(Article from Securities Law Alert, April 2022)
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On April 7, 2022, the Eighth Circuit affirmed a district court’s dismissal, on the grounds of failure to plead demand futility, of a derivative action alleging that a pre-merger proxy statement contained false and misleading statements in violation of Section 14(a) of the Exchange Act. Carpenters’ Pension Fund of Illinois v. Neidorff, 2022 WL 1039671 (8th Cir. 2022) (Shepherd, J.). The court held that plaintiffs failed to plead a material misrepresentation or omission and therefore failed to plead facts demonstrating that at least half of the board faced a substantial likelihood of liability on the Section 14(a) claim. The court thus affirmed the district court’s dismissal based on plaintiffs’ failure to allege that demand would have been futile.
A few months after merging with a target company, the corporation disclosed an increase in reserves for the target’s increased liabilities. A stock drop followed. Plaintiffs alleged five derivative claims[1] against certain of the corporation’s former and then-current directors and officers. As to the claim alleging a violation of Section 14(a), plaintiffs alleged that from the time the proxy statement was issued until the closing date, the corporation’s directors and officers concealed their knowledge of the target’s various financial and business problems.
Defendants moved to dismiss on the grounds that plaintiffs failed to plead demand futility. The district court granted defendants’ motion and dismissed the case with prejudice.
Delaware’s Demand Futility Test
Before reaching the merits, the court noted that it must first determine the proper framework for assessing demand futility. Because the nominal defendant was a Delaware corporation, the court applied Delaware law and the demand futility test articulated last year by the Delaware Supreme Court in UFCW Union & Participating Food Indus. Emps. Tri-State Pension Fund v. Zuckerberg, 262 A.3d 1034 (Del. 2021) (Tri-State).[2] After reviewing Tri-State’s three-part test, the court focused exclusively on the second Tri-State question, i.e., whether at least half of the board (here, five of the nine directors) faced a substantial likelihood of liability as to any of plaintiffs’ claims.[3]
Demand Not Excused Because Plaintiffs Failed to Plead a Material Misrepresentation or Omission
The court concluded that plaintiffs failed to plead particularized facts demonstrating that at least half of the directors faced a substantial likelihood of liability on the Section 14(a) claim because plaintiffs failed to plead facts showing that the proxy statement contained a material misrepresentation or omission. The court pointed out that the proxy statement used bold type to warn stockholders of “the uncertainties inherent in the unaudited financial projections” and cautioned them “not to place undue, if any, reliance on such unaudited financial projections.” The court found that this cautionary language related directly to the allegedly misleading pro forma analyses and therefore rendered the alleged omissions immaterial as a matter of law.
[1] The five claims were: (1) violation of Section 14(a) of the Exchange Act; (2) breach of fiduciary duties of good faith, fair dealing, loyalty, and due care; (3) breach of fiduciary duty of loyalty, good faith, and candor in connection with securities law violations; (4) insider trading; and (5) unjust enrichment. Below, we focus exclusively on the court’s reasoning concerning plaintiffs’ Section 14(a) claim.
[2] Please click here to read our discussion of the Delaware Supreme Court’s decision in Tri-State.
[3] The Tri-State demand futility test consists of three questions to be analyzed on a director-by-director basis: “(i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand; (ii) whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and (iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.” Demand is excused as futile if the answer to any of the three questions is “yes” for at least half of the members of the demand board. The court did not analyze the first or third question beyond noting that there was no appellate issue requiring resolution.