Gumm et al v. Molinaroli et al
Filing
89
ORDER DISMISSING CASE signed by Chief Judge Pamela Pepper on 11/3/2021. 55 Defendants' motion to dismiss Counts I and II of amended complaint GRANTED; those counts DISMISSED WITH PREJUDICE. 55 Defendants' motion to dismiss Counts III th rough XII of amended complaint GRANTED; those counts DISMISSED WITHOUT PREJUDICE; the court DECLINES TO EXERCISE supplemental jurisdiction over plaintiffs' state law claims. 71 Plaintiffs' motion for leave to file supplemental brief GRANT ED; Clerk of Court to docket supplemental brief at dkt. no. 71-1 as separate supplemental brief in opposition to defendants' motion to dismiss. 76 Plaintiffs' motion to modify PSLRA stay of discovery DENIED AS MOOT. 81 Plaintiffs' motion for leave to serve subpoenas on non-parties DENIED AS MOOT. (cc: all counsel)(cb)
UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF WISCONSIN
ARLENE D. GUMM, et al.,
Plaintiffs,
Case No. 16-cv-1093-pp
v.
ALEX A. MOLINAROLI, et al.,
Defendants.
ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS COUNTS I AND II
OF AMENDED COMPLAINT WITH PREJUDICE (DKT. NO. 55), GRANTING
DEFENDANTS’ MOTION TO DISMISS COUNTS III THROUGH XII WITHOUT
PREJUDICE AND DECLINING TO EXERCISE SUPPLEMENTAL
JURISDICTION OVER THOSE CLAIMS (DKT. NO. 55), GRANTING
PLAINTIFFS’ UNOPPOSED MOTION REQUESTING LEAVE TO FILE
SUPPLEMENTAL BRIEF (DKT NO. 71), DENYING AS MOOT PLAINTIFFS’
MOTION TO MODIFY STAY OF PSLRA DISCOVERY (DKT. NO. 76),
DENYING AS MOOT PLAINTIFFS’ MOTION FOR LEAVE TO SERVE NONPARTY SUBPOENAS (DKT. NO. 81) AND DISMISSING CASE
The plaintiffs are a group of former shareholders of Johnson Controls,
Inc. (JCI). In August 2016, they brought this class action suit against JCI, its
officers and directors, the Irish corporation Tyco (with which JCI since has
merged to form a new company) and Merger Sub (the subsidiary through which
the merger was effectuated). Dkt. No. 1. The 134-page complaint alleged that
JCI and its leadership, as well as the entities with whom it (at that time)
intended to merge, had (in various combinations) violated federal and state
securities laws and federal tax laws, breached fiduciary duties to the plaintiffs,
been unjustly enriched, committed state-law conversion, conspired, committed
1
tortious interference with contract and breach of contract and breached the
covenant of good faith and fair dealing. Id. In January 2017, the court denied
the plaintiffs’ motion for a preliminary injunction, dkt. no. 52, after which the
plaintiffs amended the complaint, dkt. no. 53. On April 3, 2017, the defendants
moved to dismiss the amended complaint for failure to state a claim. Dkt. No.
55. They seek dismissal with prejudice. Dkt. No. 56 at 48.
The motion was fully briefed by June 15, 2017. See Dkt. No. 60
(defendants’ reply brief in support of their motion to dismiss). The court,
however, did not rule. In fact, it took over two years for the court to hold oral
argument on the motion to dismiss; the court held that hearing on October 17,
2019. Dkt. Nos. 67-69.
At the end of the hearing, the court took the motion to dismiss under
advisement. Dkt. No. 69. It had planned to contact the parties “shortly” to
schedule a date for the court to issue an oral ruling on the motion to dismiss,
and it told the parties as much. Id. But although at the October 17, 2019
hearing, the court had apologized to the parties for the already-extensive delay
in addressing the motion, the court did not act “shortly,” or promptly. It did not
rule, either orally or in writing. It has been over two years since that hearing
with no ruling on the motion, even though the plaintiffs since have filed a
motion for leave to file a supplemental brief, dkt. no. 71, a motion to modify the
stay of the discovery under the Private Securities Litigation Reform Act, dkt. no.
76, and a Civil Local Rule 7(h) (E.D. Wis.) expedited, non-dispositive motion to
serve subpoenas, dkt. no. 82.
2
This delay finally prompted the plaintiffs to petition for mandamus from
the Seventh Circuit Court of Appeals. Dkt. No. 88. While the court has
explanations for the delay, they are of no moment or succor to the parties.
There is no excuse for the court having delayed this long in ruling on the
motion to dismiss, or the other pending motions. The court will dismiss Counts
I and II with prejudice, dismiss Counts III through XII without prejudice and
dismiss the case.
I.
The Amended Complaint
A.
Context
The court stated the following in its January 25, 2017 order denying the
plaintiffs’ motion for a preliminary injunction:
Generations of Wisconsin citizens are familiar with a company
called, until recently, Johnson Controls. Born in Wisconsin in the
1880s, for much of its lifespan the company manufactured, installed
and serviced thermostats—actually, devices that could control the
temperature in commercial buildings. In January 2016, the
Wisconsin company announced that it was going to merge with an
Irish company called Tyco. Among other things, the merger
agreement would move the company headquarters from Wisconsin
to Ireland. The named plaintiffs hold shares of common stock in the
merged company (now called “Johnson Controls, Inc.” or “JCI”,1),
and they hold those shares in taxable accounts. They challenge the
tax structure that resulted from the merger—one that, they argue,
improperly places the tax burden on them, rather than on the newlyformed company.
Dkt. No. 52 at 1-2.
The court got this detail wrong. The new company that resulted from the
merger is called Johnson Controls International plc (“JCplc”). Dkt. No. 53 at p.
6.
1
3
B.
The Players
Prior to January 2016, Johnson Controls, Inc. was a corporation
organized under Wisconsin law and headquartered on Green Bay Avenue in
Milwaukee; it was publicly traded on the New York stock exchange. Dkt. No. 53
at ¶46. Tyco International plc had its U.S. headquarters in Princeton, New
Jersey. Id. at ¶47. Defendant Merger Sub was a limited liability subsidiary of
Tyco used to effectuate the January 2016 merger of JCI and Tyco. Id. at ¶48.
The entity that resulted from the merger was incorporated and is
headquartered in Ireland and is known as Johnson Controls International plc
(the plaintiffs sometimes refer to it as “Tyco/JCplc”). Id. at ¶47.
There are forty-six named plaintiffs, id. at ¶¶28-30; the amended
complaint asserts that as of January 25, 2016 (the day after the merger
agreement was executed), they and their immediate family members held more
than 1.2 million shares of JCI “representing tens of millions of dollars of
taxable capital gain and/or ordinary income and millions of dollars of capital
gain, ordinary income, and other taxes,” id. at ¶31.
Defendants Molinaroli, Stief, Guyett and Janowski were officers of JCI;
Abney, Black, Bushman, Conner, Goodman, Joerres, William H. Lacy (now
represented by his estate), del Valle Perochena and Vergnano were directors.
Id. at ¶¶32-44.
The plaintiffs allege that the corporate entities had several financial and
legal advisors helping them in the months leading up to the merger: U.S.registered broker/dealers Centerview Partners LLC and Barclays Capital, LLC,
4
whom the plaintiffs assert were financial advisors to JCI; Wachtell, Lipton,
Rosen & Katz (the firm representing the defendants in this litigation) and A&L
Goodbody, whom the plaintiffs assert were legal advisors to JCI; Lazard Freres
& Co. and Goldman Sachs, whom the plaintiffs assert were financial advisors
to Tyco; and Simpson Thacher & Bartlett and Arthur Cox, whom the plaintiffs
alleged were Tyco’s legal advisors. Id. at ¶¶50-57.
C.
Chronology of Events
The plaintiffs allege that on July 24, 2015, JCI announced that it
planned to separate its “Automotive Experience business” from Johnson
Controls proper “by means of a spin-off of a newly formed company, to be
named Adient.” Id. at ¶¶176, 194(h). The amended complaint cites a July 24,
2015 news release indicating that the spin-off was to be “tax free.” Id. at ¶176
and n.55. The plaintiffs assert that Adient “represented over half of JCI’s
market capitalization.” Id.
The amended complaint alleges that on November 25, 2015, the JCI
board of directors had a telephonic board meeting with representatives of
financial advisor Centerview and legal counsel Wachtell Lipton in attendance,
discussing the progress of the merger discussions with Tyco and the “potential
synergies” from the merger, including JCI management’s estimates of hundreds
of millions in operational and U.S. tax “synergies.” Id. at ¶209(b).
On December 8, 2015, JCI’s executive director of corporate development
(defendant Guyette) and representatives from Centerview met with someone
named “Mr. Armstrong”—presumably from Tyco—and representatives of Tyco’s
5
financial advisor Lazard Freres to discuss the merger, including stock exchange
ratios for the stockholders of each company. Id. at ¶236(c).
On December 10, 2015, the JCI board of directors held another
telephonic board meeting, attended by representatives from Centerview and
Wachtell Lipton, where the board was updated on the discussions with Tyco
and the proposed method of calculating the stock exchange ratio. Id.
On December 11, 2015, defendants Molinari (CEO of JCI) and Guyette
had a phone call with “Messrs. Oliver2 and Armstrong” to discuss “key terms of
the potential business combination,” including the exchange ratio and the
assumptions underlying it. Id.
On December 16, 2015, JCI’s counsel, Wachtell Lipton, sent a draft
merger agreement and term sheet to Simpson Thacher (Tyco’s legal counsel);
according to the plaintiffs, the defendants described the agreement as
providing for a merger that would be structured as a “‘reverse merger,’ in which
Tyco would be the parent entity of the combined company and Johnson
Controls would be merged with a wholly owned subsidiary of Tyco.” Id. Between
December 18, 2015 and January 23, 2016, there was a series of phone calls
and meetings—internal to each entity and between entities—discussing the
structure of the merger and the stock exchange ratio. Id. at ¶¶209(c), 236(c).
The plaintiffs allege that on January 20, 2016—four days before the
merger agreement was signed—defendant Merger Sub was formed “for the sole
purpose of effecting the merger.” Id. at ¶188(b). They allege that Merger Sub, a
2
Presumably George Oliver, Tyco’s CEO. Dkt. No. 53 at ¶78.
6
Wisconsin limited liability company, was a wholly owned subsidiary of Tyco. Id.
Merger Sub was to merge with and into JCI, leaving Johnson Controls as a
wholly owned subsidiary of Tyco. Id. at ¶188(c).
The plaintiffs assert that as of January 4, 2016, JCI’s market
capitalization was $27 billion (“648 million shares times $35 per share as of
January 4, 2016”). Id. at ¶158.
On January 24, 2016, JCI and Tyco executed an “Agreement and Plan of
Merger;” the companies later announced that their boards had unanimously
approved the agreement. Id. at ¶¶1, 68. Under the merger agreement, JCI
merged with Merger Sub, which the plaintiffs allege “result[ed] in JCI becoming
a directly and indirectly wholly-owned subsidiary of Tyco/JCplc,” JCplc
standing for “Johnson Controls International plc,” the name of the new entity.
Id. at ¶69.
Section 6.13 of the merger agreement provided:
Tax Matters. From and after the execution of this Agreement until
the earlier of the Effective Time or the date, if any, on which this
Agreement is terminated pursuant to Section 8.1, except as may be
required by Law, notwithstanding anything to the contrary in
Section 5.1 or Section 5.2, none of Parent, Merger Sub or the
Company shall, and they shall not permit any of their respective
Subsidiaries to, take any action (or knowingly fail to take any action)
that causes, or could reasonably be expected to cause, the
ownership threshold of Section 7874(a)(2)(B)(ii) of the Code to be met
with respect to the Merger.
Id. at ¶103 (quoting “S-4 at A-72 (emphasis supplied)”).
The plaintiffs allege that although there was no requirement that the new
company be domiciled in Ireland, JCI reincorporated in Ireland. Id. at ¶¶97-98.
They allege that what made it necessary for the new corporation to be
7
reincorporated in Ireland was the defendants’ need “to establish the platform
upon which Defendants’ tax avoidance schemes depended . . . .” Id. at ¶21.
They assert that although the merger was structured as an acquisition of
Johnson Controls by Tyco, Johnson Controls paid approximately $16.5 billion
for Tyco (citing an article from Reuters). Id. at ¶3, n.2.
The plaintiffs allege that the next day—January 25, 2016—JCI
announced the merger. Id. at ¶68. The plaintiffs allege that the announcement
indicated that the merger would be “tax-free to Tyco shareholders and taxable
to JCI shareholders.” Id. at ¶6. They claim that in announcing the merger, the
defendants “touted” a list of benefits that they expected to result from the
merger—growth opportunities and expanded global reach, better partnerships
with customers, one of the largest “energy storage platforms with capabilities
including traditional lead acid as well as advanced lithium ion battery
technology serving the global energy storage market” and the possible delivery
of “at least $500 million in operational synergies over the first three years after
closing.” Id. at ¶74.
The plaintiffs allege that on April 4, 2016, the defendants filed “the S-4
with the Securities and Exchange Commission . . . .” Id. at ¶2. In a footnote,
the plaintiffs state that “all references to the JCI/Tyco joint proxy/registration
statement (‘S-4’) are to the document as filed with the SEC in final form on July
6, 2016.” Id. at n.1. According to the plaintiffs, the “S-4” stated that
Tyco and Johnson Controls have agreed that, from and after the
execution of the merger agreement until the earlier of the effective
time of the merger or the date, if any, on which the merger agreement
is terminated, except as be required by law, none of Tyco, Merger Sub
8
or Johnson Controls will, and they will not permit any of their
respective subsidiaries to, take any action (or knowingly fail to take
any action) that causes, or could reasonably be expected to cause,
the 60% ownership test to be met with respect to the merger.
Id. at ¶104. (Emphasis added by the plaintiffs.)
The plaintiffs assert that on April 8, 2016, the JCI board met by
telephone with JCI management to discuss certain tax regulations and their
impact on the transaction; the plaintiffs allege that after this discussion, “all
members of the Johnson Controls board of directors present unanimously
determined that the merger transaction with Tyco was still in the best interest
of Johnson Controls and its shareholders because of, among other things, the
strategic rationale for the combination and the operational synergies that could
be achieved from the transaction.” Id. at ¶209(d). The plaintiffs allege that the
board decided that management should proceed with the merger on the terms
set out in the agreement. Id. On April 21, 2016, “Johnson Controls and Tyco
announced that they intended to proceed with the merger and that the
combined company expected to deliver at least $650 million in operational and
global tax synergies by the third year after closing.” Id.
The plaintiffs allege that between January 4 and September 2, 2016,
JCI’s shares “traded between $35 and $46 per share.” Id. at ¶169.
The merger closed on September 2, 2016; “JCI shareholders sold their
JCI shares to Tyco for Tyco shares constituting 56% of Tyco/JCI plus cash at a
price that was below or at the bottom of the ranges of values of JCI shares
determined by Defendants’ financial advisors.” Id. at ¶1. The plaintiffs assert
that
9
JCI shareholders received in exchange for approximately 83% of
their JCI shares one ordinary share of JCplc for each share of JCI
common stock plus cash for the remaining 17% of their JCI shares
at $34.88 per share, which was below or at the bottom of the ranges
of fair values of JCI shares determined by JCI’s advisers. On
September 2, 2016, JCI shares closed at $42.72. Tyco shareholders
received for each ordinary share of Tyco 0.955 of an ordinary share
of JCplc.
Id. at ¶5.
The plaintiffs allege that the new company has an eleven-member board
of directors—six former JCI directors and five former Tyco directors. Id. at ¶78.
They assert that at the time the amended complaint was filed in February
2017, defendant Molinaroli—formerly chairman, president and CEO of JCI, id.
at ¶32—was the chairman and CEO of the new company, id. at ¶78. In
February 2017, George Oliver, whom the plaintiffs assert was Tyco’s CEO, was
president and chief operating officer of the new company. Id. at ¶78. Molinaroli
was to serve as chairman and CEO of the new company for eighteen months,
after which Oliver would become CEO and Molinaroli would spend one year as
executive chair; then Oliver would become chairman and CEO. Id.
The plaintiffs assert that on September 16, 2016—two weeks after the
merger closed—JCI made a new disclosure on its website, stating that it
intended to “‘take the position’ with the IRS that both the cash payment for the
forced sale to JCI of approximately 17% of each Minority Subclass member’s
JCI shares and an additional portion of the JCplc shares received by JCI
shareholders ‘could potentially be treated as dividend’ subject to ordinary
income taxes.” Id. at ¶129. “Thus, a substantial portion of the proceeds from
the ‘sale’ of JCI shares in the merger may be taxed at what may be higher
10
ordinary income tax rates, not the previously understood more favorable
capital gains rates.” Id.
On October 3, 2016, JCplc disclosed in an Information Statement
attached to an SEC Form 8-K “that the holding period of U.S. shareholders in
JCplc was restarted as a result of the JCI/Tyco merger being treated as a
taxable transaction and that this could have adverse tax effects on JCplc
shareholders with respect to the distribution of Adient.” Id. at ¶182. Recall that
in the summer of 2015, JCI had indicated that the Adient spin-off would be tax
free; the plaintiffs allege that by waiting until after the merger to complete the
Adient spin-off, the defendants rendered the Adient spin-off taxable. Id. at
¶181.
D.
The Structure of the Merger
Early in the amended complaint, the plaintiffs explain that they
do not take issue with the purported business or financial merits of
the Merger; Plaintiffs challenge only structuring the deal as an
“inversion” (i.e., reincorporating JCI in Ireland and otherwise
rendering the Merger taxable to JCI shareholders) to enable
JCI/JCplc to implement earnings-stripping and other tax avoidance
schemes to reduce U.S. taxes at the expense of JCI’s minority
taxpaying shareholders and diluting the JCI public shareholders’
equity interest in JCplc to under 60% to avoid the inversion-related
adverse tax consequences under IRC [Internal Revenue Code]
§§ 4985 and 7874. Because it is the inversion structure and the
accompanying tax avoidance schemes that have and will cause the
injuries to Plaintiffs and fellow class members, and not JCI’s
acquisition of Tyco itself, the term “Inversion” is hereinafter from
time to time used to refer to the Merger.
Id. at ¶8.
To understand the named plaintiffs’ allegations, one first must
understand how they held their stock. As of the day after JCI and Tyco signed
11
the merger agreement, each of the named plaintiffs held more than 200 shares
of common stock in taxable accounts. Id. at ¶¶17, 28-30.3 The named plaintiffs
allege that because the defendants structured the merger in a way that made
the transaction taxable to JCI shareholders, “JCI shareholders who held their
JCI shares in taxable accounts and who have held the stock for over a year will
pay federal taxes at rates of 20% to 30% on their gains, in addition to state
capital gains and potentially ordinary income taxes.” Id. at ¶17. The plaintiffs
also allege that “[a]ll JCI public shareholders have been harmed,” id. at ¶18,
and their proposed class appears to be all public shareholders, not just those
who held their shares in taxable accounts, id. at ¶64(a).4
Next, one must understand what the plaintiffs mean by an “inversion.”
The plaintiffs describe an inversion as
a process by which a U.S.-domiciled “target” corporation (here, JCI)
becomes a subsidiary of a foreign parent corporation (Tyco) and the
shareholders of the U.S. corporation (JCI) become shareholders of
the foreign parent in an exchange of their U.S. corporation’s stock
for stock in the foreign parent.
Paragraph 30(rr) of the amended complaint states that Philip Zena of Town &
Country, Missouri held in excess of 200 shares of JCI common stock but does
not allege that he held it in a taxable account. The court assumes this is an
oversight.
3
The amended complaint alleges a “class” and a “minority subclass.” Dkt. No.
53 at ¶64. The class is defined as JCI shareholders who held shares of JCI
common stock during the relevant period “who were injured by the failure to
disclose” and other “wrongful conduct” or who were entitled to vote on the
merger or who sold their shares in connection with the merger for cash and
JCplc ordinary shares as part of the share exchange. Id. at ¶64(a). The
“minority subclass” is defined as those members of the class who held their
shares in taxable accounts and includes those who “received the Adient spinoff as of October 21, 2016.” Id. at ¶64(b).
4
12
Id. at ¶9. They allege that by changing the country in which it is domiciled,
the U.S. corporation (which remains a U.S. corporation subject to
U.S. taxes on its U.S.-source income) is able to shield the earnings
from its foreign and, to a lesser extent, domestic operations from
U.S. federal and state corporate income taxes; the new foreign
parent is subject to a lower home country tax rate and no tax on its
or its subsidiaries’ foreign-source income derived from other
countries.
Id. According to the plaintiffs, this is because, while the U.S. taxes all income of
U.S. corporations regardless of the source, “almost all developed countries (and
all of the popular foreign lower-tax domiciles, like Ireland) tax only the income
earned by the locally-domiciled company in that country (‘territorial taxation’).”
Id. The plaintiffs explain that
[a]lthough widely viewed as a “tax inversion,” the Merger technically
was not an inversion to the extent that it evaded the anti-inversion
provisions found in [26 U.S.C.] § 7874 and the anti-inversion excise
tax found in [26 U.S.C.] § 4985, which evasion was accomplished by
the improper dilution of JCI shareholders’ equity interest in JCplc
to under 60%. However, the Merger was structured to enable JCI to
move its domicile to Ireland to take advantage of its lower corporate
tax rate and earnings-striping and other tax avoidance schemes, as
a result of which certain JCI shareholders are being forced to pay
taxes, all of which are characteristic of “inversions.”
