Opinion

Alison Frankel

Amid ‘activist’ debate, Strine sides with hedge fund dogging SandRidge

Alison Frankel
Mar 12, 2013 21:01 UTC

Leo Strine, the Chancellor of Delaware Chancery Court, is no particular friend of the activist shareholder, as hedge funds and institutional investors who press corporate boards for change have become known. Strine is after all on record, in a November 2010 essay for the American Bar Association’s The Business Lawyer, arguing that short-term shareholder pressure impedes corporate boards from building long-term value. That’s a theme echoed loudly last week by a pair of gray eminences of corporate law, Martin Lipton of Wachtell, Lipton, Rosen & Katz and Ira Millstein of Weil, Gotshal & Manges, in warnings about the potentially deleterious effect of what Millstein called “newfound activism (with a) focus on short-term results.” Both Milstein’s relatively moderate opinion piece in Dealbook and Lipton’s bellicose client alert argued that hedge funds focused on quarterly results and shareholder returns are fundamental threats to U.S. corporations. Or, as Strine put it in his prescient 2010 essay, “It is increasingly the case that the agenda-setters in corporate policy discussions are highly leveraged hedge funds, with no long-term commitment to the corporations in which they invest.”

Nevertheless, when Strine had to take sides last week between an activist hedge fund and a self-interested corporate board in a showdown involving seats on the board of the oil and natural gas company SandRidge Energy, his choice was emphatic: SandRidge’s board, he ruled in a 38-page opinion, “failed to exercise its discretion in a reasonable manner” when it used the threat of a $4.3 billion “proxy put” bond buyback to try to sway shareholders against supporting an alternative slate of directors proposed by the hedge fund TPG-Axon. Strine granted a shareholder motion to enjoin SandRidge from continuing to use the maneuver (which I’ll explain in more detail below) in its campaign against the TPG slate.

As usual, Strine’s opinion is dense and fact-intensive, so I’m not suggesting that the chancellor has changed his message on short-term investors. In fact, shareholder counsel Stuart Grant of Grant & Eisenhofer told me that the SandRidge record and the opinion itself do not indicate that hedge fund backing for the alternative slate was a factor in Strine’s decision. Instead, Grant said, the chancellor’s focus was on the board’s interest in its own entrenchment. “Chancery Court bends over backward to give boards discretion as long as there’s no conflict,” he said. “If there’s a conflict, the court is going to look really, really hard at the board’s conduct.” And in this case, said Mark Lebovitch of Bernstein Litowitz Berger & Grossmann, who argued for shareholders at the March 7 injunction hearing, “the chancellor saw a board that was clearly behaving badly.” If there’s a broad message in the ruling, in other words, it’s that boards are not always in the right in Delaware, even when they’re fending off meddlesome hedge funds.

SandRidge, as Strine discusses (and as Reuters chronicled in investigative reports earlier this year), has had a spectacularly bad track record since July 2008, when its shares traded at a high of $68. They now trade at less than $6. Despite that plummet, CEO Tom Ward continues to be paid handsomely and accorded what Reuters called “wide latitude in personal oil and gas deals.” Frustrated with this state of affairs, one of SandRidge’s biggest shareholders, TPG, began agitating last November for Ward’s removal, new directors and a possible sale of the company.

After the board adopted a poison pill to counter the hedge fund, TPG announced a shareholder consent solicitation that would effectively replace the existing board with directors supported by the hedge fund. The day after TPG filed its preliminary statement, the company responded with a preliminary revocation statement warning shareholders that ouster of the board was a control change that would trigger proxy put provisions requiring the company to buy back $4.3 billion in debt. A SandRidge shareholder then sued the company, arguing that the board could avert the proxy put if it simply voted to approve the rival slate for a shareholder vote. With the vote on TPG’s consent solicitation about to kick off – and with the SandRidge board refusing to commit to approval of TPG’s slate for a vote – the shareholder asked for a preliminary injunction to require the SandRidge board to approve the rival slate for the purpose of averting the proxy put or to explain why it wouldn’t do so.

