Investment banker liability in M&A: complex, unsettled law heightens need for expert counsel


Financier Worldwide Magazine

May 2019 Issue

On 4 January 2019, the US Supreme Court agreed to hear an appeal of the unusual securities law case of Varjabedian v. Emulex (2018). Argument is scheduled for 25 April 2019. The issue before the high court will be: “Whether the U.S. Court of Appeals for the 9th Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on the negligent misstatement or omission made in connection with a tender offer.”

In other words, can someone be sued under 14(e) for an innocent mistake? The answer is highly unpredictable. While some may hope for a “no” based on the arrival of Justice Brett Kavanaugh, who has replaced retired Justice Anthony Kennedy as the newest member of a putative pro-corporate ‘Roberts Five’, the high court’s final decision could turn on narrow technicalities.

Whatever the outcome will be, it will matter in the lives of investment bankers and M&A advisers for three reasons: most mergers trigger lawsuits, many of these lawsuits name financial advisers, and federal securities claims such as 14(e) are increasing in popularity as a plaintiff’s tool. Based on Cornerstone research, of the 403 securities class actions filed in 2018, nearly half (182) were merger-related.

If the Supreme Court agrees with the 9th Circuit in the Emulex case, this could open the floodgates of lawsuits against those who are involved in transactions where there are material errors or omissions in the offering documents – even if they did not engage in any self-dealing or misrepresentation. That includes financial and M&A advisers.

The possibility of a negative outcome for Emulex in appeal is particularly worrisome given the fact that federal courts interpreting federal law are now the new place for many M&A lawsuits. Ever since 2016, when the Delaware Supreme Court declared in the Trulia decision that it would no longer hear disclosure-only cases, many M&A lawsuits moved to federal courts, switching their focus from fiduciary concerns under state law to disclosure themes under federal law.

While the Emulex case did not name Emulex’s adviser (Goldman Sachs) as a defendant, the case is a canary in a coal mine. The connection between director breach and adviser abetment can be uncomfortably close. In state court, claims against directors and officers who allegedly breach their fiduciary duties often go hand-in-hand with claims against their advisers for aiding and abetting those breaches.

The Rural/Metro case in the wake of Trulia and Del Monte

There has been a continued trend of cases in state courts that allege aiding and abetting a breach of fiduciary duties. But this common claim against financial advisers can easily be prevented or deflected with the hindsight of the landmark case of Rural/Metro (2014) involving RBC Capital Markets, LLC (RBC) – a bank that arguably did commendable work for its client, running an auction and achieving a high deal premium, but still wound up paying damages of $75.8m, representing 83 percent of alleged stockholder losses. This arguably unfair decision provides a cautionary tale to all investment banks, including those that, like RBC, strive to operate with transparency and diligence.

On 7 March 2014, when Delaware Court of Chancery Vice Chancellor J. Travis Laster held RBC Capital Markets, LLC (RBC) liable for “aiding and abetting the individual defendants’ breaches of the duty of care and the duty of disclosure” in relation to a buyout, veteran Chancery watchers in the financial services world were no doubt deeply disappointed, but they were not surprised. Nor were they shocked when the vice chancellor later ordered the bank to pay the aforementioned sum to former Rural/Metro shareholders in alleged damages.

Understanding the issues involved can help investment banks follow a safer path as they advise clients on M&A and other financial transactions.

Tough on bankers

Seasoned observers saw it all coming despite the strong merits of RBC’s case. During his first five years on the Chancery bench, the vice chancellor had developed a reputation for being ‘tough on bankers’ – most notably with his landmark decision on Del Monte Foods in February 2011, criticising an adviser (Barclays) that Vice Chancellor Laster claimed “secretly and selfishly manipulated the sale process to engineer a transaction” that would permit it “to obtain lucrative buy-side financing fees”.

The landmark Del Monte case had marked an end to nearly 20 years of pro-banker decisions (1990-2009) and the start of a tougher approach we have seen over the past 10. In the Del Monte case, Vice Chancellor Laster had put a 20-day hold on the stockholder vote scheduled to approve the leveraged buyout of the food giant and on activation of the merger agreement’s no shop and breakup fee provisions, leaving the company open to competing bids. The Del Monte case was settled in December 2011 for $89.4m in damages.