Id. at ¶7.
A section of the amended complaint titled “The Notoriety of Inversions”
expands on the plaintiffs’ implication that in structuring the merger as an
“inversion,” the defendants did something increasingly recognized in policy
circles as improper or ill-advised.5 Id. at ¶¶116-123. Citing articles from the
Washington Post and the New York Times (one of which allegedly quoted former
The plaintiffs also refer to what the defendants did as “tax sleight-of-hand.”
Dkt. No. 53 at ¶12.
5
13
President Barak Obama), a legal blog and a law review article by a pair of
authors (one of whom was Deborah Paul, a partner at the law firm of defense
counsel Wachtell Lipton), the plaintiffs argue that inversions have been
criticized for eroding the U.S. tax base and assert that “[t]he practice of
reimbursing directors of inverting corporations for inversion-related taxes
imposed on directors and senior officers has been widely criticized.” Id. at
¶¶118, 122.
At paragraph 20 of the amended complaint, the plaintiffs first mention
the phrase “‘busted’ merger.” Id. at ¶20. In a footnote, they state that a
“busted” merger “is a merger that fails to satisfy one or more of the
requirements of [26 U.S.C.] § 368 to achieve a tax-free reorganization.” Id. at
n.5. Later in the amended complaint, the plaintiffs assert that “[w]hile the
usual corporate acquisition or merger is arranged to be tax-free under IRC
[Internal Revenue Code] § 368 to its shareholders for obvious reasons, here the
JCI Defendants intentionally avoided § 368 by ‘busting the merger,’ so that the
Merger would fall outside of the tax-free treatment of § 368 and would be
taxable to tax-paying shareholders without regard to § 367(a)’s taxing of
inversions.” Id. at ¶131. They assert that “[a] publicly held corporation will
construct a ‘busted merger’—i.e., to deliberately deny their shareholders taxfree treatment of a merger—to enable losses to be recognized or to increase
basis, which invariably requires the payment of capital gains taxes.” Id. at
14
¶134.6
In asserting that the defendants deliberately chose an “inversion” and a
“busted merger” for the tax advantages they allegedly provide, the plaintiffs
reference several tax statutes: 26 U.S.C. §§7874, 4985, 367, 368 and 1001.
The plaintiffs characterize the first two statutes—§§7874 and 4985—as “antiinversion regulations.” Id. at ¶12. Section 7874 is titled “Rules relating to
expatriated entities and their foreign parents,” and it subjects a “foreign”
corporation to certain tax treatment if that entity acquired all or substantially
all the properties of a domestic corporation and, after the acquisition, at least
60% of the stock of the entity was held by former shareholders of the domestic
corporation. 26 U.S.C. §7874. Section 4985 is titled “Stock compensation of
insiders in expatriated corporations,” and imposes a tax on those who meet the
definition of “insiders” in the event a gain is realized from an “inversion.” The
definition of “expatriated corporation” is the same definition provided in §7874,
which includes the requirement that at least 60% of the stock in the “foreign”
corporation be held by former shareholders of the acquired domestic
corporation. 26 U.S.C. §4985(e)(2).
The plaintiffs assert that 26 U.S.C. §368 “provides that, if the
reorganization satisfies the requirements of § 368, the transaction is tax-free to
The court could not find in the amended complaint a citation to any authority
or source for the plaintiffs’ definition of the phrase “busted merger.” A quick
Google search of that phrase brings up articles about mergers that fell apart
after protracted negotiation and due diligence, which is not the way the
plaintiffs use the phrase.
6
15
the corporation’s shareholders.” Dkt. No. 53 at ¶148.7 They assert that 26
U.S.C. §367(a) “provides an exception from such tax-free treatment for
inverting corporations,” id.8, and contend that it, too, is intended to “discourage
inversions,” id. at ¶10. Finally, the plaintiffs cite 26 U.S.C. §1001, which is the
provision of the tax code that governs the computation of the amount of gain or
loss and the recognition of gains or losses.
On top of this collection of tax statutes, the plaintiffs state that there are
two relevant rules created by IRS regulations. The first rule “requires
shareholders of inverting U.S. corporations to recognize capital gain and pay
taxes if applicable, in part to offset some of those corporations’ future lost U.S.
income taxes.” Id. at ¶149 (citing §367(a) and 26 C.F.R. §1.367(a)-3). The
second is a “separate rule” under §367(b) and Treas. Reg. §1.367(b)-10, which
the plaintiffs allege requires the inverting corporation to pay taxes “to the
extent that corporation uses the inversion as an opportunity to distribute
earnings as part of the transaction.” Id. at ¶149 and n.45. The plaintiffs allege
that when both rules apply, a “special tiebreaker rule imposes only the rule
resulting in the greater amount of income subject to tax.” Id. at ¶149. As the
The title of §368 is “Definitions relating to corporate reorganizations;” it
applies to mergers generally, not just mergers that result in a change in the
domicile of the corporate entity.
7
“If, in connection with any exchange described in section 332, 351, 354, 356,
or 361, a United States person transfers property to a foreign corporation, such
foreign corporation shall not, for purposes of determining the extent to which
gain shall be recognized on such transfer, be considered to be a corporation.”
26 U.S.C. §367(a)(1), “Transfers of Property from the United States; General
Rule.”
8
16
plaintiffs explain it, “in the circumstance when both rules apply, the larger of
the inverting corporation’s income subject to tax under § 367(b) or the
shareholders’ built-in gain under § 367(a) takes priority in determining whether
the corporation or the shareholders are to be taxed on the inversion.” Id.
The plaintiffs allege that the defendants paid “careful attention to the
intricacies of the . . . anti-inversion regulations,” id. at ¶12, and used that
knowledge to structure the merger to “skirt [JCplc’s] obligation to pay its fair
share of taxes to the United States” and instead seek “tax shelter in Ireland as
an Irish corporation,” id. at ¶15, thus shifting “a significant portion of its
liability for future U.S. taxes on its historic and future earnings to its taxpaying
shareholders, by forcing them to pay capital gains and potentially ordinary
income taxes, and at the direct expense of all JCI public shareholders, by
improperly diluting their equity interest in JCplc,” id. at ¶11. They assert that
[t]he inversion-imposed tax consequences cause a significant
divergence of interests between the inverting corporation and the
inverting corporation’s non-taxable shareholders, on the one hand,
and the inverting corporation’s taxable shareholders, on the other.
The inverting corporation’s non-taxable shareholders include
pension funds, non-profit organizations, institutional investors, and
those individual shareholders who hold their JCI shares in IRAs,
401(k), 403(b), or other tax-deferred accounts, for whom taxable
gain realized by shareholders under the 367(a) rules is not subject
to tax and thus not a relevant consideration.
Id. at ¶152.
Understanding the tax statutes and regulations is necessary to
understand the plaintiffs’ allegations of a “busted merger” and the dilution of
their equity in the new company. The plaintiffs allege that the defendants failed
to disclose the fact that the defendants deliberately “busted” the merger (by the
17
plaintiffs’ definition, structured the merger so that it would fail the
requirements of §368) to prevent the company from having to pay taxes under
§367(b). Id. at ¶133. They assert that given the interplay between the two antiinversion regulations—the fact that, as they put it, “the larger of the inverting
corporation’s income subject to tax under § 367(b) or the shareholders’ built-in
gain under § 367(a) takes priority in determining whether the corporation or
the shareholders are to be taxed on the inversion,” id. at ¶149—there was no
way that the merging entities could have stated unequivocally in the January
25, 2016 merger announcement that the merger would be taxable to JCI
shareholders unless they had deliberately taken some action to ensure that
§367(b) would not apply, and the plaintiffs allege that that “action” was the
intentional “busting” of the merger. Id. at ¶¶148-174.
As best the court can tell, the amended complaint does not specify what
actions the plaintiffs believe the defendants took to ensure that the merger
would not meet the requirements of §368, but the amended complaint
references two declarations from the preliminary injunction briefing. See id. at
¶133 (citing Dkt. No. 37 at ¶¶6–7; Dkt. No. 38 at ¶¶10–11). One is a declaration
from Steven Janowksi, vice president of corporate global taxation at JCI. Dkt.
No. 37. The other is a declaration from an attorney named H. David
Rosenbloom of the law firm of Caplin & Drysdale, Chartered and a visiting
professor of tax at NYU Law School. Dkt. No. 38. The declarations list several
reasons the affiants believe the merger didn’t meet the requirements of §368:
•
Janowski and Rosenbloom stated that Merger Sub was a limited
18
liability company, not a corporation. Dkt. No. 37 at ¶6; Dkt. No. 38
at ¶10.
•
Rosenbloom and Janowski stated that JCI shareholders received a
combination of consideration rather than just stock or just cash.
Id.
•
Rosenbloom stated, citing Revenue Ruling 74-564, that “the other
consideration” JCI shareholders received other than cash “was
stock of a corporation (Tyco) that was both a direct and indirect
owner of the merged limited liability company.” Dkt. No. 38 at ¶10.
•
Rosenbloom stated that after the merger JCI didn’t “hold
substantially all of the properties held by JCI and the merged
limited liability company prior to the Merger.” Id.
•
Janowski stated that even if Merger Sub had been a corporation,
“the Merger still would not have qualified as a reorganization due
to the introduction of additional leverage at JCI and the recent
spin-off of JCI’s automotive business.” Dkt. No. 27 at ¶6.
The plaintiffs imply that these declarations show that the defendants
engineered the above circumstances deliberately to ensure that the merger
would not meet the requirements of §368, stating that “[t]he ‘busted merger’
was first disclosed by Defendants in their response to Plaintiffs’ motion for a
preliminary injunction that JCI deliberately employed the ‘busted’ merger,
which rendered IRC ¶ 368 inapplicable to the Inversion.” Dkt. No. 53 at ¶133.
The plaintiffs allege that the S-4 “failed to disclose both the use of a ‘busted’
19
merger and an earnings-stripping scheme.” Id.9 The plaintiffs also allege that
the defendants waited until after the merger to reveal that JCI would treat the
shareholders’ consideration for the merger as a dividend under tax law. Id. at
¶¶129–136.
The plaintiffs allege that the defendants contractually bound themselves
“to prevent JCI public shareholders from getting 60% or more of JCplc’s
equity.” Id. at ¶105. They allege that the defendants took steps to reduce JCI
shareholder equity in JCIplc to less than 60% to avoid the merger being subject
to taxes under 26 U.S.C. §7874 and to avoid the insiders being subject to the
excise tax imposed by 26 U.S.C. §4985. Id. at ¶¶107, 111. The plaintiffs assert
that as a result, “JCI public shareholders were short-changed by $5.46 billion
to enable the Individual Defendants to dodge $4 million in excise taxes and
JCI/JCplc to protect $450 million in tax savings.” Id. at ¶111.
The plaintiffs identify two strategies that they contend the defendants
used to ensure that the transaction did not trigger the 60% threshold:
First, they allege that the defendants “determined that 17% of JCI’s
shares would need to be redeemed in order to reduce the amount of JCplc
equity to be allocated to JCI shareholders to significantly less than 60% to
shield JCI/JCpls’s senior officers and directors and JCI/JCIplc from the antiinversion tax consequences otherwise applicable to inverting corporations and
The information the defendants provided in these declarations and other
documents they filed in opposition to the plaintiffs’ motion for injunctive relief
appears to be what prompted the plaintiffs to amend the complaint—the
plaintiffs wanted to add the allegations of deliberate “merger busting.”
9
20
their senior officers and directors under IRC §§ 4985 and 7874.” Id. at ¶196.
So, they allege, the defendants “forced” JCI stockholders to sell approximately
17% of their shares at $34.88 per share. Id. at ¶72. The plaintiffs assert:
JCI stockholders were given the option to receive either one share of
JCplc for each of their JCI shares or cash equal to $34.88 per share.
Elections by JCI shareholders to receive cash were subject to
proration such that an aggregate of no more than $3.86 billion in
cash would be paid in the merger; elections by JCI shareholders to
receive only JCplc share were subject to enough JCI shareholders
electing to receive the $3.86 billion in cash. Because holders of only
1.1% of JCI shares elected to receive cash for their shares, all JCI
shareholders were forced to sell approximately 17% of their JCI
shares to JCplc for cash at $34.88 per share and receive JCplc
ordinary shares for the remaining approximately 83% of their JCI
shares. Stated differently, for each JCI share, a JCI shareholder
received $6.085 and 0.8255 JCplc share, which valued each JCI
share at $34.88.
Id. at ¶72.
The plaintiffs claim that $34.88 per share “was below or at the bottom of
the ranges of fair values of JCI shares determined by JCI’s and Tyco’s advisors,
amounting to a 25% discount to the average of the medians of the ranges of per
share values for JCI shares by said advisers ($46.24),10 notwithstanding that
JCI was the acquired company according to the transaction’s legal structure
In their response to the plaintiffs’ a supplemental brief, the defendants
challenge the plaintiffs’ repeated assertion that the calculations of the financial
advisors show that JCI shareholders should have received a per-share price of
$46.24. Dkt. No. 72 at 3. They point out that the plaintiffs took the information
disclosed in the proxy statement about the financial advisors’ calculations,
then “selected the ‘average of the median values’ of the [advisors’] valuation
ranges without explanation (why not the median of the medians? why not the
75th percentile?) and unilaterally declared that this is the price JCI
stockholders should have received.” Id. (emphasis in the original). See Dkt. No.
53 at ¶199 for the plaintiffs’ summary of the S-4’s disclosures about how
Barclays, Centerview and Lazard Freres calculated ranges of values for a share
of JCI common stock.
10
21
and tax treatment.” Id. at ¶73 (emphasis in the original).
They assert that in contrast, “[p]rior to the merger, Tyco effected a
reverse stock split pursuant to which Tyco shareholders received a fixed
exchange ratio of 0.9550 of a JCplc share for each of their existing Tyco shares,
resulting in Tyco shareholders receiving shares valued at $34.88 per share for
their Tyco shares.” Id. at ¶71.
The plaintiffs appear to argue that the defendants engineered a discount
in the price of JCI shares so that the merger would avoid triggering the 60%
post-acquisition threshold and the ensuing anti-inversion tax consequences.
Second, the plaintiffs claim that the defendants deliberately delayed what
was supposed to have been a tax-free spin-off of the new company, Adient.
When JCI announced in the summer of 2015 that it planned to separate its
automotive business into a new business, JCI said that this “spin-off” would be
tax-free. Id. at ¶176. The plaintiffs assert, however, that in April 2016 when the
defendants first filed the S-4, the S-4 revealed that JCI would complete the
spin-off after consummation of the merger. Id. at ¶177. The S-4 revealed that
former JCI shareholders would own only approximately 56% of Adient shares
after the spin-off. Id. at ¶178. The plaintiffs allege that
[g]iven that Adient represented over half of JCI’s market
capitalization, spinning off Adient before the Merger closed likely
would have reduced JCI shareholders’ share of JCplc’s equity to
under 50%, in which case the Merger would not have been subject
to §§ 367, 4985, or 7874, and there would have been no need for the
dilution or the “busted” merger. In that event, JCI would not have
been able to tout the Merger as an acquisition of Tyco by JCI, the
Individual JCI/JCplc Defendants would not have been able to
become a majority of the JCI/JCplc board and Molinaroli might not
have been able to become chief executive officer.
22
Id. at ¶179. Relevant to the defendants’ alleged desire to avoid triggering the
60% post-acquisition threshold, the plaintiffs assert that “[a]n Adient spin-off
prior to the Merger risked being subject to the IRS’s ‘skinnying-down’ antiinversion rules, pursuant to which the IRS might disregard the spin-off in
calculating whether JCI shareholders’ equity interest in JCplc was under 60%.”
Id. at ¶181 n.57 (citing the S-4 at 55-56).
Reiterating that in October 2016, after the merger closed, the new
company revealed that the Adient spin-off would be treated as a dividend, id. at
¶192, the plaintiffs also assert that because the defendants delayed the Adient
spin-off until after the merger, the plaintiffs who held their JCI shares in
taxable accounts were taxed twice—once when the value of Adient was
included in “their taxable capital gain triggered by the exchange of their JCI
shares for Tyco/JCplc shares,” and again when “the value of Adient, already
having been taxed as a capital gain, was again taxable as a dividend at
ordinary income tax rates,” id. at ¶193. They assert that the S-4 did not reveal
that this would happen. Id. at ¶¶194-195.
Finally, the plaintiffs argue that the S-4 (and thus, the defendants)
misled them into believing that the merger was for and in their best interests.
Id. at ¶223. The plaintiffs allege that much of the millions of dollars in fees paid
to JCI’s financial advisors—Centerview and Barclays—was contingent on the
completion of the merger. Id. at ¶213. Both advisors concluded the merger was
fair to shareholders. Id. at ¶¶214, 219. Centerview qualified, however, that it
was not opining on the fairness of the “forced buyback” of shares or the
23
exchange ratio. Id. at ¶217. Barclays specified that it was not opining as to the
tax consequences of the transaction, the value of the shares to JCI
stockholders, the fairness of compensation to the officers or the fairness of
cash and stock consideration. Id. at ¶221. The plaintiffs assert that in opining
that the merger was “fair” to the shareholders, neither Centerview nor Barclays
considered “the substantial adverse tax consequences to the Minority
Taxpaying JCI Shareholders” or the “Inversion-Driven Costs to all JCI public
shareholders.” Id. at ¶225.
The plaintiffs allege that the defendants had five options for structuring
the merger, given the requirements of the tax code:
(a)
No inversion (i.e., no reincorporation in Ireland), thereby
avoiding exposure to IRC §§ 4985 and 7874 and the need (i) to limit
JCI shareholders’ equity interest in JCplc to under 60% to evade
§§ 4985 and 7874, (ii) to “bust” a tax-free merger to protect earningsstripping and other tax avoidance schemes, (iii) to delay the Adient
spin-off, and (iv) to force the Minority Taxpaying JCI Shareholders
to pay capital gains, ordinary income, and other taxes;
(b)
Structure the Merger (reincorporation in Ireland) in a manner
whereby JCI/JCplc would avoid U.S. income taxes on its future
foreign earnings but would pay U.S. withholding taxes on its existing
earnings and profits (up to the value of JCI), thereby sparing JCI
shareholders from being forced to pay the Inversion/Mergerimposed taxes, and pay all JCI shareholders a fair value for their
shares in the Merger;
(c)
Structure the Merger (also reincorporating in Ireland) in a
manner whereby JCI/JCplc would avoid U.S. income taxes on its
future foreign earnings but force its shareholders to pay capital
gains taxes instead of paying the inversion-imposed taxes itself;
(d)
Structure the acquisition as a “busted” merger, thereby
finessing the choice between the second and third options, to enable
JCI to avoid U.S. taxes on both its historic domestic and
unrepatriated foreign earnings (through the earnings-stripping and
other tax avoidance schemes) and future foreign earnings (through
24
the reincorporation) and also protect the Individual Defendants from
the excise tax but subject it shareholders to the Inversion-Driven
Costs, including the inversion-imposed taxes because of the
reincorporation (third choice); and/or
(e)
Allow the Adient spin-off to proceed as tax-free, and thus allow
the Merger (including the reincorporation and the accompanying tax
savings) to be tax-free to JCI shareholders, or to delay it to protect
Defendants’ tax avoidance scheme and thereby convert the spin-off
into a doubly taxable event and preclude the Merger from tax-free
treatment.
Id. at ¶271. The plaintiffs assert that the defendants chose “[t]he third, fourth,
and fifth options,” with the result that they obtained the “maximum tax
benefits that they were seeking but imposed the maximum Inversion-Driven
Costs on JCI public shareholders and the Minority Taxpaying JCI
Shareholders.” Id. at ¶274.
And the plaintiffs contend, over seventy-four pages and seventy
paragraphs containing multi-part block quotes from the S-4, that the
defendants did not disclose that these options existed, which of these options
had been considered and what the likely impact of the defendants’ choices—the
ones that were not made and the ones that were—would be on shareholders
who held their JCI shares in taxable accounts, either by omitting information
or providing false and misleading information. Id. at ¶¶183-253.
E.
The Allegations of Concealment
The section of the amended complaint that alleges that the defendants
concealed material facts from the plaintiffs is Section IV. It consists of fiftyeight paragraphs of factual allegations, many of which appear in other sections
of the amended complaint. The plaintiffs summarize the factual allegations in
25
the opening paragraph of the section:
Defendants’ “Inversion/Merger Tax avoidance Scheme” consisted of
five elements:
(a)
JCI’s reincorporation in Ireland pursuant to which JCI will
achieve a lower tax rate and avoid US. taxes on future foreign
earnings;
(b)
The “busted” merger by which JCI/JCplc will protect its
earnings-stripping and other tax avoidance schemes to avoid U.S.
taxes on existing “trapped” foreign earnings and reduce U.S. taxes
on domestic earnings;
(c)
Delaying the Adient spin-off, by which what would have been
a tax-free spin-off of JCI’s automotive business became, first, part
of the §§ 367(a)/1001 taxable capital gain and, second, a dividend
taxable as ordinary income to ensure JCI shareholders received less
than 60% of JCplc’s equity;
(d)
The dilution of JCI public shareholders’ equity interest in
JCplc to protect Defendants from the adverse tax consequence
applicable to inverting corporations and their officers and directors
pursuant to §§ 4985 and 7874, which included pricing JCI’s shares
below or at the bottom of the ranges of fair values of JCI shares
determined by JCI’s and Tyco’s advisers for purposes of allocating
JCplc’s equity between JCI and Tyco shareholders; and
(e)
The forced buyback11 of 17% of JCI shares from its
shareholders at a price of $34.88 per share, which was below or at
the bottom of the ranges of fair values calculated by JCI’s and Tyco’s
financial advisers, to reduce JCI shareholders’ share of JCplc equity
to under 60%.
