April in London

St. James’s Park, London

The D&O Diary is on assignment in Europe this week, with a first stop in London for meetings and for an industry event. I have been to London many times before but I have to say I think I like it more every time I travel there. And it is a particularly enjoyable to be there in the Spring, when the flowers are in blooming and the trees are blossoming.

The most important reason I traveled to London was to participate in an event co-sponsored by Beazley and Zurich. This well-organized annual event was held at Beazley’s offices and attended by a large number of people from around the London insurance market. I participated on a panel moderated by Beazley’s Tracy Holm and that included Zurich’s Adrian Jenner and Beazley’s Tom Ielapi. During the reception following the panel, I had a chance to greet many friends from around the London market. It was a pleasure to be a part of this event again this year. I would like to thank Beazley and Zurich for inviting me to participate, and to Tom, AJ, and Tracy for organizing this event.

With Adrian Jenner of Zurich and Tracy Holm and Tom Ielapi of Beazley

While I had many meetings during my time in London, I did have some time to enjoy the city a little bit as well. I was fortunate that the rain predicted for a much of the time never really materialized, and instead I enjoyed pleasant albeit a bit chilly spring weather. On my arrival day, I enjoyed my obligatory arrival stroll through St. James’s Park, Green Park, and Hyde Park. The well-tended gardens were filled with a profusion of blooming flowers, making for a very enjoyable ramble through the royal parks.

 

The wysteria and lilacs were also in bloom during my visit, making it pleasant to stroll around the residential neighborhoods as well as the parks.

One of my long-stranding practices when visiting London it to try to do only things I have never done before. It is amazing after many visits over the years, I continue to find new things to do and places to explore. On this trip, my new things and new places included visits to Richmond-upon-Thames and to the Royal Botanic Gardens at Kew. Both Richmond and Kew can be reached on the District Line and are surprisingly easy to reach – only about 25 minutes from the underground station near my hotel.

A view of Richmond Park

Richmond is famous for its huge royal park, which I enjoyed visiting and exploring. However, I found myself drawn to the river. Richmond is located on the Thames, and the Thames pathway stretches for miles along the river. The woods along the riverside were filled with birdsong and I found myself walking along the river for several hours. The riverside stroll was completely unplanned, but the river and the springtime air seemed to require it. I would have been content to walk on indefinitely, but I needed to make it make into town for another meeting.

A view of the Thames and of Marble Hill House

A view back toward Richmond from the Thames riverside

 

I have always wanted to visit the Kew Gardens, and now that I have been there and seen how easy it is to get there, I can’t believe I never made time to go out there. The Gardens are vast, far beyond what could be seen in a single day. I was fortunate that the azalea and rhododendron were in bloom while I was there. But the real treat was that the bluebells, for which the Garden is famous, were also in bloom while I was there. There were vast areas of the woodland floors that were carpeted with the blue flowers. There was also an exhibit of interesting and extraordinary glass sculptures by the American artist Dale Chihuly. I really enjoyed visiting Kew, and because there is still so much of the Gardens that I didn’t get to see, I will have to go back another time.

 

The blooming azalea in Kew Gardens

Bluebells carpet the woodland floor

 

 

 

 

More Pictures of London

For those who are fans of the TV show. a version of the Police Box where Dr. Who kept the TARDIS time machine is located just outside the Earl’s Court underground station.

 

A trio of pelicans in St. James’s Park

 

A quiet tribute on a residential side street — this statue of Mozart as a child memorializes the time he spent in London. On Ebury Street, near Sloan Square.

One of the pleasures of wandering around London’s residential streets is the chance to discover hidden treasures, like this wall painting on a side street in South Kensington

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Guest Post: Allocation of Defense Costs in D&O Litigation

Peter Selvin

Ben Clements

In the following guest post, Peter Selvin and Ben Clements take a look at the legal principles involved in the allocation of defense expense under a D&O insurance policy. Peter Selvin is a member of TroyGould PC, and Ben Clements is an associate at the firm. I would like to thank Peter and Ben for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Peter and Ben’s article.

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Lawsuits involving directors and officers often include claims or parties covered by a D & O policy, as well as claims or parties the D & O carrier deems to be uncovered.  Frequently, these policies include allocation provisions directing the carrier and insured to use their “best efforts” to allocate defense costs incurred in an underlying lawsuit.

In coverage disputes, carriers commonly argue that such provisions limit their obligation to fund these costs.  Indeed, the general utility of an allocation provision is its ability to delimit the scope of a carrier’s liability.  For this reason, at least one court has characterized an allocation provision as “in effect a partial exclusion of the insurer’s liability.”  Owens Corning v. Nat’l Union Fire Ins. Co. of Pitt., 257 F.3d 484, 493 (6th Cir. 2001).

