Bringing an End to “Derivative” Section 14(a) Claims – Without Waiting for the Supreme Court to Weigh In
Much has been written lately about a circuit split on the question whether a company’s forum selection bylaw mandating shareholder derivative lawsuits be brought in Delaware state court trumps a federal lawsuit asserting a derivative claim under Section 14(a) of the Securities Exchange Act of 1934 (which can only be asserted – if at all – in federal court). The Seventh Circuit answered this question “no”[1] while the Ninth Circuit sitting en banc answered “yes,”[2] in both cases over vigorous dissents. Many have speculated that the U.S. Supreme Court may weigh in to resolve this clear circuit split.
Regardless of whether the Supreme Court agrees to weigh in on the forum selection bylaw issue, however, there is a more direct path for public company boards to obtain dismissal of derivative Section 14(a) claims. This path does not depend on enforcement of a forum selection bylaw (which not all public companies have) and thus does not directly implicate the policy considerations that have animated the split between the Seventh and Ninth Circuits. But this path has so far been underutilized by the defense bar, despite a proliferation of cases filed in federal court seeking to assert derivative Section 14(a) claims against public company boards (in some cases successfully extracting significant settlements from the defendants).[3]
Specifically, derivative Section 14(a) claims should be dismissed under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim because, under Delaware law, these claims are properly considered direct, not derivative.[4] That is dispositive (at least for companies incorporated in Delaware, which most public companies are) because federal courts have uniformly held that the question whether a federal securities claim is considered direct or derivative is governed by state law.[5] And Delaware law is settled that disclosure claims, which by definition seek to redress harm to shareholders’ ability to cast an informed vote, are direct claims belonging to individual shareholders, not derivative claims belonging to the company.[6]
It may seem counterintuitive to many in the defense bar to argue that these claims are direct rather than derivative. After all, it is clear that shareholders are permitted to bring direct claims under Section 14(a) (including on behalf of a shareholder class), while in contrast derivative claims are potentially subject to dismissal under the doctrine of forum non conveniens, at least for companies with a forum selection bylaw requiring that derivative claims be brought in Delaware state court. If these claims are found to be direct, won’t plaintiffs just amend their complaints and pursue them as direct claims, rather than accept dismissal of their derivative claims? In most cases, the answer would appear to be no – for example, in the Ninth Circuit case, Lee v. Fisher, plaintiffs asserted that their claims were solely derivative and indicated they would not be pursued if they were found to be direct.[7]
This is not surprising when one considers the nature of these suits – in most, if not all, of the recent wave of derivative Section 14(a) suits, plaintiffs have sought relief that would not be available in a direct suit (including, for example, corporate governance reforms or damages to redress harm to the company, as opposed to harm to the shareholders).[8] Put differently, these derivative Section 14(a) claims seek redress for harms that, in most if not all cases, were not caused by the alleged misstatements in the company’s proxy disclosures, which is what Section 14(a) governs. Section 14(a), however, requires plaintiffs to allege a causal connection between the alleged misstatement and loss to shareholders (i.e., loss causation), and in nearly all of these cases, plaintiffs are unable to identify any cognizable direct harm any shareholder has suffered.[9] That is the reason typically they have sought to shoe-horn these claims into a derivative cause of action in the first place. Thus, even if plaintiffs were, in the alternative, to press their claims on a direct basis, the claims would still be subject to dismissal for failure to state a claim.