Id. at ¶124. They claim that these tactics were employed to achieve three tax
As the defendants point out in the brief in support of their motion to dismiss,
it is not clear why the plaintiffs refer to surrender of their JCI shares as a
“buyback.” Dkt. No. 56 at 27 n.8. The defendants recount that “JCI
shareholders were able to choose between receiving cash (at a rate of $34.88
per share), shares, or a mix of both as consideration in the merger. Those
shareholders who opted for shares and faced proration were not selling their
shares of JCI back to JCI; shares of JCI no longer exist. . . . The value of their
new shares of JCplc going forward will be set by the market, not the merger.”
Id. (citing Dkt. No. 56-1 at 31; Dkt. No. 53 at ¶46).
11
26
advantages: avoiding taxes on future foreign earnings, shifting “current U.S.derived earnings to Ireland to be taxed under Ireland’s lower tax rates,” and
shifting JCI’s “existing trapped foreign earnings to Ireland to be taxes under
Ireland’s lower tax rates.” Id. at ¶125.
Subsection IV(D) lists six categories of allegedly material facts that the
plaintiffs assert the defendants concealed: facts regarding “JCI shareholders’
liability for taxes and JCI/JCplc’s avoidance of taxes” (Section IV(D)(1), id. at
¶¶183-187); facts regarding “the ‘busted’ merger” (Section IV(D)(2), id. at
¶¶188-190); facts about “the doubly taxable Adient spin-off” (Section IV(D)(3),
id. at ¶¶191-195); facts about “the forced buy-back of 17% of JCI shares to
avoid §§ 4985 and 7874” (Section IV(D)(4), id. at ¶¶196-203); facts about “the
Individual Defendants’ lack of exposure to the Inversion/Merger-related taxes
and the cost to JCI public shareholders of shielding the Defendants from
§§ 4985 and 7874” (Section IV(D)(5), id. at ¶¶204-208); and facts about “the
projected $450 million in tax savings from the Inversion” (Section IV(D)(6), id.
at ¶¶209-210). Each of these sections first states factual allegations about the
merger, then quotes large chunks of the S-4, then concludes by listing facts
that the plaintiffs argue should have been disclosed in the quoted sections of
the S-4 about the particular factual allegations.
II.
The Procedural History
The plaintiffs filed their complaint on August 16, 2016. Dkt. No. 1. At
that time, the merger was pending. Forty-five days later, the plaintiffs filed a
motion for injunctive relief, dkt. no. 14, asking the court to enjoin the “JCI
27
Defendants” “from continuing to act in a manner that will force the Minority
Subclass to pay taxes and from falsely reporting to the IRS that JCI
shareholders owe capital gains taxes in connection with the Inversion,” dkt. no.
15 at 32. After the motion had been fully briefed, the plaintiffs asked for an
extension of the deadline by which to amend the complaint. Dkt. No. 44. The
court granted that request. Dkt. No. 50.
On January 4, 2017, the court held a hearing on the motion for
preliminary injunction. Dkt. No. 51. Three weeks later, it denied the motion.
Dkt. No. 52. On February 15, 2017, the plaintiffs filed the amended complaint.
Dkt. No. 53. The defendants filed their motion to dismiss on April 3, 2017. Dkt.
No. 55. As the court has conceded, it did not hold a hearing on the motion until
October 17, 2019. Dkt. Nos. 67-69. Four days later, the plaintiffs asked for
leave to file a supplemental brief. Dkt. No. 71. The defendants responded that
while the plaintiffs had provided no basis for filing a supplemental brief, they
did not object to the court considering it as long as the court also considered
their response. Dkt. No. 72.
On June 4, 2021—some twenty months after oral argument on the
motion to dismiss—the plaintiffs asked the court to allow them to conduct
discovery to obtain documents produced by the defendants in a 2016 statecourt putative class action in which the plaintiffs had alleged that JCI and its
directors had breached their fiduciary duties in relation to the merger. Dkt. No.
76. The defendants opposed this motion, arguing that the plaintiffs had not
alleged any undue prejudice and that they had not identified any particularized
28
discovery they would seek if the court were to grant the motion. Dkt. No. 78.
Finally, in early August of this year, the plaintiffs asked the court to
modify the stay to allow them to serve subpoenas on non-parties. Dkt. No. 81.
The defendants also objected to this motion. Dkt. No. 84.
III.
The Claims
The amended complaint raises twelve claims. The first two are based on
federal statutes. Count I asserts that in making the allegedly false and
misleading statements in the S-4, the JCI defendants violated §14(a) of the
Securities and Exchange Act of 1934 (15 U.S.C. §§78n(a)), SEC Rule 14a-9 (17
C.F.R. §240.14a-9) and SEC Rule 14a-101 (17 C.F.R. §240.14a-101). Dkt. No.
53 at ¶302-307. It also asserts that the individual defendants violated §20 of
the Act as “controlling persons.” Id. at ¶308-310.
In Count II, the plaintiffs allege that the corporate defendants either filed,
or were going to file, false Forms 1099 in violation of the Taxpayer Bill of Rights
II (26 U.S.C. §7434). Id. at ¶¶312-317.
The last ten claims are state-law claims. In Count III, the plaintiffs allege
that the individual defendants violated state law fiduciary duties of due care,
disclosure, good faith, loyalty, and fair dealing by structuring the merger to
benefit the corporation and harm the plaintiffs. Id. at ¶¶318-337. Count IV
alleges that the corporate defendants aided and abetted the individual
defendants in violating these duties. Id. at ¶¶338-347. Count V alleges that all
the defendants were unjustly enriched by the merger structure and demands
restitution. Id. at ¶¶348-353. Count VI alleges that the individual defendants
29
aided and abetted the unjust enrichment of JCI and JCplc. Id. at ¶¶354-360.
Count VII claims that the corporate defendants wrongfully converted the
plaintiffs’ JCI stock through the merger, and that the individual defendants
aided and abetted that conversion. Id. at ¶¶361-366. Count VIII asserts that
the JCI defendants violated Wis. Stat. §180.0601 by treating shareholders with
shares in taxable accounts differently from shareholders with shares in nontaxable accounts. Id. at ¶¶367-373. Count IX alleges that all the defendants
conspired to “(1) shift a substantial portion of JCI’s and JCplc’s liability for U.S.
income taxes to the Minority Taxpaying JCI Shareholders and (2) impose on
JCI shareholders the Inversion-Driven Costs to enable Defendants to avoid the
anti-inversion tax consequences imposed by the Code on inverting corporations
and their officers and directors.” Id. at ¶376. Count X alleges that the JCI
defendants tortiously interfered with JCI’s duties under its articles of
incorporation, a valid contract under Wisconsin law. Id. at ¶¶380-387. Count
XI alleges that JCI breached its contractual duties under its articles of
incorporation by structuring the merger to impose tax burdens on the plaintiffs
and to reduce the plaintiffs’ equity in the new company. Id. at ¶¶388-393.
Finally, Count XII alleges that JCI breached the covenants of good faith and
fair dealing. Id. at ¶¶394-402.
IV.
Jurisdiction
The amended complaint does not identify the statutory basis for the
court’s jurisdiction. The court assumes that the plaintiffs intended to assert
that the court has 28 U.S.C. §1331 federal question subject matter jurisdiction
30
over the claims in Count I (violations of federal securities laws) and Count II
(violation of the federal Taxpayer Bill of Rights II), because the plaintiffs
describe those two claims in the jurisdictional statement. Dkt. No. 53 at ¶25.
They also mention “the Court’s pendent jurisdiction;” by this, the court
assumes they mean that because the court has federal question jurisdiction to
hear the first two claims, it may exercise its supplemental jurisdiction under 28
U.S.C. §1367 over the ten state-law claims. Id.
V.
Legal Standard
To survive a motion to dismiss brought under Rule 12(b)(6), “a complaint
must contain sufficient factual matter, accepted as true, to ‘state a claim to
relief that is plausible on its face.’” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)
(quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). Rule 12(b)(6)
“tests the sufficiency of the complaint, not the merits of the case.” McReynolds
v. Merrill Lynch & Co., 694 F.3d 873, 878 (7th Cir. 2012). The allegations in
the complaint must set forth a “short and plain statement of the claim showing
that the pleader is entitled to relief.” Fed. R. Civ. P. 8(a)(2). Plaintiffs need not
provide detailed factual allegations, but they must provide enough factual
support to raise their right to relief above a speculative level. Twombly, 550
U.S. at 555. A claim must be facially plausible, meaning that the pleadings
must “allow . . . the court to draw the reasonable inference that the defendant
is liable for the misconduct alleged.” Iqbal, 556 U.S. at 678 The claim must be
described “in sufficient detail to give the defendant ‘fair notice of what the . . .
claim is and the grounds upon which it rests.’” E.E.O.C. v. Concentra Health
31
Servs., Inc., 496 F.3d 773, 776 (7th Cir. 2007) (quoting Twombly, 550 U.S. at
555).
In ruling on a 12(b)(6) motion to dismiss, the court generally considers
only those facts alleged within the four corners of the complaint. See Fed. R.
Civ. P. 12(d) (“If, on a motion under Rule 12(b)(6) . . . matters outside the
pleadings are presented to and not excluded by the court, the motion must be
treated as one for summary judgment under Rule 56.”) But “[d]ocuments
attached to a motion to dismiss are considered part of the pleadings if they are
referred to in the plaintiff’s complaint and are central to his claim.” Adams v.
City of Indianapolis, 742 F.3d 720, 729 (7th Cir. 2014) (quoting Menominee
Indian Tribe of Wis. v. Thompson, 161 F.3d 449, 456 (7th Cir. 1998)). The
defendants presented the court with documents outside the pleadings, both as
attachments to the motion to dismiss, dkt. nos. 56-1 through 56-5, and as an
exhibit to a declaration of defense counsel, dkt. no. 57-3. The amended
complaint references some of those documents, but not all of them; the court
has considered only those documents referenced in, and central to the claims
in, the amended complaint, such as the combined registration/proxy statement
(dkt. no. 56-1; the plaintiffs also provided it at dkt. no. 59-1) and the Form 8-K
(dkt. no. 56-2). The amended complaint also referenced documents the
defendants filed in opposition to the motion for injunctive relief, Dkt. Nos. 37
and 38. Because the Seventh Circuit has held that on a motion to dismiss, a
court may consider attached “documents that are central to the complaint and
are referred to in it,” Williamson v. Curran, 714 F.3d 433, 436 (7th Cir. 2013)
32
(citing Geinosky v. City of Chi., 675 F.3d 743, 745 n.1 (7th Cir. 2012)), the
court has considered those documents.
The Private Securities Litigation Reform Act (PSLRA), 15 U.S.C. §78u-4,
“is applicable to suits under section 14a [of the Securities and Exchange Act].
Beck v. Dobrowski, 559 F.3d 680, 681-82 (7th Cir. 2009). The PSLRA states
that complaints alleging omissions or untrue statements of material fact “shall
specify each statement alleged to have been misleading, the reason or reasons
why the statement is misleading, and, if an allegation regarding the statement
or omission is made on information and belief, the complaint shall state with
particularity all facts on which that belief is formed.” 15 U.S.C. §78u–4(b)(1). If
a plaintiff fails to meet this standard, “the court shall . . . dismiss the
complaint.” 15 U.S.C. §78u-4(b)(3).
VI.
The Parties’ Arguments
A.
Ddefendants’ opening motion
The defendants first argue that Count I of the amended complaint does
not meet the heightened pleading standard that the PSLRA imposes on §14(a)
claims. Dkt. No. 56 at 20. Second, they argue that to state a claim under
§14(a), the plaintiff must plead that any misrepresentation or omission was
“material;” they contend that the plaintiffs have failed to demonstrate that any
of the alleged misrepresentations or omissions were material. Id. at 24. Third,
they argue that the PSLRA and the case law require the plaintiff to plead loss
causation—that the alleged misrepresentations or omissions caused the losses
for which the plaintiffs seek to recover damages. Id. at 31. The defendants
33
argue that the plaintiffs have alleged no harm caused by the combined S-4
registration statement/proxy statement and have not tied any injury to the
alleged misrepresentations or omissions. Id. Fourth, they argue that the
complaint does not plead a §14(a) claim against the non-director officers of JCI
or the directors who did not sign the proxy statement. Id. at 33. Finally, they
assert that the amended complaint does not state a “plausible control-person
claim” under §20(a). Id. at 34.
The defendants argue that the court also must dismiss Count II, the
claim that the corporate defendants (the term the plaintiffs use to refer to JCI,
Tyco/JCplc and Merger Sub, dkt. no. 53 at ¶49) violated the Taxpayer Bill of
Rights II (26 U.S.C. §7434). Id. at 35. They assert that the corporate defendants
complied with the tax code and, in any event, that the plaintiffs have not
alleged that there was any fraudulent intent, concealment or deception in the
information on the Forms 1099 the corporate defendants filed. Id.
The defendants assert that the court must dismiss any claims relating to
breach of fiduciary duty because the Wisconsin business judgment rule
supports the judgment of corporate boards, officers and directors and because
“with a shareholder base as broad and diverse as JCI’s, it is simply not possible
to please each shareholder with every decision, and the law does not require
that boards do so.” Id. at 37-38.
Finally, the defendants assert that the remaining state law claims are
“just aliases” for the breach of fiduciary duty claims and must fail for the same
reasons. Id. at 45.
34
B.
Plaintiffs’ opposition
The plaintiffs respond that the amended complaint meets the heightened
pleading standard under the PSLRA, because with respect to each alleged false
and misleading statement in the S-4, they have given reasons why the
statement is misleading. Dkt. No. 58 at 20. They assert that because the
sufficiency of a pleading under the PSLRA’s heightened pleading standard is
determined on a case-by-case basis, “rulings in other cases on the adequacy of
a complaint’s allegations [are] of limited utility.” Id. They next assert that the
omitted facts are material, emphasizing the failure to disclose that JCI
stockholders allegedly were short-changed $5.46 billion to achieve a tax
savings of only $450 million and the allegation that the defendants and their
financial advisors did not consider the impact of the inversion structure on
stockholders like them. Id. at 25. They assert that they have adequately alleged
loss causation by alleging the $5.46 billion cost of the $450 million tax savings
and the fact that they are being forced to pay hundreds of millions in taxes. Id.
at 28. They assert that they have alleged “control person” liability under
Section 20, noting that this is a factual question often not susceptible to
determination at the pleadings stage. Id. at 29.
The plaintiffs also assert that they have stated a claim under the
Taxpayer Bill of Rights II, arguing that the 1099s issued by JCplc to the JCI
shareholders were “the product of a scheme that was conceived by the
Individual Defendants in breach of their fiduciary duties and approved by
uninformed JCI shareholders on the basis of a misleading proxy statement that
35
violated Rule 14a-9.” Id. at 45. The plaintiffs assert that the actions that led to
the issuance of the 1099s constituted intentional violations of legal duties; had
those violations not happened, the plaintiffs would not have had to pay taxes
and 1099s would not have been needed. Id. at 45-46.
The plaintiffs assert—reiterating many of the claims from the amended
complaint—that the amended complaint states a claim for various breaches of
fiduciary duty. Id. at 32. They emphasize a board’s duty to maximize
shareholder value, id., and while they concede that there were shareholder
groups with varying interests, they argue that the defendants chose to
maximize their own interests over those of any shareholder group, id. at 33-37.
They argue that the Wisconsin business judgment rule applies only when
corporate directors make “informed good faith decisions.” Id. at 37. They assert
that the defendants did not do that in structuring the merger and in failing to
disclose information about that structure. Id. They assert that their other statelaw claims are sufficiently pled. Id. at 46.
C.
Defendants’ reply
In their reply brief, the defendants argue that the amended complaint
violates Fed. R. Civ. P. 8. Dkt. No. 60 at 7.
They argue that despite the length of their opposition brief, the plaintiffs
still have not identified what statements were misleading as the result of what
omissions or why. Id. at 8-9. They assert that the plaintiffs have clearly
conceded that the defendants disclosed that the merger would be taxable and
that JCI shareholders would ultimately own 56% of the new company, and
36
characterize this as “fatal to plaintiffs’ Section 14 claim.” Id. at 11. They
reiterate that the plaintiffs seek to assert a Section 20 claim against individual
defendants who did not allow their names to be used to solicit proxies or
participate in any drafting. Id. at 17.
The defendants again emphasize that the plaintiffs have not identified
how the 1099s were inaccurate and repeat that the court must dismiss the
Taxpayer Bill of Rights claim. Id. at 18.
They argue that the plaintiffs’ fiduciary duty claims cannot survive the
application of the Wisconsin business judgment rule. Id. at 18-19. They also
urge the court to dismiss the claim as to the individual officer defendants
because the amended complaint does not specify what each did wrong. Id. at
23. They conclude by briefly touching, again, on the remaining state-law
claims. Id. at 24-27.
D.
Plaintiffs’ motion for leave to file a supplemental brief
After the October 2019 hearing on the motion to dismiss, the plaintiffs
asked the court to allow them to file a supplemental brief. Dkt. No. 71. They
sought to respond to two issues raised at that hearing. Id. The proposed
supplemental brief is only five pages. Dkt. No. 71-1. In it, the plaintiffs first
sought to respond to a case the defendants had cited at oral argument, Trahan
v. Interactive Intelligence Grp., Inc., 308 F. Supp. 3d 977 (S.D. Ind. 2018). Dkt.
No. 71-1 at 1. The plaintiffs argue that Trahan is distinguishable from the facts
in this case for several reasons. Id. at 1-4. Second, the plaintiffs recount that at
oral argument, “the Court mentioned TSC Industries, Inc. v. Northway, Inc., 426
37
U.S. 438 (1976) and asked whether the Amended Complaint contained any
allegations that the shareholder vote would have been different had the alleged
omissions been disclosed.” Id. at 4. The plaintiffs point out that they need not
prove that the allegedly omitted information would have caused any
shareholder to change his or her vote. Id. at 4-5.
The defendants responded to the motion. Dkt. No. 72. They asserted that
the plaintiffs’ attempt to distinguish Trahan does the opposite—it supports the
defendants’ assertion that the court should dismiss the amended complaint. Id.
at 1-4. As for the question the court asked at the hearing, the defendants
responded that “it is black letter law that plaintiffs must plead facts that
demonstrate that an omitted fact would have been significant to a reasonable
investor in deciding how to vote.” Id. at 4.
VII.
Analysis
A.
Count I—Violations of §§14(a) and 20 of the Securities and
Exchange Act of 1934
A “proxy” is a consent or authorization. 17 C.F.R. §240.14c-1. Section
14(a) of the Securities and Exchange Act of 1934—15 U.S.C. §78n—governs the
solicitation of proxies from shareholders or investors. It states that it is
“unlawful” for anyone to use the mail or interstate commerce to solicit proxies
in violation of SEC rules and regulations. “Rule 14a-9”—17 C.F.R. §240.14a9—states that
[n]o solicitation subject to this regulation shall be made by means of
any proxy statement, form of proxy, notice of meeting or other
communication, written or oral, containing any statement which, at
the time and in the light of the circumstances under which it is
made, is false and misleading with respect to any material fact, or
38
which omits to state any material fact necessary in order to make
the statements therein not false or misleading or necessary to
correct any statement in any earlier communication with respect to
the solicitation of a proxy for the same meeting or subject matter
which has become false or misleading.
17 C.F.R. §240-14a-9(a).
“To state a claim under §14(a), a plaintiff must allege: (i) that the proxy
contained a material misrepresentation or omission that (ii) caused the
plaintiff’s injury, and (iii) that the proxy solicitation was an essential link in
accomplishing the transaction.” Kuebler v. Vectren Corp., 13 F.4th 631, 637
(7th Cir. 2021) (citing Mills v. Elec. Auto-Lite Co., 396 U.S. 375, 384-85 . . .
(1970)). “An omitted fact is material if there is a substantial likelihood that a
reasonable shareholder would consider it important in deciding how to vote.”
TSC Indus., 426 U.S. at 449.
It does not require proof of a substantial likelihood that disclosure
of the omitted fact would have caused the reasonable investor to
change his vote. What the standard does contemplate is a showing
of a substantial likelihood that, under all the circumstances, the
omitted fact would have assumed actual significance in the
deliberations of the reasonable shareholder. Put another way, there
must be a substantial likelihood that the disclosure of the omitted
fact would have been viewed by the reasonable investor as having
significantly altered the “total mix” of information made available.
Id.