With time, “best efforts” provisions have evolved, often in response to court decisions resolving such arguments.  See, e.g., In re WorldCom, Inc. Sec. Litig., 354 F. Supp. 2d 455, 466 & n.12 (S.D.N.Y. 2005) (liability policy requiring D & O carrier to advance defense costs prior to the final disposition of a claim “is an explicit repudiation of prior law”).  In this evolving landscape, it is therefore important to remember a key principle: the language of the policy controls.  See Nordstrom, Inc. v. Chubb & Son, Inc., 54 F.3d 1424, 1432 (9th Cir. 1995) (“[W]e consider the particular policy in question to determine which rule best effectuates the reasonable expectations and intentions of the parties under the insurance contract.”).

For example, the Ninth Circuit has held that a “best efforts” allocation provision “‘requires an allocation analysis,’ but not necessarily an allocation.”  Safeway Stores, Inc. v. Nat’l Union Fire Ins. Co., 64 F.3d 1282, 1289 (9th Cir. 1995); accord Silicon Storage Tech., Inc. v. Nat’l Union Fire Ins. Co., 2015 WL 7293767, at *6 (N.D. Cal. Nov. 19, 2015); see also Nat’l Bank of Cal. v. Progressive Cas. Ins. Co., 938 F. Supp. 2d 919, 936 (C.D. Cal. 2013) (finding genuine issue of material fact whether D & O carrier undertook allocation analysis required by policy).  Some courts, however, have held that a “best efforts” provision may mandate an allocation in the circumstances.  See, e.g., Endurance Am. Specialty Co. v. Lance-Kashian & Co., 2011 WL 5417103, at *25 (E.D. Cal. Nov. 8, 2011) (finding that provision stating “there must be an allocation between insured and uninsured Loss” “mandates an allocation under the circumstances here”).

Likewise, “best efforts” provisions sometimes incorporate the “relative legal exposure” rule as the contemplated method of allocation.  See, e.g., Dobson v. Twin City Fire Ins. Co., 2015 WL 12698443, at *9 (C.D. Cal. Aug. 5, 2015) (holding that allocation provision specifying “relative legal exposure” rule controlled over default rule).  Under this rule, allocation generally concerns “the relative exposures of the respective parties to the [suit].”  PepsiCo, Inc. v. Cont’l Cas. Co., 640 F. Supp. 656, 662 (S.D.N.Y. 1986).  Often, these allocations turn on “some notion of relative fault.”  Id.

But this was not always the case.  And even today there exist D & O policies that do not specify a particular allocation method.  In this circumstance, the nature of the analysis will depend on the law of the forum.

In the Ninth Circuit, the “reasonably related” rule remains the default test for allocating defense costs under a D & O policy.  Under that rule, a D & O policy covers defense costs that “are reasonably related to the defense of the insured [parties], even though they may also have been useful in defense of the uninsured [parties].”  Safeway Stores, 64 F.3d at 1289; see also Raychem Corp. v. Fed. Ins. Co., 853 F. Supp. 1170, 1182 (N.D. Cal. 1994).  This rule applies, not only where there are covered and uncovered parties, but also to allocate costs among covered and uncovered claims.  See Pan Pac. Retail Props., Inc. v. Gulf Ins. Co., 471 F.3d 961, 970-71 (9th Cir. 2006) (“Appellants must show that the expenses at issue were related to claims that actually fell within the basic scope of coverage.”).

The following scenario illustrates the breadth of the “reasonably related” rule.  In a lawsuit against a company and its Ds and Os, a single firm represents both sets of defendants.  Counsel must represent one of the Ds and Os at his or her deposition, but the policy covers only the company, not the Ds and Os.  May the carrier insist that counsel allocate its time as between the defense of the (insured) company and the (uninsured) Ds and Os?

The answer should be no, in part because the company’s potential liability derives from the acts or omissions of its Ds and Os.  See Safeway Stores, 64 F.3d at 1287-89.  Deposition testimony by the (uncovered) D and O will be germane to the liability of the (covered) company.  Therefore, counsel’s attendance at the deposition, and representation therein of one of the Ds and Os, is “reasonably related” to the defense of the company.  This is because it is often impossible, especially before resolution of the underlying matter, for counsel or the carrier to differentiate work done strictly on behalf of the company from work done on behalf of the Ds and Os.

The decision in Acacia Research Corp. v. National Union Fire Ins. Co., 2008 WL 4179206 (C.D. Cal. Feb. 8, 2008) makes this point.  There, Nanogen sued Combimatrix and its officer, Montgomery, alleging that Montgomery stole Nanogen’s technology.  After settling with Nanogen, Combimatrix sued its D & O carrier for reimbursement of settlement and defense costs incurred in the Nanogen action, arguing that the costs incurred provided a common defense to (covered) Combimatrix and (uncovered) Montgomery.  Id. at *1-2.

