Below we’ve embedded New York appeals in court filings in two cases, Ezrasons v. Rudd (“Barclays”) and Haussmann v. Baumann (“Bayer”). Even though the particulars of executive and board misconduct, as well as the home jurisdiction differ, both suits have similar high level strategies (along with some others filed by Bottini & Bottini, with Michelle Lerach and her husband Bill Lerach, as advisor, playing major roles, see for instance here, here, and here).
Lawsuits on behalf of shareholders to bring epically incompetent (and in the case of Bayer, corrupt) managements and boards might seem to those not in the investor classes be of little consequence to them. But high level corporate misdeeds can and do have broader consequences. Having executives and boards be afraid of their shareholders would almost certainly reduce the level of self-serving conduct. More frequent shareholder suits that actually made a difference would also lower the bar for criminal prosecution of executives, as in it would not seem like such an unusual or risky event for a prosecutor to haul them into court.
These cases serve to illustrate how perversely hard it is for shareholders to discipline or turf out value-destroying executives and boards. This is a point we’ve made regularly, following the observations of Amar Bhide in his landmark 1994 Harvard Business Review article, Efficient Markets, Deficient Governance: US securities laws have focused on creating a clean and fair environment for investors in the buying and selling of securities, at the expense of these investors having incentives (and as we’ll see, the means) to oversee and discipline incompetent and grifting executives and boards. For instance: how could companies once as well-positioned as Intel and Boeing have gotten into such horrible shape? The simple reason is in a world of low transaction costs and well functioning markets, it’s easier and much cheaper to sell your interest if you don’t like how a company is being run than do anything about it (Bhide cites additional important factors, but this is the most obvious).
To put this post in a much bigger context: we’ve mentioned in passing that even though the Global South is succeeding in chipping away at the use of the dollar in international trade, those transactions are only 3% to 5% of total foreign exchange transactions. The rest is investment related. Even though the Global South now exceeds the so-called Collective West in GDP, this does not translate into investment clout. First, much of the capital in advanced economies reflects past profit-making and other rentierism commercial exploitation. Second, income levels per capita in the Global South on average are still much lower than in advanced economies, meaning that even though the surplus accumulation gap has been falling, it still remains. The result is that advanced economies still considerably dominate in terms of investment funds.
However, the weight of money in advanced economies is not the only reason that the dollar is likely to persist (even if somewhat diminished) as a reserve currency past what ought to be its sell-by date, given wild US over-use of economic sanctions. US markets are deep and liquid, which means low transaction costs. The US also has strong investor protections, such as extensive disclosure, and prohibitions against insider trading and market manipulation like front running. You may pooh pooh these ideas in light of Nancy Pelosi’s remarkable stock-picking record, but on this front, the US is still the cleanest shirt in the dirty laundry. They also feature many key and very professional service provides, such as custodians and specialized brokers to accounting firms, to make investors’ lives simpler.
Access to a perceived-to-be-evenhanded legal system is also important in defending the position of financial centers and their currencies. Investors want to have their disputes heard in US or UK courts. We’ll have more on this in later posts, but a short illustration. Cyprus, which has English-law courts, was the route for corporate investment into Russia back in the days when that happened. Not only would multinationals paper up their Russian deals in Cyprus, but even wealthy Russians would round trip their investments into Russian companies through Cyprus to get the benefit of its courts. We have also pointed out that the unduly harsh treatment of Cyprus in its banking crisis (due to no small measure to financial tsuris in Greece) in 2013 looks, with the benefit of hindsight, to be a first salvo in the neocon escalation against Russia.
And even when US sanctions have deterred foreign companies from raising funds here, the home countries have too often fail to take advantage of the opportunity the US created. For instance, from a late June 2024 New York Times story:
As the geopolitical relationship between China and the United States has deteriorated, it has become increasingly difficult for Chinese companies to find a foreign market where a listing might not be jeopardized by political scrutiny.
Things are hardly looking better in China. As part of a push by Beijing to assert greater control over the Chinese market, regulators have made it harder to go public, drastically slowing the pace of domestic listings. Around 40 Chinese companies have gone public at home this year. They have raised less than $3 billion, a fraction of the value typically raised by this point in the year, according to data from Dealogic.
If the current pace continues, this year will bring the fewest Chinese initial public offerings worldwide in more than a decade.
Hopefully this is not too long-winded an intro. Now to the cases and their state of play
One way to think of them is as legal arbitrage. Many countries in Europe formally provide for vastly stronger shareholder protections than in the US, both by statue and via shareholder agreements. But then they vitiate these rights by making them hard to enforce in their courts.
European companies who sell shares in the US confer the same rights as at home (forgive me for skipping over the reasons for this practice). But New York law in the 1960s codified the then-established standard that companies who elect to do business in New York have agreed to the jurisdiction of New York courts. That includes beneficial owners of share (shares held in street name) who have what is formally called derivative rights. All the companies at issue in these suits did a lot more than just sell shares in New York. They also have very substantial operations there, including have top level executives as New York state or area residents.