Causation in securities law consists of two components: transaction
causation and loss causation. Dura Pharmaceuticals, Inc. v. Broudo,
544 U.S. 336, 341-42 . . . (2005); Grace v. Rosenstock, 228 F.3d 40,
47 (2d Cir. 2000). Transaction causation, often called reliance, is
generally easier to establish than loss causation. See Dura
Pharmaceuticals, 544 U.S. at 345-46 . . . . Where materiality is
alleged and proven, proof of reliance on the particular statement or
omission is not necessary. Mills, 396 U.S. at 384-85 . . . (rejecting
court of appeals’ additional requirement of proof that specific defect
39
in proxy statement actually had a decisive effect on voting). The
proxy solicitation itself serves as the causal link in the transaction—
that the challenged violation(s) caused the plaintiff to engage in the
challenged transaction. Id. at 385 . . .: Virginia Bankshares, Inc. v.
Sandberg, 501 U.S. 1083, 1099-1100 . . . (1991). The loss causation
requirement, codified in the Private Securities Litigation Reform Act
(PSLRA), requires a plaintiff to allege and prove that the challenged
misrepresentations or omissions caused her economic loss. 15
U.S.C. § 78u-4(b)(4); Dura Pharmaceuticals, 544 U.S. at 342 . . .; see
also Law v. Medco Research, Inc., 113 F.3d 781, 786-87 (7th Cir.
1997) (§ 78u-4(b)94) codified judge-made “loss causation” rule).
Kuebler, 13 F.4th at 637-38. Although the Supreme Court has not yet decided
whether both loss causation and transaction causation must be proven under
Section 14(a), the Seventh Circuit has been “persuaded by the Second and
Ninth Circuits” that the Supreme Court’s reasoning that both must be proved
under Section 10(b) of the Securities and Exchange Act “extends to Section
14(a) claims.” Id. at 638 n.1 (citing Grace, 228 F.3d at 47; N.Y. City Emps. Ret.
Sys. v. Jobs, 593 F.3d 1018, 1023 (9th Cir. 2010), overruled in part on other
grounds by Lacey v. Maricopa Cty., 693 F.3d 896 (9th Cir. 2012) (en banc)).
1.
The complaint does not meet the heightened pleading
standard of the PSLRA.
In 2007, the Supreme Court explained why there is a heightened
pleading standard in private securities fraud litigation. In Tellabs, Inc. v. Makor
Issues & Rights, Ltd., 551 U.S. 308, 313 (2007), Justice Ginsberg wrote:
This Court has long recognized that meritorious private actions to
enforce federal antifraud securities laws are an essential
supplement to criminal prosecutions and civil enforcement actions
brought, respectively, by the Department of Justice and the
Securities and Exchange Commission (SEC). See, e.g., Dura
Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 345 . . . (2005); J.I.
Case Co. v. Borak, 377 U.S. 426, 432 . . . (1964). Private securities
fraud actions, however, if not adequately contained, can be
40
employed abusively to impose substantial costs on companies and
individuals whose conduct conforms to the law. See Merrill Lynch,
Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71,81 . . . (2006). As a
check against abusive litigation by private parties, Congress enacted
the Private Securities Litigation Reform act of 1995 (PSLRA), 109
Stat. 737.
Exacting pleading requirements are among the control measures
Congress included in the PSLRA. The PSLRA requires plaintiffs to
state with particularity both the facts constituting the alleged
violation, and the facts evidencing scienter, i.e., the defendant’s
intention “to deceive, manipulate, or defraud.” Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 194, and n. 12 . . . (1976); see 15 U.S.C.
§ 78u-4(b)(1), (2). . . . As set out in § 21D(b)(2) of the PSLRA,
plaintiffs must “state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of mind.”
15 U.S.C. § 78u-4(b)(2).
The Seventh Circuit has held, however, that “[t]here is no required state
of mind for a violation of section 14(a) [of the Securities and Exchange Act of
1934] . . . .” Beck, 559 F.3d at 682. The court explained that
a proxy solicitation that contains a misleading misrepresentation or
omission violates the section even if the issuer believed in perfect
good faith that there was nothing misleading in the proxy materials.
Kennedy v. Venrock Associates, 348 F.3d 584, 593 (7th Cir. 2003);
In re Exxon Mobil Corp. Securities Litigation, 500 F.3d 189, 196-97
(3d Cir. 2007); Shidler v. All American Life & Financial Corp., 775
F.2d 917, 926-27 (8th Cir. 1985); Gerstle v. Gamble-Skogmo, Inc.,
478 F.2d 1281, 1300-01 (2d Cir. 1973); 3 Alan R. Bromberg & Lewis
D. Lowenfels, Bromberg & Lowenfels on Securities Fraud &
Commodities Fraud § 8.4(430), pp. 204.71-72 (2d ed. 1996). The
requirement in the Private Securities Litigation Reform Act of
pleading a state of mind arises only in a securities case in which
“the plaintiff may recover money damages only on proof that the
defendant acted with a particular state of mind.” 15 U.S.C. § 78u4(b)(2). Section 14(a) requires proof only that the proxy solicitation
was misleading, implying at worst negligence by the issuer. Kennedy
v. Venrock Associates, supra, 348 F.3d at 593. And negligence is not
a state of mind; it is a failure, whether conscious or even
unavoidable (by the particular defendant, who may be below average
in his ability to exercise due care), to come up to the specified
standard of case. E.g., Desnick v. ABC, 223 F.3d 514, 518 (7th Cir.
41
2000); United States v. Ortiz, 427 F.3d 1278, 1283 (10th Cir. 2005);
W. Page Keeton et al., Prosser and Keeton on the Law of Torts § 31,
p. 169 (5th ed. 1984) (“negligence is conduct, and not a state of
mind”). That is a basic principle of tort law, though it is sometimes
overlooked, as in Dasho v. Susquehanna Corp., 461 F.2d 11, 29-30
n. 45 (7th Cir. 1972).
Id.
Section 14(a) plaintiffs, then, need not allege scienter; rather, they “must
identify each statement alleged to have been misleading, the reason why each
statement was misleading, and all relevant facts supporting that conclusion.”
Kuebler, 13 F.4th at 638 (citing 15 U.S.C. §78u-4(b)(1)).
The defendants argue that the plaintiffs “point to 65 paragraphs
(spanning 82 pages) of the Amended Complaint in which they cite more than
80 block quotations from the Proxy (several of which go on for multiple pages),
some of which they claim were made misleading due to allegations in an
assortment of preceding paragraphs, and all of which they claim were rendered
misleading due to more than 130 alleged omissions.” Dkt. No. 56 at 21 (citing
the amended complaint, Dkt. No. 53 at ¶307, in which the plaintiffs reference
the amended complaint at ¶¶183-248). They assert that this is “impermissible,”
and that “courts have aptly termed this improper method of pleading ‘puzzle
pleading’ because it ‘requires the Court and the defendants to piece together
exactly which statements the plaintiff is challenging and which allegations
contradict those statements.’” Id. (quoting Constr. Workers Pension Fund-Lake
Cty. & Vicinity v. Navistar Int’l Corp., No. 13 C 2111, 2014 WL 3610877, at *4
(N.D. Ill. July 22, 2014) (“Courts around the country have made clear that a
complaint does not satisfy the PSLRA’s pleading standards when it quotes the
42
defendant at length and then uses a stock assertion that the statement is false
or misleading for reasons stated in an earlier paragraph,” and collecting
cases)). The defendants characterize the amended complaint as a “mash-up” of
block quotes and “imprecise allegations.” Dkt. No. 56 at 21. They assert that
the plaintiffs have not alleged what other statements became misleading or
false as a result of any alleged omission, and that stuffing the amended
complaint with lengthy block quotes from the proxy statement does not suffice.
Id. at 21-22. The defendants also argue that the plaintiffs have not alleged why
any fact transformed by an alleged omission is misleading or false,
characterizing the plaintiffs’ claims as “vague allegations that the block-quoted
disclosures were ‘false and misleading when made for failing to disclose’
(Compl. ¶¶189, 195, 202, 248(c)) pages and pages of over a hundred items,
labeled in conclusory fashion ‘material facts . . . .’” Id. at 22.
As noted, in their reply brief, the defendants tossed in the argument that
the amended complaint violated Fed. R. Civ. P. 8. It does. Rule 8(a)(2) requires
a pleading to contain a “short and plain statement” of the claim. The amended
complaint is not short; as the Seventh Circuit once colorfully said, it suffers
from “extreme logorrhea.” Davis v. Anderson, 718 F. App’x 420, 423 (7th Cir.
2017). It is 195 pages long—sixty-one pages longer than the original
complaint—and contains 402 numbered paragraphs. Many of these paragraphs
have dozens of sub-paragraphs (and even sub-sub-paragraphs). See, e.g., Dkt.
No. 53 at ¶186. There are dozens of pages of block quotes, some of which have
bolded or italicized language for emphasis. See, e.g., Id. at ¶185. The amended
43
complaint often is repetitive—for example, ¶¶6, 68 and 184 assert the same
facts, as do ¶¶176 and 191; there are many more examples of duplication
throughout the pleading. Four pages of the complaint are devoted to a
discussion of the policy arguments against inversions; it is not clear what
bearing this has on the legal claims, given that the plaintiffs do not (and
cannot) allege that inversions are unlawful.
Nor is the complaint “plain.” For example, the Section 14(a) cause of
action is premised on the allegation that the defendants omitted information
from a proxy statement. The amended complaint never directly states that the
defendants issued a proxy statement or how. Paragraph 2 of the amended
complaint states that by “causing, participating in, and agreeing to, or
acquiescing in the filing of the S-4 filed with the Securities and Exchange
Commission (‘SEC’) on April 4, 2016 as successively amended,” some of the
defendants breached their fiduciary duties. Dkt. No. 53 at ¶2. Nowhere do the
plaintiffs explain that an “S-4” is an SEC registration statement. See
https://www.sec.gov/files/forms-4.pdf. They drop a footnote to paragraph 2 in
which they assert that “all references to the JCI/Tyco joint proxy-registration
statement (“S-4”) are to the document as filed with the SEC in final form on
July 6, 2016.” Id. at ¶2 n.1. The amended complaint then refers both to the S-4
and the “JCI/Tyco proxy/registration statement.” Piecing this information
together, it appears that on April 4, 2016, the defendants simultaneously filed
with the SEC the first version of their S-4 Registration Statement and a
shareholder proxy statement, or maybe they filed both as a combined
44
document, and that any references in the amended complaint to the “S-4,” a
“proxy” or a “registration statement” are references to the joint filing of these
two documents. The amended complaint would be easier to follow if, early on,
the plaintiffs simply had explained that on April 4, 2016, the defendants filed
something called an S-4 registration statement with the SEC, and that they
combined with that the proxy statement advising shareholders of the details of
the proposed merger.
The amended complaint is not consistent in how it refers to the
defendants. It indicates that “[d]efendants Molinaroli, Abney, Black, Joerres,
del Valle Perochena, and Vergnano are sometimes referred to herein as the
‘Individual JCI/JCplc Defendants.’” Dkt. No. 53 at ¶45 (emphasis added). It
says that “[d]efendants Stief, Guyett, Jasnowski, Bushman, Conner, and
Goodman are sometimes referred to herein as the ‘Individual JCI Defendants.’”
Id. (emphasis added). It says that “[d]efendants Molinaroli, Abney, Black,
Bushman, Conner, Goodman, Joerres, Lacy Estate, del Valle Perochena, and
Vergnano are sometimes collectively referred to herein as the ‘Director
Defendants.’” Id. (emphasis added). The amended complaint sometimes calls
the new company “JCplc” and sometimes calls it “Tyco/JCplc.” The amended
complaint refers to “Individual Defendants,” “Individual JCI/JCplc
Defendants,” “Individual JCI Defendants” and “Director Defendants”—as well
as just “Defendants.” Id.
The amended complaint often buries the lede, dropping into footnotes or
later sections of the pleading facts that would help the reader better
45
understand the earlier claims. For example, the plaintiffs repeatedly reference
the fact that the defendants had announced in 2015 that the Adient spin-off
would be tax free but that they then waited to spin off the new business until
after the merger. It is only in footnote 57 at page 65, ¶181 that the plaintiffs
link the alleged deliberate delay in consummating the spin-off with any tax
consequences, stating that completing the spin-off prior to the merger could
have caused the IRS to “disregard the spin-off in calculating whether JCI
shareholders’ equity interest in JCplc was under 60%.”
The early portions of the amended complaint discuss concepts that the
plaintiffs do not explain (or sort of explain) until pages and pages later, and
reference events that the plaintiffs do not explain until pages and pages later.
As the court discusses below, later sections of the amended complaint cite
earlier paragraphs which one must go back to and read to understand the
allegations made in the later sections. A reader must flip forward and back to
different portions of the amended complaint to determine what happened and
when and how what happens relates to the claims.
But though the defendants made the Rule 8 argument in their reply
brief, the Rule 8 violation is not the basis for their motion to dismiss. This
court (and perhaps the defendants) likely would have found a more compact,
concise and differently-organized complaint easier to digest and comprehend,
but that is not a basis for dismissing a lawsuit with prejudice. The question is
whether Count I of the amended complaint meets the heightened pleading
standard under the PSLRA. The court thus turns to the portion of the amended
46
complaint in which the plaintiffs assert that the defendants concealed material
facts—¶¶183-253.
In Section IV(D)(1), the plaintiffs allege that the defendants concealed
material facts about their liability for taxes and the new company’s avoidance
of taxes. Dkt. No. 53 at ¶183. They reiterate that in its January 25, 2016
announcement of the merger, JCI advised shareholders—without
qualification—that the merger would be taxable to them. Id. at ¶¶183-184.
They assert that the only way JCI could have known with certainty on January
25, 2016 that the merger would be taxable to its shareholders was because
they had structured the merger to make it so. Id. at ¶183. The amended
complaint then reproduces a two-page, single-spaced section of the S-4 with
four subsections. Id. at ¶185. The first sentence in the quoted section is, “Q:
WHAT ARE THE U.S. FEDERAL INCOME TAX CONSEQUENCES OF THE
TRANSACTION TO JOHNSON CONTROLS SHAREHOLDERS?” Id. The plaintiffs
bolded several phrases and sentences in the paragraphs that follow, including
“will be treated as a taxable transaction for U.S. federal income tax purposes,”
“Certain U.S. Federal Income Tax Consequences . . .,” “will be treated as a
taxable transaction for U.S. federal income tax purposes,” “will be taxable for
U.S. federal income tax purposes,” “U.S. Federal Income Tax Consequences of
the Merger to Johnson Controls Shareholders,” and “receipt of combined
company ordinary shares . . . will be a taxable transaction for U.S. federal
income tax purposes.” Id.
The amended complaint next asserts that these representations, as well
47
as representations in ¶¶129 and 162 of the amended complaint, “were false
and misleading for the reasons alleged in ¶¶ 128-69 and for failing to disclose
the following material facts . . . .” Id. at ¶186. The reader must go back to ¶129
(which references the S-4’s disclosure that the merger would be taxable and
discusses the September 16, 2016 announcement on JCI’s web site that it was
going to take the position with the IRS that the cash and stock the JCI
shareholders received could potentially be treated as a dividend subject to
income taxes) and ¶162 (in which the plaintiffs aver that JCI stated with
confidence in the January 25, 2016 announcement of the merger that it would
be taxable to JCI shareholders “[n]otwithstanding the foregoing inherent
uncertainties”) to collect all of the representations the plaintiffs allege were
false and misleading. Having reviewed these sections of the amended
complaint, the court concludes that the plaintiffs are asserting that JCI’s
unequivocal representation to the shareholders in the S-4 (and in the public
announcement of the merger, although that is not actionable under Section
14(a)) was false and misleading. The plaintiffs have identified which statements
in the portion of the S-4 reproduced in ¶185 that they claim were false and
misleading.
As to why they claim these statements were false and misleading, the
plaintiffs reference forty-one paragraphs of the amended complaint—¶¶128169—as well as asserting that the defendants “fail[ed] to disclose” five and a
half pages of what the plaintiffs characterize as material facts. Id. at ¶186.
Paragraphs 128-169 are the plaintiffs’ description of what they characterize as
48
the “busted merger.” In the five and a half pages of allegedly material facts, the
plaintiffs assert that the S-4 omitted information about: (a) whether, in
considering the merger, the “Director Defendants” considered:
(i)
that the need to pay capital gains and ordinary income taxes
would particularly affect long-term Minority Taxpaying JCI
Shareholders with a low basis in their JCI shares and could, among
other things, force them to sell a significant number of their shares
to provide the cash to pay the taxes;
(ii)
that forcing Minority Taxpaying JCI Shareholders to sell
shares to pay these taxes would also deprive those shareholders of
the dividends they have been receiving on those shares and upon
which many of such shareholders depend for their retirement or
other income;
(iii) that the Inversion/Merger-related tax consequences would
create a divergence of interests between the Minority Taxpaying JCI
Shareholders, on the one hand, and the majority non-taxpaying JCI
shareholders and JCI, on the other;
(iv)
that the JCI Defendants’ determination to avoid the Inversionrelated tax consequences pursuant to §§ 4985 and 7874 by limiting
JCI shareholders’ equity interest in JCplc to under 60% would create
a divergence of interests between the JCI Defendants and JCI public
shareholders;
(v)
that the Inversion was structured as a “busted” merger to
protect JCI/JCplc’s earning-stripping and other tax avoidance
schemes, not to enable shareholders to realize losses;
(vi)
that structuring the Inversion as a “busted” merger to protect
JCI/JCplc’s tax avoidance schemes would mean circumventing the
option to impose the Inversion-mandated taxes on JCI/JCplc,
instead of the Minority Taxpaying JCI Shareholders;
(vii) that related-party debt was to be created to enable
JCI/JCplc’s earnings-stripping scheme, resulting in JCplc being
paid twice for the shares it issued in exchange for the shares of JCI
shareholders (see ¶146 supra); and
(viii) whether to reject reincorporating JCI in Ireland and thereby
spare Minority Taxpaying JCI Shareholders from being forced to pay
the Inversion-imposed taxes; or
49
(ix)
if JCI was to incorporate in Ireland, whether to structure the
Inversion to avoid forcing Minority Taxpaying JCI Shareholders to
pay taxes and, instead, to impose the Inversion-mandated taxes on
JCplc; or
(x)
instead, whether to structure the Inversion as a “busted”
merger in order to enable Minority Taxpaying JCI Shareholders to
claim losses.
Id. at ¶186(a). They also list “all facts relevant to the facts recited in the
preceding two paragraphs and ¶¶129 and 162 that the Inversion ‘will be
taxable’ to JCI Shareholders, including” three facts (that JCI allegedly chose to
structure the transaction to impose taxes on the shareholders holding their
shares in taxable accounts by structuring a busted merger, that the busted
merger avoided imposing the inversion-related taxes on the new company and
“if such option was considered, all calculations and methodologies in support
of the option chosen”). Id. at ¶186(b). They list seventeen other “facts,” ranging
from questions about what alternatives to the merger the defendants
considered to whether JCI estimated certain taxable income and consequences
to itself and to shareholders to whether JCI sought advice of counsel on the tax
consequences of the merger. Id. at ¶¶186(c)-(s). Finally, they list ten facts that
they assert were “necessary to avoid making the statements recited at ¶¶ 129,
162, and 184-85 false and misleading when made,” such as—again—the
allegations that the JCI defendants structured the merger as a “busted”
merger, that reincorporating in Ireland was not necessary to achieve “the
expected non-tax benefits” of the merger, whether the “Individual Defendants
considered compensating Minority Taxpaying JCI Shareholders for the capital
50
gains and ordinary income taxes they will be forced to pay,” the fact that the
defendants chose to conduct the merger as an inversion and the facts
surrounding the alleged delay of the Adient spin-off. Id. at ¶187.
This is an example of “puzzle pleading.” As Judge Kennelly of the
Northern District of Illinois recently explained:
Though the Seventh Circuit has never used the term “puzzle
pleading,” Hughes v. Accretive Health, Inc., No. 13 C 3688, 2014 WL
4784082, at *5 (N.D. Ill. Sept. 25, 2014), many of this circuit’s
district courts have used that term to describe a complaint that
would “require[] the Court and the defendant to piece together
exactly which statements the [p]laintiffs are challenging and which
allegations contradict those statements,” rather than the complaint
itself doing so. See Constr. Workers Pension Fund-Lake Cty. &
Vicinity v. Navistar Int’s Corp., No. 13 C 2111, 2014 WL 3610877, at
*5 (N.D. Ill. July 22, 2014).
Courts have found so-called “puzzle pleadings” where the complaint
“quotes the defendant at length and then uses a stock assertion that
the statement is false or misleading for reasons stated in an earlier
paragraph.” See Alizadeh v. Tellabs, Inc., No. 13 C 537, 2014 WL
276676, at *4 (N.D. Ill. June 16, 2014). Courts have also dismissed
complaints whose “net effect” is to “leave the reader … jumping from
page to page in an attempt to link the alleged statements to the
background that supposedly makes them false or misleading,”
especially where it is “difficult to discern where the supposedly
challenged statements end and [] context or characterization
begins.” Conlee v. WMS Indus., Inc., No. 11 C 3503, 2012 WL
3042498, at *4 (N.D.Ill. July 25, 2012).
Macovski v. Groupon, Inc., No. 20 C 2581, 2021 WL 1676275, at *5 (N.D. Ill.
Apr. 28, 2021).