The Court held that “[b]ecause the wrongful acts alleged in the underlying action all involved the alleged wrongful acts of Montgomery, no allocation of defense costs between Combimatrix and Montgomery is needed.”  Id. at *10.  In other words, the costs incurred to defend the uncovered party (Montgomery) were necessarily related to the defense of the covered party (Combimatrix).

In reaching this conclusion, the Court cited testimony from Combimatrix that defense counsel “was divided by issues, not by parties.”  Id. at *4.  The company’s general counsel testified that counsel defended “‘both Combimatrix and [Montgomery],’” and that it was not possible “‘to discern between the defense of the two.’”  Id.  Defense counsel confirmed that he was “‘responsible for the patent law and trade secret law aspects of the case, and also the development of the facts relating to the technology … both for my client and … Montgomery.’”  Id.  Thus, because all defense costs arose out of a single and joint defense, allocation was inappropriate.

Courts in the Second Circuit have followed a similar approach to allocation.  For example, at issue in Doran Jones, Inc. v. Per Scholas, Inc., 2017 WL 2197100 (S.D.N.Y. May 2, 2017), was Doran Jones’s obligation to indemnify a former officer, Klain, for claims based on his conduct as an officer of the company.  The Court concluded that the company’s corporate charter required it to advance Klain’s defense costs on a current basis and rejected Doran Jones’s attempt to allocate those costs among claims based on Klain’s “individual obligations” and those arising from his official duties as an officer.  Id. at *7-8.  Given the “intertwined nature” of the claims, which were “premised on the same factual allegations,” the Court reasoned that permitting allocation would put form over substance.  Id.

If, in the context of a “best efforts” provision, the parties’ best efforts fail to produce an agreement on allocation, the issue often arises whether the carrier must advance costs on a current basis in the underlying litigation and, if so, whether those advanced costs may be allocated.

Relevant here is the D & O carrier’s obligation to contemporaneously pay the insured’s defense costs as they come due.  In both Okada v. MGIC Indemnity Corp., 823 F.2d 276, 280-82 (9th Cir. 1986) and Gon v. First State Insurance Co., 871 F.2d 863, 868-69 (9th Cir. 1989), the Ninth Circuit affirmed the “contemporaneous payment” rule, which directs a D & O carrier to fund an insured’s ongoing defense costs.

The policies in those cases were liability policies, not indemnity policies, a key distinction.  “In D&O policies, there is generally no duty to defend clause.  Instead, defense costs are defined as part of ‘Damages’ for which indemnification is to be paid.”  Health Net, Inc. v. RLI Ins. Co., 206 Cal. App. 4th 232, 259 (2012).  But not all D & O policies are reimbursement policies.  Some are liability policies, which obligate insurers “to pay [the insured’s] defense costs as soon as they were incurred.”  Millennium Labs., Inc. v. Allied World Assurance Co., 726 F. App’x 571, 574 (9th Cir. 2018).  Thus, identifying the type of policy at issue is critical to determining whether a carrier is obligated to contemporaneously fund defense costs.

Of course, the parties may also agree there is no duty of contemporaneous funding.  That scenario was illustrated in Commercial Capital Bankcorp v. St. Paul Mercury Insurance Co., 419 F. Supp. 2d 1173 (C.D. Cal. 2006), where the policy stated that, absent an agreed-upon allocation, “‘the Insurer shall advance on a current basis Defense Costs which the Insurer believes to be covered under this Policy until a different allocation is negotiated, arbitrated or judicially determined.’”  Id. at 1177.  The Court held that this language signified that the parties may “contract out” of the default rule and provide for a different funding mechanism.  Id. at 1181.

If there is an obligation to advance defense costs on a current basis, any allocation before resolution of the underlying suit may likely be premature.  Indeed, Gon declared that carriers should exercise restraint in attempting to limit or allocate the costs they pay on a contemporaneous basis.  871 F.3d at 869.  The Court reasoned that “apportioning legal expenses where coverage is not yet clear, because the facts are not fully developed, may deny the insureds the benefits of the protection they purchased.”  Id.; see also St. Paul Fire & Marine Ins. Co. v. Scopia Windmill Fund, LP, 2015 WL 5440694, at *13-14 (S.D.N.Y. Sept. 9, 2015) (construing “best efforts” provision as “designed to ensure that defense costs are advanced, instead of paid after the fact, even when the parties disagree about allocation”).

