The Delaware Court of Chancery’s post-trial decision in Legent Group, LLC v. Axos Financial, Inc., No. 2020-0405 (Del. Ch. Nov. 7, 2025) underscores how important it is for buyers to scrutinize a seller’s disclosure schedules and ensure that the definitive purchase or merger agreement between the parties accurately allocates responsibility for known risks and exposures.
The buyers acquired a securities clearing firm (Clearing) from the sellers. Clearing is a Financial Industry Regulatory Authority (FINRA)-regulated business that serves its broker-dealer customers by acting as an intermediary in securities transactions. In these transactions, Clearing is responsible for ensuring trades are settled correctly and efficiently. While some of the broker-dealer customers use Clearing’s direct services to facilitate trades (i.e., trading through Clearing’s platform), some utilize third-party platforms to facilitate trades (i.e., trading away from Clearing). When a broker-dealer trades away from Clearing, Clearing is still obligated to settle any such trades, even though Clearing did not directly monitor the trades through its own system.
In its 2017 cycle examination (the FINRA Report), FINRA determined that Clearing was not compliant with at least one FINRA rule and lacked adequate systems to enforce trade limits and monitor high-risk trade-away activity in real time. The report was published in March 2018 and included certain recommendations for Clearing to implement in order to become compliant. Around the same time it received the FINRA Report, Clearing hired a chief risk officer (CRO); this CRO similarly recommended a real-time monitoring system and a pre-trade gateway that could intercede a trade-away transaction based on aggregate risk inputs.
The buyers also began their due diligence process around the same time that Clearing received the FINRA Report. During the due diligence process, Clearing shared with the buyers the FINRA Report, along with subsequent correspondence between Clearing and FINRA related to the findings.
The parties signed a merger agreement in September 2018, just six months after the FINRA Report was received and the CRO was hired. The parties closed the deal in January 2019. Critically, despite disclosing the documents that identified deficiencies in and recommendations to improve Clearing’s oversight systems, it is important to note that Clearing did not meaningfully act on any of the recommendations from FINRA or the recently hired CRO until November 2018; that is, after the merger agreement was signed but before closing.
Shortly after the closing, Scott Reynolds, a trader at one of Clearing’s broker-dealer customers, had intentionally circumvented internal controls and was caught in a short squeeze. This resulted in a $15.2 million loss to Clearing (the Reynolds Loss). Though Clearing had the ability to “hit the kill switch” and close out Reynolds’s position or make other trades to limit its exposure, Clearing instead relied on Reynolds’s promise that he would remedy the trade to avoid the loss.
The buyers claimed that the Reynolds Loss was caused by premerger deficiencies in Clearing’s risk management systems and by the broker-dealer customer’s alleged noncompliance with the agreement in place between the broker-dealer and Clearing. The buyers claimed that (i) these two deficiencies made two representations in the merger agreement inaccurate—specifically the legal-compliance representation and the counterparty-breach representation—and (ii) accordingly, they were entitled to indemnification for the Reynolds Loss flowing from the two premerger deficiencies. Based on this claim for indemnification, the buyers withheld certain amounts of the merger consideration. This, in turn, prompted the sellers to seek from the Delaware Court of Chancery a declaratory judgment that no such indemnification obligation existed.
In a post-trial decision resolving the buyer’s indemnity claim, the Court of Chancery determined that the buyers failed to prove that the two representations in the merger agreement were inaccurate and that those purported inaccuracies caused the loss. Importantly, the merger agreement contained an anti-reliance provision, which states that the buyers did not rely on any representations made by the sellers other than those explicitly set forth in the agreement.
According to the Court, sellers generally do not have a separate obligation to articulate any negative inferences or characterizations of misconduct related to an item in its disclosure schedules. Although it was clear that Clearing’s supervisory risk systems lacked critical controls prior to closing the transaction, the examinations investigating these vulnerabilities were listed in the seller’s disclosure schedules. In the disclosure schedules, the sellers noted that Clearing has “been the subject of… examinations by FINRA or the SEC that are currently closed and, in each case FINRA or the SEC, as the case may be, made certain findings in respect of [Clearing’s] compliance with applicable [l]aw.” Critically, this disclosure does not state that any deficiencies were resolved or addressed, just that the examinations were “closed.” Nonetheless, these examinations were included in the schedules, were sufficiently carved out of the legal-compliance representation, and therefore, cannot be a basis for the buyers’ recovery for the Reynolds Loss.
The buyers also failed to demonstrate that the inaccuracy of the counterparty-breach representation. The buyers argued that the contract between Reynolds’s firm and Clearing was a “material contract” in default when the merger closed. The Court did not touch the issue as to whether the contract was in default because the contract was not a material contract as defined in the merger agreement. The merger agreement defined material contract as a contract that would fall into one of 11 enumerated categories of contracts, whether or not set forth in the disclosure schedule. Though the contract at issue was in the same form as other agreements disclosed in the material contract schedule, the contract at issue did not fall within one of the 11 categories set forth in the merger agreement. As drafted, the “whether-or-not clause” in the definition of material contracts “commands that a reader disregard the [d]isclosure [s]chedule for purposes of the definition.” Therefore, despite being included in the list of material contracts, a third party’s breach of the contract could not result in a breach of Clearing’s counterparty-breach representation.
The Court ultimately found that the Reynolds Loss was primarily attributable to post-merger business decisions, specifically Clearing’s decision to rely on Reynolds’s assurances rather than to intervene and mitigate or otherwise offset its potential exposure once the short became apparent. The Court emphasized that Delaware law requires proof that the purported breach of a representation (i.e., an undisclosed premerger condition or missing controls) was the direct cause of the Reynolds Loss, and without such breach, the Reynolds Loss would not have occurred.
Perhaps the buyers could have prevailed on their legal arguments had the merger agreement and the disclosure schedules been drafted with greater precision. In particular, the buyers could have required that the sellers make an express disclosure of the findings from the FINRA and the Securities and Exchange Commission (SEC) examinations rather than make generalized references to the status of each examination being “closed.” Further, the buyers could have fared better if the definition of material contracts was not qualified by the whether-or-not clause, which had the effect of limiting the scope of what would be considered a material contract.
The takeaway here is that a buyer is put on notice of issues facing a target company vis-à-vis a seller’s disclosure schedules. If the issue is put before the Court of Chancery, the Court will look solely within the four corners of the disclosure schedules, so it is a buyer’s responsibility to read between the lines and develop its own independent insight into the underlying risks of the items disclosed. And when a disclosure schedule signals a potential exposure, a buyer must ensure that the deal terms, whether economic or legal, appropriately account for that risk.