While the plaintiffs have identified, by bolding or italicizing them, some of
the statements in the S-4 that they allege are misleading, the amended
complaint forces the reader to flip between various paragraphs of the 402paragraph document to determine which facts the plaintiffs believe
51
demonstrate that the bolded statements are misleading. In some instances, the
plaintiffs have not bolded or italicized any bits of extended sections of the S-4,
forcing the reader to assume that they allege that every word of multiple
paragraphs or pages is false or misleading, or to guess which portion of the
long excerpt the plaintiffs believe is false or misleading. That is “puzzle
pleading” under the definition articulated in Macovski.
Despite the puzzle pleading, the court believes that it can identify the
facts that the plaintiffs claim provide a reason for why the bolded statements
are misleading. The question is whether any or all of these facts—the facts
about the choice to structure the merger as an inversion, about what the
plaintiffs deem the “busted merger,” about what JCI or its board or officers or
directors considered or didn’t consider when deciding how to structure the
merger, about how the merger could have been structured to avoid imposing
tax consequences on those shareholders who held their shares in taxable
accounts—provide a reason why the statements in the S-4 that the merger
would be treated as a taxable transaction for U.S. federal income tax purposes
was misleading. They do not. They provide reasons why the plaintiffs believe
the defendants should have done things differently, but they do not provide a
reason why, for example, the S-4’s statement that “[t]he receipt of combined
company ordinary shares and/or cash in exchange for Johnson Controls
common stock pursuant to the merger will be a taxable transaction for U.S.
federal income tax purposes” was either false or misleading. Dkt. No. 53 at
¶185(d). It appears undisputed that that statement is true, and the plaintiffs do
52
not identify what is misleading about the statement or how any of the omitted
“facts” show that the statement is misleading.
If the S-4 had said, for example, that there was no way for the
defendants to have avoided the merger resulting in taxable events for JCI
shareholders, the facts the plaintiffs recite might provide a reason why that
statement could have been false or misleading. If the S-4 had said that the
defendants had no choice but to reincorporate in Ireland, the facts the
plaintiffs cite could have provided a reason why that statement might have
been false or misleading. But none of the many facts the plaintiffs cite (or in
many instances, questions they pose) provide a reason why the statement that
the merger would result in a taxable event for shareholders was misleading.
The plaintiffs imply that the S-4 was misleading because it should have
said something like, “The receipt of ordinary shares of the combined company
and/or cash in exchange for Johnson Controls common stock pursuant to the
merger will treated as a taxable transaction for U.S. federal income tax
purposes, but it didn’t have to be for the following reasons,” or “The fact that
consideration received by Johnson Controls shareholders in the merger will be
taxable for U.S. federal income tax purposes, but it didn’t have to be for the
following reasons.” The court will discuss whether the facts that the plaintiffs
claim were omitted from the S-4 were material, but the fact that the plaintiffs
would like to have known, before the merger was consummated and before
they were asked to vote whether to approve it, if there were other options that
would not have resulted in taxable events for them does not make the
53
statement that the merger did result in taxable events for them misleading.
The same is true of the plaintiffs’ allegations in Section IV(D)(2) that the
defendants concealed material facts about the “busted” merger. Id. at ¶¶188190. The amended complaint begins by quoting ten paragraphs from the S-4
disclosing that Merger Sub was a Wisconsin limited liability corporation and an
indirect, wholly owned subsidiary of Tyco, that Merger Sub would merge with
Johnson Controls and that Johnson Controls would emerge as an indirect,
wholly owned subsidiary of Tyco. Id. at ¶188. The plaintiffs then cite to the
affidavit of H. David Rosenbloom, which the defendants filed in opposition to
the motion for injunctive relief, in support of statements such as “Merger Sub
was not an ‘indirect wholly owned subsidiary of Tyco’; it was structured as
partially indirectly wholly owned and partially directly owned by Tyco to ‘bust’
the Merger.” Id. at ¶189(a) (citing Dkt. No. 38 at ¶10). The amended complaint
reiterates its allegations that Merger Sub was created to bust the merger by
rendering §368 inapplicable, referencing Rosenbloom’s affidavit. Id. at ¶189(b)(f).
Again, it appears undisputed that the facts stated in the S-4 were true.
The plaintiffs’ insistence that the merger was effectuated through a Wisconsin
limited liability company for the purpose of avoiding the requirements of §368
of the tax code does not explain why the statements that Merger Sub was a
Wisconsin limited liability company, that it was going to merge with Johnson
Controls and that Johnson Controls would emerge as an indirect wholly owned
subsidiary of Tyco, were misleading. Had the S-4 stated that this was the only
54
option for effectuating the merger, the facts the plaintiffs identify might have
provided a reason that that statement could have been false or misleading. But
the facts the plaintiffs emphasized (in italics, this time) do not show why the
statements in the S-4 were misleading.
The plaintiffs next attack the sections of the S-4 that discuss the Adient
spin-off. After reiterating the facts surrounding the July 2015 announcement
that the spin-off would be tax-free and the October 2016, post-merger
announcement that it would be taxable, id. at ¶¶191-193, the plaintiffs quote
over four, single-spaced pages of the S-4, id. at ¶194. The plaintiffs bolded only
four portions of this section of the S-4 and it is not clear how those portions
link to the facts. The plaintiffs bold two headings that read “Spin-off of Johnson
Controls’ Automotive Experience Business.” Id. at ¶¶194(b), 194(h). These are
headings identifying the topics of the paragraphs that follow. The court
assumes that the plaintiffs did not mean to allege that those headings were
false or misleading. The plaintiffs also bolded and italicized the heading of
subsection (d) of the excerpted portion of the S-4, which reads: “There can be
no assurance that the separation of Johnson Controls’ Automotive Experience
business will occur following the closing of the merger, or at all, and until it
occurs, the terms of the separation may change.” Id. at ¶194(d). And they
bolded and italicized the heading of subsection (e) of the excerpted portion,
which reads: “The combined company and its shareholders may not realize the
potential benefits from the separation of Johnson Controls’ Automotive
Experience business.” Id. at ¶194(e). Finally, the plaintiffs italicized one
55
sentence in the four-page, single-spaced excerpt: “The spin-off is a separate,
independent transaction from the merger, and is currently expected to generally
proceed in substantially the same manner as originally planned and on the
timeline previously announced by Johnson Controls, with such adjustments to
reflect that the distributing corporation will be the combined company instead
of Johnson Controls.” Id. at ¶194(b).
The plaintiffs allege that this section of the S-4 was false and misleading
because it did not disclose that the Adient spin-off allegedly was purposefully
delayed until after the closing of the merger “to avoid or minimize the risk that
the IRS would disregard the spin-off in determining whether the former JCI
shareholders in fact own less than 60% of JCplc, thereby threatening
Defendants’ scheme to avoid §§ 4985’s and 7874’s adverse tax consequences.”
Id. at ¶195. They cite to ¶¶103-115 and 175-182 of the amended complaint. Id.
The plaintiffs’ assertions that the Adient spin-off was deliberately delayed for
the purpose of assisting the defendants in their alleged tax-avoidance efforts
seem to have little to do with the bolded headings from the S-4 concerning the
uncertainty that the Adient spin-off would come to fruition or produce benefits
to the company or its shareholders. It appears that the plaintiffs meant to
argue that the omitted “facts” render the statement that the spin-off was going
to proceed “in substantially the same manner as originally planned” false and
misleading. If this is what the plaintiffs meant, it is not clear. Do the plaintiffs
interpret “in the same manner as originally planned” to mean that the Adient
spin-off would be tax free to shareholders, and argue that given that, the
56
statement was false or misleading because the defendants knew that it would
not be tax free? If it were clearer, this allegation might come closer to meeting
the PSLRA’s heightened pleading standard.12
Next, the plaintiffs assert that the defendants concealed facts about the
“forced buyback” of the 17% of JCI shares. They reiterate the details of their
claim that the defendants calculated the percentage of JCI shares that would
need to be redeemed to reduce JCI shareholder equity in the new company
below 60% and engineered achieving that percentage by pricing the shares. Id.
at ¶¶196-200. They then quote seven, single-spaced pages of the S-4. Id. at
¶201. This time, they did not bold or italicize anything other than headings.
They appear to assert that all seven pages, as well as statements recounted in
¶199 of the amended complaint, were false and misleading. Id. at ¶202.
Paragraph 199 of the amended complaint describes twelve portions of the S-4
having to do with how JCI’s financial advisors—Centerview and Barclays—
determined the ranges of fair values for the shares (a range the plaintiffs assert
was higher than the $34.88 “forced buyback” price).
The seven quoted pages are from the section of the S-4 that advises
shareholders that the merger will be a “reverse merger,” in which Tyco would
The defendants argued at the January 2017 hearing on the motion for
injunctive relief that Adient filed its own information statement with the SEC,
disclosing information about the spin-off transaction, dkt. no. 51; they repeat
that argument in their brief in support of the motion to dismiss, asserting that
Adient filed the information statement in April 2016, dkt. no. 56 at 28 and n.9.
They also attach that statement to their motion to dismiss. Dkt. No. 56-3. The
plaintiffs have not addressed this filing in the amended complaint or in their
briefing and the court has not considered the statement attached to the
defendants’ motion to dismiss.
12
57
end up being the parent of the new company. Id. at ¶201(a). It tells
shareholders that they can elect whether to accept a share in the new company
or $34.88 for each of their current JCI shares. Id. It tells them that elections
will be prorated, which means they may not get the number of shares or cash
they indicate on their election form. Id. at ¶201(b). It advises them of the risk
that they may not be sure of the valuation they will receive from the merger. Id.
at ¶201(d). It tells them that the value of new company shares to Tyco
shareholders, as of July 5, 2016, was $40.86. Id. It tells them that neither
Johnson Controls nor Tyco was recommending whether they should elect stock
or cash. Id. at ¶201(h). It tells them that they should get their own personal
financial advice “immediately from your stockbroker, bank manager, solicitor,
accountant or other appropriate independent financial advisor . . . .” Id. at
¶201(i).
If the plaintiffs mean to allege that every word of those seven pages of the
S-4, including the information recounted above, is false and misleading
because it did not tell the shareholders that the defendants designed the
transaction and set the stock price as tax-avoidance mechanisms for the new
company, this set of allegations suffers from the same defects as the prior ones.
The plaintiffs next assert fourteen facts, or allegations, about the
unfairness of the $34.88 “forced buyback” price and their allegations that that
price was set lower than the financial advisors had calculated was fair only to
assist the defendants in accomplishing their alleged tax-avoidance scheme. Id.
at ¶202. One of the “facts” that the plaintiffs assert made the S-4 false and
58
misleading is that “[t]he complexity of the Inversion/Merger was such that the
accountants, brokers, financial advisers, and attorneys accessible to most JCI
public shareholders, and especially the Minority Taxpaying JCI Shareholders,
lacked the knowledge and experience that would enable them to provide the
advice that JCI shareholders required in order to understand this transaction
and to mitigate their injuries.” Id. at ¶202(l).
The plaintiffs next assert that the S-4 concealed material facts about the
individual defendants’ lack of exposure to merger-related taxes and the costs of
that lack of exposure to JCI shareholders. In this section of the amended
complaint, the plaintiffs reproduced only two paragraphs of the S-4:
(a)
In addition, the Temporary Section 7874 Regulations (and
certain related temporary regulations issued under other provisions
of the Code) include new rules that would apply if the 60%
ownership test were met, . . . in such case, Section 4985 of the Code
and rules related thereto would impose an excise tax on the value of
certain stock compensation held directly or indirectly by certain
“disqualified individuals” at a rate equal to 15%. The merger
agreement permits Johnson Controls and Tyco to enter into
agreements with their directors and executive officers providing for
the reimbursement of any taxes imposed under Section 4985 of the
Code in connection with the merger. S-4 at 56.
(b)
The merger agreement also permits Johnson Controls to enter
into agreements with its directors and executive officers providing
for the reimbursement of any taxes that may be imposed under
Section 4985 of the Code in connection with the merger, though no
such reimbursements are currently expected to become necessary
or payable. Id. at 157-58.
Id. at ¶207.
This section also asserts that “the S-4’s statements recited in ¶¶ 103,
104, and 106, supra” were rendered false or misleading by omitted material
facts. Id. Those paragraphs state the following:
59
103. While exposing JCI shareholders to the Code’s forced
Inversion/Merger-related taxes, Defendants took great care to
structure the Merger to avoid the Inversion-imposed tax
consequences that JCI and the Individual Defendants would have
faced if JCI shareholders got 60% or more of JCplc’s shares. The
Merger Agreement provided:
Section 6.13 Tax Matters. From and after the execution of this
Agreement until the earlier of the Effective Time or the date, if
any, on which this Agreement is terminated pursuant to
Section 8.1, except as may be required by Law,
notwithstanding anything to the contrary in Section 5.1 or
Section 5.2, none of Parent, Merger Sub or the Company shall,
and they shall not permit any of their respective Subsidiaries
to, take any action (or knowingly fail to take any action) that
causes, or could reasonably be expected to cause the
ownership threshold of Section 7874(a)(2)(B)(ii) of the Code to
be met with respect to the Merger.
S-4 at A-72 (emphasis supplied).
104. The obligation set out in the Merger Agreement was described
as follows in the S-4:
Tax Matters
Tyco and Johnson Controls have agreed that, from and after
the execution of the merger agreement until the earlier of the
effective time of the merger or the date, if any, on which the
merger agreement is terminated, except as may be required
by law, none of Tyco, Merger Sub or Johnson Controls will, and
they will not permit any of their respective subsidiaries to,
take any action (or knowingly fail to take any action) that
causes, or could reasonably be expected to cause, the 60%
ownership test to be met with respect to the merger.
S-4 at 202 (emphasis supplied).
* * * * * *
106. Following the Merger Agreement, certain procedures were to
be followed by JCI and Tyco to ensure that the 60% obligation set
forth in ¶ 103 was satisfied. S-4 at 202; see also id. at 223.
The plaintiffs assert that the S-4 was materially misleading for
60
failing to disclose the facts alleged in ¶¶ 86-94, 105, 107-09, 111,
and 202-04, as it concealed (i) the extent to which the Individual
Defendants and senior JCI executives were shielded from the
Inversion/Merger-related taxes being imposed on Minority
Taxpaying JCI Shareholders, (ii) the dollar amount of the § 4985
excise tax that they sought to avoid ($4 million), and (iii) the harm
to JCI public shareholders in the form of the reduction of the JCplc
equity allocated to JCI public shareholders to enable the Individual
Defendants to avoid the excise tax and JCplc to avoid § 7874’s
adverse tax consequences ($5.46 billion [see fns. 63, 65]).13
Id. at ¶205. They also assert that the omitted information “concealed the
potential cost to JCI and JCplc of their agreement to reimburse the Individual
Defendants for any such excise tax, including whether such reimbursement
would, if made, be ‘grossed up’ for the income taxes due on such
reimbursement.” Id. at ¶206.
Again, the plaintiffs do not provide reasons why the omitted information
rendered the statements in the S-4 false or misleading. The S-4 told
shareholders that the parties to the merger were not going to take any action to
let the JCI equity hit the 60% threshold. It identified the relevant provisions of
the tax code and told shareholders that if the 60% threshold were to be met,
certain disqualified individuals would be subject to a 15% excise tax. It told
them that the agreement allowed JCI and Tyco to reimburse those disqualified
individuals should they be subject to such a tax. The plaintiffs do not explain
how the dollar amounts involved render those statements false or misleading.
They imply that the S-4 should have said, “The merger agreement also permits
Johnson Controls to enter into agreements with its directors and executive
It is sentences like this that make it hard to credit the plaintiffs’ insistence
that the amended complaint does not constitute puzzle pleading.
13
61
officers providing for the reimbursement of any taxes that may be imposed
under Section 4985 of the Code in connection with the merger, and the amount
of those taxes would be in the millions of dollars.” The italicized language, while
perhaps relevant and of interest to JCI shareholders before their vote on the
merger, does not render the preceding, unitalicized language false or
misleading.
The plaintiffs assert that the defendants concealed material facts about
the merger’s projected tax savings. They reproduce nine paragraphs of the S-4
spanning four pages, discussing (often in obtuse accountant-speak, with terms
like “synergy DCF analysis” and “P/E multiple” and “EV/EBITDA multiples”)
the “tax synergies” that JCI and Tyco hoped or anticipated the merger would
create and how they predicted or calculated those “synergies.” Id. at ¶209. The
plaintiffs argue that these statements were rendered false and misleading by
the fact that the S-4 did not disclose that the hoped-for “synergies” allegedly
were dependent on a tax-avoidance scheme that required the individual
defendants to breach their fiduciary duties to shareholders, to give Tyco
shareholders more than 40% of the equity in the new company, to price the JCI
shareholders’ shares at a 25% discount “to the average of the medians of the
ranges of per share fair values for JCI shares determined by JCIs’ and Tyco’s
advisers ($46.24)” and to “bust” the merger. Id. at ¶210. The plaintiffs also
assert that other “omitted material facts alleged elsewhere herein at ¶¶ 186,
187, 195, and 202” would have revealed “that Defendants’ tax avoidance
schemes were driving a deal that would not generate for JCI shareholders the
62
best value reasonably attainable.” Id. Again, these allegations do not
demonstrate that the calculations and the hoped-for “synergies” were false or
misleading.
None of these allegations14 meet the PSLRA heightened pleading
standard. They do not explain why the omitted facts would have rendered the
identified S-4 statements false or misleading.
The plaintiffs have amended their complaint once with leave of court. It is
not uncommon for courts that have identified defects in pleadings to give the
plaintiffs leave to amend those pleadings to correct the defects, and Fed. R. Civ.
P. 15(a)(2) instructs courts to “freely give leave” to amend “when justice so
requires.” But “district courts have broad discretion to deny leave to amend . . .
The defendants included one other set of allegations of omissions. In Section
V, titled “Additional Material Omissions,” id. at 152, the plaintiffs alleged that
the S-4 “purported to disclose differences between the Wisconsin Business
Corporation Law (“WBCL”) and Irish law but contains material omissions,” id.
at ¶250. It reproduced two sections of the S-4, one describing the duties of
directors under Wisconsin law. Id. at ¶¶251-252. The plaintiffs then argue that
the statements in these two sections were false and misleading because they
did not disclose “the standards of conduct for directors that have developed
through American statutory and case law,” omitted references to American
statutory and case law “which defines, and is indispensable to an
understanding of, shareholders’ rights and a corporation’s and its officers’ and
directors’ obligations to its shareholders,” the fiduciary duties of officers and
directors under Wisconsin law, the fact that the Wisconsin business judgment
rule “does not apply to officers” and the extent to which such protections, “to
the extent that they exist under Irish law, are directly enforceable by
shareholders and extend liability to third parties for aiding and abetting a
breach of fiduciary duty by a corporation’s officers and directors.” Id. at ¶253.
As the court explains later in this order, it has concluded that the plaintiffs’
Section 14(a) allegations are claims of breach of fiduciary duty labeled as
federal securities violations. These allegedly omitted facts are nothing more
than an allegation that the defendants had a fiduciary duty to educate
shareholders on American, Irish and Wisconsin law relating to fiduciary duty.
14
63
where the amendment would be futile.” Mulvania v. Sheriff of Rock Island Cty.,
850 F.3d 849, 855 (7th Cir. 2017) (quoting Arreola v. Godinez, 546 F.3d 788,
796 (7th Cir. 2008)).
Allowing the plaintiffs to amend the complaint would be futile. The
plaintiffs have not plausibly alleged that the information in the S-4 was not
true or explained why the omitted information rendered that information
misleading. Their allegations boil down to a claim that JCI could have
effectuated the merger without using the inversion structure and without using
tax strategies that would shift the tax burden of the merger onto the
shareholders, but that it did not tell the JCI shareholders that because it was
trying to reduce the tax exposure to its officers and directors and to the new
company at the expense of the shareholders. The question is whether, if the
plaintiffs could surmount the pleading deficiencies, those allegations would
state a federal claim under Section 14(a). If not, allowing them to amend would
be futile. The allegations do not state a federal claim under Section 14(a)/Rule
14a-9 because the plaintiffs have failed to plead the first two elements of that
cause of action—a material misrepresentation or omission and loss causation.
2.
The amended complaint fails to plead a material
misrepresentation or omission.
The defendants argue that the plaintiffs have not sufficiently pled the
first element of a Section 14(a) claim—that the alleged omissions were
“material.” “An omitted fact is material if there is a substantial likelihood that a
reasonable shareholder would consider it important in deciding how to vote.”
TSC Indus., 426 U.S. at 449.
64
It does not require proof of a substantial likelihood that disclosure
of the omitted fact would have caused the reasonable investor to
change his vote. What the standard does contemplate is a showing
of a substantial likelihood that, under all the circumstances, the
omitted fact would have assumed actual significance in the
deliberation of the reasonable shareholder. Put another way, there
must be a substantial likelihood that the disclosure of the omitted
fact would have been viewed by the reasonable investor as having
significantly altered the “total mix” of information made available.
Id.
