A silver lining for banks in Delaware aiding-and-abetting opinion?

December 1, 2015

(Reuters) – There was good news and bad news for investment banks in Monday’s hotly anticipated Rural/Metro opinion from the Delaware Supreme Court. The bad: The state justices affirmed a $76 million judgment against RBC Capital Markets, finding that the bank manipulated Rural/Metro’s 2011 sale process in an attempt to win a lucrative financing deal from the ambulance company’s private equity acquirer. The decision marks the first time the Delaware justices have held a financial adviser liable to shareholders for aiding and abetting a corporate board’s breach of duty – certainly a scary prospect for banks.

On the other hand, the justices specifically repudiated language in the lower court’s decision that called on banks to act as “gatekeepers” of corporate conduct in M&A deals. “Adhering to the trial court’s amorphous ‘gatekeeper’ language would inappropriately expand our narrow holding here by suggesting that any failure by a financial adviser to prevent directors from breaching their duty of care gives rise to an aiding and abetting claim against the adviser,” the decision said. That should allay bankers’ fears about their exposure to shareholders.

The big question, of course, is whether the Rural/Metro ruling will change the behavior of financial advisers. As my Reuters colleague Tom Hals noted in his story Monday about the decision, corporations and their bankers have already become more transparent about bankers’ potential conflicts, after a 2011 Chancery Court ruling suggested that Del Monte’s financial adviser, Barclays, gave the board tainted advice to secure buy-side financing fees. Many banks now avoid such financing deals involving public corporation clients they’re advising on M&A transactions.

But financial advisers will always run into conflicts between their institutional interests and the interests of their corporate board clients. If it’s not buy-side financing fees, it will be something else. (Just ask Goldman Sachs.) Will the Rural/Metro decision keep banks from putting their own interests first?

Interestingly, the two shareholder lawyers who led the case – Joel Friedlander of Friedlander & Gorris and Randall Baron of Robbins Geller Rudman & Dowd – offered different answers to that question. Baron told me the Rural/Metro opinion, written by Justice Karen Valihura, articulates a very high bar for aiding and abetting liability. Shareholders first have to prove that the corporate board breached its duty to investors (although the Delaware justices did give plaintiffs a break by finding that board conduct should be scrutinized under the tough Revlon standard). Then shareholders have to show financial advisers intentionally deceived their clients on the board – and that the deception caused real harm to investors.

In the Rural/Metro decision, Baron said, the Delaware justices “are saying over and over, you have to be bad guys doing bad things for selfish reasons.” Baron told me it may still be too easy for financial advisers to get away with misbehavior. “For shareholders,” he said, “maybe (aiding and abetting) shouldn’t be such a tough standard.”

Friedlander said, however, that the Rural/Metro ruling will force financial advisers – and their corporate board clients – to be vigilant about conflicts. “The decision reveals a level of corruption in the process that people have to address,” he told me. Fear of liability to shareholders, he predicted, will eliminate banks’ most egregious disloyalty to clients. The ruling also shows plaintiffs’ lawyers that they can win shareholder claims against financial advisers, Friedlander said. And finally, he told me, the opinion should spur lawyers representing corporate boards to police bankers’ potential conflicts.

That process has already begun, as Eric Klinger-Wilensky and Nathan Emeritz of Morris Nichols Arsht & Tunnell wrote in a forthcoming paper for Business Lawyer, “Financial Advisor Engagement Letters: Post-Rural/Metro Thoughts and Observations.” Friedlander said the Supreme Court’s affirmance means deal lawyers will continue to refine contracts between boards and their bankers.

It’s worth pointing out that the Rural/Metro case may have also influenced the judges in Delaware Chancery Court. As you know, Chancery Court has recently taken a hard line on M&A class action settlements that give shareholders only enhanced disclosures in exchange for broad releases of their claims. Early in the Rural/Metro litigation, plaintiffs’ lawyers from Faruqi & Faruqi agreed to just such a settlement. Friedlander and Robbins Geller objected, and Vice-Chancellor Travis Laster eventually rejected the disclosure-only deal and appointed Friedlander and Baron to lead the case. The result was more than $100 million in recovery for shareholders.

In a soon-to-be-published paper for Penn’s Institute for Law and Economics, Friedlander hypothesizes that Vice-Chancellor Laster’s oversight of the Rural/Metro case deepened the judge’s skepticism about disclosure-only settlements. Ultimately, he postulates, it was this case that “prompted a decisive break with an era of routine approval of disclosure settlements.”

Or, as Baron put it: “The dialogue changed. The fact that the bank got caught changed it.”

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