This reasoning should control unless the policy provides otherwise.  “D & O insurance is not only designed to provide financial security for the individual insureds, but also plays an important role in corporate governance in America.  Unless directors can rely on the protections given by D & O policies, good and competent men and women will be reluctant to serve on corporate boards.”  In re WorldCom, Inc. Sec. Litig., 354 F. Supp. 2d at 469.  This basic tenet should drive the analysis in circumstances where allocating advanced costs is at issue.  By arguing for allocation of contemporaneous funding, a D & O carrier that declined to bargain for policy language permitting such an allocation deprives the insured of the policy’s full benefits.  See id. at 469 (holding that the “failure to receive defense costs when they are incurred constitutes ‘an immediate and direct injury’” that deprives insureds of the “‘protection from financial harm that insurance policies are presumed to give’”).

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Updates in FTC and California’s Continuing Enforcement of Continuity Programs

Thought that the FTC and California planned to cool off on enforcing trial and subscription programs? Think again. The FTC and California continue to bring these actions with alarming regularity.

For those of you who haven’t been tracking these issues, last year California’s Automatic Renewal Law was amended to tighten the restrictions on continuity programs. The amendments increased restrictions on companies providing trial or discounted introductory programs, and required companies to provide an “exclusively online” cancellation mechanism for consumers who originally accepted the service agreement online.

In addition, both the FTC and the California Autorenewal Task Force (a team of district attorneys who enforce the statute) have brought multiple challenges against companies offering continuity programs. We wrote a few weeks ago about the FTC’s settlement with Urthbox, which included charges challenging how that company’s free trial and subscription offerings were disclosed.

The Urthbox settlement followed California’s autorenewal task force’s settlement with j2 Global. That settlement was unsurprising in most respects (it imposed $1.2 million in monetary redress, required the company to provide “clear and conspicuous” disclosures, obtain affirmative consent from consumers before charging the consumer, provide post-purchase confirmation, and afford consumers an easy cancellation mechanism). However, the order bears noting because it expanded the definition of “consumer,” which the California statute defines as “any individual who seeks or acquires, by purchase or lease, any goods, services, money, or credit for personal, family, or household purposes.” The order expanded the statute’s reach to any “individual consumer with a California billing zip code,” thereby reaching individuals outside the traditional definition of consumer.

The j2 Global case came on the heels of the FTC announcing its case against F9 Advertising, alleging violations of the federal Restore Online Shoppers’ Confidence Act, which governs online negative option and continuity programs. These settlements are not alone, as California has brought cases against DropBox, AdoreMe, multiple dating websites, and others, demonstrating that the California task force and FTC aren’t showing any signs of slowing their enforcement of these laws.

With the landscape surrounding trial and continuity programs shifting rapidly, advertisers would be wise to double-check that their programs comply with the most up-to-date laws and regulators’ expectations. And advertisers shouldn’t bank on falling outside the reach of these laws. Otherwise, they run the risk of falling onto regulators’ radar.

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Senator Warren’s Proposed Executive Liability Legislation is Contrary to Legal Traditions

One of the now-standard storylines about the global financial crisis is that despite all the chaos very few corporate executives were prosecuted and even fewer went to jail. However, rather than interpreting these circumstances to suggest that there was insufficient evidence to convict corporate executives beyond a reasonable doubt, some observers have decided that the problem was that there is something wrong with our criminal justice system.

One observer who has made a hobby horse out of these issues is the U.S. Senator and Presidential Candidate, Elizabeth Warren. Senator Warren has now introduced new legislation that would lower the standard of criminal liability for corporate executive. Among other things, the new legislation would make corporate executives criminally liable for mere negligence in certain circumstances, even in the absence of the degree of intent that has for centuries been viewed in our legal system as the indispensable basis for a criminal conviction. As discussed below, this legislation is not only a bad idea in terms of our country’s corporate competitiveness, it also threatens one of our legal system’s bedrock principles.

The Proposed Legislation

As reflected in her office’s press release (here), on April 3, 2019, Senator Warren introduced the Corporate Accountability Act, which, according to the press release, “holds corporations criminally responsible when their companies commit crimes, harm large numbers of Americans through civil violations, or repeatedly violate federal law.” At the same time, Senator Warren also introduced the Ending Too Big to Jail Act, which the press release describes as “a comprehensive bill to hold big bank executives accountable when the banks they lead break the law.” The text of the Corporate Accountability Act can be found here. The text of the Ending Too Big to Jail Act can be found here.

According to Senator Warren’s summary of the Corporate Executive Accountability Act the bill “makes it easier to send executives to jail” by “expanding criminal liability” to executives of corporations with more than $1 billion in annual revenues who “negligently permit or fail to prevent” violations of the law at their companies.

This expanded executive liability would not only apply when corporations plead are found guilty of, plead guilty to, or enter a deferred prosecution agreement for any crime, but would also apply when corporations are found liable under or enter a settlement with any state or Federal regulator for the violation of any civil law that affects the health, safety, finances, or personal data or 1% of the U.S. population or 1% of the population of any state. The expanded liability would also mandate jail time for executives at companies that are found guilty of a second violation while operating under a civil or criminal judgment of any court or under deferred prosecution agreements with any court.