At the October 2019 hearing, the court asked the plaintiffs’ counsel
whether the amended complaint alleged that the shareholder vote to approve
the merger would have been different had the omitted information been
disclosed. In their supplemental brief (Dkt. No. 71-1 at 4-5) the plaintiffs
responded that they were not required to plead (nor prove) that the omitted
information would have had a decisive effect on the vote of any JCI shareholder
to approve or disapprove the merger. They are correct. The court’s question did
not appropriately frame the inquiry. The question is whether there is a
substantial likelihood that reasonable shareholders would have considered the
omitted information important to making their voting decision.
Generally, the defendants argue that despite the volume of information in
the proxy statement (including the ballot page, it is 539 pages long, dkt. no.
56-1), the plaintiffs’ arguments amount to “tell me more” pleading. Dkt. No. 56
at 25-26. They assert that courts have deemed immaterial detailed information
about board decision-making. Id. at 25. They argue that the proxy statement
disclosed the structure of the transaction, the fact that it would be taxable, the
fact that JCI shareholders would own 56% of the new company, the fact that
65
the Adient spin-off was taxable and that Adient had filed its own registration
form with the SEC providing information about the spin-off and the fact that
some portions of the merger consideration could be treated as ordinary taxable
income. Id. at 25-29. They argue that the proxy statement was not required to
disclose all the financial information an investor would need to determine for
herself the fair market value of the merger. Id. at 26 n.7. They assert that
failing to disclose “pejorative characterizations” and “adverse inferences” is not
enough to state a Section 14(a) claim. Id. at 27. Finally, they argue that the
plaintiffs have “bootstrapped” their fiduciary duty claims to a Section 14(a)
claim under the rationale of upholding Section 14(a)’s goal of protecting
investors. Id. at 29.
The court first addresses some of the defendants’ broader arguments.
The defendants argue that the plaintiffs’ assertions that the S-4 should have
revealed whether the directors considered certain factors or options—whether
to decline to reincorporate in Ireland, what impact the various facets of the
merger might have on shareholders with shares in taxable accounts, etc.—are
demands for “play-by-play details” of board activity that “courts in this circuit
have deemed immaterial in assessing claims brought under Section 14(a).” Dkt.
Id. at 25. Despite using the plural, the defendants cite only one decision in
support of this claim, Himmel v. Bucyrus Int’l., Inc., Nos. 10-C-1104, 10-C1106, 10-C-1179, 2014 WL 1406279, *17-18 (E.D. Wis. Apr. 11, 2014), and
they take the quoted language out of context. The Himmel court said, “If a
company discloses some history leading to a merger, the company must
66
provide an accurate, full, and fair characterization of those events. However, it
need not provide a play-by-play description of merger negotiations.” Id. at *17
(citing Globis Partners, LP v. Plumtree Software, Inc., No. 1577-VCP, 2007 WL
4292024, at *14 (Del. Ch. Nov. 30, 2007)).
The amended complaint alleges that the S-4 disclosed some history of
the merger—for example, ¶¶209 and 236 excerpt paragraphs that discuss
several board meetings and explain how the board decided on the exchange
ratio and decided to approve going ahead with the merger. Under the reasoning
in Himmel and Globis Partners, any omitted information necessary to provide a
full, fair and accurate recitation of that history would be material.
Granted, many of the plaintiffs’ allegations about “omitted” facts appear
to be inferences. The plaintiffs assume, for example, that the decision-makers
either compared “whether to structure the Inversion to avoid forcing Minority
Taxpaying JCI Shareholders to pay taxes and, instead, to impose the Inversionrelated taxes on JCplc” or “instead, whether to structure the Inversion as a
‘busted’ merger in order to enable Minority Taxing JCI Shareholders to claim
losses,” dkt. no. 53 at ¶¶186(a)(ix) and (x), or that they deliberately chose not to
investigate that comparison. This appears to be an inference the plaintiffs have
drawn from information they possess (much of which, the defendants point
out, they obtained from the proxy statement, dkt. no. 56 at 27, citing dkt. no.
53 at ¶¶76, 202(e)), their research into the tax laws and the results they have
experienced (being taxed). Though the plaintiffs allege that the proxy statement
left out of its recitation of the history “the fact that JCI deliberately chose to
67
structure the transaction so as to impose capital gains and ordinary income
taxes on the Minority Taxpaying JCI Shareholders by structuring the Inversion
as a ‘busted’ merger to protect JCI/JCIplc’s earnings-strippings and other tax
avoidance schemes,” dkt. no. 53 at ¶186(b)(i), implying that JCI intentionally
structured the merger for the purpose of shifting the tax obligations to them,
that omitted “fact” may be nothing more than an inference drawn from the
events that occurred. That said, it is not an implausible or impermissible
inference, and on a motion to dismiss, the court must construe their claims in
the light most favorable to the plaintiffs as the non-moving parties. See, e.g.,
Koppel v. 4987 Corp., 167 F.3d 125, 133 (2d Cir. 1999).
The defendants argue that “[n]ot disclosing ‘pejorative characterizations
and adverse inferences which, it appears, the plaintiff has drawn without the
defendants’ help’ is not grounds for a disclosure claim.” Dkt. No. 56 at 27
(citing Klamberg v. Roth, 473 F. Supp. 544, 553 (S.D.N.Y. 1979)). Again, that is
not exactly what the cited case said. The Klamberg court found that failure to
disclose that the company was “considering” divesting itself of certain holdings
was not materially deceptive, then said, “[t]he remainder of the paragraph [in
the complaint] comprises pejorative characterizations and adverse inference
which, it appears, the plaintiff has drawn without the defendants’ help.”
Klamberg, 473 F. Supp. at 553.
Perhaps the defendants meant to argue that the drafters of the proxy
statement were not required to frame the information in it in the light least
favorable to JCI and Tyco and most favorable to shareholders who held their
68
stock in taxable accounts. While the court has not found a case that puts it
that way, that appears to be true—Rule 14a-9 prohibits “false or misleading”
statements of material fact, or omissions that would make facts in the
statement false or misleading. It does not appear to require characterization of
information as “positive” or “negative” to shareholders (or to the merging
entities). In Virginia Bankshares, the Supreme Court stated that “[s]ubjection
to liability for misleading others does not raise a duty of self-accusation; it
enforces a duty to refrain from misleading.” 501 U.S. at 1098 n.7. But the
question of whether an omitted fact was “pejorative” or a “self-accusation,” as
opposed to a fact that a reasonable investor would have found important to her
vote in the overall mix of information she received, is a question of fact.
Whether one characterizes it as “pejorative” or “self-accusation,” the materiality
element requires the court to determine whether a reasonable investor would
have found important the fact that some of the decision-makers who decided
on the structure of the merger could have faced millions of dollars in excise
taxes had JCI shareholders ended up with more than 60% of the equity in the
new company, or that there may have been other ways to structure the merger
that would not have resulted in the plaintiffs’ merger-related gains being taxed
to them.
The defendants cite a series of cases which, they say, stands for the
awkwardly worded proposition that “[a] plaintiff does not state a disclosure
claim by asking whether or not something happened.” Dkt. No. 56 at 25 (citing
In re Sauer-Danfoss Inc. S’holders Litigation, 65 A.3d 1116, 1132 (Del. Ch.
69
2011); In re Lukens Inc. S’holders Litigation, 757 A.2d 720, 736 (Del. Ch.
1999), aff’d sub nom Walker v. Lukens, Inc., 757 A.2d 1278 (Del. 2000); In re
Plains Expl. & Prod. Co. Stockholder Litigation, C.A. No. 8090-VCN, 2013 WL
1909124, at *10 (Del. Ch. May 9, 2013)). These cases did not involve Section
14(a) suits alleging that proxy statements omitted material facts. They involved
suits brought in Delaware state court for breach of fiduciary duty. The cited
cases admittedly make a logical point; the court in Sauer-Danfoss reasoned
that
[o]mitting a statement that the board did not do something is not
material, because “requiring disclosure of every material event that
occurred and every decision not to pursue another option would
make proxy statements so voluminous that they would be practically
useless.” In re Lukens Inc. S’holders Litig., 757 A.2d 720, 736 (Del.
Ch. 1999). If a disclosure document does not say that the board or
advisors did something, then the reader can infer that it did not
happen. See In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d
171, 204 (Del. Ch. 2007) (“[S]o long as what the investment banker
did is fairly disclosed, there is no obligation to disclose what the
investment banker did not do.”)
Sauer-Danfoss, 65 A.3d at 1132. But the defendants have not cited a federal
case applying the same reasoning in a Section 14(a) suit—particularly the
holding that if a proxy statement does not say that the board or advisors did
something, they can be presumed not to have done it.
There is a federal case from this circuit—decided long after the parties
briefed the motion—that analyzes “how much information is enough” in the
context of Section 14(a) claims. In Kuebler, Judge Hamilton wrote:
In TSC Industries, the Supreme Court explained the logic
underpinning the materiality standard and its requirement that a
reasonable investor would have viewed the omitted fact “as having
70
significantly altered the ‘total mix’ of information made available.”
426 U.S. at 449 . . . . The Court emphasized that “the disclosure
policy embodied in the proxy regulations is not without limit.” Id. at
448 . . ., citing Mills, 396 U.S. at 384 . . . . To that effect, the Court
reasoned that:
if the standard of materiality is unnecessarily low, not only
may the corporation and its management be subjected to
liability for insignificant omissions … but also management’s
fear of exposing itself to substantial liability may cause it
simply to bury the shareholders in an avalanche of trivial
information.
Id. The goal is to strike the proper balance between “not enough”
information and an “avalanche” of information.
TSC Industries rejected this court’s more expansive standard of
materiality, under which material facts had included “all facts which
a reasonable shareholder might consider important.” Id. at 445 . . .
, quoting Northway, Inc. v. TSC Industries, Inc., 512 F.2d 324, 330
(7th Cir. 1975) (emphasis added). Such a standard, the Court
reasoned, painted the operative inquiry in broad brushstrokes
unintended by the Court’s earlier decisions. Id. at 446-47 . . .; see,
e.g., Mills, 396 U.S. at 381 . . . (Section 14(a)’s purpose is to ensure
that disclosures by corporate management enable shareholders to
make informed choices). Rather, the Court explained, the function
of the materiality standard was to evaluate whether there was a
substantial likelihood that a reasonable shareholder would have
considered the omitted fact important in deciding how to vote. TSC
Industries, 426 U.S. at 449 . . . . It made sense, then, to formulate a
standard of materiality that acknowledged the value of the omitted
information in light of the total mix of information made available to
shareholders. Id. Because shareholders did not decide how to vote
in the abstract, it did not make sense to assess the value of an
omitted fact in the abstract.
Kuebler, 13 F.4th at 641-42.
This brings the court to the defendants’ more specific arguments about
what, exactly, the proxy statement disclosed. The proxy statement provided
over 540 pages of information. The amended complaint itself asserts that the
proxy statement informed shareholders:
71
*
that the receipt of ordinary shares in JCplc and/or cash
in exchange for Johnson Controls common stock as part of the
merger would be treated as a taxable transaction for federal income
tax purposes, dkt. no. 53 at ¶185;15
*
that the merger would be effectuated through a
Wisconsin limited liability company (Merger Sub), which was formed
in January 2016 for the sole purpose of effecting the merger and
which would merge with Johnson Controls and result in Johnson
Controls becoming an indirect, wholly owned subsidiary of Tyco, id.
at ¶188;
*
that in July 2015 Johnson Controls had announced
that it would spin-off the Automotive Experience business as Adient,
that it expected to complete the spin-off after the consummation of
the merger, that it was expected that the spin-off would “generally”
proceed in “substantially” the same manner as originally planned
and on the same timeline, that there was no assurance that the
separation would occur on that timeline or at all or in the same
manner, that the terms of the separation might change and that the
new company and its shareholders might not realize the potential
benefits from the spin-off, id. at ¶194;
*
that the merger would be structured as a “reverse
merger” with Tyco becoming the parent entity, id. at ¶201;
*
that each share of Johnson Controls stock would be
converted, at the shareholder’s election, into either one share of new
company’s stock or $34.88 in cash, with JCI shareholders receiving
approximately $3.864 billion in cash, id.;
*
that elections would be subject to proration, meaning
that depending on the elections made by other JCI shareholders, a
particular shareholder might not receive the amount of cash or
number of shares she requested on her election form, id.;
*
that because the market value of JCI and Tyco shares
would fluctuate, JCI shareholders could not be sure of the value of
the consideration they would receive, id.;
*
that just before the merger, Tyco shareholders would
The amended complaint reproduces multiple sections of the S-4 that
reference each of the pieces of information listed in the text above. In the
interest of relative brevity, the court has cited only one source paragraph for
each piece of information.
15
72
receive 0.955 shares of Tyco, which would convert to one share of
the new company, and that the implied value of the 0.955 Tyco share
as of July 5, 2016 was approximately $40.86, id.;
*
that Tyco would finance the transaction with $4,000
million in debt through credit agreements with Citibank, Citigroup,
Merrill Lynch, Wells Faro and JP Morgan Chase, id.;
*
that 26 U.S.C. ¶7874 would result in consequences if
the “60% ownership test” was met, including the imposition of a 15%
excise tax rate on certain “disqualified individuals” under 26 U.S.C.
§4985, id. at ¶207;
*
that the merger agreement allowed Johnson Controls
and Tyco to enter into agreements reimbursing their directors and
officers for any excise taxes imposed on them under §4985, id.;
*
that certain tax regulations could adversely affect the
new company’s ability to “realize the $150 million of previously
identified annual U.S. tax synergies of the merger), that there could
be other “global” tax synergies, and that former JCI shareholders
would bear 56% of those potential adverse consequences and former
Tyco shareholders would bear 44%, id. at ¶209;
*
that the financial advisors had performed calculations
to try to calculate the “present value of the operational synergies and
tax synergies anticipated to be achieved as a result of the proposed
transaction” (with an explanation of those calculations), id.;
*
that the financial advisors had concluded that the
merger was “fair” to shareholders (with detailed explanations of what
factors the financial advisors had and had not considered in
reaching those opinions), id. at ¶¶214, 216-217, 219, 221;
*
that the JCI board had concluded that the merger was
fair to common stock holders and that the board recommended that
shareholders vote in favor of the merger, id. at ¶223;
*
that Johnson Controls shareholders would have a
reduced ownership and voting interest after the merger and would
exercise less influence over management, id. at ¶228;
*
that under §7874, if JCI shareholders owned 80% or
more of the new equity in the new company and the new company
did not have “substantial business activities” in Ireland, the IRS
could treat the new company as a U.S. company for tax purposes,
73
id.;
*
that under the same statute, if JCI shareholders owned
between 60% and 80% of the equity in the new company and the
new company didn’t do substantial business in Ireland, there could
be certain adverse tax consequences to Johnson Controls and its
U.S. affiliates (“which, among other things, could limit their ability
to utilize certain U.S. tax attributes to offset U.S. taxable income or
gain resulting from certain transactions”), id.;
*
that Johnson Controls shareholders were expected to
own less than 60% of the equity in the new company, id.; and
*
that the rules under §7874 were fairly new and complex
and so “there can be no assurance that the [IRS] will agree with the
position that the [new company] should not be treated as a U.S.
corporation for U.S. federal tax purposes or that Section 7874 does
not otherwise apply as a result of the merger,” id.
The amended complaint also reproduces numerous excerpts from the S-4
disclosing financial data, as well as information about how share cost, earnings
per share, present values for JCI and Tyco, the exchange ratio, the percentage
of JCI equity in the new company, the total merger consideration and other
financial elements of the merger were calculated. Dkt. No. 53 at ¶¶231-242.
And the amended complaint reproduces sections of the S-4 advising
shareholders to consult with their own financial and legal advisors before
making their elections. See, e.g., id. at ¶201(i). The sheer volume of information
provided in the proxy statement weighs against a finding that the alleged
omissions are material.
Also weighing against a materiality determination is the fact that the
plaintiffs’ arguments rely on assumptions, requiring the court to consider the
value of omitted facts in the abstract. Their argument depends on the
assumption that there existed a way to successfully merge JCI and Tyco
74
without the new company being reincorporated in Ireland; if there was no other
way to structure the merger, the proxy statement omitted nothing in that
regard.16 Their argument that the $34.88 share price for JCI stock was a 25%
discount is an assumption, based on the plaintiffs’ own selection of a price
calculation method using the financial advisors’ projections reflected in the
proxy statement. Because they are assumptions, it is difficult to conclude that
the alleged omissions were material facts that a reasonable investor would have
considered important in deciding how to vote.
The plaintiffs’ arguments imply that Section 14(a) and Rule 14a-9
required the decision makers to select the form of transaction that was most
fair to its shareholders. But as the Supreme Court has explained in the context
of Section 10(b) of the Securities and Exchange Act and the accompanying Rule
10b-5, the “fundamental purpose” of the Securities and Exchange Act is to
“implement[] a ‘philosophy of full disclosure.’” Santa Fe Indus., Inc. v. Green,
430 U.S. 462, 477-78 (1977) (citing Affiliated Ute Citizens v. United States, 406
U.S. 128, 151 (1972)). For that reason, “the fairness of the transaction is at
most a tangential concern of the statute.” Id. The Santa Fe Court stated that it
was “reluctant to recognize a cause of action . . . to serve what is ‘at best a
subsidiary purpose’ of the federal legislation.” Id. at 478.17
The defendants assert, without citation, that “Plaintiffs’ counsel confirmed
that Tyco, which had already domiciled in Ireland, likely would not have
accepted a different structure.” Dkt. No. 72 at 2.
16
On the other hand, proof that the merger was “fair” does not foreclose
Section 14(a) liability. Mills, 396 U.S. at 381.
17
75
As the court noted, the amended complaint reproduces multiple pages
from the S-4 disclosing financial data and explaining how the parties reached
certain valuations and financial conclusions. The plaintiffs argue that despite
the amount of information disclosed, the disclosures were misleading because
they “created the illusion that the allocation of JCplc’s equity between JCI and
Tyco shareholders was based solely on such data and factors” and because the
S-4 failed to disclose that “[t]hese financial data and the other matters recited
in said paragraphs were not the only factors in determining the allocation of
JCplc’s equity between JCI and Tyco shareholders but that factors wholly
unrelated to such financial and other data improperly influenced the
determination of such allocation.” Dkt. No. 53 at ¶243. The plaintiffs do not
assert that the S-4 did not give them enough financial data. That would be a
difficult claim to support. “[S]hareholders are not entitled to the disclosure of
every financial input used by a financial advisor so that they may double-check
every aspect of both the advisor’s math and its judgment.” Kuebler, 13 F.4th at
643-44. “Section 14(a) is not a license for shareholders to acquire all the
information needed to act as a sort of super-appraiser: appraising the
appraiser’s appraisal after the fact.” Id. Nor do the plaintiffs claim that the
extensive financial data in the S-4 was false. Rather, they read into the proxy
statement a representation that is not there: that the decision-makers made
their choices about merger structure and share price based solely on the
financial information in the paragraphs the plaintiffs reproduce. The S-4 does
not say that.
76
Nor does the fact that the plaintiffs would have liked more information
render the omitted information material. As the Seventh Circuit held in Beck,
“there is nothing in the complaint to suggest that any shareholder was misled
or was likely to be misled by the dearth of backup information—that is, that
the shareholder drew a wrong inference from that dearth.” Beck, 559 F.3d at
685.
What weighs most heavily against a finding of materiality is the fact that,
despite being framed as Section 14(a)/Rule 14a-9 arguments that the S-4 was
false or misleading, the plaintiffs’ arguments boil down to a claim that the
defendants breached their fiduciary duties to their shareholders by failing to
act in the shareholders’ best interests. The plaintiffs have not alleged that the
information in the S-4 was false. They have alleged that the defendants did not
structure the merger or price the JCI shares in a way that would avoid
personal tax liability to the JCI shareholders when they had the ability to do
so.
In 1977, the Supreme Court rejected the argument that “a breach of
fiduciary duty by majority stockholders, without any deception,
misrepresentation, or nondisclosure, violates [Section 10(b) and Rule 10b-5].”
Santa Fe, 430 U.S. at 476. Four years later, in the context of reviewing a
district court’s grant of a motion for a directed verdict, the Seventh Circuit
considered whether a shareholder could claim a breach of fiduciary duty via a
Section 10(b)/Rule 10b-5 claim. Panter v. Marshall Field & Co., 646 F.2d 271
(7th Cir. 1981). The plaintiff shareholders had alleged that the defendants’
77
directors had “wrongfully deprived [them] of an opportunity to dispose of their
shares at a substantial premium over market when the defendants successfully
fended off a takeover attempt . . . .” Id. at 277. They asserted that the directors
had acted in accordance with a “long-standing undisclosed policy of
independence and resistance to all takeover attempts, designed to perpetuate
the defendant directors’ control of the corporation.” Id. at 287. They claimed
that the defendants’ “failure to disclose this policy was an omission of a
material fact which made other statements and conduct of the defendants
misleading.” Id.
In concluding that this argument was nothing more than a claim for
breach of fiduciary duty, the Seventh Circuit explained:
As the Supreme Court noted in Santa Fe Industries, Inc. v. Green,
430 U.S. 462, 47-78 . . . (1977), [Rule 10b-5] is a manifestation of
the “philosophy of full disclosure,” embodied in the Securities
Exchange Act of 1934; it therefore requires proof of the element of
deception, and does not provide a remedy for the breach of fiduciary
duty a director owes his corporation and its shareholders under the
law. See In re Sunshine Mining Securities Litigation, (1979-80
Transfer Binder) Fed.Sec.L.Rep. (CCH) P97, 217 at 96, 635 (S.D.N.Y.
