USA – NEW YORK Trends and Developments Contributed by: Sam Lieberman, Ben Hutman and Claiborne Hane, Sadis & Goldberg LLP
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Second Circuit Rules That Fraud-on-the-Market Presumption of Reliance Applies to Minority Shareholders in Freeze-Out Mergers On 3 February 2025, the US Court of Appeals for the Second Circuit held, in a 2-1 decision, that “the fraud- on-the-market presumption” of reliance “is available to minority-shareholder[s]... who sold their shares in a freeze-out merger” in which their shares are cashed out (In Re Shanda Games Ltd. Sec. Litig. , 128 F.4th 26, 54 (2d Cir. 2025)). This is important because the “fraud-on-the-market” presumption is critical for class certification of a securities fraud class action; other- wise, each class member would have to prove reliance individually, which would make it nearly impossible to proceed as a class action. Under Shanda Games , investors whose shares are acquired in a cash-out merger are presumed to rely on public misrepresenta- tions and the company’s market price, even though the merger price is negotiated privately. This ruling opens the door to many more class actions in New York federal courts challenging freeze-out mergers for using an unfair merger price to buy out minority share- holders – particularly since so many of these merg- ers involve companies publicly traded on New York’s stock exchanges (ie, the NYSE, NASDAQ). In Shanda Games , the company’s CEO joined a “buyer group” that held “90 percent of all shareholder votes” in acquiring the company by cashing out the minor- ity shareholders’ American depositary shares (ADS) “for $7.10 per share” (the “merger”) (128 F.4th at 38–40). In publicly filed proxy statements proposing the merger, the company relied heavily on (i) new earn- ings “Projections, which suggested a serious decline in [company] prospects”; and (ii) representations by
the company’s board and Special Committee that the merger price was “fair” and in the “best interests” of minority stockholders (id at 38–39). But between the time of the company’s initial proxy statement and the “final proxy” before the vote to approve the merger, the company released a new video game product that “generated many times the” projected revenue (id at 40). Three shareholders (the “dissenters”) objected to the merger price and “filed an appraisal action in the Grand Court of the Cayman Islands” (the “appraisal action”). The appraisal action held that the USD7.10 per share merger price “did not represent the fair value of the shares and awarded the dissenters USD12.84 per ADS” share – a price almost two times higher (id). Next, certain investors filed a class action on behalf of all minority shareholders cashed out in the merger (the “class action”). The class action alleged that the company and the buyer group (the “defendants”) made two primary categories of misrepresentations: (i) misrepresenting the accuracy and validity of the company’s earnings projections, and (ii) misrepresent- ing the fairness of the merger, in order to induce the minority shareholders to acquiesce in being cashed out at the unfair USD7.10 per share merger price. Notably, the class action alleged reliance and loss causation based on the misrepresentations, causing the class not to exercise appraisal rights that could have led to the higher USD12.84 per share apprais- al action award. The class action alleged that the defendants made their misrepresentations to conceal that the “Merger price did not reflect the fair value of Shanda’s shares, and thereby discourage the exercise of appraisal rights” (id at 37). The class action com-
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