The bill mandates that any violation will require up to a year in jail, with a second violation requiring up to three years in jail. In addition to this expanded criminal liability, the bill would also require executives at companies with over $10 billion in annual revenues to certify that there is no criminal conduct or civil fraud within the institution.

Discussion

The obvious motivation for this legislation is an underlying belief that there is something defective with our existing system if we can’t put those corporate bastards in jail when thing go wrong. Whatever you may think about this proposition as a general principle, the problem with the various “solutions” that Senator Warren has proposed is that they are deeply contrary to centuries-old bedrock principles of our legal system.

One of the most basic notions in our legal system is that criminal liability attaches only to those who act with intent or knowledge. It has been called a “bedrock principle” of our legal system that criminal liability cannot be imposed without “mens rea,” or a guilty mind. A “negligence” standard of the type that Senator Warren’s legislation seeks to introduce, is, as one commentator noted in a April 21, 2019 Wall Street Journal column relating to the legislation, “an extremely low standard, normally reserved for civil enforcement and tort law.” The real problem with the proposed negligence standard is that it means that people could wind up in jail even if they lack the criminal intent that our system has traditionally required before anyone can be deprived of their liberty and put in jail.

To be sure, there are, as Senator Warren’s press release notes, already existing laws that allow for the imposition of criminal liability in the absence of criminal intent. In the areas of food, drug, health and safety law, as well as in environmental law, there are circumstances in which individuals can be held liable even if they were not involved in or even aware of the legal violation. These imposition of criminal liability in these circumstances are supported by the so-called “Park doctrine” in the case of the health and safety cases, or more generally, under the “Responsible Corporate Officer” doctrine.

These existing doctrines do indeed represent examples of where criminal liability can be imposed in the absence of proof of criminal intent. I have long been a critic of the creeping tendency to expand the narrow exceptions these examples represent. I previously have criticized the increasing willingness of legislatures and even courts to impose criminal liability on corporate officials in the absence of culpability.

The idea that liability can be imposed on an individual for corporate misconduct, in apparent disregard of the corporate form and without culpable involvement or even a requirement of a culpable state of mind, is inconsistent with the most basic concepts surrounding the corporate form. The doctrine arguably imposes liability for nothing more than a person’s status. The word “responsible” in the “Responsible Corporate Officer” doctrine does not mean that the individual is responsible for the misconduct, but only that that the individual is responsible for the corporation.

More fundamentally, the imposition of imprisonment without any fault or even culpable state of mind is fundamentally inconsistent with the fault-based framework of our criminal justice system.

Even if there are circumstances where, as the U.S. Supreme Court has recognized, public health and welfare may justify the imposition of liability without culpability under certain circumstances, the enormous burden this possibility imposes on the civil rights and liberties of the affected individuals would seem to argue that these principles be used to impose liability on individuals only in the rarest and most extreme situations.

Senator Warren’s proposed legislation does not seek to impose criminal liability – and more specifically imprisonment – in a narrow way or in narrow circumstances. Instead, it proposes to impose liability across a broad spectrum of potential legal violations, and it proposed to impose criminal liability not just where a company has committed a criminal violation, but even where the company has merely settled an allegation of civil liability, if a minimal number of people were affected by the alleged misconduct.

Not only does the legislation propose a wholesale expansion of criminal liability, it does so in an odd, unbalanced way that arguably runs contrary to the equal protection of the laws. Under her proposed legislation only corporate executives at larger companies can be held criminally liable while executives at smaller companies cannot; persons responsible for other types of enterprises where criminal misconduct takes place (say, for example, the office of a member of Congress) are not subject to this expanded liability.

The proposed bill’s imposition of criminal liability even to executives of companies that merely settle regulatory claims of civil liability introduces some deeply complicated incentives. As the Wall Street Journal commentator I cited above notes, “It’s one thing for your company to pay a fine, another for your life to be ruined.” CEO’s, the commentator notes, “may simply refuse to settle, and victims will either lose out on the money they are due or have to spend exorbitantly to get it.”

As Wayne State University Law Professor Daniel Henning put it in an April 22, 2019 article in the New York Times Dealbook column (here), “Executives may even cover up violations rather than reporting them if they are more worried about personal exposure to a prison term than in ensuring their companies are in compliance with the law.”  That is without even considering what would happen to the competitiveness of U.S. companies in the global economy if U.S. corporate executives, unlike their foreign counterparts, have to constantly be looking over their shoulder for corporate mishaps that could put them at risk of imprisonment.