1979) (An interpretation of 10b-5 “which would include instances of
corporate mismanagement where shareholders were treated unfairly
by a fiduciary, however, would be wholly inconsistent with the
Congressional intent.”).
In the wake of Santa Fe, courts have consistently held that since a
shareholder cannot recover under 10b-5 for a breach of fiduciary
duty, neither can he “bootstrap” such a claim into a federal
securities action by alleging that the disclosure philosophy of the
statute obligates defendants to reveal either the culpability of their
activities, or their impure motives for entering the allegedly improper
transaction. See, e.g., Bucher v. Schumway, (1979-80 Transfer
Binder) Fed.Sec.L.Rep. (CCH) P 97,142 at 96,300 (S.D.N.Y. 1979),
aff’d, 622 F.2d 572 (2d Cir.), cert denied, — U.S. —, 101 S. Ct. 120
. . . (1980) (“The securities laws, while their central insistence is
upon disclosure, were never intended to attempt any such measures
78
of psychoanalysis or preported (sic) self-analysis.”)
Id. at 287-88.
The Seventh Circuit has reiterated this holding since. See Atchley v.
Qonaar Corp., 704 F.2d 355, 358 (7th Cir. 1983); Kademian v. Ladish, 792
F.2d 614, 622 (7th Cir. 1986) (proxy statement’s omission of a “market freeze”
allegedly perpetrated by president and board chairman and his alleged selfinterest in controlling the company prices and keeping them artificially low was
“simply a failure to reveal a breach of fiduciary duty, and this court has already
held, in [Panter] . . . that a plaintiff may not ‘bootstrap’ a state law claim into a
federal case ‘by alleging that the disclosure philosophy of the statute obligates
defendants to reveal either the culpability of their activities, or their impure
motives for entering the allegedly improper transaction.’”). See also, Dixon v.
Ladish Co., 597 F. Supp. 20, 23 (E.D. Wis. 1984) rev’d in part on other grounds
by Kademian, 792 F.2d at 630 (citing Panter for the proposition that “[i]t is . . .
fundamental that the securities laws do not penalize traders merely for failing
or refusing to confess their ‘true’ motives or characterize the fairness of the
transaction.”); Coronet Ins. Co. v. Seyfarth, 665 F. Supp. 661, 667-68 (N.D. Ill.
1987) (“The critical issue, according to the Panter and Kademian courts, is not
whether the defendant breached a fiduciary duty or failed to disclose a breach
of duty or the reason behind a breach of duty, but ‘whether the conduct
complained of includes the omission or misrepresentation of a material fact.’”);
Washington Bancorporation v. Washington, No. CIV. A. 88-3111 (RCL), 1989
WL 180755, at *17 (D.D.C. Sept. 26, 1989) (“Accordingly, a party does not state
79
a claim under section 14(a) ‘where the failure to disclose involves the “true”
motivations of the directors and so would require a court to probe the business
judgment of the directors.’”).18
The Third Circuit cited Panter in stating that “we must be alert to ensure
that the purpose of Santa Fe is not undermined by ‘artful legal draftsmanship;’
claims essentially grounded on corporate mismanagement are not cognizable
under federal law.” Craftmatic Securities Litigation v. Kraftsow, 890 F.2d 628,
638 (3d Cir. 1989) (citing Panter, 646 F.2d at 288). The Ninth Circuit cited
Panter in upholding a grant of summary judgment for the defendants in a case
where the plaintiffs had alleged that the undisclosed purpose behind the
merger was to prevent competition with another company. Bleich v. American
Network, Inc., 958 F.2d 376 (Table), 1992 WL 55855, at *5 (9th Cir. Mar. 23,
1992).
The omitted information described in the amended complaint is not
material to a claim of a violation of Section14(a)/Rule 14a-9 because it does not
render the statements in the S-4 false or misleading and that is because it
asserts violations of the defendants’ fiduciary duties to the shareholders, not
The Second Circuit has “long recognized that no general cause of action lies
under § 14(a) to remedy a simple breach of fiduciary duty.” Koppel, 167 F.3d at
133-34 (citations omitted) (characterizing the plaintiffs’ allegations that
decision-makers did not recommend a more cost-effective alternative, failed to
disclose conflicts of interest and implemented an unreasonably coercive buyback provision were “no more than state law breach of fiduciary duty claims
under a thin coat of federal paint.”). The Koppel court found that to the extent
that the plaintiffs were harmed by such misstatements or omissions, “they may
seek their remedies through state fiduciary breach law, not through federal
securities law.” Id. at 134.
18
80
fraud. The plaintiffs’ counsel almost conceded as much at the October 2019
hearing. During the hearing, the plaintiffs’ counsel told the court that this case
raised a basic question of “whether structuring a deal to avoid taxes can give
rise to breach of a fiduciary duty and under federal securities law for
undisclosed facts when such avoidance was achieved at the expense of
shareholders.” Dkt. No. 68 at approximately 24:12. He also told the court that
the fiduciary relationship had been riddled with conflicts.
In arguing at the hearing that the court should not dismiss the Section
14(a)/Rule 14a-9 claim, the plaintiffs’ counsel urged the court to look at Kas v.
Fin. Gen. Bankshares, Inc., 796 F.2d 508, 512-13 (D.C. Cir. 1986). Kas
involved allegations of omissions or misrepresentations in the Section 10(b)
proxy statement issued in relation to the merger of Financial General
Bankshares, Inc. and FGB Holding Corporation; the D.C. Circuit concluded
that the failure to disclose in the Rule 10b-5 statement the fact that two of the
directors of Financial General “served not only as officers, directors, and legal
advisors for Financial General but also as attorneys for the Investors and as
attorneys, officers and directors for the Investors’ various corporate vehicles,
including FGB Holding Corporation,” could not be considered immaterial as a
matter of law for disclosure purposes. Id. at 511, 515. The court concluded
that their “dual roles would in all probability have assumed actual significance
in the deliberations of a reasonable shareholder.” Id. (citing TSC Industries,
426 U.S. 438). The court found, however, that the proxy statement had
disclosed the dual roles. Id. at 515-517.
81
Kas does not support the plaintiffs’ argument; it undermines it. Aside
from the factual distinction—the plaintiffs have not alleged that any of the
individual defendants on the JCI side of the merger also acted as advisors to
investors and/or Tyco—the Kas court’s explanation of the difference between
an allegation of a breach of fiduciary duty in federal securities law clothing and
an allegation of a breach of the Securities Exchange Act illustrates why the
plaintiffs in this case have not stated a claim under Section 14(a)/Rule 14a-9.
The Kas court began by stating that “an action under the Securities
Exchange Act based on a material nondisclosure or misrepresentation” is not
precluded “simply because the undisclosed facts involved might also support a
breach of fiduciary duty claim.” Id. at 512. It reasoned that “Santa Fe requires
a court to distinguish between an actionable omission or misrepresentation of
a material fact and a claim solely for breach of a state-law fiduciary duty.” Id.
at 513. The court conceded that “[t]his distinction has admittedly proven
somewhat difficult to apply in practice,” and cited Panter’s holding that a
plaintiff could not “bootstrap” claims of breaches of fiduciary duties into federal
securities claims simply by “alleging that directors failed to disclose that breach
of fiduciary duty.” Id. The court said, “This is true even though knowledge that
an officer or director had actually breached his fiduciary duty might well satisfy
the materiality requirement that the omitted or misstated fact be likely to ‘have
assumed actual significance in deliberations of the reasonable shareholder.’
TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 . . . (1976)).” Id.
The Kas court turned to the Supreme Court’s decision in Santa Fe to
82
help “resolve this apparent tension.” Id. It concluded that “liability under the
federal securities laws should not turn on the resolution of essentially state-law
issues,” and held that
if the validity of a shareholder’s claim of material misstatement or
nondisclosure rests solely on a legal determination that the
transaction was unfair to a minority shareholder or that an officer
or director’s conduct amounted to a breach of his fiduciary duty, the
claim does not state a cause of action under sections 10(b) or 14(a)
of the Securities Exchange Act. Similarly, where the failure to
disclose involves the “true” motivations of the directors and so would
require a court to probe the business judgment of the directors,
Santa Fe holds that the claim states no cause of action under the
1934 Act.
Id.
The validity of the plaintiffs’ claims of false or misleading statements in
the S-4 rests solely on determinations that the merger was not structured or
priced fairly to shareholders who held their JCI shares in taxable accounts and
that the JCI defendants breached their fiduciary duties to the JCI
shareholders. Many of the alleged omissions are failures to disclose the “true”
motivations of the individual defendants on the JCI side of the merger. Under
the reasoning in Kas, the plaintiffs have not stated a Section 14(a)/Rule 14a-9
claim.
At the October 2019 hearing, the plaintiffs argued that it was not
appropriate for the court to determine materiality as a matter of law at the
pleadings stage. “A court may resolve the question of materiality as a matter of
law . . . when the information at issue is ‘so obviously unimportant’ to an
investor ‘that reasonable minds could not differ on the question.’” Kuebler, 13
F.4th at 638 (quoting Ganino v. Citizens Utilities Co., 228 F.3d 154, 162 (2d
83
Cir. 2000)). As the Supreme Court observed in TSC Industries, the materiality
determination “requires delicate assessments of the inferences a ‘reasonable
shareholder’ would draw from a given set of facts and the significance of those
inferences to him, and these assessments are peculiarly ones for the trier of
fact.” TSC Industries, 426 U.S. at 450. So the court has proceeded cautiously
in evaluating the defendants’ arguments that none of the alleged omissions
from the S-4 were material as a matter of law. But after paging through the
amended complaint repeatedly, the court concludes that the alleged omissions
are not material to a Section 14(a)/Rule 14a-9 claim—not because they may
not have been of interest to shareholders deciding whether to approve the
merger or how to make their post-merger elections, but because they are
fiduciary duty claims under a thin coat of federal paint.
3.
The amended complaint fails to plea loss causation.
In an abundance of caution, the court also considers the defendants’
arguments that the plaintiffs have not pled the second element of a Section
14(a)/Rule 14a-9 claim—that the alleged false statements or omissions caused
injury to the plaintiffs.
As stated, there are two components to “causation” in securities law—
transaction causation and loss causation. Kuebler, 13 F.4th at 637. If a
plaintiff alleges and proves materiality, she does not have to prove that she
relied on the particular false statement or omission in the proxy statement. Id.
(citing Mills, 396 U.S. 384-85). “The proxy solicitation itself serves as the
causal link in the transaction—that the challenged violation(s) caused the
84
plaintiff to engage in the alleged transaction.” Id. Putting it another way, “where
a materially deficient proxy statement was an essential link in the
consummation of a transaction that the plaintiff alleges caused him financial
harm,” he demonstrates transaction causation. Id. at 645. The plaintiffs cannot
demonstrate transaction causation because the S-4 was not materially
deficient.
“To plead loss causation, a Section 14(a) plaintiff must plead both
economic loss and proximate causation.” Id. (citing 15 U.S.C. § 78u-4(b)(4);
Dura Pharmaceuticals, 544 U.S. at 342; N.Y. City Emps.’ Ret. Sys., 593 F.3d at
1023; Grace, 228 F.3d at 46). The plaintiffs have not done so.
Count I of the amended complaint contains ten paragraphs—¶¶302-311.
The paragraphs reproduce the text of Section 14(a) and Rule 14a-9. Dkt. No. 53
at ¶¶303-304. Paragraph 307 alleges that the defendants violated the statute
and the rule (as well as Rule 14a-101). Id. at ¶307. The remaining paragraphs
discuss “controlling person” liability under Section 20. There is no mention of
injury, economic loss or proximate causation.
The amended complaint contains a section titled “The Injuries and the
Injured.” Dkt. No. 53 at 25. In this section—as they do throughout the
amended complaint—the plaintiffs allege that they had been and would be
forced to pay capital gains (and possibly ordinary income) taxes on the
consideration they received from the merger, that they were doubly taxed on
85
the “delayed” Adient spin-off,19 that their equity in the new company was kept
below 60% and thus diluted,20 and that their shares were purposefully
undervalued. Id. at ¶60. These allegations do not state a claim for economic
loss. There is no allegation that the plaintiffs would have been in a better
economic position had the merger not occurred (and they state early in the
amended complaint that they do not “take issue with the purported business or
financial merits of the Merger,” dkt. no. 53 at ¶8). While they imply that the
merger could have been structured differently—without reincorporation in
Ireland, without ensuring that the JCI shareholders ended up with less than
60% of the equity of the new company, without allegedly undervaluing the JCI
shares, without the Adient spin-off being delayed until after the merger was
consummated—the plaintiffs have not alleged that the merger would have
been, or could have been, consummated had it been structured in the ways
they hypothesize.
The amended complaint alleges that the plaintiffs were economically
harmed by having to pay capital gains, and possibly ordinary income, taxes on
the consideration they received due to the merger. But it does not allege that
This argument appears to apply only to those plaintiffs who elected to receive
JCplc stock as some or all of their merger consideration.
19
This argument appears to apply only to the plaintiffs who elected to receive
JCplc stock as some or all of their consideration for the merger. And as the
defendants point out, at least one federal appellate court has concluded that a
claim of dilution of shareholders’ interests does not necessarily equate to
economic loss and has found allegations of dilution insufficient to adequately
plead economic loss under Section 14(a). Dkt. No. 56 at 32-33 (citing N.Y. City
Emps.’ Ret. Sys., 593 F.3d at 1024).
20
86
the plaintiffs would have been economically better off had the merger been
structured in such a way that the new company was taxed under U.S. tax laws.
It alleges that such a hypothetical structure would have avoided tax
consequences to the plaintiffs personally, but that is only part of a complicated
equation. If the new company had been subject to higher U.S. tax rates on all
income, regardless of where the company earned it, that fact would have
affected the terms of the financial agreement between Tyco and JCI, the
calculation of share price for both JCI and Tyco shares, the value of the new
company and the new company’s profits (a relevant factor for valuing the
consideration of any shareholders who elected to receive new company stock).
The plaintiffs’ assertions of economic loss are, at best, speculative. For
example, they allege the following:
From January 4, 2016 to September 2, 2016, JCI’s shares traded
between $35 and $46 per share. Assuming that 100% of JCI’s shares
turned over at the median price of $40 per share between January
4 to September 2 (see ¶¶ 160-161 supra) and given that the market
value of JCI’s stock was $42.72 on the closing date, September 2,
the cost basis of JCI shareholders’ shares would range from $35 to
$46 per share (see ¶ 157 supra), JCI shareholders’ theoretical
§ 367(a) taxable gain would be dramatically reduced, making it likely
that JCI’s 367(b) income would exceed the shareholders’ 367(a) gain.
Accordingly, JCI could—and should—have chosen to structure the
transaction so as to spare the JCI shareholders from being forced to
pay capital gains taxes by subjecting JCI to tax under § 367(b), and
the Individual Defendants’ fiduciary duties to JCI public
shareholders required them to so choose.
Id. at ¶169. The plaintiffs assume and theorize and hypothesize—that JCI and
Tyco could have reached an agreement to reincorporate the new company in
the United States; that JCI could have completed the Adient spin-off before the
JCI/Tyco merger; that JCI shares would have had a median price of $40 had
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the merger been structured to make all the new company’s income taxable
under the U.S. tax code—but assumptions, theories and hypotheses do not
equate to facially plausible allegations of economic loss.
The amended complaint says that the plaintiffs are seeking
(1) to compel JCI to compute and disclose its estimate of the JCI
shareholders’ capital gains pursuant to [26 U.S.C.] § 367(a) and
JCI’s potential tax liability pursuant to [26 U.S.C.] § 367(b) with
reasonable certainty; (2) if JCI’s shareholders’ taxable capital gains
are higher than JCI’s taxable income, damages or other remedies to
compensate
JCI’s
tax
paying
shareholders
for
such
Inversion/Merger-imposed taxes; (3) damages and other remedies
for being deprived of a tax-free spin-off of Adient . . . .
¶59. This wording of the requested relief implies that at the time they filed the
amended complaint, the plaintiffs did not know whether the merger was likely
to result in a total taxable gain to them that would exceed the total taxable gain
to (presumably) the new company. And it is not clear from the amended
complaint that if “JCI’s taxable income”21 was less than “JCI shareholders’
taxable capital gains,”22 that would equate to economic loss to the plaintiffs.
A final note on this element: the defendants argued in their written
pleadings and at the October 2019 hearing that the plaintiffs filed this lawsuit
even though they had accumulated gains due to the merger. The defendants
imply that for someone who made money from a merger to argue that being
taxed on that money constitutes a loss makes an absurd and frivolous
21
The pre-merger entity’s taxable income? During what period?
During what period? Gains resulting from receiving cash consideration?
Gains resulting from increased basis in shares of the new company?
22
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argument. Toward the end of the amended complaint, the plaintiffs included a
section titled “Damages.” Id. at 165. They alleged the following:
292. The damages suffered by the Minority Subclass are
particularly acute. Many Minority Subclass members are either
retired or nearing retirement. Many obtained their shares in the
course of their JCI employment (or employment by a company
acquired by JCI) or inherited their JCI shares from a parent who was
employed by JCI. Accordingly, their cost basis is very low—i.e., the
capital gain as a percentage of the market value of JCI shares on
September 2 was very high. These retirees generally saw their JCI
investment as a demonstration of their loyalty to JCI; JCI
encouraged its employees to invest in its shares. Dkt. Nos. 16-2644, 47.
293. For these retirees, their JCI shares were a substantial,
if not the major, part of their retirement savings. The JCI dividend
was a substantial part of their fixed retirement income. The need to
pay the Inversion/Merger-imposed taxes will permanently deprive
them of the income attributable to the shares they have been or will
be forced to sell to pay such taxes. Id.
294. A provision in the federal income tax laws encouraged
employees who invested in their employer’s stock in their employer’s
401(k) plan, and whose investments were matched by their
employer, to hold their shares after retirement in a taxable account,
instead of an IRA. Because of their low basis, JCI’s history of
substantial dividends, their belief in the company for which they or
their father or mother worked, and their expectation to pass their
JCI shares to their heirs at the stepped-up basis at death, they were
reasonably motivated to retain their JCI shares. This financial and
tax planning, wholly in accordance with the [Internal Revenue Code]
and encouraged by JCI, has been devastatingly disrupted by the JCI
Defendants’ decision to shift to them JCI’s liability for its inversionimposed taxes.
Id. at ¶¶292-294.
In other words, the plaintiffs assert that not all of the plaintiffs who held
their JCI shares in taxable accounts were well-heeled, experienced market
players who were wealthy enough to purchase lots of shares of stock in a large,
publicly traded company; many earned their shares through hard work or
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inherited them from those who had earned them that way. They allege that the
tax laws gave them an incentive to hold the shares in taxable accounts instead
of in individual retirement accounts. They allege that they had good reasons—
some emotional, some financial—not to sell their JCI shares. They allege that
they banked on the JCI dividends, and the value of the shares, to fund their
retirements and their legacies to their children. The amended complaint alleges
that some of these plaintiffs sold those JCI shares before the merger for no
other reason but to avoid the taxes that they learned would be imposed on the
merger consideration. Id. at ¶64(b). It alleges that others sold the shares for no
other reason than to obtain more than the $34.88-per-share “substantial[ly]
discount[ed]” price set for the merger. Id. It alleges that still others held on to
their shares until the merger, then made their elections—cash, JCplc shares or
a combination of the two—and were subjected to tax consequences. Id. Finally,
it alleges that some of the plaintiffs either, or also, “received the Adient spin-off
as of October 21, 2016.” Id.
In finding that the plaintiffs have not pleaded loss causation, the court
does not take the above allegations lightly. The court does not base its ruling
on some belief that the plaintiffs are rich people crying “woe is me” because
they have made so much money that they must pay taxes on it. The court
comprehends that many of the plaintiffs find themselves, at a critical stage of
their lives, in a different financial position than they had anticipated before the
merger was agreed upon or consummated—perhaps a worse one. But even
those claims to do not plausibly state a claim for economic loss. Each group of
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plaintiffs save one can state a claim for economic loss only if it can plausibly
allege (not hypothesize or speculate) that there was a viable merger option that
would have resulted in no tax consequences to the shareholders who held their
JCI shares in taxable accounts. And for the group that accepted JCplc shares
as consideration, there is the complicating factor of how to compare the
consideration the members received with their pre-merger assets. Did they
suffer an economic “loss” if the receipt of JCplc shares created no increase in
taxable basis? Did they suffer an economic “loss” if the value of the JCplc
shares increased in value such that even with increased basis, the plaintiffs
still realized gains after taxes? Did they suffer an economic loss if their taxable
basis decreased after the merger? At what point is the “loss” or “gain” to be
measured?
As the Seventh Circuit has said, the plaintiffs’ economic loss allegations
are “heavy on hindsight and speculation, [and] light on verifiable fact.” Kuebler,
13 F.4th at 647 (quoting Beck, 559 U.S. at 684)). The plaintiffs have failed to
plead economic loss.
4.
The defendants’ remaining arguments are moot.
