The Guardian: Company-Side Shareholder Activism Alert

Decision Consistent With Holdings By Other Federal Circuits

On May 27, 2008, the U.S. Court of Appeals for the Fifth Circuit affirmed a decision by the U.S. District Court for the Northern District of Texas, in "Motient Corp. v. Dondero et al.",1 holding that there is no private cause of action for monetary damages under Section 13(d) of the Securities Exchange Act of 1934 (Exchange Act).

Section 13(d), which was enacted as part of the Williams Act amendments to the federal securities laws, imposes disclosure and reporting requirements with respect to attempts to acquire control of publicly traded companies. The purpose of Section 13(d) is to provide investors with adequate disclosure with respect to the accumulation of blocks of stock representing 5% or more of a public company's registered equity securities. Pursuant to Rule 13d-1, as promulgated by the Securities and Exchange Commission (SEC) under Section 13(d), any person, who acquires, directly or indirectly, beneficial ownership of 5% or more of a public company's registered equity securities, is generally required to file with the SEC a statement on Schedule 13D containing information regarding: (i) the identity and background of the acquiring person; (ii) the source and amount of funds or other consideration used to purchase the issuer's securities; (iii) the purpose of the transaction, including any plans or proposals which such person may have to effect a change in the present board of directors or management of the issuer, effect a change in the issuer's charter or bylaws, impede the acquisition of control of the issuer by any person, liquidate the issuer, sell its assets to or merge it with any other persons, or make any other major change in its business or corporate structure; (iv) the number of shares of the securities which are beneficially owned by such person; and (v) any contracts, arrangements, understandings, or relationships with respect to such securities. The SEC's rules also require that the Schedule 13D be filed no later than 10 days from the time that the acquiring person became the beneficial owner of 5% or more of the issuer's registered equity securities and that a copy of the Schedule 13D also be sent to the issuer at its principal executive offices.

If any material change occurs in the facts set forth in the Schedule 13D, including, but not limited to, any material increase or decrease in the percentage of the class beneficially owned, the person or persons who were required to file the Schedule 13D are required to promptly file or cause to be filed with the SEC an amendment disclosing that change.2 An acquisition or disposition of beneficial ownership of securities in an amount equal to 1% or more of registered equity securities is deemed "material" for these purposes; acquisitions or dispositions of less than those amounts may be material, depending upon the facts and circumstances.

Litigation involving Section 13(d) is not uncommon among public companies and activist shareholders; and such litigation, while costly, is one of the various quivers in a public company's arsenal that may be utilized in its attempt to defend itself against a contested solicitation brought by a hedge fund or other activist investor. The issues that are typically the subject of Section 13(d) litigation relate to, among others: (i) whether or not the investing parties are acting as a group that should have their ownership aggregated for purposes of meeting the 5% beneficial ownership threshold that triggers the requirement to file a Schedule 13D, and, accordingly, whether or not they have failed to file a Schedule 13D within the time frame required by Section 13(d); (ii) whether or not the investor has made less than accurate and complete disclosure in its Schedule 13D about its holdings, plans, and motivations in violation of Section 13(d); and (iii) whether or not the investor has made materially false and/or misleading disclosures in its Schedule 13D.

In recent months, in addition to the instant case, there have been at least two other relatively high-profile cases brought by public companies alleging various violations of Section 13(d). Among those is the lawsuit brought by Charming Shoppes, Inc., against Crescendo Partners relating to a proxy contest that has since been settled and the still-pending lawsuit brought by CSX Corporation against the Children's Investment Fund and 3G Capital Partners which relates to a proxy contest that is ongoing. While litigation brought by an issuer in connection with a proxy contest may have a variety of strategic purposes and may seek various forms of relief, typically injunctive, many public companies engage in litigation as a way to force a resolution of the proxy contest by creating another "battle front" on which to engage the activist and, accordingly, to increase the cost to the activist of continuing its proxy contest. Clearly, if the activist was faced with the prospect of Section 13(d) litigation that, if decided unfavorably, could result in it being forced to pay substantial compensatory, and perhaps punitive, exemplary and/or special, damages, the activist may be incented towards either: (i) full and strict compliance with the requirements of Section 13(d), particularly with respect to its completion and timely filing of its Schedule 13D, such that litigation against it is less likely, as least on the basis of a violation of Section 13(d); or (ii) once litigation has been commenced, an early resolution of the proxy contest to forestall a court decision on the issue of damages.