How SCOTUS wiretap ruling helps Internet privacy defendants

Alison Frankel
Mar 12, 2013 13:26 UTC

I’ve spent the last two weeks vacationing out of the country, with only intermittent access to headlines from the United States. Every time I checked in, I felt as though I’d missed another huge legal story: the U.S. Supreme Court’s ruling on materiality and securities class certification in Amgen v. Connecticut Retirement Plans; oral arguments in Argentina’s appeal in the renegade bondholder litigation; a New York state court’s long-awaited holding that insurance regulators were within their rights to approve MBIA’s $5 billion restructuring in 2009; Credit Suisse throwing in the towel on Ambac’s mortgage-backed securities claims; and the slashing of Apple’s billion-dollar patent infringement damages against Samsung. But one of the great things about legal journalism is that first-day coverage isn’t usually the end of the story, especially when it comes to judicial opinions.

Take, for example, the Supreme Court’s ruling late last month in Clapper v. Amnesty International. On its face, the decision addresses a challenge by human rights advocates and media groups to a 2008 amendment of the Foreign Intelligence Surveillance Act that makes it easier for the government to obtain approval from a special court for wiretaps on intelligence targets outside of the United States. Opponents of the amendment, who asserted that their work requires them to engage in sensitive phone and email communications with likely targets of such surveillance, claimed the law violates the First and Fourth Amendments and the separation of powers doctrine. The court, as you probably read soon after the decision was announced on Feb. 26, said that the 2nd Circuit Court of Appeals erred when it concluded the plaintiffs had standing to bring their case. In a 5-to-4 ruling, the Supreme Court held that the human rights and media groups could not show, without resorting to speculation, that they faced “certainly impending” harm from the 2008 amendment. The majority also said that the plaintiffs could not establish standing through the costs they incurred to prevent harm from the new law.

That’s good news for government spooks, of course. But as Ropes & Gray noted in a very smart client alert last week, it’s also good news for companies facing class actions based on alleged breaches of their customers’ online privacy. Defendants have shelled out tens of millions of dollars (mostly in charitable contributions and legal fees for the other side) in consumer class actions filed in the wake of data breaches or revelations of undisclosed customer tracking. The Clapper ruling should make it easier for Internet businesses to win the quick dismissal of these cases on standing grounds.

In MBS litigation, NCUA is FHFA’s Mini Me

Alison Frankel
Feb 22, 2013 23:14 UTC

The next time Congress creates a conservator for failed government-backed entities such as credit unions and mortgage finance outfits, it would sure be nice if lawmakers were specific about just how long the bailout groups have to bring litigation to recover for their members’ losses. You already know about the statute of repose question looming over the Federal Housing Finance Authority’s cases against 18 banks that sold supposedly deficient mortgage-backed securities to Fannie Mae and Freddie Mac. With the 2nd Circuit Court of Appeals now weighing UBS’s Hail Mary argument that FHFA’s suits are time-barred under the statute of repose, which was not explicitly extended in the law creating the FHFA, most of the other banks in the litigation are waiting for an appellate ruling before they buckle down and settle the conservator’s billions of dollars of claims. (The exception, as my Reuters colleague Nate Raymond was the first to report, is GE, which had relatively small exposure to FHFA and settled last month.)

You may not have been aware that the same congressional language that created a wedge for defendants in the FHFA cases has also led to tussling in a series of suits against MBS sponsors and arrangers by the National Credit Union Administration, which oversees failed credit unions. Those institutions weren’t MBS investors on the order of Fannie Mae and Freddie Mac – no one was – but NCUA’s lawyers at Kellogg, Huber, Hansen, Todd, Evans & Figel and Korein Tillery have quietly filed suits against more than a dozen banks that sold mortgage-backed securities to failed credit unions. NCUA touts itself as the “the first federal regulatory agency for depository institutions to recover losses from investments in faulty securities on behalf of failed financial institutions,” citing the $170 million in MBS settlements it has reached with Deutsche Bank, Citigroup and HSBC.

But there’s a little something standing in the way of additional NCUA settlements: that pesky statute of repose, which Congress didn’t explicitly address in language that extended the NCUA’s time to sue on behalf of its members. The so-called “extender statute” of the Federal Credit Union Act includes a specific extension of the statute of limitations, and the credit union authority has fared well in federal court in Kansas with arguments that Congress clearly intended the law to apply also to the statute of repose. Defendants argue otherwise – JPMorgan’s lawyers at Cravath, Swaine & Moore asserted this week in a motion to dismiss the NCUA’s case against the bank in Kansas that, among other things, the credit union overseer’s case is time-barred – but Kansas federal judges have resisted that argument.