The fundamental problem with Senator Warren’s legislation is that it is premised on the idea that there is something wrong with our existing system because it really ought to be easier to put corporate fat-cats in jail. Underlying this premise is a willingness to demonize corporate executives; once they are demonized it is of course easier to argue that they should be put in jail even in circumstances when “real people” would not.

However, the reason it has proven hard to criminally convict corporate executives is that our criminal justice system is founded on the notion that before anyone can be deprived of their liberty and put in jail, or subject to all of the other loss of status and reputation that goes with a criminal conviction, there must be a finding that the accused individual acted with intent.

In other words, our system is built on the notion that criminal liability cannot be imposed without criminal culpability. This principle protects everyone. The value of this protection would be apparent to anyone who finds themselves accused of a criminal offense. There is no principled basis to deprive only executives of corporations above a certain size of these protections while everyone else retains the protections.

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Supreme Court Punts on Tender Offer Pleading Standard Case

In a terse, unsigned one-sentence April 23, 2019 per curiam opinion, the U.S. States Supreme Court has just one week after oral argument dismissed the grant of certiorari in the case of Emulex Corporation v. Verjabedian as “improvidently granted.” The Court had granted cert in the case in order to address a circuit split on the question of whether or not a claimant in must plead scienter in order to establish a tender offer misrepresentation claim under Section 14(e) of the Securities Exchange Act of 1934, or whether allegations of negligence are sufficient. In the merits briefing and at oral argument, the question arose whether or not there is even a private right of action under Section 14(e) at all. As discussed below, the Court’s dismissal leaves all of these questions unaddressed.  The April 23, 2019 opinion in the case can be found here.

Background

As discussed here, the case arises out of the 2015 merger of two technology companies, Emulex Corporation and Avago Wireless Technology. An Emulex shareholder filed a securities class action lawsuit against Emulex and certain of its directors and offices in the Central District of California. In an amended complaint in the action, the plaintiff alleged that in materials associated with Emulex’s tender offer recommendation statement misleadingly created the impression that the premium the Emulex shareholders were to receive in the transaction was significant.

In a January 13, 2016 order (here), Central District of California Judge Cormac J. Carney granted the defendants’ motion to dismiss. Judge Carney held, relying on case law from five different federal appellate courts, that in order to plead a viable claim for misrepresentation in connection with a tender offer under Section 14(e), a plaintiff must plead that the defendants acted with scienter. Judge Carney rejected the plaintiff’s argument that “only negligence” is required.

In an April 20, 2018 opinion written by Judge Mary Murguia for a unanimous three-judge panel of the Ninth Circuit (here), the Ninth Circuit reversed in relevant part Judge Carney’s ruling with respect to requirements to plead a claim under Section 14(e). The Ninth Circuit said, among other things, that “because the text of the first clause of Section 14(e) is devoid of any suggestion that scienter is required, we conclude that the first clause of Section 14(e) requires a showing of only negligence, not scienter.” The Ninth Circuit expressly declined to follow the Second, Third, Fifth, Sixth and Eleventh Circuits in holding that allegations that the defendants acted with scienter are required in order to state a claim under Section 14(e).

The company filed a petition to the United States Supreme Court for a writ of certiorari.

Supreme Court Proceedings

As discussed here, on January 4, 2019, the U.S. Supreme Court granted cert in order to determine what a plaintiff must plead to state a claim for false statements or omissions in connection with a tender offer under Section 14(e) .

While the nominal issue that the company’s cert petition raise was the question of the proper pleading standard to state a claim under Section 14(e), a larger (and intellectually prior) question emerged both in the merits briefs in and at oral argument. As discussed here, both the company’s briefs and briefs submitted by amicus curiae raised the question of whether or not there is even a private right of action under Section 14(e). At the request of the Court, the Solicitor General also submitted a brief (here), in which, in addition to arguing that negligence allegations are sufficient to state a claim under Section 14(e), the government argued that Section 14(e) does not create a private right of action.

At oral argument in the case on April 15, 2019, the discussion focused on the private right of action question rather than the pleading standard, as reported here. One question that seemed to particularly trouble a number of the justices was whether or not the private right of action question had been properly presented to the courts below and therefore whether the question was ripe for the U.S. Supreme Court to consider. Several of the Justices’ questions seemed to reflect a concern that the Court had granted cert on one issue (that is, the pleading standard question) but the petitioner was presenting arguments on another issue (the private right of action issue).

The court dismissed the case just one week after the oral argument, which is hardly the outcome the company was looking for in pursuing the case to the Supreme Court.

Discussion

The practical effect of the Court’s dismissal order is that the case will now go back to the Ninth Circuit, which had overturned the dismissal of the case, and from there the case will go back to the district court. In its 2018 ruling, the Ninth Circuit had remanded the case to the district court for the district court to reconsider the defendants’ motion to dismiss in light of the negligence pleading standard. Presumably, that is what will happen now. The question for the company on remand is whether and how to raise the absence of the private right of action question as well.

