Senator Asks SEC to Act Regarding Fee-Shifting Corporate Bylaws

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By Michael Greene

Nov. 5 — Sen. Richard Blumenthal (D-Conn.) has asked the Securities and Exchange Commission to take action regarding fee-shifting bylaws that allow corporations to recover litigation expenses from investors that unsuccessfully file derivative lawsuits against them.

In an Oct. 29 letter sent to SEC Chairman Mary Jo White, Blumenthal criticized unilaterally adopted bylaws that allow corporations to “effectively immunize themselves from the possibility of shareholder lawsuit.”

He called on the commission to “protect investors and America's capital markets” from what he perceives as a “serious and imminent threat.”

“[O]ne of the key checks on corporate malfeasance—private citizen suits—may soon become an empty threat,” he wrote.

‘ATP Tour' Criticism

Responding to a certified question in May in ATP Tour Inc. v. Deutscher Tennis Bund, the Delaware Supreme Court found that fee-shifting provisions in the bylaws of a Delaware non-stock corporation can be enforceable.

In the aftermath of this decision, both plaintiffs' firms and academics have raised concerns regarding the impact of such bylaws. Experts have estimated that at least 24 companies have adopted one-way bylaws. A legal challenge to one such bylaw is ongoing in the Delaware Chancery Court, and the Delaware General Assembly is scheduled to take up a bill in January that would prohibit all “loser pays” bylaws.

Blumenthal's letter provided some harsh criticism of ATP Tour.

“[T]he 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,” he wrote.

“The potential ramifications from this decision are immense,” he continued. “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.”

The active Delaware lawsuit has attacked the bylaw at issue on the grounds of its potential breadth

Blumenthal also mentioned that ATP Tour is beginning to have a ripple effect in other jurisdictions as well.

Recently, the Oklahoma legislature adopted a bill, which goes into effect Nov. 1, that mandates fee-shifting in derivative lawsuits.

Potential SEC Action

The letter detailed some of the ways that the SEC could respond to these provisions and specifically called for an investigation of Alibaba Group Holding, Ltd., one of several companies that has adopted fee-shifting provisions in their articles of incorporation.

According to Blumenthal, the SEC can label such provisions as “major risks factors,” requiring “corporations to publicly disclose them before any initial public offering” and clarifying that these provisions are “inconsistent with federal law.”

He also urged the SEC at a minimum, “to refuse to permit registration statements to move forward for any company that includes these provisions in violation of our federal securities laws.”

John C. “Jack” Coffee, Jr., a professor at Columbia Law School and director of the school's Center on Corporate Governance told the SEC Investor Advisory Committee Oct. 9 that, among the ways to prevent the “chilling effect” of these bylaws, the SEC could refuse to accelerate registration statements for the companies that enact certain fee-shifting provisions.

To contact the reporter on this story: Michael Greene in Washington at mgreene@bna.com

To contact the editor responsible for this story: Ryan Tuck at rtuck@bna.com

The letter is available at http://www.blumenthal.senate.gov/newsroom/press/release/blumenthal-calls-on-sec-to-protect-critical-check-on-corporate-malfeasance.