Securities Regulation Daily Yahoo did not act as an unregistered investment company
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Thursday, October 20, 2016

Yahoo did not act as an unregistered investment company

By Amy Leisinger, J.D.

A California court has dismissed claims against Yahoo, Inc. and certain of its current and former officers and directors predicated on the company allegedly acting as an investment company without SEC registration. According to the court, the plaintiff sufficiently established the demand on Yahoo’s board would have been futile, but the claims must fail because the SEC never revoked Yahoo’s registration exemption and, as such, the company never operated illegally as an unregistered investment company. Additionally noting that no private right of action exists under Investment Company Act Section 47(b) and that the plaintiff failed to sufficiently allege breach of fiduciary duty or ultra vires activities, the court dismissed the complaint in its entirety with leave to amend (UFCW Local 1500 Pension Fund v. Mayer, October 19, 2016, Seeborg, R.).

Yahoo activities. In 2000, approximately 57 percent of Yahoo’s income came from its operating business, while approximately 44 percent came from investments, and the company applied for and obtained an SEC order exempting it from registering as an investment company. The Commission noted that Yahoo was "primarily engaged in a business other than that of investing, reinvesting, owning, holding, or trading securities." In the years since then, Yahoo’s business has changed to reflect substantially more investment, particularly with regard to Chinese e-commerce company Alibaba. In 2013, Yahoo considered spinning-off its Alibaba holdings into a separate company that would register as an investment company.

Following these changes, the plaintiff filed a complaint alleging that Yahoo lost the protection of its exemption and was required to register with the SEC in order to engage in interstate commerce. According to the complaint, this failure renders voidable contracts Yahoo has entered into since 2013, and company officials deliberately disregarded the registration obligation in order to protect their positions and contracts. Specifically, the complaint alleged violations of Investment Company Act Section 47(b), breach of the fiduciary duty of loyalty, unjust enrichment, and violations of corporation and unfair competition laws.

Demand futility. The individual defendants argued that the derivative claims must fail because the plaintiff did not show that demand on Yahoo’s board was excused for futility. The court rejected this argument, noting that the Rales test for determining the sufficiency of demand-futility pleading allows for proof of either personal financial benefit not equally shared by the stockholders or a substantial likelihood of personal liability. Each of plaintiff’s claims challenges director compensation (a personal benefit), stating with particularity why demand should be excused, the court found.

Registration exemption. Whether such claims are legally viable, the court found, is another matter. The SEC has never revoked Yahoo’s exemption order, regardless of whether Yahoo no longer qualifies for exemption or violated the order by investing in Alibaba, the court stated. Judicial revocation would improperly encroach on SEC authority; "it is only for the SEC to revoke an exemption and deem a company an unregistered investment company forbidden from engaging in interstate commerce," the court explained. When a company has a validly obtained and unrevoked exemption, the court stated, it is not an investment company under the Investment Company Act. As such, Yahoo never has operated illegally as an unregistered investment company, and, given that all of the plaintiff’s claims rely on this alleged misconduct, they all must fail as a matter of law, the court concluded.

Other grounds for dismissal. The court did, however, consider the defendants’ other grounds for dismissal, including their argument that the plaintiff fails to state a claim under Section 47(b) because the statute provides no private right of action and because the applicable statute of limitations has expired. Other courts have found that Section 47(b) contains no implied private right of action, and, in any case, the applicable statute of limitations would have run for interstate transactions completed before January 27, 2015, the court found. In addition, according to the court, the defendants’ alleged activities do not amount to ultra vires acts supporting liability under state corporation law (as Yahoo was not required to register), and the plaintiff has failed to allege that the defendants’ compensation was unjustified so as to support an unjust enrichment claim.

While noting that "it is not immediately obvious" how the plaintiff can save the claims, the court granted leave to amend within 30 days.

The case is No. 16-cv-00478-RS.

Attorneys: James Matthew Wagstaffe (Kerr & Wagstaffe LLP) and Ira M. Press (Kirby McInerney LLP) for UFCW Local 1500 Pension Fund. Mark R.S. Foster (Morrison & Foerster LLP) for Marissa Mayer.

Companies: Yahoo, Inc.

MainStory: TopStory CorporateGovernance FiduciaryDuties InvestmentCompanies CaliforniaNews

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