Despite this troubling precedent, the RBC legal team decided to keep fighting to defend the investment bank anyway (the defendant directors had settled, so were not involved in the appeal). RBC had highly qualified lawyers for the appeal, including retired Supreme Court Justice Myron Steele, partner with Potter Anderson & Corroon, past Delaware Supreme Court Chief Justice (2004-2013) and past Delaware Chancery Court Vice Chancellor (1994-2000), joined with colleague T. Brad Davey to defend the bank and the directors, finding numerous errors in jurisprudence in the lower court’s ruling, as well as numerous examples of “unfair” treatment of RBC bank.

Trial by fire?

Rural/Metro’s board and adviser had been sued by shareholders for approving the sale of the company to private equity firm Warburg Pincus LLP. The sale process had included the formation of a special committee, procurement of two fairness opinions (one from an independent investment banker; one from a potential lender, RBC), and a six-party auction that elicited a single offer by the sale deadline. While RBC did have a position as a lender, the board knew this and therefore sought a second valuation opinion from an independent investment banker, as mentioned. Nonetheless, the defence was still shot down in Chancery Court, which by that time had become a trial-by-fire for adviser liability. Specifically, the Court found that RBC misled the directors by failing to: (i) provide sufficient valuation analysis at interim points in the process; and (ii) disclose to the directors its ongoing efforts to be involved in the buy-side financing. It also found that the directors had breached their duties by: (i) initiating the sale of the company; (ii) failing to supervise RBC; and (iii) disseminating false or misleading statements in proxy statements after the merger agreement was signed.

Now defence turned to the Delaware Supreme Court which, headed by Chief Justice Leo Strine, still offered hope of reversal. Although Justice Strine had issued a rebuke to the financial adviser in the El Paso Corp. case in 2012 when he was presiding over Delaware’s Chancery, he did ultimately rebuff the plaintiffs in that case. To be sure, the adviser lost its fee, but this was not due to Strine’s verdict but rather to the conditions of the subsequent settlement. By a quirk of history, however, for the RBC appeal, the presiding judge was Justice Karen L. Valihura. Chief Justice Strine, who oversaw early motions in the Rural/Metro case when he was on the Chancery Court, recused himself from deciding the high court appeal. Justice Valihura upheld the Chancery Court’s decisions in the Rural/Metro matter, delivering RBC a decisive defeat.

The Rural/Metro Chancery cases were part of a new trend of outliers in departures from a long line of Delaware cases for nearly 20 years (from 1990-2009) that were generally favourable to advisers. Only recently had the tide turned, with a few decisions cracking down on advisers, and the fact patterns there were different.

Nonetheless, in November 2015, when the high court affirmed the decisions, it sent shockwaves through the defence bar and the investment banking community. The message was clear: M&A advisers must dot their i’s and cross their t’s – or else.

The RuralMetro case had turned around the narrow question of whether RBC had aided and abetted a breach of fiduciary duty by directors. The directors had been protected against paying monetary damages by Rural/Metro’s indemnification clause. Section 102(b)(7) of Delaware law allows corporations to include exculpatory provisions in their charters shielding directors from liability. Although these provisions cannot excuse director self-dealing or intentional wrongdoing, they provide some liability buffer – at least for directors. One might argue, as RBC did in Rural/Metro, that with these in place it may be more difficult to prove that an adviser aided and abetted breach of fiduciary duty (since such a breach is exculpated). At least one court before had clearly stated that there cannot be an aid-and-abet case if there was no breach.

On the other hand, this particular defence did not work in Rural/Metro or its appeal, which in vain pointed out the negative repercussions that could ensue from affirmation of the Chancery decision: “Under the trial court’s approach, stockholders would no longer be able to enjoy the benefits of the corporate risk-taking encouraged by an exculpatory charter provision. Advisors will refuse to advise any board that even appears to be at risk of breaching its duty of care since they can be held solely liable for that breach (the director would be exculpated with no contribution obligation). This regime would undermine the public policy underlying Section 102(b)(7).”