Victim in SCOTUS generics case has powerful amici: Harkin and Waxman

Alison Frankel
Feb 21, 2013 23:12 UTC

Last week a New Hampshire woman who suffered grievous side effects when she took a generic pain reliever manufactured by Mutual Pharmaceutical filed her merits brief at the U.S. Supreme Court, in a case that will determine whether the Food and Drug Administration’s regulation of generic drugs pre-empts state-law design defect claims against manufacturers. Karen Bartlett’s lawyers at Kellogg, Huber, Hansen, Todd, Evans & Figelargue that design defect claims, unlike failure-to-warn claims, do not depend on the FDA-approved labels generics are required to carry under the Hatch-Waxman Act. That fact, they contend, distinguishes Bartlett’s case (and the underlying 1st Circuit Court of Appeals ruling Mutual is challenging) from the reasoning the Supreme Court applied in its 2011 decision in Pliva v. Mensing, which held that generics are not liable for failing to warn of dangerous side effects because they are required to carry the same labels approved by the FDA for brand-name versions of their products.

Bartlett’s brief, which also urged the justices to disregard the U.S. government’s changing position on pre-emption for drugmakers, said that the Supreme Court really should consider congressional intent – as the court itself acknowledged when it ruled that FDA regulation doesn’t pre-empt state-law product liability suits against brand-name drugmakers in the 2009 case Wyeth v. Levine. Congress was certainly aware of state-court product liability litigation when it passed the Hatch-Waxman Act in 1984, just as it was previously aware of such litigation when it originally enacted the Food, Drug and Cosmetic Act establishing the FDA’s regulation of pharmaceuticals. Neither law, Bartlett’s brief said, includes a provision expressly stating that those product liability claims are pre-empted by federal regulation. Quoting from the Supreme Court’s Levine decision, the brief argues that the absence of pre-emption clauses in Hatch-Waxman and the FDCA is “powerful evidence” that Congress didn’t intend FDA regulation to pre-empt common law claims.

Here’s even more powerful evidence of Congress’s intent: a newly filed amicus brief filed by Senator Tom Harkin (D-Iowa) and Representative Henry Waxman (D-California, and, yes, the Waxman of Hatch-Waxman) in support of Bartlett. Harkin and Waxman, who are represented by Allison Zieve of the Public Citizen Litigation Group, say lawmakers’ intentions couldn’t be clearer. If Congress wanted federal regulation to preclude personal injury suits, it would have said so. It’s no accident that Congress did not, according to the brief.

Will 2nd Circuit limit on UBS liability in terror case have ripples?

Alison Frankel
Feb 20, 2013 23:04 UTC

Have you heard about the story by a reporter for the New York Daily News who says he inadvertently started a rumor that Senator Chuck Hagel, President Obama’s nominee to head the Defense Department, received speaking fees from a group called Friends of Hamas? The reporter, Dan Friedman, wrote in a piece Monday that earlier this month, he called a congressional staffer to check out reports that Hagel had received fees from controversial groups. He pressed for details on the groups, using what he considered farcical, made-up names like “Junior League of Hezbollah” and “Friends of Hamas.” The next thing Friedman knew, conservative websites published speculation that Hagel had accepted fees from Friends of Hamas, citing Capitol Hill sources. Eventually, after mainstream sites questioned the existence of the group, the story fizzled.

“Friends of Hamas” may be fictional, but according to ongoing litigation against financial institutions including Arab Bank, National Westminster Bank and Credit Lyonnais, Hamas and other terror groups had, at least, friendly customer relationships with their bankers. In cases in federal court in Brooklyn and Manhattan, victims of terrorist acts have asserted that the banks violated the Anti-Terrorism Act (ATA) by enabling groups like Hamas to finance bombings. More than a half-dozen suits involving thousands of terror victims have survived defense motions to dismiss and are headed for summary judgment rulings.

The banks believe their defenses received a boost last week from the 2nd Circuit Court of Appeals in a decision captioned Rothstein v. UBS. A three-judge appellate panel (Judges Amalya Kearse, Raymond Lohier andChristopher Droney) upheld the dismissal of an ATA case against UBS, finding that the plaintiffs hadn’t shown a proximate link between UBS’s admission of forbidden transfers of U.S. currency to Iran and acts of terror by Iran-sponsored groups like Hamas and Hezbollah. The plaintiffs had argued that because UBS was fined $100 million for breaching U.S. financial sanctions against Iran, the bank bore the burden of showing that its money transfers to Iran were not used to finance terror. The 2nd Circuit disagreed on burden shifting, holding that the language of the ATA indicates that Congress wanted terror victims to show a direct nexus between their injuries and defendants’ actions. In this case, the appeals court said, the plaintiffs couldn’t show that Iran specifically used transfers from UBS to finance terror operations by groups it backed. The ruling said the ATA does not carry a strict liability standard that would open up claims against anyone who provided money to a state sponsor of terrorism. It also held there’s no cause of action for aiding and abetting under the ATA.

