Case Name: Curt Hemmingson, et al. v. Michael Elkins, et al.
Case No.: 2015-1-CV-278614

Case Name: Stephen Bushansky, et al. v. R. Douglas Norby, et al.
Case No.: 2015-1-CV-281284

These stockholder derivative actions are brought on behalf of MagnaChip Semiconductor Corporation against certain of its current and former officers and directors and its former controlling stockholder, Avenue Capital Management, II L.P. (along with its affiliate, Avenue Capital Group). Currently before the Court is plaintiffs’ motion for preliminary approval of the parties’ settlement, which is unopposed.

I. Factual and Procedural Background

MagnaChip is a publicly-traded, Korea-based designer and manufacturer of semiconductor products. (Hemmingson Complaint, ¶¶ 7, 28-29.) Beginning in 2012, the company experienced substantial financial success, repeatedly beating analysts’ estimates. (Id., ¶ 30.) During this time, it conducted several secondary offerings in which Avenue Capital sold down 77.7% of its holdings in MagnaChip, for total proceeds of over $214 million. (Id., ¶¶ 31-37.)

In March 2014, MagnaChip disclosed that its financial statements for 2011, 2012, and the first three quarters of 2013 should not be relied on and would need to be restated due violations of the United States Generally Accepted Accounting Principles (“GAAP”). (Hemmingson Complaint, ¶ 2.) As the restatement progressed, the company disclosed numerous accounting errors and internal control deficiencies, and its CEO and CFO both resigned. (Id., ¶ 3.) Ultimately, MagnaChip’s net income of $21.8 million in 2011 was restated to a net loss of $11.3 million, and its net income of $193.3 million in 2012 was reduced to $110 million. (Ibid.) The company reported a net loss of $64.2 million for 2013, despite having reported net income of $43.7 million for the first three quarters of 2013. (Ibid.) Share prices declined over 57% during the restatement. (Id., ¶ 4.)

Plaintiffs allege that defendants willfully ignored the significant deficiencies in MagnaChip’s accounting and financial reporting systems and benefitted themselves by selling shares of MagnaChip stock at artificially inflated prices. (Hemmingson Complaint, ¶ 1.)

Plaintiffs Curt Hemmingson and Vic Vandegriff filed their action for breach of fiduciary duty, insider trading, and unjust enrichment on March 25, 2015 (Case No. 2015-1-CV-278614). On June 1, 2015, plaintiff Stephen Bushansky filed his action for breach of fiduciary duty and aiding and abetting arising from the same events at issue in the Hemmingson action (Case No. 2015-1-CV-281284). Both actions were stayed pending the resolution of two related securities class actions in the United States District Court for the Northern District of California, and the parties undertook settlement discussions.

The parties have now reached a settlement. Plaintiffs move for an order preliminarily approving the settlement; approving the form and method of notice to shareholders; and scheduling a final fairness hearing.

II. Legal Standard for Preliminary Approval of a Derivative Settlement

“A court reviewing a settlement agreement considers whether the proposed settlement is fair and reasonable in light of all relevant factors. [Citations.] A court reviews the settlement of a derivative suit as a means of protecting the interests of those who are not directly represented in the settlement negotiations.” (Robbins v. Alibrandi (2005) 127 Cal.App.4th 438, 445.) “The duty of a court reviewing a settlement of a class action provides a useful analogy because the court in such cases seeks to protect the members of the class who, like the corporation and non-named shareholders in a derivative suit, may have no independent representation and little control over the action.” (Id. at p. 449, fn. 2.) Thus, in evaluating the fairness of this derivative settlement, the Court’s analysis is guided by relevant legal authorities regarding approval of class action settlements.

Generally, “questions whether a settlement was fair and reasonable, whether notice to the class was adequate, … and whether the attorney fee award was proper are matters addressed to the trial court’s broad discretion.” (Wershba v. Apple Computer, Inc. (2001) 91 Cal.App.4th 224, 234-235, citing Dunk v. Ford Motor Co. (1996) 48 Cal.App.4th 1794.)

In determining whether a class settlement is fair, adequate and reasonable, the trial court should consider relevant factors, such as the strength of plaintiffs’ case, the risk, expense, complexity and likely duration of further litigation, … the amount offered in settlement, the extent of discovery completed and the stage of the proceedings, the experience and views of counsel, the presence of a governmental participant, and the reaction of the class members to the proposed settlement.

