NY judge: Shareholders can have two bites at News Corp board

September 20, 2012

Never underestimate the power of a lone Exchange Act claim in federal district court in Manhattan.

On Tuesday, U.S. District Judge Paul Gardephe refused to stay a consolidated derivative case claiming that the directors of News Corp breached their duty to shareholders in the phone-hacking scandal — even though a nearly identical case in Delaware Chancery Court is so much further along that Vice Chancellor John Noble heard arguments on the board’s motion to dismiss on Wednesday. Gardephe’s justification for allowing the New York federal case to proceed was that, in addition to their breach-of-duty claims under Delaware law, shareholders also asserted federal securities claims under the Exchange Act of 1934. “Because federal courts have exclusive jurisdiction over [those] claims,” the judge wrote, “they will not be resolved in the Delaware action. Staying this action in favor of the Delaware action is therefore improper.”

Gardephe shrugged off arguments by the board’s lawyers at Skadden, Arps, Slate, Meagher & Flom that the New York plaintiffs had tacked on the Exchange Act allegations simply to distinguish their case from the Delaware suit, which predated the New York litigation. According to the judge, the threshold issue under the U.S. Supreme Court’s 1976 ruling in Colorado River Water Conservation District v. U.S. was whether the New York and Delaware cases were parallel. He concluded they were not, because the Delaware case didn’t include a federal cause of action. So even though the New York case involves Delaware law questions about whether shareholders can establish the futility of demanding action from the News Corp board, Gardephe said, the Exchange Act claim cannot be resolved by the Delaware court.

Tuesday’s ruling sets up the possibility of a scenario similar to the mess Bank of America faced this spring when it settled derivative claims related to the Merrill Lynch merger with New York shareholder lawyers only to face loud objections from another set of plaintiffs’ lawyers, who had litigated nearly identical claims in Delaware. Like Gardephe in the News Corp case, U.S. District Judge Kevin Castel of Manhattan had ruled in the BofA case that the New York derivative suit could proceed at the same time as the Delaware action because the New York case asserted an Exchange Act claim.

News Corp obviously hasn’t reached settlements in the New York or Delaware derivative cases, but Gardephe’s refusal to stay the New York suit means the board may have the option of negotiating a deal with either set of plaintiffs’ lawyers. (The Delaware case was brought by Grant & Eisenhofer and Bernstein Litowitz Berger & Grossmann, with a separate suit brought by Labaton Sucharow consolidated into the original case; the New York litigation is being handled by Murray Frank and Glancy Binkow & Goldberg.) The likelihood of any derivative settlement depends on a ruling by Noble that the Delaware shareholders have amassed enough preliminary evidence to get past the board’s motion to dismiss, but Louis Boyarsky of Glancy Binkow, who represents the New York plaintiffs, said he’s pleased with Gardephe’s ruling and looking forward to moving ahead with the New York claims.

Interestingly, Gardephe wasn’t the only federal judge to issue a ruling Tuesday that considered the question of whether an Exchange Act claim justifies federal jurisdiction under Colorado River. U.S. District Judge Richard Kyle of Minneapolis looked at a similar set of facts as Gardephe and reached an opposite conclusion. Kyle denied a shareholder motion for a preliminary injunction blocking a vote on FSI International’s merger with Tokyo Electron Limited, ruling that the federal suit should be stayed in favor of more advanced state court litigation.

Kyle said that even though the federal plaintiffs had asserted a cause of action under the Exchange Act, “the disposition of the state claims is ‘substantially likely’ to dispose of the Exchange Act claims,” he wrote, citing a similar ruling from a federal court in Boston in a case called In re: Novell Shareholder Litigation. The state court failure-to-disclose claims against FSI’s board, Kyle wrote, would be judged under a standard that echoed the federal materiality standard under the Exchange Act. “Hence, the state cases will necessarily adjudicate the very issue on which [the federal court plaintiffs’] Exchange Act claims turn,” the judge said. For good measure, he not only denied the injunction motion but also stayed the federal case in favor of the state litigation.

I left messages for Scott Musoff at Skadden, who represents the News Corp board, but didn’t hear back. I also didn’t hear back from Juan Monteverde of Faruqi & Faruqi, who is counsel to FSI shareholders in the now stayed Minnesota case.

(Additional reporting by Nate Raymond)

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