In Wake Of Delaware Supreme Court Decision, Senator Urges SEC To Declare Illegal Provisions Designed To Insulate Corporations From Shareholder Lawsuits
(Hartford, CT) – In a letter to Securities and Exchange Commission (SEC) Chairman Mary Jo White, U.S. Senator Richard Blumenthal (D-Conn.) today called on the SEC to protect a key check on corporate malfeasance – private citizen suits. Specifically, Blumenthal calls on the SEC to investigate Alibaba Group Holding, Ltd., one of several companies that failed to disclose to investors the existence of provisions limiting private citizen suits. The letter follows a Delaware Supreme Court Ruling (ATP Tour v. Deutscher Tennis Bund) that allowed corporations to unilaterally amend their bylaws and require an investor who files suit against the corporation to pay the corporation’s legal expenses unless the investor receives substantially all of the relief he or she seeks.
Blumenthal wrote: “The potential ramifications from this decision are immense. No rational investor, even with significant financial interests at stake and when presented with clear evidence of corporate misconduct, will brave litigation when the corporate defendant can force the investor to face financial ruin unless he substantially wins on every point. While ATP Tour only affects corporations headquartered in Delaware, Delaware is home to many of the country’s largest public companies. Further, the Delaware Supreme Court’s action is already beginning to have a ripple effect in other jurisdictions, leading other state courts to reconsider longstanding doctrine in this area.”
The full text of Blumenthal’s letter to Chairman White is below:
October 29, 2014
The Honorable Mary Jo White
Securities and Exchange Commission
100 F Street, NE
Washington, D.C. 20549
Dear Chairman White:
I write to ask that the Commission protect investors and America’s capital markets from a serious and imminent threat. A recent Delaware Supreme Court decision allows corporations headquartered in that state to unilaterally amend their bylaws and effectively immunize themselves from the possibility of shareholder lawsuits. As a result, one of the key checks on corporate malfeasance—private citizen suits—may soon become an empty threat. The Commission has the authority and the responsibility to help address this situation.
The United States Supreme Court has long recognized that the private enforcement of securities and corporate governance law is a necessary supplement to public enforcement by the SEC and the US Department of Justice. Corporate executives know that even if the government is unable or unwilling to enforce the law, they can be held accountable for any illegal conduct by their own shareholders. The prospect of liability in private suits encourages compliance with the law just as much as the threat of public action.
Increasingly, corporations are changing their bylaws to limit shareholders’ ability to hold corporate management accountable. One of the most egregious examples is the attempt by Alibaba Group Holding, Ltd. to prevent shareholder suits following its record-setting initial public offering. Alibaba included in its articles of incorporation a provision that requires shareholders who file suit against the company to pay Alibaba’s legal expenses unless the suit is essentially 100 percent successful. Worse, Alibaba failed to make any mention of the aggressive fee-shifting mechanism included in its articles of incorporation before proceeding to sell $25 billion in shares to unwitting investors.
Alibaba is not alone. In recent months, dozens of corporations have added provisions to their bylaws or articles of incorporation designed to stop shareholders from vindicating their legal rights. They are responding to a court decision that upended existing doctrine and left the door open to this kind of legal gamesmanship. Last May, in ATP Tour v. Deutscher Tennis Bund, the Delaware Supreme Court allowed a corporation to unilaterally amend its bylaws and require an investor who files suit against the corporation to pay the corporation’s legal expenses unless the investor receives substantially all of the relief he seeks. Worse, the Court held that it is legitimate for corporations to change their bylaws as part of an effort to insulate themselves from litigation. In other words, the Delaware court found no problem with corporate executives unilaterally changing the rules that will govern any lawsuit against them, even if their clear goal is to stop shareholders from holding them legally accountable.
The potential ramifications from this decision are immense. No rational investor, even with significant financial interests at stake and when presented with clear evidence of corporate misconduct, will brave litigation when the corporate defendant can force the investor to face financial ruin unless he substantially wins on every point. While ATP Tour only affects corporations headquartered in Delaware, Delaware is home to many of the country’s largest public companies. Further, the Delaware Supreme Court’s action is already beginning to have a ripple effect in other jurisdictions, leading other state courts to reconsider longstanding doctrine in this area.
This change in corporate law not only leaves shareholders unable to protect their interests; it undermines the integrity of our capital markets, threatens to decrease market participation, and ultimately puts America’s prosperity at risk. Participants in America’s capital markets—including millions of small investors who rely on their investment for retirement security—feel confident providing their money to American corporations because they trust that deceptive or abusive conduct will be discovered and punished. For decades, they have been able to rest assured that even if government cannot ferret out every incidence of wrongdoing, millions of investors like them have the ability to find and punish malfeasance through civil litigation. With corporations able to dramatically reduce their risk of facing civil litigation, shareholders can no longer feel so confident.
The risks are clear. The question is what action the SEC will take in response to the increasing number of publicly traded companies adopting these immunity-granting provisions.
The SEC’s recent responses to similar, anti-shareholder action by public companies hopefully provides the model for Commission enforcement in this context. When Carlyle Group LP amended the documents for its initial public offering to include a provision that would have required future shareholders to resolve any claim against Carlyle through arbitration rather than in court, the SEC made clear that Carlyle’s IPO would not be accelerated as long as the provision was included. In an earlier action, the Commission blocked a stock sale by Franklin First Financial Corp., which had also included a forced arbitration provision in its corporate charter. In both instances, as here, the provisions would have deprived investors of their ability to vindicate their statutory rights.
I call upon the Commission to commence investigation of Alibaba Group Holding, Ltd., one of several companies that have elected to include fee-shifting provisions in their governing documents but failed to disclose it in offering statements. The SEC should label such provisions as major risk factors and require corporations to publicly disclose them before any initial public offering. More broadly, the SEC should clarify that fee-shifting provisions are inconsistent with federal securities law. At a minimum, I urge the SEC to refuse to permit registration statements to move forward for any company that includes these provisions in violation of our federal securities laws.
Thank you for your consideration. If you have questions, please do not hesitate to contact me or have your staff contact Sam Simon in my office at Sam_Simon@blumenthal.senate.gov or (202) 224-2823.
United States Senate