We’ll use our earlier write-up of Bayer to give more detail. From a 2021 post:
Even though Covid has produced clogged courts, cases are still moving forward, including a series of cases using similar, novel legal arguments to storm the barricades of incestuously and poorly managed major European companies. We’ve written the most about Bayer, which is in the dock for its disastrous, executive and banker serving acquisition of Monsanto. Credit Suisse, Deutsche Bank, UBS, Barclays and Volkswagen are also in the crosshairs in parallel cases detailing their corporate dereliction of duty.
Even though the misconduct and the destruction of value has been glaring, European shareholders have an uphill road in trying to gain restitution. However, as we’ll explain below, by virtue of having ADRs and significant US shareholdings and operation, the managements, boards, and advisers to these companies can be hauled into court in the US. And that’s where the fun begins.
We’ve posted the latest round of filings, all rejoinders to arguments made by the defendants in the Bayer case. But the Bayer case, like its siblings, are derivative lawsuits, which make for complicated lawyering. So we’ll review the foundations before continuing to the latest round of jousting.
We’ll start by quoting an August 2020 post:
Each suit targets an epic level of value destruction, but they are not shareholder suits. They are derivative lawsuits, in which a shareholder steps in to act on behalf of a company that has been done wrong, typically by key members of its management and board. Important advisers may also be targets.
The Novel Legal Angle: Using New York Courts for Derivative Cases Against Major European Companies
The novel feature in these cases is suing in New York state court but using the parent company’s governing law, which for Bayer is the German Stock Corporation Act as the basis for asserting causes of action.1 The abstract from a 2015 article by Gerhard Wagner, Officers’ and Directors’ Liability Under German Law: A Potemkin Village:
The liability regime for officers and directors of German companies combines strict and lenient elements. Officers and directors are liable for simple negligence, they bear the burden of proof for establishing diligent conduct, and they are liable for unlimited damages. These elements are worrisome for the reason that managers are confronted with the full downside risk of the enterprise even though they do not internalize the benefits of the corporate venture. This overly strict regime is balanced by other features of the regime, namely comprehensive insurance and systematic under-enforcement. Even though the authority to enforce claims against the management is divided between three different actors – the supervisory board, the shareholders assembly, and individual shareholders – enforcement has remained the exception. Furthermore, under the current system of Directors’ and Officers’ (D&O) liability insurance, board members do not feel the bite of liability as they are protected by an insurance cover that is contracted and paid for by the corporation. Thus, the current German system may combine the worst of two worlds, i.e., the threat of personal liability for excessively high amounts of damages in exceptional cases, and the practical irrelevance of the liability regime in run-of-the-mill cases.
Notice here the low bar for misconduct: simple negligence, plus the managers and board members bear the burden of proof that they behaved well! So the linchpin of these cases is getting a non-captured court to measure corporate conduct against these standards.
Also observe another key feature: extremely generous D&O policies. That is serving as one of the deep pockets for this litigation….
The other deep pockets are the investment banks, Bank of America and Credit Suisse. As the suit explains, they too have duties defined under German law, yet they failed abjectly in acting as independent advisers because they were hopelessly conflicted. In addition to acting as merger advisers, they were also providing financing, since Bayer, to avoid needing to get shareholder approval, did an “all cash” deal. That in turn led to Bayer engaging in over a dozen financings, including pricey bridge loans. That meant the banks had huge incentives to see the deal close, which resulted in them not looking at the Monsanto garbage barge very hard.
Alert readers will note that these battles started in 2020 and the appeals below are dated 2024. In both cases, the lower courts rejected the original filings. This is not as surprising as it might seem; New York trial courts (perversely called the Supreme Court) are allergic to derivative suits. If you skim the filings, it might seem almost unfathomable that the cases are having to be appealed. New York statues, and the legislative discussion at the time, make it clear that “foreign” as in not-New York, corporations are subject to New York gatekeeping rule. A problem is that (aside from judges not liking derivative cases; they have little appetite for being made to feel stupid; this was huge obstacle to legally sound “chain of title” arguments back in the foreclosure crisis days) many judges are deferential to the so-called internal affairs doctrine. Per Wikipedia:
The internal affairs doctrine is a choice of law rule in corporations law. Simply stated, it provides that the “internal affairs” of a corporation (e.g. conflicts between shareholders and management figures such as the board of directors and corporate officers) will be governed by the corporate statutes and case law of the state in which the corporation is incorporated.
But New York statutes, and related case law, is (with a few outlier decisions) are clear that if a company does business in New York, it has made itself subject to New York jurisdiction. And there’s no carveout for internal affairs. In fact, a provision of the 1960s statutes explicitly protected the aforementioned beneficial shareholders, contemplating that New York laws would conflict with established “internal affairs” notions and New York law and courts should have primacy. So another way to think about these case is that the power, jurisdiction and outreach of the New York courts over large corporations incorporated in other countries who do a great deal of business in New York is at stake.
The “Argument” section in the Table of Contents of each filing gives a good summary of what follows. In Bayer, the big bone of contention is over a “forum non convenines” ruling (as in the case should be in Germany because too hard for defendant to argue in New York) when the New York statutes limit its use and Bayer’s behavior makes it subject to them. With Barclays, it is the internal affairs doctrine plus rejecting (despite statutory provisions otherwise) that beneficial owners have standing to pursue derivative actions against foreign corporations operating in New York.
The appeals court is expected to hear the oral arguments in January.
Bayer00 Barclays