Beyond the immediate question of what the parties in this case will now do is the larger question of what litigants in other pending 14(e) claims will now do, and also what the impact will be on future 14(e) cases as well.

Given the question raised before the Supreme Court in the Emulex case, it seems likely that the defendants in current and future 14(e) cases will now also include in their motions to dismiss a separate section in which they argue that there is no private right of action under Section 14(e), and it also seems likely this issue will get a workout at both the district court and the appellate court level. You can probably put a clock on it – the Section 14(e) private right of action question will be back before the U.S. Supreme Court in two or three years’ time. (In the interim, we will have a bunch of district court and appellate court opinions on the subject.)

Assuming the various district courts get past the private right of action question, the courts will then have to turn to the pleading standard question. With respect to the pleading standard question, the Supreme Court’s decision to dismiss the cert petition in Emulex leaves us with a state of affairs that the Supreme Court usually does everything it can to avoid; that is, in most of the rest of the country, plaintiffs in Section 14(e) cases will have to plead scienter, whereas in the Ninth Circuit, it will be sufficient for Section 14(e) claimants to plead negligence.

The upshot is, at least to the extent the district courts concluded there is a private right of action at all, cases the might be dismissed in other circuits under the scienter pleading standard may not be dismissed in the Ninth Circuit under the negligence pleading standard.

If you assume for the sake of argument that the private right of action question does not discourage plaintiffs from pursuing Section 14(e) claims, the split in the circuits on the pleading standard question would seem to encourage plaintiffs to file these kinds of claims in district courts in the Ninth Circuit, rather than the district courts in other federal judicial circuits.

Although the current state of affairs on the pleading standard issue does seem like it might encourage forum shopping, I am not sure we need to be worried the courts in the Ninth Circuit being flooded by these kinds of claims. Although there are a significant number of merger transactions that involve tender offers, many of the transactions that are the subject of merger objection lawsuits do not involve tender offers, and the merger objection lawsuits filed in connection with those transactions do not allege violations of Section 14(e). Most federal court merger objection lawsuits allege violations not of Section 14(e), but rather allege violations of Section 14(a), relating to solicitation of proxies.

To put these generalizations into perspective, let’s take a look at the 2018 federal court merger objection lawsuits. There were 185 federal court merger objection lawsuits filed in 2018. Of those 185, only 30 (or about 16%) were filed under Section 14(e). Almost all of the other federal court merger objection lawsuits (about 84%) alleged proxy misrepresentations in violation of Section 14 (a). In other words, the vast majority of federal court merger objection lawsuits do not involve allegations under Section 14(e).

“Improvidently Granted?” What is THAT About?: Some readers may, like me, be puzzled by the Court’s dismissal of the cert petition as having been “improvidently granted.” The fact that the Court issued its dismissal just one week after oral argument certainly suggests that the Court’s conclusion that cert had been improvidently granted has something to do with what happened at oral argument. We may never know for sure, but I suspect strongly that the Court’s decision to dismiss the cert petition has something to do with a issue discussed in a colloquy that occurred between Emulex’s counsel and Justice Sonia Sotomayor.

Several justices had been pressing Emulex’s counsel on the question of whether or not the private right of action question had been raised properly in the court below. Emulex’s counsel tried to argue that it was sufficient for the Supreme Court to take up the private right of action issue because the company had raised it in its cert petition (even though cert was granted on the pleading standard issue, not the private right of action issue). In response, Justice Sotomayor said (Transcript, pages 9-10):

Aren’t we rewarding you for not raising it adequately below, rewarding you for mentioning it in two sentences in your cert petition and not asking us to take it as a separate question presented? Where should we draw the line as to when we stop rewarding counsel for … moving the ball on cert grounds. … You could write almost any question and throw the kitchen sink in if you choose.

That comment certainly does sound as if at that moment, Justice Sotomayor at least had real concerns about the cert grant. Indeed, viewed through the prism of Justice Sotomayor’s comment, the dismissal of the cert petition just one week later as “improvidently granted” arguably is (at least maybe in hindsight) no surprise. Ronald Mann’s April 23, 2019 column on the SCOTUSblog about the Emulex case’s dismissal (here) has a similar view.

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EEOC Charges Overall Down, But Sexual Harassment Charges Increased

The number of workplace discrimination charges filed with the U.S. Equal Employment Opportunity Commission during Fiscal Year 2018 (which ended September 30, 2018) declined to the lowest level since FY 2006, according the EEOC’s recent statistical release. But while the  number of charges overall are down, the number of sexual harassment charges increased, as did the number of sexual harassment lawsuits the agency filed. The increase in sexual harassment actions seems to suggest a greater awareness of these issues in the wake of the #MeToo movement. The EEOC’s enforcement and litigation statistics can be found here. The EEOC’s April 10, 2019 press release about the 2018 FY statistics can be found here.