(Wershba v. Apple Computer, Inc., supra, 91 Cal.App.4th at pp. 244-245, internal citations and quotations omitted.)

The list of factors is not exclusive and the court is free to engage in a balancing and weighing of factors depending on the circumstances of each case. (Wershba v. Apple Computer, Inc., supra, 91 Cal.App.4th at p. 245.) The court must examine the “proposed settlement agreement to the extent necessary to reach a reasoned judgment that the agreement is not the product of fraud or overreaching by, or collusion between, the negotiating parties, and that the settlement, taken as a whole, is fair, reasonable and adequate to all concerned.” (Ibid., quoting Dunk v. Ford Motor Co., supra, 48 Cal.App.4th at p. 1801, internal quotation marks omitted.)

The burden is on the proponent of the settlement to show that it is fair and reasonable. However “a presumption of fairness exists where: (1) the settlement is reached through arm’s-length bargaining; (2) investigation and discovery are sufficient to allow counsel and the court to act intelligently; (3) counsel is experienced in similar litigation; and (4) the percentage of objectors is small.”

(Wershba v. Apple Computer, Inc., supra, 91 Cal.App.4th at p. 245, citing Dunk v. Ford Motor Co., supra, 48 Cal.App.4th at p. 1802.) The presumption does not permit the Court to “give rubber-stamp approval” to a settlement; in all cases, it must “independently and objectively analyze the evidence and circumstances before it in order to determine whether the settlement is in the best interests of those whose claims will be extinguished,” based on a sufficiently developed factual record. (Kullar v. Foot Locker Retail, Inc. (2008) 168 Cal.App.4th 116, 130.)

III. Settlement Process

Beginning in September 2015, the plaintiffs and certain defendants in the federal class actions, including MagnaChip, commenced settlement discussions. The Honorable Layn R. Phillips (Ret.) was retained as a mediator to oversee the discussions in both the federal class actions and the instant, Hemmingson action. Counsel for Hemmingson and Vandegriff attended and participated in two mediation sessions with Judge Phillips in September and November 2015. On December 10, 2015, a settlement in principle was reached in the federal actions.

The parties to the Hemmingston action were unable to reach an agreement during the 2015 mediation sessions. However, they continued their discussions with the assistance of Judge Phillips, who made a mediator’s proposal to settle the action on January 6, 2016. Hemmingson, Vandegriff, and MagnaChip accepted Judge Phillips’s proposal and executed a term sheet on January 7, memorializing their agreement in principle. On January 22, Hemmingson, Vandegriff, Bushansky, MagnaChip, and the other Settling Defendants all executed a stipulation further memorializing the terms of the settlement of both actions at issue herein.

Pursuant to the term sheet and stipulation, MagnaChip has produced, and plaintiffs’ counsel has reviewed and analyzed, over 4,000 pages of confidential documents relating to the allegations in the instant actions. Following their review of this confirmatory discovery, plaintiffs’ counsel asked questions and requested additional information, and MagnaChip provided answers to these questions and unredacted copies of certain previously-produced documents. On February 9, 2016 plaintiffs determined that the settlement is fair, reasonable, and adequate to MagnaChip and its shareholders.

IV. Provisions of the Settlement

The settlement provides for a payment of $3 million by MagnaChip’s directors’ and officers’ liability insurance carriers, which will be remitted to MagnaChip less (i) any applicable taxes and other costs of maintaining the escrow account, (ii) any award of attorney fees and litigation expenses awarded by the Court, and (iii) the costs of disseminating notice of the settlement to shareholders. (Stipulation of Settlement, § 2.1.) Plaintiffs’ counsel will apply to the Court for an award of attorney fees and expenses not to exceed $750,000. (Id., § 5.1.)

