It’s frequently been observed that (perhaps until recently) Delaware’s real competition was not horizontal, but vertical – if Delaware did not at least appear to be meting out appropriate corporate discipline, the federal government would step in to preempt its law. Right now, however, we’re seeing a full on horizontal race to the bottom, as Texas, Delaware, and Nevada compete to absolve corporate managers of any fiduciary liability. All three states could, of course, just say that – explicitly provide that shareholders have no cause of action for fiduciary breach – but all three (especially Texas and Delaware) feel the need to create a maze of procedural limitations on shareholder action that collectively add up to eliminating litigation rights without saying as much in so many words. All of which provides support for the argument I made in my paper, The Legitimation of Shareholder Primacy, that the rules are intended as a display to the general public in order to create the illusion that limits are being placed on managerial power.
One possibility I raise in the paper (which was actually drafted before SB 21, though I’ll update it eventually) is that we are in a moment when there is little risk of robust federal intervention in corporate governance, and so corporate managers feel free to demand – and states are willing to supply – a more lax corporate law. By contrast, when the threat of federal intervention is more imminent, corporate managers are willing to tolerate greater restrictions from the states (Delaware) as a less-intrusive alternative.
But that’s a story about federal legislation (and federal regulation). It’s not a story about the federal courts.
Which brings me to In re Shanda Games Securities Litigation, 128 F.4th 26 (2d Cir. 2025), decided by the Second Circuit earlier this year. Shanda Games was a Chinese firm incorporated in the Cayman Islands, with American Depository Shares that traded on the NASDAQ. A buyout group that held 90% of the votes, and included the CEO and certain board members, agreed to a freeze-out merger and issued a proxy statement that allegedly low-balled the company’s performance and prospects in order to justify the merger price of $7.10 per ADS. Eventually, the merger was completed. Three shareholders who sought appraisal under Cayman law were able to obtain $12.84.
So, remaining shareholders sued under the federal securities laws. Now, the false information was contained in a proxy statement, but, because the buyout group controlled 90% of the votes, technically, the minority shareholders’ votes were irrelevant – therefore, Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991), barred shareholders from bringing a Section 14(a) claim that the false proxy misled shareholders into voting for a bad deal.
Instead, the shareholders sued under Section 10(b), alleging that the false proxy statement misled them into giving up their statutory right of appraisal. (That, by the way, is also a claim that can be brought under Section 14(a), see Wilson v. Great American Industries Inc, 979 F.2d 924 (2d Cir. 1992), but the shareholders chose to go the 10(b) route, possibly? Because they didn’t want to get into a thing about how individual shareholders voted. I dunno.).
But 10(b) is kind of an odd fit for a loss-of-appraisal-rights claim. Under Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), the fraud must have occurred in connection with a purchase or sale, so, in this case, the shareholders claimed that they tendered their shares for the merger consideration, instead of holding them back to exercise their appraisal rights, and that counted as the “sale” for Blue Chip purposes.
But then the shareholders had a second problem: reliance. They could, of course, individually claim that they read the proxy statement and made a decision about appraisal based on its contents, but that kind of thing cannot be adjudicated on a class basis. Normally, in class cases, Section 10(b) shareholders solve this problem by satisfying the element of reliance via the fraud on the market presumption. We presume that share prices were affected by the fraud; we presume that people who buy and sell at the market price “rely” on that price as a reflection of its value; therefore, anyone who trades at the market price relies, indirectly, on the fraudulent statements, and there is no need for plaintiff-by-plaintiff proof.
Here, though, the shareholders didn’t trade at the market price; they were forced into a bad merger, and in that sense, they didn’t rely on anything. So, the shareholders argued that the market price reflected the false proxy information, and they were entitled to a presumption that they relied on the market price when making the decision not to seek appraisal. It was that market price that lulled them into thinking an appraisal action wouldn’t be worth it.
The Second Circuit panel, in a 2-1 decision, agreed. The court reasoned that the market price of the stock reflected the information contained in the false proxy statement; therefore, the market price was depressed. Therefore, the merger consideration looked good by comparison; therefore, shareholders chose not to seek appraisal. Thus, shareholders “relied” on the market price, not for trading decisions, but for decisions about whether to exercise their appraisal rights.
In sum, shareholders did not have the burden to prove they would have exercised their appraisal rights had they known the truth; instead, the Second Circuit afforded them a classwide presumption of reliance – and shareholders could advance their claims.
In dissent, Judge Jacobs pointed out that, even if the proxy statement had been truthful, the market price would still have been depressed because the consideration in the pending freeze-out merger would have put a ceiling on it. The majority dismissed that argument in a footnote, hypothesizing that if the proxy statement had been accurate, appraisal arbs would have bid up the stock price in anticipation of later filing Cayman Islands lawsuits.
So. This is quite an extension of the fraud on the market presumption. Theorists have long been troubled by the presumption that traders “rely,” in a subjective sense, on the market price as an indicator of value – as Justice White in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), and Justice Thomas in Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014), point out, often the fact that you traded means that you don’t think market price reflects value. Still, even if you ignore that part of the fraud on the market doctrine, there still remain the otherwise-reasonable presumptions that (1) market prices are distorted by fraud; and (2) this causes injury to those who trade at market prices.
But in Shanda Games, the Second Circuit took the “presumption” to a whole ‘nother level. Leaving aside the back and forth about what the market price would or would not have reflected had the truth been disclosed, it requires a different chain of inferences to adopt a legal presumption that NASDAQ traders would have gone to the trouble of bringing appraisal actions if they had known the truth. It ignores the costs associated with such actions, the downside risks of litigation, they delays, and so forth.
To put it another way, in a typical fraud on the market action, it’s relatively easy to assume that if the truth had been known, the plaintiff might have done the exact same thing they did before – buy or sell – but at a different (better) price. Or, to assume that if the price had changed, the plaintiff would have changed trading strategies. Either way, the critical thing you’re assuming is something about markets – the market in which the plaintiff traded would have been a different one had the truth been disclosed. The plaintiff literally could not have done the same thing – buy that security at that exact same price – had the truth been disclosed, because the security itself would have had a different price.
Here, however, a presumption that the market would have looked different – the market price would have been higher – does not necessitate that plaintiff shareholders would have behaved differently. You still have to add the extra inference that they would have looked at that market price and done something completely different and far more burdensome, namely, seek appraisal.
The court, in other words, reached pretty far to get where it wanted to go.
But. Let us engage in a hypothetical.
Suppose Shanda Games had been incorporated in Delaware. Pre-SB 21.
Suppose therefore there had been robust protections in place for minority shareholders facing a freezeout merger – indeed, likely there would have been a vigorously litigated parallel state court action.
Would the Second Circuit have come out the same way? Maybe, but I suspect not. I suspect that on some level, what may have been driving the court here was the obvious unfairness of the situation and the complete lack of alternative remedy, because the company was organized in a jurisdiction that is sort of infamous as a place to incorporate in order to avoid obligations to shareholders (or anyone else).
The lesson is, then, that Texas, Delaware, and the corporate bar may be making the correct calculation that no federal regulators are going to step in to fill the corporate governance gap – but federal regulators are not the only players.
And no other thing. No new Shareholder Primacy podcast this week but Mike and I will be back next week. In the meantime, peruse our old episodes, or email us with stuff you’d like us to talk about at shareholderprimacy@freefloat.llc