Court Rejects Disclosure Only Class Action Settlement

On February 8, 2018, Justice Kornreich of the New York County Commercial Division issued a decision in City Trading Fund v. Nye, 2018 NY Slip Op. 28030, rejecting a disclosure-only settlement to a class action.

In City Trading Fund, the parties to a class action relating to a merger sought court approval of a settlement in which the only relief awarded was additional disclosures regarding the merger (and a sizeable award of attorneys' fees to plaintiffs' counsel).

First, the court reviewed the standard for approving a disclosure-only settlement:

In Gordon, the First Department noted the increasingly negative view of disclosure-only settlements and that decisions of courts in both Delaware and New York called for drastic curtailment of such class action suits, finding them to amount to meritless lawsuits filed in order to raise a threat of enjoining or delaying closure of the transaction.

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In Gordon, the First Department . . . held that to determine whether to grant final approval of a disclosure-only settlement of a class action, courts should apply the classic Colt factors — the likelihood of success, the extent of support from the parties, the judgment of counsel, the presence of bargaining in good faith, and the nature of the issues of law and fact — plus two new factors: whether the proposed settlement is in the best interests of the putative settlement class as a whole and whether the proposed settlement is in the best interest of the corporation. According to the First Department, the new, sixth factor (regarding the best interests of the class) is satisfied where the supplemental disclosures provide some benefit to the shareholders. Hence, approval under Gordon requires a lesser showing than under [the Delaware Chancery Court decision in] Trulia.

That said, while Gordon, unlike Trulia, does not requires the plaintiff to remove any doubt that the supplemental disclosures are material, this court does not read Gordon . . . to permit approval if plaintiff merely makes a showing that the supplemental disclosures are "arguably beneficial" — the expression used in City Trading II. This court does not believe that the First Department in City Trading II purported to opine on whether the subject supplemental disclosures provide "some benefit" to the class. The First Department found it appropriate to defer such a determination to the final approval hearing, describing the disclosures as "arguably" beneficial, thereby invoking the lesser standard applicable on a motion for preliminary approval. This court, now, must evaluate the supplemental disclosures under the standard set forth in Gordon.

Nonetheless, before doing so, it is necessary for the court to determine what the First Department meant in Gordon when it used the words "some benefit" to describe the requisite threshold of importance the supplemental disclosures must meet. As discussed herein, while not explicitly stated in Gordon, the "some benefit" test appears to have been derived from the standard applicable to a mootness fee application under Delaware law. In Delaware, a mootness fee can be awarded if the disclosure provides some benefit to stockholders, whether or not material to the vote, and even where the settlement does not warrant court approval. . . . "Helpful" is a lower bar than "material." Information can be helpful even if it does not significantly alter the total mix of available information.

That being said, regardless of whether Gordon's some benefit test was intended to mirror the Delaware mootness fee standard, the only reasonable way to interpret "some benefit" is that while the plaintiff need not . . . rule out all doubts as to the materiality of the supplemental disclosures, the court must be able to plausibly conclude that the supplemental disclosures would, in fact, aid a reasonable shareholder in deciding whether to vote for the merger. If the supplemental disclosures would not do so, then there is no basis to conclude that such disclosures were of any benefit to the shareholders. After all, the whole point of a lawsuit challenging the sufficiency of pre-merger disclosures is to ensure that shareholders have all the information they need to make an informed vote on the merger's wisdom. For the relief in such a suit to be beneficial, the procured new disclosures must actually be useful to the shareholders — that is, the disclosures must aid them in the decision-making process. If the disclosures reveal information that has no bearing on the wisdom of the merger — such as a disclosure of the CEO's favorite baseball team — no one would contend such revelation makes a shred of difference to a voting shareholders. There is no benefit to such disclosure.

On the other hand, if a management projection made in the ordinary course of business (e.g., not solely for the purpose of soliciting bids) was not originally disclosed, and such projection reveals a valuation based upon a discounted cash flow (DCF) analysis that materially deviates from the agreed-upon sale price, such a revelation surely would bear on the shareholders' desire to approve the merger. Indeed, such a disclosure would not only be of "some benefit", but would likely qualify as plainly material.

Second, the court assessed the proposed disclosures, and held that they were not helpful. The court denied the motion to approve the settlement, noting in a footnote:

Since companies are only legally required to disclose all material facts in connection with a merger, every single proxy will surely omit at least some immaterial fact that might be of some benefit to the shareholders. It is easy to see why permitting a significant attorneys' fee award for the procurement of an immaterial disclosure, but which is of some benefit, incentivizes a lawsuit in connection with every single merger. This court does not understand what public policy is served by creating this incentive (which Trulia meant to eliminate). Nor does this court understand why the procurement of immaterial supplemental disclosures are a feat worth rewarding. Surely, with minimal effort, the board can find some immaterial, supposedly "useful" fact to provide to plaintiff's counsel that will allow the company to dispose of the lawsuit for less than it would cost to file a motion to dismiss. A lawyer who files the case with the intention of settling, not for the procurement of a supplemental material disclosure, but for the mere disclosure of minimally beneficial facts, is not seeking to protect or vindicate the legal rights of the shareholders he purports to represent (i.e., since shareholders only have the right to material information). The very point of the lawsuit was simply to get paid — by the shareholders — to go away. This is a pernicious motive for lawsuit.

(Internal quotations and citations omitted).

This decision relates to a controversial issue: shareholder actions relating to mergers where all the relief sought is additional disclosures. As you can see, the courts take a dim view of such actions, concerned that they provide little value to shareholders. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding a shareholder class action.