There were 76,418 discrimination charges filed in FY 2018, a decrease of 9.3% from the 84,254 filed in FY 2017, and well below the 2008-2016 annual average of 94,000. The 76,418 charges filed in FY 2018 is the lowest annual number of charges filed since FY 2006.

An April 19, 2019 post about the EEOC statistics on the Human Resource Executive blog (here) quotes a commentator who suggested that the decrease number of charges in FY 2018 is a reflection of the current booming economy and low unemployment rate. The robust employment situation makes it easier for employees experiencing a problem just to change jobs. The fact that the last time the number of charges was as low as the number in 2018 was in 2006, which was the last time unemployment approached current levels, is consistent with the suggestion that the lower number of charge filings is due to the current low unemployment levels.

While the overall number of charges filed with the EEOC decreased in FY 2018, the number of sexual harassment charges increased. There 7,609 sexual harassment charges filed in FY 2018, which represents a 13.6 percent increase over the 6,696 sexual harassment charges filed in FY 2017. The number of sexual harassment charges filed in FY 2018 is the highest annual number of sexual harassment charge filings since FY 2011, a year in which the EEOC received almost 24,000 more charges overall than it did in FY 2018. The EEOC also filed more lawsuits alleging sexual harassment in 2018; the agency filed 41 in 2018, representing a 50 percent increase from FY 2017. The agency specifically noted in its press release the impact of #MeToo movement during FY 2018.

The increase in the number of sexual harassment charges in 2018, according to one commentator quoted in the Human Resource Executive blog, shows that employees have a greater awareness of these issues and an increased willingness to file these types of charges. The increased number of EEOC lawsuits, the commentator further noted, show that the “in the #MeToo era, the EEOC has shifted its focus to identifying and remedying workplace harassment issues.”

But while the number of sexual harassment charges has increased, sexual harassment allegations are far from the most frequently cited basis for a charge. The top five reasons charges were filed in FY 2018 were: Retaliations (39,469 charges, 51.6% of all charges); Sex Discrimination (24,655, 32.3%); Disability (24,605, 32.2%); Race (24,600, 32.2%); Age (16,911, 22.21%). The percentages total over 100% because some charges allege more than one kind of misconduct. While sexual harassment charges increased in FY 2018, sexual harassment charges represent a relatively small number of charges compared to other types of allegations.

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Grooming Standards: No Longer So “Hair-Larious”

After seeing several players’ hair covering their jersey numbers during a performance of the Star Spangled Banner, former New York Yankees’ owner, George Steinbrenner, instructed the players to cut their hair. It was then, in 1973, that the New York Yankees’ grooming policy was born.  The official team policy states that, “all players, coaches, and male executives are forbidden to display any facial hair other than mustaches (except for religious reasons), and scalp hair may not be grown below the collar.” Over the years, many have commented about the policy and some have openly rebelled.

In 1991, Don Mattingly (current Miami Marlins’ Manager), defied the policy and refused to cut his hair. In response, he was removed from the team’s starting lineup and was fined repeatedly until he trimmed his hair.   As with employers with similar policies, Steinbrenner wanted the Yankees to adopt “a corporate attitude.”

New York City, however, has recently warned businesses that bans on hairstyles commonly worn by African-Americans may violate anti-discrimination laws.  On February 18, 2019, the New York City Commission on Human Rights said, in part, that employers may face liability under New York City’s Human Rights Laws if their policies subject African-American employees to disparate treatment – such as the banning of “cornrows, dreadlocks, Afros, or fades.”  Under the guidelines, the Commission can impose a penalty of up to $250,000 on those who harass, demote, or fire individuals because of their hair.

New York City is leading the charge. Not many other local governments (if any) have considered similar ordinances. But this warning serves as reminder that overbroad appearance and grooming policies can lead to discrimination concerns in the workplace. Ways to curb potential concerns include drafting concise, easy-to-understand policies, carving out exceptions based on protected categories (such as for religious reasons like the Yankees’ policy did), and, of course, making sure that the policies are enforced consistently.

Something tells me that if The Boss were still around, he would likely pay a $250,000 fine per player to make sure that his Yankees look clean-cut … but how many other employers would do the same?

Register Here for our 2nd Annual Tampa Labor & Employment Law Seminar from 8am-4pm on Friday May 10, 2019 at the Tampa Bay History Museum.

Register Here for our 29th Annual Miami Labor & Employment Law Seminar from 8am-4:15pm on Friday, May 17, 2019 at the Hard Rock Stadium.

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