On June 18, 2020, a Third Circuit panel of three judges partially reversed a district court ruling, reviving certain securities fraud claims against a bank (the “Bank”) and several individual defendants in connection with alleged statements made in a joint proxy statement issued to shareholders prior to the Bank’s merger. Jaroslawicz v. M&T Bank Corp, et al., No. 17-3695 (3d Cir. June 18, 2020). Plaintiffs, a putative class of shareholders, alleged violations of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 14(a)-9 promulgated thereunder, as well as breach of fiduciary duty under Delaware law. Plaintiffs alleged defendants made misstatements or omissions in proxy statements in violation of Item 105 of Regulation S-K by inadequately disclosing the risks involved in the Bank’s compliance with federal anti-money laundering regulations (AML) and practices concerning its consumer checking program.
According to the amended complaint, in February 2013, the Bank and another financial institution filed a joint proxy with the SEC in advance of their proposed merger, which was shortly declared effective and shared with all shareholders. The proxy outlined various risks related to potential regulatory compliance issues that could affect the merger and further incorporated by reference the Bank’s 2011 Form 10-K—which similarly “warned” of regulatory risks—but stated that its “approved policies and procedures [are] believed to comply” with regulatory requirements. Days before the vote on the merger, the institutions notified shareholders that “additional time will be required to obtain regulatory determination” critical to completing the merger. The Bank issued a supplemental proxy revealing that the Federal Reserve Board had regulatory concerns regarding the Bank’s AML compliance practices and announced that the merger closing would be postponed so the Bank could address the concerns. The shareholder vote, however, would still take place as scheduled. After shareholders approved the merger but before the merger closed, the Consumer Financial Protection Bureau instituted an action against the Bank for its alleged practice of offering no-fee checking accounts to consumers and later switching those accounts to a fee-based account without notice. Plaintiffs brought suit in the District Court for the District of Delaware shortly before the Bank completed its merger, alleging that the Bank failed to disclose material information with respect to its practices concerning the checking accounts and its non-compliance with federal AML regulations. The District Court dismissed plaintiffs’ claims finding that the proxy statements adequately disclosed the regulatory risks the Bank faced in connection with the merger and that plaintiffs failed to allege any misleading opinion statements by defendants. Plaintiffs requested a final order of dismissal with prejudice to file an appeal, which was granted.
The Third Circuit first turned to plaintiffs’ allegations that the Bank violated Section 14(a) and SEC Item 105 by failing to include in the proxy known “significant factors,” such as the Bank’s potential regulatory challenges, which made the investment “speculative or risky.” The Court observed that such factors must be presented in a “concise and organized” manner, be “specific,” and “include an explanation connecting the risks to the offer” in plain English. The Court next considered an SEC bulletin providing guidance on Item 105, noting that it requires “a ‘concise’ discussion, free of generic and generally applicable risks, [and] requires more than a short and cursory overview.” The Court emphasized, however, that “registrants need not list speculative facts or unproven allegations.”
Turning to the specific allegations here, the Court found that the Bank’s proxy failed “to disclose more than generic information about the regulatory scrutiny” while finding instead that the Bank’s proxy “offered breadth where depth [was] required.” As an example, the Court noted that the Bank “identified that the merger hinged on obtaining regulatory approval” of its AML program. However—the Court emphasized—“every case under the Bank Merger Act” would require compliance with AML laws and the Bank’s disclosure merely “mentioned that regulatory hoops stood between the proposed merger and a final deal . . . [but] failed to discuss just how treacherous jumping through these hoops would be.” What distinguished this case, according to the Third Circuit, was defendants’ specific knowledge regarding the significant risk factor related to AML compliance and obtaining regulatory approval to complete the merger: “[The Bank] knew the regulators would be looking into its compliance program, and specifically its BSA/AML effectiveness. They said so themselves. And they knew the failure to obtain regulatory approval would be significant, possibly fatal, to the merger.” The Court further noted that the Bank’s proxy failed to provide known risks with the specificity required to comply with Item 105, observing that the information was “generally applicable to nearly any entity operating in a regulated environment” and in fact verged on being “inadequate” according to SEC guidance. The Court thus held that plaintiffs plausibly alleged that the known risk the Bank failed to disclose would have been material to shareholders.
The Court next addressed plaintiffs’ allegations regarding the Bank’s omissions about its consumer checking practices, finding that the Bank’s disclosures were “likewise deficient.” The Court emphasized the allegations that the Bank was aware of the practices, but it allegedly failed to mention its noncompliance in the proxy, failed to take remedial measures, and notably “unlike [the AML] deficiencies, [the Bank] did not later attempt to cure its omission—even as it became aware that the merger faced indefinite delays upon learning of the regulatory investigation” into the AML deficiencies. Agreeing with plaintiffs, the Court found that such information would have been “material enough that a reasonable shareholder would consider it important in deciding how to vote.”
Turning next to plaintiffs’ allegations that the Bank issued actionable, misleading opinion statements, the Court affirmed the District Court’s decision, which held that plaintiffs failed to allege any such actionable statements. The Court observed that although the Bank’s opinions on when “the merger might close” and its belief that its compliance programs would meet regulatory approval ultimately did not come to pass, the Supreme Court’s decision in Omnicare “rejected that premise” holding that a plaintiff “cannot state a claim by alleging only that an opinion was wrong.” The Court similarly dispensed with plaintiffs’ other allegations—that the two financial institutions omitted information about their due diligence process in reviewing the Bank’s compliance program—finding that the proxy statement “provided enough information [for shareholders] to understand what the banks did” with respect to due diligence efforts, and observed the Bank’s statements included sufficient cautionary language.
Notably, the Court emphasized the concerns it had with its decision, stating that its opinion should be considered with “caveats, cautions, and qualms,” given the proliferation of securities class actions. The Court further made clear that Item 105 does not require clairvoyance or that companies “predict regulatory action before it occurs,” emphasizing that the issue in the present case was that the Bank allegedly “knew the regulators would be looking into its compliance program” and “knew the failure to obtain regulatory approval would be significant,” yet still “offered little more than generic statements about the process of regulatory review.” The Court further noted that the Bank allegedly “knew that its consumer checking program skirted regulatory standards, as they claim [the Bank] curtailed its misconduct shortly after signing the merger agreement”—all which leads to an inference that such information would have been material to shareholders. The Court “reiterated,” despite its ruling on these allegations, the continued “longstanding limitations on securities fraud actions that insulate issuers from second-guesses, hindsight clarity, and a regime of total disclosure.”
While the Court remanded in part plaintiffs’ claims, the decision by the Third Circuit makes clear that circumstances specific to the case—specifically, that defendants identified that the merger “hinged on obtaining regulatory approval” and had “singled out that determining the effectiveness of its BSA/AML program would be crucial to obtaining that approval”—led to its ruling and that it continues to have reservations about “these kinds of aggregate claims,” further observing that whether the steady increase in securities class actions is an “efficient current or ‘muddled logic and armchair economics’” is a “question that deserves a more searching inquiry.”
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Jaroslawicz v. M&T Bank Corp.