July 2019

Disclosure-based strike suits have died an inglorious and richly-deserved death in Delaware. Lest deal practitioners and their clients be lulled into a false sense of security, recent decisional law drives home the point (again) that disclosures are potentially very important. In Chester County Employees’ Retirement Fund et al. v. KCG Holdings, Inc. et al., C.A. No. 2017-0421-KSJM (Del. Ch. June 21, 2019) (“KCG Holdings”), for example, the Delaware Court of Chancery declined to extend Corwin protection in the context of a motion to dismiss where it determined that allegations supported a pleading-stage inference that proxy disclosures relating to the challenged merger were inadequate. Consequently, rather than having the sanitizing effect it may have had under Corwin and progeny, the shareholder vote itself was challenged in costly litigation allowed to proceed toward a disposition on the merits.

What is the “Corwin doctrine” in Delaware parlance? The Corwin doctrine came by way of Corwin v. KKR Financial Holdings LLC, 125 A. 3d 304 (Del. 2015). In that case, the Delaware Supreme Court held that a change in control transaction otherwise subject to enhanced judicial scrutiny is protected by the business judgment rule if the transaction is approved by a fully-informed, uncoerced, disinterested stockholder vote. Id. at 314. Corwin since has been expanded to other transactions, including mergers supported by a controlling stockholder and otherwise subject to entire fairness review and Section 251(h) transactions. See, e.g., van der Fluit v. Yates, 2017 WL 595314 (Del. Ch. Nov. 30, 2017).

The recent decision in KCG Holdings involved a fiduciary duty suit by former stockholders of KCG Holdings, Inc. (“KCG”) challenging the consideration received in a July 2017 acquisition of KCG by Virtu Financial, Inc. (“Virtu”). The former KCG stockholders alleged generally that KCG’s directors failed to maximize value for the KCG stockholders in negotiating the merger. Id. at 1-2. Specifically, the former KCG stockholders alleged that there were secret dealings between Jefferies LLC, KCG’s financial advisor and largest stockholder, and Virtu, and that the CEO of KCG voted to approve the merger at a lower purchase cost per share than a previous offer after the new, lower offer increased the compensation and retention pool for himself and his management team. Id.

The KCG director defendants moved to dismiss, arguing that the board’s actions were protected by the business judgment rule because, in accordance with Corwin, the merger was approved by an informed, uncoerced majority of KCG’s disinterested stockholders. Id. at 4. The Court denied the motion to dismiss, finding that although the merger was approved by a disinterested stockholder vote, the vote was not fully informed because the directors had failed to disclose material information to the stockholders ahead of the vote. Id. at 4-6. In particular, the Court noted that the complaint contained allegations which, taken as true, demonstrated that the proxy materials (1) failed adequately to discuss merger alternatives proposed by KCG’s financial advisor and discussed secretly with Virtu; (2) failed to disclose that the KCG CEO initially took the position that $20.21 per share was “too low” despite his later support of a $20 per share deal price with adjustments to his and his management team’s compensation packages; and (3) failed to disclose earlier, more optimistic pre-merger financial projections that were adjusted downward mid-stream, and the circumstances leading to the revised projections. Id.

The takeaway is this: The Court of Chancery is not a form over substance tribunal and does not wilt from peering behind the façade of process where well-pleaded allegations suggest procedural infirmities. While poorly-conceived strike suits reflexively challenging disclosures upon the announcement of a merger will not be countenanced, this does not mean that attention to proxy disclosures may be relaxed. On the contrary, in Delaware disclosures still count, and in some instances may bear directly on the level of judicial scrutiny applied to a transaction if challenged. As KCG Holdings reminds, the distinction may mean the difference between a stockholder suit dying an early death or proceeding to a costly settlement or disposition on the merits. Proxy disclosures, alas, still should occupy a position of prominence in the minds of transacting parties and their advisors where circumstances dictate, rather than be critically evaluated as an afterthought.