At bottom, the plaintiffs’ bar’s attempted use of the shareholder derivative mechanism to bring claims under Section 14(a) is a shoe that does not fit. Not only is it inconsistent with Delaware law (and with federal caselaw deferring to state law on the direct/derivative issue), these suits are a thinly disguised attempt to regulate the internal affairs of Delaware corporations – matters that are indisputably committed to Delaware state legislation and courts – through federal litigation under the Exchange Act, which is limited to the regulation of disclosures and is not intended to govern companies’ internal affairs.[10] Indeed, in a typical case, the company (i.e., the issuer) is also a defendant in a securities action, and it is only if and when the company is found to be liable to investors under the federal securities laws (or if there is a material settlement) that a derivative claim on behalf of the company is even ripe to be pursued against the directors and officers alleged to be responsible for causing harm to the company (i.e., causing the company’s liability to investors). By seeking to bring Section 14(a) disclosure claims themselves derivatively, plaintiffs effectively seek to blend together these two distinct actions in an effort to avoid threshold legal doctrines that may result in the failure and dismissal of both (e.g., the loss causation requirement in a securities suit and exculpation of directors and officers under DGCL § 102(b)(7) in a derivative suit). Fortunately, public company directors and officers have a path to bring these cases to an end by moving for their dismissal as improper derivative actions under Delaware law. And because this defense does not rely on the existence of a forum selection bylaw, it does not implicate the split between the Seventh and Ninth Circuits and is available even for companies that lack a forum selection bylaw.[11]
[1] Lee v. Fisher, Case No. 21-15923 (9th Cir. June 1, 2023) (en banc),
[2] Seafarers Pension Plan v. Bradway, 23 F.4th 714 (7th Cir. 2022).
[3] See, e.g., Emps. Ret. Sys. of City of St. Louis v. Jones, 2022 WL 14160253, at *1 (S.D. Ohio Aug. 23, 2022) (approving settlement of a derivative action alleging claims under Section 14(a) against certain directors and officers of FirstEnergy Corp.); In re Pinterest Derivative Litig., 2022 WL 484961, at *2–*5 (N.D. Cal. Feb. 16, 2022) (granting preliminary approval of a settlement of a Section 14(a) derivative claim arising from allegations of race and sex discrimination).
[4] See In re JPMorgan Chase & Co. S’holder Litig., 906 A.2d 766, 772 (Del. 2006) (“where it is claimed that a duty of disclosure violation impaired the stockholders’ right to cast an informed vote, that claim is direct”). The Ninth Circuit’s en banc majority in Lee v. Fisher correctly found that, applying Delaware law to this question, the Section 14(a) claims in that case were direct, not derivative, see slip op. at 15-17, but nonetheless went on to analyze (and hold) that those claims were precluded by the company’s forum selection bylaws (which applied only to derivative claims), see slip op. at 55. As a result, the court did not consider whether the Section 14(a) claims instead should have been dismissed for failure to state a claim.
[5] See, e.g., Freedman v. magicJack Vocaltec Ltd., 963 F.3d 1125, 1131-32 (11th Cir. 2020) (collecting cases). See also Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 108-09 (1991) (holding state law applied to demand requirement in derivative actions asserting claims under the Investment Company Act of 1940).
[6] See supra note 4; see also Lee v. Fisher, slip op. 16-17.
[7] See Lee v. Fisher, slip op. 18 n.8.
[8] For example, in Lee v. Fisher, the plaintiff sought “injunctive and equitable relief” on behalf of the company and conceded she was not seeking damages caused by the alleged misstatements. Slip op. at 11.
[9] See, e.g., DCML LLC v. Danka Bus. Sys. PLC, No. 08 Civ. 5829(SAS), 2008 BL 277090, at *5-6 (S.D.N.Y. Nov. 26, 2008) (“To state a claim under Section 14(a), a plaintiff must plead loss causation, that is, the plaintiff must demonstrate that the economic harm that it suffered occurred as a result of the alleged misrepresentations”) (internal quotations omitted).
[10] See, e.g., In re Delmarva Sec. Litig., 794 F. Supp. 1293, 1301-02 (D. Del. 1992) (“[C]orporations are creatures of state law, and . . . except where federal law expressly requires certain responsibilities of directors with respect to stockholders, state law governs the internal affairs of the corporation . . . .”).
[11] One potential hurdle to be overcome is the argument that the U.S. Supreme Court authorized derivative Section 14(a) claims in J.I. Case Co. v. Borak, 377 U.S. 426 (1964). But as the en banc majority persuasively explained in Lee v. Fisher, Borak’s discussion of derivative suits was mere dicta and is no longer consistent with modern precedent and should no longer be followed. See Slip op. at 24-35.