Facebook IPO derivative ruling: a cure for multiforum madness?

Alison Frankel
Feb 15, 2013 00:22 UTC

Every company considering an IPO owes a hearty thanks to U.S. District Judge Robert Sweet of Manhattan for his decision Wednesday to dismiss four shareholder derivative suits against Facebook board members. Sweet’s painstaking 70-page opinion includes holdings that are great for Facebook’s defense of a parallel securities class action over its disclosures to IPO investors, but the judge also reached precedent-setting conclusions on standing and ripeness that will help other derivative defendants ward off IPO-based claims in state court. Facebook’s lead lawyers, Andrew Clubok of Kirkland & Ellis and Richard Bernstein of Willkie Farr & Gallagher, certainly deserve credit for coming up with innovative arguments to establish valuable precedent in IPO cases.

I believe Sweet’s ruling may have application beyond IPO derivative suits, though. The decision could represent a way for defendants to address the proliferation of derivative suits that are inevitably filed in multiple state courts after M&A deals are announced.

First, a refresher on the allegations and procedural background of the Facebook derivative suits. The complaints allege that under the direction of Facebook’s board, the company failed to make adequate disclosures to IPO investors about Facebook’s revenue projections and challenges in adapting to smart device usage. (If those sound an awful lot like securities class action claims, that’s because the derivative suits parallel a securities case against Facebook that is also before Judge Sweet.) Three derivative suits were filed in state courts in California. A fourth was filed in federal court in Manhattan. Defendants removed the three California cases to federal court in San Francisco. Then, before shareholders could litigate motions to remand them to state court, the Judicial Panel on Multidistrict Litigation transferred all of the derivative litigation to Sweet in Manhattan federal court.

FDA confirms: It’s considering rule change for generic labels

Alison Frankel
Feb 13, 2013 22:37 UTC

Last month, when I wrote about the Obama administration’s apparent flip-flop on the question of federal pre-emption of product liability claims against generic drugmakers, I mentioned a curious footnote in the Justice Department’s Supreme Court amicus brief in Mutual Pharmaceutical v. Barrett. All the wrangling over liability for generics, which are required by law to use the same labels as the brand-name drugs they replicate, could be unnecessary, Justice hinted. “This office has been informed that Food and Drug Administration is considering a regulatory change that would allow generic manufacturers, like brand-name manufacturers, to change their labeling in appropriate circumstances,” the brief said. “If such a regulatory change is adopted, it could eliminate pre-emption of failure-to-warn claims against generic-drug manufacturers.”

I should have given the footnote more attention. In the last couple of weeks, it has prompted speculation by a number of pharma websites about whether the FDA really intends to upend longstanding policy barring generics from altering their labels, and, if so, what that portends for their product liability exposure. On Wednesday, I emailed the FDA to ask. In an email response, an FDA representative confirmed what the Justice Department footnote suggested: “FDA is considering a regulatory change that would allow generic manufacturers, like brand-name manufacturers, to change their labeling in appropriate circumstances,” the agency said. “FDA intends to provide an opportunity for public comment with respect to any such proposed changes to its regulations.”

The FDA email, according to Kurt Karst of Hyman, Phelps & McNamara (and the FDA Law Blog), is the first confirmation of what FDA watchers have been anticipating since the U.S. Supreme Court’s 2011 ruling in Pliva v. Mensing freed generics from liability for failing to warn consumers about dangerous side effects.

Whistle-blower claims Cadwalader, Wittels ruined his life

Alison Frankel
Feb 12, 2013 22:44 UTC

A new complaint against Cadwalader, Wickersham & Taft and Sanford Heisler by a onetime engineer for Seagate Technology who became a whistle-blower against his former employer, is the latest evidence that whistle-blowers lead difficult lives. And according to the engineer, Paul Galloway, the lawyers who were supposed to be helping him instead made him unemployable.

