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Chester County Employees’ Retirement Fund v. KCG Holdings, Inc., et al., C.A. No. 2017-0421-KSJM (Del. Ch. June 21, 2019) (McCormick, V.C.)

June 21, 2019

In this memorandum opinion, the Delaware Court of Chancery declined to apply the Corwin “cleansing” doctrine at the pleadings stage, finding it reasonably conceivable that stockholders of KCG Holdings, Inc. (“KCG”) were not fully informed when they voted to approve a merger with Virtu Financial, Inc. (“Virtu”).  The Court further held that the plaintiff adequately pled claims for: (1) breach of fiduciary duty against KCG’s directors (“Director Defendants”) in connection with the negotiation and approval of the merger, (2) aiding and abetting the Director Defendants’ breach of fiduciary duty against Virtu and Jefferies, LLC (“Jefferies”), and (3) civil conspiracy against Virtu and Jefferies.

Virtu acquired KCG, a financial services firm, in a cash-out merger for $20 per share.  The plaintiff, a former KCG stockholder, alleged that the Director Defendants failed to maximize value for KCG stockholders in negotiating and approving the merger. 

The plaintiff alleged that, at the beginning of the process, Jefferies, KCG’s largest stockholder and then-financial advisor, secretly met with Virtu to discuss a potential sale of KCG.  Jefferies purportedly indicated to Virtu that a sale of KCG’s bond-trading platform, BondPoint, would increase KCG’s tangible book value to over $21 per share.  Jefferies also supplied Virtu with confidential information related to BondPoint, which Jefferies had obtained as KCG’s financial advisor. Thereafter, Jefferies and Virtu purportedly agreed to a deal price for the sale of KCG of $20 per share, and for Jefferies to act as Virtu’s financial advisor in a post-transaction sale of BondPoint.

Jefferies first informed KCG’s board of directors (“Board”) of some, but not all, of its discussions with Virtu immediately before the Board received Virtu’s initial offer in the range of $18.50 to $20 per share.  Suspicious of Jefferies’s involvement with Virtu, the Board tried to exclude Jefferies from negotiations and hired a new financial advisor.  Jefferies is alleged to have continued to pressure the Board to pursue a deal with Virtu and remained KCG’s financial advisor with respect to a restructuring plan that KCG management believed was financially superior to a deal with Virtu. 

The plaintiff further alleged that, at the back end of the process, the Director Defendants engaged in misconduct that undermined KCG’s ability to extract maximum value from Virtu.  Daniel Coleman, KCG’s CEO, initially was not supportive of Virtu’s offer.  Despite his misgivings that a $20 offer was too low, Coleman allegedly promised the Board that he would support the offer if he could negotiate a compensation plan for himself and his management team.  Rather than limiting Coleman’s role in the negotiations, the Director Defendants instead authorized him to negotiate the deal and the executive compensation plan.  Further, the night before the Board approved the deal, Coleman allegedly revised KCG’s financial projections downward in an effort to manipulate the fairness opinion that was to be issued by KCG’s new financial advisor. 

The Director Defendants moved to dismiss on the grounds that the Board’s decision to approve the merger was subject to the protections of the business judgment rule under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), because an informed, uncoerced majority of minority of KCG stockholders approved the deal.  The Court disagreed, holding that the plaintiff sufficiently alleged that the stockholder vote was not fully informed.  The Court found that the plaintiff adequately alleged multiple categories of deficient disclosures, including with respect to: (1) Jefferies’s proposed post-acquisition plan to divest BondPoint and the effects of that divestiture on the valuation of KCG, (2) Coleman’s change of position on the merger and his conflict of interest in simultaneously negotiating the deal and his own compensation plan, and (3) KCG’s earlier, more optimistic projections and the circumstances surrounding the revised projections. Finding Corwin inapplicable, the Court determined that the transaction should be reviewed under the Revlon enhanced scrutiny standard. 

The Court then addressed the Director Defendants’ argument that KCG’s exculpatory charter provision adopted pursuant to Section 102(b)(7) of the General Corporation Law of the State of Delaware shielded them from monetary liability for the breach of fiduciary duty claims.  The Court disagreed, holding that the Complaint adequately stated non-exculpated claims for breach of fiduciary duties.  The Court found that the plaintiff adequately alleged that the Director Defendants, though aware of Coleman’s conflict of interest, failed to limit his role in negotiations with Virtu, and even authorized him to simultaneously negotiate the merger price and his own compensation plan.  In light of that conduct and the Board’s last-minute approval of downward revisions to KCG’s projections, the Court held that the Complaint supported a pleadings-stage inference of bad faith.

Next, the Court denied Jefferies’s and Virtu’s motions to dismiss the aiding and abetting claims.  With respect to Jefferies, the Court found that the plaintiff adequately alleged that Jefferies secretly negotiated with Virtu, committed to a $20 per share price before notifying the Director Defendants of Virtu’s interest, and used confidential information to develop a divestiture strategy for BondPoint without informing the Board.  With respect to Virtu, the Court found that the plaintiff sufficiently alleged that Virtu worked with Jefferies to pressure the Board to approve the deal for a less-than-value-maximizing price, accepted confidential information regarding BondPoint to develop an acquisition strategy, and exploited Coleman’s conflict of interest to obtain his support for the deal. 

The Court therefore denied the motions to dismiss the aiding and abetting claims, finding the plaintiff sufficiently alleged that Jefferies and Virtu knowingly participated in the Director Defendants’ breach of fiduciary duties by misleading them and creating an informational vacuum.

Finally, the Court denied Jefferies’s and Virtu’s motions to dismiss the civil conspiracy claims.  The Court found it reasonably conceivable that Jefferies and Virtu engaged in conduct that damaged the stockholder class, including by (1) secretly agreeing upon a merger price before the Board knew of Virtu’s interest, (2) secretly agreeing to sell BondPoint post-acquisition, (3) working together to achieve those goals, and (4) and interfering with the Director Defendants’ exercise of their fiduciary duties by exploiting confidential information related to BondPoint.

The full opinion is available here