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From Securities Regulation Daily, June 30, 2014

Proudly private company had duty to disclose merger talks

By Anne Sherry, J.D.

Having repeatedly boasted to employees that it was privately held and intended to remain so, Stiefel Laboratories, Inc. (SLI) had a duty to update those statements when it began merger negotiations, if not to the public, then at least to a retirement-plan participant selling his shares back to the company. Although silence during the merger discussions may have benefitted investors overall, “secrecy ceases to be in the investors’ interests when corporate insiders exploit the nonpublic information in their possession and engage in self-dealing” (Finnerty v. Stiefel Laboratories, Inc., June 30, 2014, Anderson, R.).

Background. SLI had been a private company since its founding in 1847. According to the appellate decision, “the Stiefel family brought up this fact at nearly every company meeting and impressed upon employees their commitment to keeping SLI under the family’s control.” When The Blackstone Group bought a minority investment in the company in 2007, SLI reassured the public, and Charles Stiefel reassured employees, that the company would continue to be privately held. However, beginning in November 2008, the Stiefel family began exploring the possibility of selling SLI and eventually shopped the company to potential buyers. In April 2009, SLI and GlaxoSmithKline (GSK) agreed to a transaction in which SLI stockholders received approximately $68,500 per share, not including a performance bonus.

In the meantime, a former SLI employee, Timothy Finnerty, exercised his rights under SLI’s employee stock bonus plan without knowledge of the merger talks. The plan entitled terminated employees to a distribution of vested benefits and granted them a “put” option on distributed stock. Finnerty, in January 2009, elected to receive his distribution of SLI stock and to put the stock to SLI at the then-effective fair market value of approximately $16,500 per share, less than one-fourth the value assigned in the merger.

Finnerty sued SLI alleging violations of ERISA and Exchange Act Section 10(b); the jury returned a verdict for Finnerty and awarded him compensatory damages of $1.5 million. After the district court denied SLI’s renewed motion for judgment as a matter of law and alternative motion for a new trial, SLI appealed to the Eleventh Circuit.

Amicus brief. The SEC, which has an enforcement action pending against SLI and Charles Stiefel, filed an amicus brief in this case. The SEC opined that the case implicated two distinct duties of disclosure: (a) SLI and Charles Stiefel both had a duty to correct and update their prior statements where their failure to do so would render those statements materially misleading; and (b) SLI had a duty to disclose or abstain when purchasing its shares from its stockholder employees on the basis of material, non-public information.

Duty to disclose. The appeals court held that SLI had a duty to disclose facts necessary to make its “will continue to be privately held” statements not misleading. The company was not obligated to disclose the existence or status of merger negotiations, the court stressed; it could have merely said that a sale of the company was under consideration. But Finnerty had testified that the company’s privately held status was brought up in virtually every meeting and was continually impressed upon employees. “SLI employees, who had heard generations of Stiefels express their commitment to keeping SLI under the family’s control, could reasonably have understood the ‘will continue to be privately held’ statements to be assurances that SLI remained unavailable for acquisition even after Blackstone’s investment,” the appeals court determined.

The court did not decide whether SLI had an immediate duty to update the public when the merger negotiations became serious, but held that SLI had a duty to update Finnerty before it repurchased shares of its own stock from him. The court thus found a duty to disclose but left open “the issue of precisely when and to whom the requisite disclosure must be made.” The timing of disclosures may be entrusted to the business judgment of corporate officers where “a duty to update exists but silence would yield benefits for investors as a group, so long as the company and its insiders abstain from trading in the company’s securities during this period of nondisclosure,” the court wrote, “But secrecy ceases to be in the investors’ interests when corporate insiders exploit the nonpublic information in their possession and engage in self-dealing.”

Federal law requiring buyback. SLI had also argued that it was required by ERISA to buy back the shares because they were distributed pursuant to a defined contribution plan. The court distinguished ERISA’s blackout provisions, which deal with distributions from a plan, from the employer’s obligation to honor a “put” option on shares that have already been distributed. “Furthermore, even if federal law does foreclose the option of abstention, it would not affect our disposition. A corporation that is unable to lawfully postpone its duty to disclose is not absolved of that duty. The Supreme Court has made clear that it is not the role of courts to interfere with the ‘philosophy of full disclosure’ embodied in the securities laws.”

The case is No. 12-13947.

Attorneys: Peter Prieto (Podhurst Orseck, PA) for Timothy Finnerty. Elliot H. Scherker (Greenberg Traurig LLP) for Stiefel Laboratories, Inc.

Companies: Stiefel Laboratories, Inc.

MainStory: TopStory FraudManipulation MergersAcquisitions AlabamaNews FloridaNews GeorgiaNews

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