Bear Stearns Shareholders Challenge Lockup Provision

The Delaware Chancery Court is poised to decide whether a key provision in the buyout of The Bear Stearns Companies Inc. passes muster. On March 16, 2008, Bear Stearns stunned the market by announcing that it would be acquired by JPMorgan Chase & Co. for approximately $2 a share. One week later, amidst concerns that shareholders of Bear Stearns would reject the deal, JPMorgan increased its offer to approximately $10 a share. The revised deal, however, also provides that JPMorgan will first acquire 95 million newly issued shares of Bear Stearns, which represents approximately 39.5% of the company. The new share issuance effectively means JPMorgan will need another 10.5% of the shareholder votes for the merger to be approved.

The new share issuance is not subject to shareholder approval, and at least two institutional shareholders have asked the Delaware Chancery Court to grant a temporary restraining order preventing the share issuance. They argue that the provision was designed to eliminate the voting rights of the current Bear Stearns shareholders and that Bear Stearns’ directors breached their fiduciary duties by agreeing to such a provision. Since the share issuance is scheduled to be completed around April 8, 2008, it is likely that the Delaware Chancery Court will address this issue shortly.

Bankruptcy Examiner in New Century Financial Collapse Blames Accounting Firm

New Century Financial Corporation was among the largest providers of subprime home loans before it collapsed and filed for bankruptcy in April 2007. Now an examiner for the bankruptcy court is pointing the finger at its former outside auditor. In his report, examiner Michael Missal asserts that the New Century bankruptcy estates have potential causes of action against KPMG for professional negligence and negligent misrepresentation as a result of KPMG’s audit practices and accounting advice. Regardless of whether the claims against KPMG have merit (KPMG strongly disagrees with the allegations), the report may be a bad omen for accounting firms. With numerous subprime lenders filing for bankruptcy, it is not unlikely that creditors and shareholders will look to the accounting firms to recoup some of their losses.

Delaware State Court Upholds Shareholder’s Right to Nominate Board Members

The Delaware Chancery Court decided on March 13,2008, to uphold the shareholder rights of JANA Master Fund, Ltd. (JANA) against CNET Networks, Inc. (CNET). JANA and its affiliates own approximately 11% of CNET’s outstanding stock. JANA sought to replace two board members, expand the size of the board from eight to thirteen and elect five individuals to fill the new positions — a move that would effectively result in a new majority control.

CNET had denied JANA’s request to inspect stockholder lists when it advised CNET of its intention to solicit proxies from CNET shareholders in favor of its board nominees. CNET claimed that JANA was prohibited by an advanced-notice provision in its bylaws that disallows JANA from making such nominations and proposals because it has not owned $1,000 of the company’s common stock for at least one year. JANA’s initial investment in CNET was made in October 2007, and it will have held shares in the company for only eight months at the time of CNET’s expected annual meeting in June 2008. 

The Delaware Court found that CNET’s advance-notice bylaw applied only to proposals and nominations a shareholder wishes to have included in the corporate proxy materials, since it made specific reference to SEC Rule 14a-8. Since JANA was not making a stockholder proposal or proposing nominees for election to CNET's Board through the CNET proxy, but rather at its own expense, the Chancery Court ruled that the advance-notice bylaw provision did not apply, affirming the traditional Delaware principle that bylaws provisions should be construed narrowly and in favor of stockholder rights.

President Bush Nominates Two Democrats to Fill Remaining Seats of Five-Member SEC Panel

President George W. Bush has nominated Elisse Walter, a senior vice president at the Financial Industry Regulatory Authority, and Luis Aguilar, partner at McKenna Long & Aldridge, to fill two seats on the five-member panel of the U.S. Securities and Exchange Commission (SEC). Before being able to join the Commission, President Bush’s nominees will have to be confirmed by the Senate.

Ms. Walter would complete the term of current Commissioner Roel Campos, which will end in 2010, and Mr. Aguilar will replace Commissioner Annette Nazareth whose term ends in 2012. Both Ms. Walter and Mr. Aguilar are Democrats. Mr. Campos and Ms. Nazarath left the SEC panel in 2007, when the panel was composed of three Republican Commissioners, including SEC Chairman Christopher Cox. There can be only three Commissioners from one political party on the panel in order to maintain nonpartisanship. Each Commissioner serves for five years, but can continue to serve for an additional 18 months.

$1.66 Billion Enron Settlement reached with Citibank

On March 26, 2008, Citigroup Inc. announced a $1.66 billion settlement with the Enron Creditors Recovery Corp. (“ECRC”) ending the Enron MegaClaims suit. The Enron MegaClaims suit attempted to hold 11 Wall Street firms liable for allegedly helping Enron’s officers maneuver its financial reports, which led to the company’s 2001 downfall as a result of flawed accounting.