Unfortunately for public companies, Section 13(d) does not provide any express right of public companies, or even the stockholders that Section 13(d) was enacted to protect, to bring a private cause of action seeking monetary or injunctive damages to redress violations of Section 13(d). Nor is there is an express right for issuers to seek injunctive relief for violations of Section 13(d). Therefore, public companies have, on numerous occasions, sought to have a federal court infer a private cause of action in order to seek monetary or injunctive remedies for violations of Section 13(d). These efforts, at least with respect to the right to seek monetary damages, have generally not been successful. The decision of the Fifth Circuit in the Motient case is just the latest decision by a federal court that there is no private cause of action for monetary damages under Section 13(d).

The background of the Motient case is as follows. James Dondero is the majority owner and president of Highland Capital Management, L.P., an investment company that operates through a number of other affiliated entities (Mr. Dondero and the Highland Entities are collectively referred to as "Highland"). On June 10, 2002, Highland filed an initial Schedule 13D indicating that it beneficially owned in excess of 5% of the common stock of Motient Corporation, a provider of integrated satellite wireless communications services.3 Between June 2002 and June 2007, Highland filed with the SEC thirty-five separate amendments to its Schedule 13D with respect to its investment in Motient's common stock. Highland would also later commence a proxy contest against Motient seeking to replace the entire Motient Board of Directors and amend Motient's bylaws.

In 2005, Motient filed suit against Highland, alleging that Highland had filed six Schedule 13D amendments between September 2005 and October 2005 that contained materially false, incomplete, and misleading information about Motient, its management, and its board. Motient alleged that the six Schedule 13D amendments in question included false and misleading statements that were made intentionally, negligently, and with reckless disregard for the truth. Motient further alleged that these statements were designed to improperly influence the vote by Motient stockholders on a number of corporate transactions and to persuade Motient's shareholders to cede control of Motient to Highland. Accordingly, Motient alleged, these statements constituted disguised proxy solicitations in violation of the federal proxy rules. In its suit, Motient sought various forms of injunctive relief as well as monetary damages for alleged violations of Schedule 13D.

In evaluating Motient's claim for monetary damages under Section 13(d), and in determining to affirm the decision of the district court that there is no private right of action for monetary damages under Section 13(d), the Fifth Circuit considered the following:

  • Legislative history of Section 13(d) and the goals of Congress in enacting Section 13(d) as part of the Williams Act: The Fifth Circuit observed that "Congress did not enact the Act to tip the scales in favor of management or its opponents, but to ensure that a public shareholder, confronted by a cash tender offer for his stock, can obtain adequate information about the qualifications and intentions of the offering party before responding to the offer";

  • Decisions by the other federal circuits. The Fifth Circuit noted that no other federal circuit has found a private right of action for monetary damages under Section 13(d). In addition, the Fifth Circuit observed that the Second4 and Eleventh5 Circuits had both issued opinions holding that Section 13(d) does not provide issuers with a private cause of action for monetary damages; and

  • Lack of a compelling reason for recognizing a private right of action for monetary damages under Section 13(d). The Fifth Circuit noted that Section 13(d), as enacted as part of the Williams Act, was enacted to protect investors, not issuers, who are forced to make decisions between bidders and management. Since Section 18(a)6 of the Exchange Act provides an investor with a private cause of action for monetary damages resulting from material misstatements or omissions made to an investor who purchase or sells the security and actually relies on that information, the court observed that there was no compelling reason for recognizing a private cause of action under Section 13(d).

The Fifth Circuit then turned to Motient's request for injunctive relief. Subsequent to Motient filing its complaint, a number of significant events occurred that the Fifth Circuit found removed any threat of irreparable harm and mooted the case. The corporate transactions that Motient was contemplating, and had alleged were being unfairly characterized by Highland in its Schedule 13D Amendments, were either competed or abandoned. On July 2, 2006, Motient's shareholders voted in favor of management's slate of directors, which ended Highland's proxy fight. In addition, Highland divested itself of its holdings in Motient. Accordingly, the Fifth Circuit did not need to rule on what type of injunctive remedies are appropriate for violations of Section 13(d) and concluded that dismissal of all of the claims for injunctive relief is proper since there was no longer any threat of irreparable harm.

