close

A. Plaintiffs and Law Firms

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1 The development of securities litigation as a lawmaking partnership 12

4 The (un)changing derivative suit 58

7 Fighting frivolous litigation in a multijurisdictional world 110

12 Disclosure settlements in the state courts post-Trulia: practical

15 Recent developments in stockholder appraisal 243

20 Jurisdiction over directors and officers in Delaware 316

PART V COMPARATIVE AND INTERNATIONAL SHAREHOLDER

22 The globalization of entrepreneurial litigation: law, culture, and incentives 351

24 A transatlantic perspective on shareholder litigation in public takeovers 415

28 CSRC enforcement of securities laws: preliminary empirical findings 513

5. COMPARATIVE AND INTERNATIONAL SHAREHOLDER

3. THE LAWMAKING PARTNERSHIP AND INSIDER

3. THE IMPACT OF THE PSLRA ON SECURITIES CLASS

5. IMPLICATIONS FOR THE FUTURE OF SECURITIES CLASS

of elements, and the aggregation of claims—as described below—FOTM class actions