Citigroup was the last defendant left in the suit, against whose claim was the largest amongst those against the other 10 defendants that had previously settled for $1.76 billion. In addition to the $1.66 billion that Citigroup will pay ECRC, it will also withdraw $249.4 million in claims pending in the bankruptcy case. In return, Citigroup will be permitted to continue with related claims, one of which includes those by parties with Enron credit-linked notes totaling $2.4 billion.

The settlement ends both the bankruptcy case in the U.S. Bankruptcy Court for the Southern District of New York and the case pending in the U.S. District Court for the Southern District of New York that was still determining whether it would hear the case.

Futility Claim Fails for Lack of Specific Allegations

Following established Delaware law principles, the 11^th Circuit Court of Appeals (“the court”) dismissed a derivative claim based on the lack of specific allegations that a majority of the Board of Directors of a Delaware corporation was interested, and therefore the threshold test for demand futility was not met.

Staehr v. Alm, No. 07-11653 (11th Cir., March 13, 2008) involved a claim by shareholders against the Board of Directors of Coca-Cola Enterprises, Inc. (“CCE”) for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. The basis of the lawsuit was that CCE had engaged in a practice known as channel-stuffing; that is, selling large volumes of product to retailers at discounts, to manipulate earnings, thereby benefiting Coca-Cola Company (“Coke”). As a result of this practice, plaintiffs alleged that CCE was forced to restate earnings and disseminate false and misleading public statements and filings with the SEC. The plaintiffs had not made a demand on the Board of CCE, alleging that a majority of the Board was not independent and therefore demand should be excused under the demand futility doctrine. The District Court for the Northern District of Georgia dismissed the complaint, finding that all of the directors were independent as a matter of Delaware law and demand could not be excused.

The Court of Appeals held that a demand futility claim must be based on particularized facts concerning director independence and is held to a higher standard of pleading under FRCP 23.1 than notice of pleading permitted in non-derivative cases. Since the plaintiff had not challenged the finding of independence by the District Court as to six of the thirteen CCE directors, the Court focused on whether there were sufficiently particular pleadings against two directors, who served on boards of companies that were large customers of Coke and CCE and who allegedly engaged in insider trading, to sustain the demand futility theory. The Court of Appeals concluded that the mere fact that a director has a collateral business relationship, that might influence his or her decisions is insufficient to overcome the presumption of independence afforded to directors under Delaware law. Further, the court deemed conclusory the allegations of insider trading, which the plaintiff had tried to bootstrap by raising the possibility that the directors could face personal liability for failure of oversight due to an exclusion under the D&O policy. With no viable theory of interestedness with respect to the two directors, the plaintiff had failed to establish a lack of independence of a majority of the board and dismissal of the action for failure to make demand was required.

IRS Issues New Regulations Permitting Disclosure of Tax Return Information to Whistleblowers; Chief Counsel Weighs in on Limitations on Contacts with Certain Informants

On March 25, 2008, the IRS announced new, temporary and proposed regulations permitting disclosure of tax return information to whistleblowers. The regulations describe the circumstances by which an officer or employee of the Treasury Department may disclose return information to whistleblowers (and, if applicable, their legal representatives) for services relating to the detection of violations of the internal revenue laws or related statutes.

The regulations permit the IRS to share tax return information with whistleblowers and their lawyers under written contracts (“tax administration contracts”) with the IRS. The temporary regulations, at Treas. Reg. § 301.6103(n)-2T(a)(1), provide that an officer or employee of the Treasury Department may, pursuant to sections 6103(n) and 7623 of the Internal Revenue Code of 1986, as amended, under a written contract, disclose return information to a whistleblower (and, if applicable, their attorney) to the extent necessary for services relating to the detection of violations of the internal revenue laws; however, the disclosure of return information is to be made only to the extent the IRS deems it necessary in connection with the reasonable or proper performance of the contract.

If return information is disclosed to the whistleblower (and, if applicable, their attorney) pursuant to such an agreement, the information should relate to relevant taxable years and types of tax and must be kept confidential. Although the regulations mention that such disclosure to whistleblowers is expected to be infrequent, the amount of information that the IRS may share with the whistleblowers pursuant to these written contracts is still unclear.

On February 27, 2008, the IRS Chief Counsel issued a notice, CC-2008-011, discussing the advice to be given to the IRS regarding the limitations on contacts with certain informants. The notice addresses contacts with an informant who is a current employee of the taxpayer in question as well as an informant who is the taxpayer’s representative in an IRS audit. The notice includes, but is not limited to, interactions with informants who seek awards as whistleblowers.

In summary, corporations involved in IRS audits or investigations should keep in mind that potentially all of what they provide to the IRS may be shared very shortly thereafter with a whistleblower who in effect will be monitoring the audit or investigation.

Contributors to this issue are Andrew Demetriou, Marlene Losier, Greg Matlock, Mark Oakes and Jack Taylor.