As noted above, the Fifth Circuit's decision that a private cause of action for monetary damages is not available as a remedy for violations of Section 13(d) is consistent with the rulings of other federal circuits. To date, no other federal circuit has issued a decision to the contrary effect with respect to the availability of monetary damages. However, on the issue of the availability of injunctive relief for violations of Section 13(d), there is less unanimity among the federal circuits. While the Fifth Circuit was able to avoid ruling on the requests for injunctive relief in this case, the Fifth Circuit has previously held7 that the right to injunctive relief by a private party asserting a violation of Section 13(d) does exist. At least four other federal circuits have held that an issuer has the right to assert a private cause of action for injunctive relief for violations of Section 13(d).8 However, the Eleventh Circuit, in addition to holding that there is no private cause of action for monetary damages for violations of Section 13(d), has held, in that same case, that neither does an issuer have the right to seek injunctive relief for such violations.9

In light of the Fifth Circuit's holding that there is no private cause of action for monetary damages under Section 13(d), which is consistent with the rulings of other federal circuits, it appears likely that monetary damages will continue to be unavailable to public companies as a remedy for violations of Section 13(d) by hedge funds and other investors. Accordingly, while public companies may be able to seek injunctive relief against an investor for violations of Section 13(d), public companies will generally not be able to rely on the threat of costly monetary damages that could result from litigation to bring about a swift conclusion to a proxy contest or other contested solicitation being waged by the investor.

Footnotes

1. Motient Corp. v. Dondero et al., No. 07-10302, (5th Cir. May 27, 2008).

2. Rule 13d-2 under the Securities Exchange Act of 1934, as amended.

3. In 2007, Motient changed its name to TerreStar Corporation.

4. See Hallwood Realty Partners, L.P. v. Gotham Partners, L.P., 286 F.3d 613, 620 (2d Cir. 2002).

5. See Liberty Nat. Ins. Holding Co., v. Charter, 734 F.2d 545, 564 (11th Cir. 1984).

6. Section 18(a) of the Exchange Act: Any person who shall make or cause to be made any statement in any application, report, or document filed pursuant to this title or any rule or regulation thereunder or any undertaking contained in a registration statement as provided in subsection (d) of section 15, which statement was at the time and in the light of the circumstances under which it was made false or misleading with respect to any material fact, shall be liable to any person (not knowing that such statement was false or misleading) who, in reliance upon such statement, shall have purchased or sold a security at a price which was affected by such statement, for damages caused by such reliance, unless the person sued shall prove that he acted in good faith and had no knowledge that such statement was false or misleading. A person seeking to enforce such liability may sue at law or in equity in any court of competent jurisdiction. In any such suit the court may, in its discretion, require an undertaking for the payment of the costs of such suit, and assess reasonable costs, including reasonable attorneys' fees, against either party litigant.

7. See Gearhart Industries, Inc. v. Smith Intern., Inc., 741 F.2d 707 (5th Cir. 1984).

8. See Chevron Corp. v. Pennzoil Co., 974 F.2d 1156 (9th Cir. 1992); Indiana Nat. Corp. v. Rich, 712 F.2d 1180 (7th Cir. 1983); Dan River, Inc. v. Unitex Ltd., 624 F.2d 1216 (4th Cir. 1980), cert. denied, 449 U.S. 1101, 101 S. Ct. 896, 66 L. Ed. 2d 827 (1981); GAF Corp. v. Milstein, 453 F.2d 709 (2d Cir. 1971), cert. denied 406 U.S. 910 (1972). See also CNW Corp. v. Japonica Partners, 874 F.2d 193 (3rd Cir. 1989); Chromalloy Am. Corp v. Sun Chemical Corp., 611 F.2d 240 (8th Cir. 1979); Gen. Aircraft Corp. v. Lampert, 556 F.2d 90 (1st Cir. 1977).

9. See Liberty National Insurance Holding Co. v. Charter Co., 734 F.2d 545 (11th Cir. 1984).

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