In addition to the settlement payment, the stipulation provides that MagnaChip will amend its insider trading policy to include, among other things, sanctions for material non-compliance; clarification that directors, executive officers, and any other officer obligated to file reports under Section 16 of the Securities Exchange Act of 1934 is subject to the policy; and a requirement that the company publicly announce any plan for share purchases adopted pursuant to Rule 10b5-1, as well as clarifications concerning the requirements for such plans. (Stipulation of Settlement, § 2.2(A).) The charter of MagnaChip’s audit committee shall incorporate clarifications including the following: that the audit committee has oversight over the insider trading policy and shall receive an annual report from the general counsel on compliance with the same; that the committee will report to the board regarding any material violations of applicable laws, regulations, or GAAP; and that the committee will meet at least six times per year. (Id., § 2.2(B).) The COO will report annually to the audit committee on audit findings; policies, practices, and procedures of the internal audit function; and emerging trends in internal control and internal audit issues. (Id., § 2.2(C).) MagnaChip will implement a compensation clawback policy and will declassify its board so that all directors are elected annually, and it will provide for continuing education programs for its directors on an annual basis. (Id., § 2.2(D)-(F).)

In exchange for these benefits, plaintiffs shall release all claims arising out of or related in any way to any of the occurrences, facts, etc. that were alleged or asserted in these actions, other than (i) claims asserted in the federal class actions, (ii) claims that might be brought by the SEC, and (iii) claims relating to the enforcement of the settlement. (Stipulation of Settlement, § 1.22.)

V. Analysis

It appears that the parties have engaged in a thorough settlement process with Judge Phillips’s assistance. While the Court does not doubt plaintiffs’ representation that their counsel are experienced in similar derivative litigation, no detail is provided to support this bare conclusion, and consequently no presumption of fairness applies. More importantly, plaintiffs provide no explanation as to how the $3 million settlement amount was chosen, nor do they present any analysis of the strength and potential value of their claims, relying on a generic discussion of the uncertainties and expenses of litigation. The Court consequently requires further briefing to intelligently analyze the monetary portion of the settlement. It notes, however, that a corporation may receive a substantial benefit from a derivative suit that is non-pecuniary. (Mills v. Elec. Auto-Lite Co. (1970) 396 U.S. 375, 395.) Here, the proposed corporate governance reforms fairly address plaintiffs’ allegations regarding MagnaChip’s insufficient accounting and financial reporting systems that allegedly led it to overstate its income, as well as their allegations of insider trading. The Court will take these benefits into account in making its fairness determination.

The Court further notes that it has an independent right and responsibility to review the requested attorney fees and only award so much as it determines reasonable. (See Garabedian v. Los Angeles Cellular Telephone Co. (2004) 118 Cal.App.4th 123, 127-128.) While an award of one-quarter of the gross settlement fund is not unusual, plaintiffs’ counsel should submit billing records and lodestar information prior to the final approval hearing in this matter so the Court can compare the lodestar information with the requested fees. Counsel should address the extent to which the plaintiffs benefitted from the efforts in the federal class actions as compared to those of counsel in this action.

VI. Notice

A class notice should include “[a] brief explanation of the case, including the basic contentions or denials of the parties,” as well as additional details regarding the process for and impact of exclusion from the class. (Cal. Rules of Court, rule 3.766(d).) Since this is not a class action, the notice need not include language regarding exclusion from a class. (See Bell Atl. Corp. v. Bolger (3d Cir. 1993) 2 F.3d 1304, 1308, fn. 4 [“In derivative suits, unlike shareholder class actions, recoveries belong to the corporation on whose behalf the suit was brought” and therefore, “shareholders normally cannot opt out of the class and pursue their own individual action.”].)

Here, the notice and summary notice inform shareholders of the nature of these actions and of the settlement, including the value of the settlement, the scope of the release, and the fees and expenses that counsel will seek. Shareholders are informed that they may object to the settlement in writing or by appearing in person at the settlement hearing. The stipulation and notice will be posted to MagnaChip’s website and filed with the SEC as an exhibit to a Form 8-K, and the summary notice will be published in PR Newswire. (Stipulation of Settlement, § 3.3.) The Court finds that the proposed form and method of notice are reasonably calculated to apprise shareholders of the pendency of these actions.

VII. Conclusion and Order
The motion for preliminary approval is CONTINUED TO JULY 1, 2016. No later than ten court days before that date, plaintiffs shall file and serve supplemental papers addressing the propriety of the monetary portion of the settlement in light of the merits and potential value of their claims.