After the gavel: lessons learned

Advisers might feel a particular chill to know that, even after a matter has been concluded in a court of law, it can live on through the post-trial commentary of the litigators. For example, Joel Friedlander of Bouchard, Margules & Friedlander, P.A., the lead counsel for the original plaintiff shareholders in the Rural/Metro case and in its appeal, recently mentioned RBC in a Harvard Law School paper on ‘Confronting the Problem of Fraud on the Board’. Astonishingly, despite the merits of the defence case, he went so far as to allege that the case against RBC could have been a fraud case. He wrote: “RBC was found to have aided and abetted the board’s breaches of its duty of care, in the dual contexts of Revlon and the duty of disclosure. An alternative reading of the post-trial rulings is that… RBC… committed frauds on the board that were not disclosed to Rural/Metro’s stockholders.” This is an unfair charge, and it may seem a disservice to quote it. But advisers need to know the long half-life that an adverse decision, however unfair, can have for them in the court of public opinion.

Advisers as gatekeepers – setting a high bar

In an interview with the advisory firm Stout in 2016, former Chief Justice Myron Steele, mentioned earlier as counsel in the appeal for RBC, pointed out many anomalies in the opinion from Vice Chancellor Laster, and concludes with useful guidance: “The lessons from the Rural/Metro case are that the Court of Chancery is focused on the retention and engagement of investment bankers to ensure the sales process isn’t tainted. Not only do conflicts need to be disclosed, but it also must be documented that conflicts have been identified and that there is robust discussion and a reasonable basis, despite conflicts, for retaining a particular investment banker. If the investment bank wants to do stapled financing, the board should document why that is OK with the board. Boards cannot leave it to the engagement letter to take care of the conflict issue. Boards also must continue to monitor the process as it goes along. It is all about process in Delaware: structure, the price produced and disclosure of material information about that process to stockholders.”

This wise advice from former Justice Steele aligns with the bright spot hidden within the final Rural/Metro decision. Justice Valihura disagreed with the lower court’s characterisation of financial advisers as gatekeepers. She wrote: “The trial court’s description does not adequately take into account the fact that the role of a financial advisor is primarily contractual in nature, is typically negotiated between sophisticated parties, and can vary based upon a myriad of factors. Rational and sophisticated parties dealing at arm’s-length shape their own contractual arrangements and it is for the board, in managing the business and affairs of the corporation, to determine what services, and on what terms, it will hire a financial advisor to perform in assisting the board in carrying out its oversight function. The engagement letter typically defines the parameters of the financial advisor’s relationship and responsibilities with its client.”

In a recent survey of recent Delaware cases involving investment banker liability, Arthur H. Rosenbloom of Consilium ADR and Gilbert E. Matthews of Sutter Securities note that liability of a financial adviser is generally based on contract law, not fiduciary law, unless the banker is specifically hired to protect shareholder interest. Furthermore, the authors state that if the standard for investment banker liability is fiduciary, it must meet the four conditions set forth in legal precedent – Malpiede (2001). These are: (i) the existence of a fiduciary relationship; (ii) a breach of the fiduciary’s duty; (iii) knowing participation in the breach by the third-party defendants; and (iv) damages proximately caused by the breach.

This sounds like a high bar to set, yet a number of cases against M&A advisers have flown over it with the help of determined trial lawyers.

In summary

The moral of the story for investment bankers and advisers is to obtain explicit client approval of any activities that may be deemed conflicts of interest, set clear expectations in the engagement letter, and remain alert to other possible sources of liability under both federal and state securities laws.

Author’s Note: On 23 April 2019, the Supreme Court issued a one-sentence ruling in Emulex Corp. v. Varjabedian, dismissing its writ of certiori as “improvidently granted”. Writing the following day, Jonathan E. Richman of Proskauer Rose wisely noted in The National Review that a Circuit split remains on the “substantive liability issue”; hence the dismissal “virtually ensures that both the liability standard and the existence of a private right of action under § 14(e) will reach the Court in the future”. Stay tuned.


Alexandra Reed Lajoux is chief knowledge officer emeritus at the National Association of Corporate Directors. She can be contacted on +1 (202) 255 7562 or by email:

© Financier Worldwide


Alexandra Reed Lajoux

National Association of Corporate Directors

©2001-2019 Financier Worldwide Ltd. All rights reserved.