In 2009 Galloway reached out to a company called Convolve, which, along with the Massachusetts Institute of Technology, was suing Seagate for patent infringement and theft of trade secrets. Galloway, who was unemployed at the time (his complaint does not provide details), suggested in an email that he might have information about Seagate violating a non-disclosure agreement. Debra Steinberg of Cadwalader, who represented Convolve and MIT, followed up with Galloway. According to the engineer’s suit, Steinberg asked if he had his own lawyer. Galloway said he didn’t. He alleges that he subsequently received a call from the CEO of Convolve, who recommended that he retain Steven Wittels, then a name partner at the noted employment firm now known as Sanford Heisler.

Galloway met with Wittels, who determined that the engineer didn’t have a cause of action against Seagate. But Wittels also mentioned that Convolve’s lawyers wanted to meet Galloway, and, according to the complaint, later sent the engineer a retainer agreement that linked Wittels’s contingency fees to the Convolve litigation. Galloway alleges that, unbeknownst to him, Wittels was a personal friend of the Convolve CEO, and Convolve was secretly paying Galloway’s legal bills.

California AG’s false claims case vs S&P: secret route to issuers?

Alison Frankel
Feb 11, 2013 23:26 UTC

If you’ve been keeping track of the Justice Department’s civil suits against banks accused of marketing deeply flawed mortgage-backed securities and collateralized debt obligations, you know there are two laws at the heart of the feds’ cases: the Financial Institutions Reform, Recovery and Enforcement Act and the False Claims Act. (Shout-outs to my Reuters colleagues Aruna Viswanatha and Nate Raymond, who noted Justice’s creative application of these two laws long before most reporters knew FIRREA from an unfortunate stomach complaint.) The FCA, which offers the prospect of triple damages, has provided the federal government with a particularly big stick to use against banks. As of last November, federal prosecutors had already cited the FCA in more than half a dozen civil fraud suits against such mortgage lenders as BofA, Citigroup, Deutsche Bank and Flagstar, obtaining more than $1.6 billion in settlements, mostly based on alleged defrauding of a federal home insurance program.

The Justice Department, in other words, isn’t shy about asserting the FCA in mortgage cases, even when its interpretation of a “claim” stretches the classic whistle-blower definition of a government contract or request for payment under a government program. Manhattan U.S. Attorney Preet Bharara, for instance, brought claims under both the FCA and FIRREA when he sued Bank of America in November for supposedly deceiving Fannie Mae and Freddie Mac about deficient underwriting of mortgages peddled by Countrywide.

So it was notable that last week, when the Justice Department sued Standard & Poor’s for knowingly promulgating false ratings of deficient securities, it brought claims under only FIRREA, not the FCA. More than a dozen states that rode sidecar with Justice sued under state trade practices or unfair competition laws rather than under state versions of the federal False Claims Act. Only one state, California, also sued S&P for violating its state false claims law.

Can we now admit it’s time to end issuer-pays credit rating model?

Alison Frankel
Feb 5, 2013 23:21 UTC

In July 2007, a recently hired analyst in Standard & Poor’s structured finance group exchanged a series of emails with an investment banking client who wanted to know how the new job was going. Things were just great, the analyst said sardonically, “aside from the fact that the MBS world is crashing, investors and media hate us and we’re all running around to save face … no complaints.” Part of the problem, the analyst said in a subsequent email, was that some people at S&P had been pushing to downgrade structured finance deals, “but the leadership was concerned of p*ssing off too many clients and jumping the gun ahead of Fitch and Moody’s.

I suspect that only an investment banker could find it in his or her heart to sympathize with a credit analyst in the summer of 2007, but this one suggested that some good might come from S&P’s internal conflict. “This might shake out a completely different way of doing biz in the industry,” the banker wrote. “I mean come on, we pay you to rate our deals and the better the rating the more money we make?!?! Whats up with that? How are you possibly supposed to be impartial????”

The email exchange, recounted deep in the Justice Department’s new civil complaint against S&P and its parent, McGraw-Hill, pretty well sums up the entire theory of the government’s case against the rating agency. S&P, according to the Justice Department, had a choice as the housing market began to collapse and subprime mortgages began to default. Rating agency analysts who monitored mortgage-backed securities knew the crash was coming and warned repeatedly that previous ratings of mortgage-backed instruments were no longer a reliable gauge. But rather than heed those warnings and toughen standards on mortgage-tied instruments, S&P continued to accept fees from banks in exchange for conferring its blessing on tens of billions of dollars of collateralized debt obligations. When truth collided with the client relationships that generated S&P’s revenue, in other words, money won out.

  •