Count I of the complaint names “the JCI Defendants.” Dkt. No. 53 at
170. It defines “the JCI Defendants” as “the Individual Defendants and JCI . . .
collectively.” Id. at ¶49. It defines the “Individual Defendants” as Molinaroli,
Stief, Guyett, Janowski, Abney, Black, Bushman, Conner, Goodman, Joerres,
the Lacy Estate, del Valle Perochena and Vergnano. Id. at ¶45.
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Count I asserts that each of these defendants “solicited proxies from JCI
shareholders for their approval of the Inversion/Merger, including the Merger
Agreement, by use of a proxy statement that was false and misleading when
published . . . .” Id. at ¶307. It also asserts that “[e]ach of the Individual
JCI/JCplc Defendants” consented to being named in the proxy statement as a
person who would become a director of the new company. Id. at ¶310. The
defendants interpret this last assertion as an allegation that only the Individual
JCI/JCplc defendants—defined in the amended complaint as those JCI officers
or directors who were going to become officers or directors of the new company,
dkt. no. 53 at ¶45—consented to the filing of the proxy statement. Dkt. No. 56
at 33-34. They argue that if the other individual defendants did not consent to
the filing of the proxy statement, the plaintiffs could not have stated a claim
against them. Id. at 34. The plaintiffs did not respond to this argument and the
court believes that the defendants misread the allegation in ¶310 of the
amended complaint; it does not say that only the Individual JCI/JCplc
defendants consented to the filing of the proxy statement. It says that each of
the Individual JCI/JCplc defendants agreed to be named in that statement “as
a person who will become a director of the [new] Company.” Nonetheless, the
defendants’ argument that the plaintiffs did not state a Section 14(a) claim
against individual defendants is moot because the court has concluded that
the plaintiffs have not stated a Section 14(a) claim against any defendant.
Finally, Count I of the amended complaint alleges that “[t]he Individual
Defendants, or the Individual JCI/JCplc Defendants, as relevant, were and/or
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are controlling persons of JCI/JCplc within the meaning of Exchange Act
§ 20(a).” Id. at ¶309. Title 15, U.S.C. §78t(a) states that
Every person who, directly or indirectly, controls any person liable
under any provision of this chapter or of any rule or regulation
thereunder shall also be liable jointly and severally with and to the
same extent as such controlled person to any person to whom such
controlled person is liable . . . unless the controlling person acted in
good faith and did not directly or indirectly induce the act or acts
constituting the violation or cause of action.
The defendants asserted in the motion to dismiss that because the
amended complaint did not state a claim for a violation of Section 14(a) and
Rule 14a-9, it could not state a “controlling persons” claim against the
individual defendants. Dkt. No. 56 at 34. They also argued that the plaintiffs
alleged only that the individual defendants were controlling persons because
they either controlled or were officers or directors of JCI and materially
participated in the conduct alleged in the complaint, asserting that these bare
legal conclusions were not sufficient to state a claim for “controlling person”
liability. Id. The plaintiffs disagreed, stating that they had pled that the
individual defendants had “both control over JCI and the power to control or
determine the terms of the transaction at issue.” Dkt. No. 58 at 30. Because
the plaintiffs have not stated a Section 14(a)/Rule 14a-9 claim, they cannot
state a Section 20(a) “controlling persons” claim and the defendants’ argument
is moot.
5.
Conclusion
The plaintiffs have failed to plead the first and second elements of a
Section 14(a)/Rule 14a-9 securities fraud claim—material omissions and loss
93
causation. It would be futile to allow the plaintiffs to amend the complaint a
second time to try to cure this defect, because the plaintiffs’ allegations are
claims of breach of fiduciary duty masquerading as securities fraud claims. The
court will grant the defendants’ motion to dismiss Count I of the amended
complaint with prejudice.
B.
Count II: Violation of the Taxpayer Bill of Rights II (26 U.S.C.
§7434(a))
1.
Applicable Law
Title 26, U.S.C. §7434(a) states that “[i]f any person willfully files a
fraudulent information return with respect to payments purported to be made
to any other person, such other person may bring a civil action for damages
against the person so filing such return.” The statute “creates a private right of
action against anyone who ‘willfully files a fraudulent information return with
respect to payments purported to be made’ to the plaintiff.” Cavoto v. Hayes,
634 F.3d 921, 923 (7th Cir. 2011).
Section 7434(f) of the statute defines “information return” as “any
statement described in section 6724(d)(1)(A).” That section states that an
“information return” is
any statement of the amount of payments to another person
required by—
(i)
section 6041(a) or (b) (relating to certain information at
source),
(ii)
section 6042(a)(1) (relating to payments of dividends),
(iii) section 6044(a)(1) (relating to payments of patronage
dividends),
(iv)
section 6049(a) (relating to payments of interest),
(v)
section 6050A(a) (relating to reporting requirements of certain
fishing boat operators),
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(vi)
section 6050N(a) (relating to payments of royalties),
(vii) section 6051(d) (relating to information returns with respect
to income tax withheld),
(viii) section 6050R (relating to returns relating to certain
purchases of fish), or
(ix)
section 110(d) (relating to qualified lessee construction
allowances for short-term leases).
“The types of false ‘information returns’ for which an injured taxpayer
may recover are limited to the nine listed in 26 U.S.C. § 6724(d)(1)(A).” Cavoto,
634 F.3d at 924. To state a claim under §7434, the plaintiff “must allege: (1)
Defendant issued an information return; (2) the information return was
fraudulent; and (3) Defendant willfully issued such a fraudulent return.”
DeMario v. Utilivate Technologies, LLC, No. 20-cv-1757, 2020 WL 11231807, at
*1 (N.D. Ill. Oct. 2, 2020) (quoting Schmelzer v. Animal Wellness Ctr. of Monee,
LLC, No. 18-cv-01253, 2019 WL 4735441, at *2 (N.D. Ill. Sept. 27, 2019)).
2.
Analysis
Count II alleges that the defendants had “filed and disseminated, or will
file and disseminate,23 false information returns (e.g., Form 1099)” to inform
the IRS of “payments” in the form of shares of JCplc ordinary shares in
exchange for shares of JCI common stock made to JCI shareholders in
connection with the Inversion and of the consequent tax liability of JCI
shareholders. Dkt. No. 53 at ¶¶313, 314. The amended complaint does not
It appears that to the extent that it alleged that the defendants would file in
the future, or had announced their intention to file in the future, the Forms
1099, this claim was not ripe when the plaintiffs filed the amended complaint.
Assuming that it would be ripe now were the court to allow the plaintiffs
another opportunity to amend, the court addresses the merits of the claim and
concludes that giving the plaintiffs an opportunity to amend would be futile.
23
95
specify which Form 1099—1099 DIV (dividends and distributions), 1099-MISC
(miscellaneous income), 1099-INT (interest income), 1099-NEC (nonemployee
compensation). It is not clear, therefore, whether whichever Form 1099 the
defendants had stated an intention to file (and by now likely have filed) meets
the definition of an “information return” under §7434.
Even if the Forms 1099 the defendants expressed an intention to file
(and likely since have filed) met the definition of an “information return,” the
plaintiffs have not alleged that the returns themselves were fraudulent. They
allege that
the information returns . . . are and will be fraudulent in that JCI
and JCplc, in connection with their Inversion/Merger Tax Avoidance
Scheme, wrongfully caused taxes owed by them pursuant to [26
U.S.C.] § 367(b) to be shifted to the Minority Subclass pursuant to
[26 U.S.C.] § 367(a) and otherwise wrongfully forced the Minority
Subclass to pay taxes in violation of Wisconsin law as a result of,
inter alia, the breach by the Individual Defendants of their fiduciary
duties to the Minority Subclass and the aiding and abetting thereof
by the Corporate Defendants, entitled the Minority Subclass to bring
this action for damages against JCI and JCplc for filing such
returns, pursuant to 26 U.S.C. § 7434(a).
Dkt. No. 53 at ¶316.
This count, like Count I, is an attempt to force the square peg of a breach
of fiduciary duty claim through the round hole of a 26 U.S.C. §7434 claim. The
plaintiffs have not alleged that the defendants were not going to make the
payments that they announced they would report on the Forms 1099. Nor have
they alleged that the payments the defendants planned to report on the Forms
1099 would fraudulently misstate the source, amounts or recipients of the
payments. They allege only that the defendants should not have had reason to
96
file Forms 1099 because they could have acted in such a way as to avoid giving
rising to the tax obligations that required the filing of the forms. As Judge
Clevert held in Lenz v. Robert W. Baird & Co., Inc., No. 16-c-0977, 2017 WL
639316, at *6 (E.D. Wis. Feb. 16, 2017), “[w]hether th[e] amount [reported on a
Form 1099] was rightly or wrongly distributed does not factor in. The amount
was distributed, so the [form] was correct.”
The plaintiffs have failed to state a claim for a violation of 26 U.S.C.
§7434. The court will grant the defendants’ motion to dismiss Count II with
prejudice.
C.
State-Law Claims
The remaining claims—Counts III through XII—are state-law claims, all
relating to the plaintiffs’ allegations that the individual defendants breached
their fiduciary duty to the plaintiffs by structuring the merger to protect
themselves and the new company from tax liability and to shift the tax burden
to the plaintiffs.
Under 28 U.S.C. §1367(a), a federal court presiding over a civil case has
supplemental jurisdiction over claims that are “so related to claims in the
action within [the court’s] original jurisdiction that they form part of the same
case or controversy under Article III of the United States Constitution.” Even
when a district court has supplemental jurisdiction, however, it may decline to
exercise that jurisdiction if, among other things, “the claim [over which the
court has supplemental jurisdiction] substantially predominates over the claim
or claims over which the district court has original jurisdiction.” 28 U.S.C.
97
§1367(c).
The Seventh Circuit “presume[s] that a district court will relinquish
jurisdiction over supplemental state-law claims when no federal claims remain
in advance of trial.” Walker v. McArdle, No. 20-3214, 2021 WL 3161829, at *4
(7th Cir. July 27, 2021) (citing RWJ Mgt. Co., Inc. v. BP Products N. Am., 672
F.3d 476, 480 (7th Cir. 2012)). See also, Matthews v. Chambers, 857 F. App’x
244, 246 (7th Cir. 2021) (“Once a district court has dismissed federal claims on
the pleadings, it properly relinquishes supplemental jurisdiction over any
remaining state-law claims.”).
During the October 2019 oral argument on the motion to dismiss,
defense counsel argued that “[g]iven Wisconsin’s business judgment rule none
of the supposed conflicts give rise to a breach and under Seventh Circuit
authorities the court can continue to exercise jurisdiction to address this.” Dkt.
No. 68 at approx. 41:46. Later in the hearing, the court asked defense counsel
whether it understood him to be arguing that the court still had the authority
to address the breach of fiduciary duty claims if it dismissed the federal claims.
Id. at approx. 55:22. Defense counsel responded that the court could continue
to exercise jurisdiction over the state-law claims if it was clear that they should
be dismissed, citing Sharp Elec. Corp. v. Metro. Life Ins. Co., 578 F.3d 505 (7th
Cir. 2009) and Van Harken v. City of Chi., 103 F.3d 1346 (7th Cir. 1997).
In Van Harken, the district court judge ruled on the state claim, even
though he had dismissed the federal constitutional claim. Van Harken, 103
F.3d at 1354. The Seventh Circuit concluded that he should not have done so,
98
explaining:
The general rule is that when as here the federal claim drops out
before trial (here way before trial), the federal district court should
relinquish jurisdiction over the supplemental claim. E.g., Boyce v.
Fernandes, 77 F.3d 946, 951 (7th Cir. 1996); Wright v. Associated
Ins. Cos., 29 F.3d 1244, 1251 (7th Cir. 1994). The district judge did
not do this, his ground being that the due process clause of the
Illinois constitution is a mirror image of the federal due process
claim [on which the dismissed federal claim had been based]. Of
course, this in itself is an interpretation of state law, and the general
rule that we have cited is designed to minimize the occasions for
federal judges to opine on matters of state law. If, however, an
interpretation of state law that knocks out the plaintiff’s state claim
is obviously correct, the federal judge should put the plaintiff out of
his misery then and there, rather than burdening the state courts
with a frivolous case. E.g., Boyce v. Fernandes, supra, 77 F.3d at
951; Bowman v. City of Franklin, 980 F.2d 1104, 1109-10 (7th Cir.
1992). The district judge evidently thought that this case was within
this “no brainer” exception to the duty to relinquish federal
jurisdiction over the supplemental claim when the main claim drops
out before trial.
We reaffirm the propriety of the exception; it is important to judicial
economy, which is at the heart of the supplemental jurisdiction. And
we acknowledge the broad discretion of district judges in making
judgments concerning the retention of supplemental claims. But
this case, especially because the supplemental claim is based on a
state constitution, does not fall within the exception. The Supreme
Court of Illinois has held that the due process clause of the Illinois
constitution is not coterminous with that of the federal constitution.
. . . From the cases city by the City dealing with specific aspects of
due process pertinent to this case, . . . it appears unlikely that the
Illinois courts would find a denial of Illinois due process . . . but it is
not so unlikely that the plaintiffs should be denied an opportunity
to try to persuade them.
Id.
In Sharp, the district court—anticipating that the Seventh Circuit might
disagree with its conclusion that the plaintiff’s state-law claims were preempted
by ERISA—“alternatively held that even if [the plaintiff] could amend its state-
99
law counts in such a way as to avoid preemption, the court would decline to
exercise supplemental jurisdiction over those claims and dismiss them
pursuant to 28 U.S.C. § 1367(c), in light of its dismissal of all claims over
which it had original jurisdiction.” Sharp Elec. Corp., 578 F.3d at 514. In
finding that the district court did not abuse its discretion in declining to
exercise jurisdiction, the Seventh Circuit wrote:
Normally, when “all federal claims are dismissed before trial, the
district court should relinquish jurisdiction over pendent state-law
claims rather than resolving them on the merits.” Wright v.
Associated Ins. Cos., Inc., 29 F.3d 1244, 1251 (7th Cir. 1994). There
are three acknowledged exceptions to this rule: when (1) “the statute
of limitations has run on the pendent claim, precluding the filing of
a separate suit in state court”; (2) “substantial judicial resources
have already been committed, so that sending the case to another
court will cause a substantial duplication of effort”; or (3) “when it
is absolutely clear how the pendent claims can be decided.” Id.
(internal quotation marks omitted).
We see no abuse of the district court’s discretion here. While it is
likely that the statute of limitations has technically run on some, if
not all, of [the plaintiff’s] state-law claims, there is an Illinois statute
that authorizes tolling in these circumstances. . . . In addition, the
district court disposed of the federal claims on a motion to dismiss,
and so it is difficult to see how “substantial judicial resources” have
been committed to this case. See Davis v. Cook County, 534 F.3d
650, 654 (7th Cir. 2008). Finally, we are not prepared to say that the
proper resolution of the state-law claims is absolutely clear. We
conclude, therefore, that the district court did not abuse its
discretion in declining to exercise supplement jurisdiction over [the
plaintiff’s] state law claims.
Id. at 514-15.
The defendants in this case rely on the third exception discussed in
Sharp: they assert that it is absolutely clear how the plaintiffs’ breach-offiduciary claims should be decided, and that the court may exercise its
supplemental jurisdiction to resolve those claims despite having dismissed the
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federal claims. In their written motion to dismiss, the defendants asserted that
[i]t is settled Wisconsin law that the decision how to structure a
transaction, including its tax effects, is left to the business judgment
of a company’s directors. Data Key [Partners v. Permira Advisers,
LLC, 356 Wis.2d 665, 682 (Wis. 2014)] (quoting Steven v. Hale-Haas
Corp., 249 Wis. 205, 221 . . . (1946)) (“The business of a corporation
is committed to its officers and directors . . . .”). It is even more
settled that actions taken in good faith and “‘in the honest belief that
[such] decisions were in the best interest of the company’” are
protected by Wisconsin’s strong business judgment rule. Id., ¶33
(quoting Reget v. Paige, . . . 242 Wis.2d 278 . . . ). Plaintiffs have
repeatedly conceded that defendants structured the merger “for the
benefit of JCI.” Compl. ¶¶61, 324. The Court’s inquiry should end
there.
Dkt. No. 56 at 35-36.
The plaintiffs responded that the officer defendants were not protected by
the business judgment rule. Dkt. No. 58 at 31. While conceding that
Wisconsin’s business judgment rule protects directors from liability for
damages resulting from a breach of fiduciary duty, the plaintiffs asserted that
it does not define either the scope of the duty or what constitutes a breach. Id.
They argued that the actions of the director defendants were not protected by
the business judgment rule, either because there were applicable exceptions to
the rule or because the statute itself did not apply to certain of their actions.
Id. at 31-32. The plaintiffs also argued that the fact that the JCI shareholders
approved the merger is not relevant to whether the defendants breached their
fiduciary duties. Id. at 42.
In their reply brief, the defendants argued that the plaintiffs had not
alleged facts showing that one of the exceptions to the business judgment rule
applied. Dkt. No. 60 at 19. The defendants relied, both in their original and
101
reply briefs, on the Wisconsin Supreme Court’s decision in Data Key Partners
v. Permira Advisers LLC, 356 Wis.2d 665 (Wis. 2014), in which the Supreme
Court listed the exceptions to the business judgment rule: “(1) a ‘willful failure
to deal fairly’ with a ‘shareholder[] in connection with a matter in which the
director has a material conflict of interest’; (2) acts from which ‘the director
derived an improper personal profit’; or 3) ‘[w]illful misconduct.’” Data Key
Partners, 356 Wis.2d at 682-83 (quoting Wis. Stat. §180.0828(1)(a), (c) and (d)).
The court disagrees that it should exercise its supplemental jurisdiction
over the state-law claims in Counts III through XII. The court has concluded
that the fiduciary duty and related state-law claims substantially predominate
over the claims over which it had original jurisdiction. Under 28 U.S.C.
§1367(c), that would have been a reason for the court to decline to exercise
supplemental jurisdiction even had it not dismissed the federal causes of
action. The Seventh Circuit repeatedly has held—even in Sharp and Van
Harken, the cases the defendants cited in support of the court’s ability to
exercise supplemental jurisdiction after dismissal of the federal causes of
action—that the general rule is that district courts should relinquish
jurisdiction over state law claims when they have dismissed all federal claims.
Although the court’s inordinate and inexcusable delay in ruling on the motion
to dismiss means that the statute of limitations likely has run on at least some
of the state-law claims, Wisconsin has a tolling statute, Wis. Stat. §893.15,
which tolls “the time for commencement of an action on a Wisconsin cause of
action” “from the period of commencement of the action in a non-Wisconsin
102
forum until the time of its final disposition in that forum;” the statute includes
“federal courts in this state” in the definition of “a non-Wisconsin forum.” Wis.
Stat. §893.15(1). Assuming the causes of action the plaintiffs might pursue in
state court are the same causes of action that they brought in this federal case,
those causes of action do not appear to be time-barred. Between ruling on the
motion for injunctive relief and ruling on the motion to dismiss, this court has
expended judicial resources on the case, but like the court in Sharp, it is
dismissing the federal claims at the pleading stage.
Finally, the court cannot say that it is “absolutely clear” that the
plaintiffs have not alleged facts sufficient to state a claim that the actions of the
individual defendants were not subject to some exception to Wisconsin’s
business judgment rule. The plaintiffs have made numerous allegations of
conflicts of interest, improper personal profit to JCI insiders, self-dealing and
failure to act in the interest of shareholders. Despite the strong protection of
the business judgment rule, the court cannot agree that a conclusion that the
plaintiffs have failed to state a claim for breach of fiduciary duty (or the related
contract, conversion and other state-law claims) is the kind of “no brainer”
described by the Van Harken court that requires this court to “put the
plaintiffs out of their misery” or that its failure to do so would “burden” the
state court with a “frivolous” case.
The court will dismiss Counts III through XII without prejudice,
relinquishing its supplemental jurisdiction over those claims.
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VIII. Remaining Motions
Because the court is dismissing the case, it will dismiss as moot the
plaintiffs’ motion to modify the PSLRA discovery stay (Dkt. No. 76) and Rule
7(h) motion for leave to serve subpoenas on non-parties (Dkt. No. 81).
IX.
Conclusion
The court GRANTS the defendants’ motion to dismiss Counts I and II of
the amended complaint and ORDERS that those counts are DISMISSED WITH
PREJUDICE. Dkt. No. 55.
The court GRANTS the defendants’ motion to dismiss Counts III through
XII of the amended complaint but DECLINES TO EXERCISE supplemental
jurisdiction over those claims and ORDERS that those counts are DISMISSED
WITHOUT PREJUDICE. Dkt. No. 55.
The court GRANTS the plaintiffs’ Request for Leave to File Supplemental
Brief. Dkt. No. 71.
The court ORDERS that the Clerk of Court must docket the
supplemental brief at Dkt. No. 71-1 as a separate, supplemental brief in
opposition to the motion to dismiss.
The court DENIES AS MOOT the plaintiffs’ motion to modify the PSLRA
stay of discovery. Dkt. No. 76.
The court DENIES AS MOOT the plaintiffs’ Rule 7(h) motion for leave to
serve subpoenas on non-parties. Dkt. No. 81.
104
The court ORDERS that this case is DISMISSED. The clerk will enter
judgment accordingly.
Dated in Milwaukee, Wisconsin this 3rd day of November, 2021.
BY THE COURT:
_____________________________________
HON. PAMELA PEPPER
Chief United States District Judge
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