In shareholder derivative litigation, one of the earliest questions for a plaintiff is whether the directors of a company are sufficiently independent and disinterested to consider a shareholder demand or whether pre-suit demand is excused. In Delaware, demand excusal is provided for by Court of Chancery Rule 23.1. In a recent Delaware Supreme Court decision, Sandys v. Pincus, authored by Chief Justice Strine, the Court confronted this question and highlighted that: (1) courts must consider real-life dynamics and human nature when deciding whether directors are independent and disinterested and (2) plaintiffs should conduct an inquiry into director independence prior to filing, including utilizing the statutory procedures for books and records requests. Sandys v. Pincus, No. 157, 2016, 2016 Del. LEXIS 627 (Del. Dec. 5, 2016).
Sandys was a derivative action filed by shareholders of Zynga, Inc. The complaint asserted the CEO and other managers and directors were granted an exception to a company rule preventing insider sales of shares until three days after an earnings announcement. Taking advantage of this exception, insiders sold 20.3 million shares at $12 per share. Immediately after the earnings announcement, the price dropped to $8.52 per share. Within three months after the earnings announcement, the share value had fallen to $3.18 per share. The complaint alleged wrongdoing by the directors who approved this exception.
The Court of Chancery dismissed the complaint for failure to adequately plead demand excusal under Rule 23.1. In evaluating the independence and disinterestedness of Zynga’s nine directors, the Court of Chancery found that only two of those directors, the two who sold shares under the exception, were interested.
The Delaware Supreme Court reversed. In its opinion, the Court analyzed the independence and disinterestedness of three additional directors and determined that when looking at the real-world implications of their relationships to the Zynga CEO, who benefitted greatly from this exception, there was a reasonable doubt that these directors could have properly exercised independent and disinterested business judgment in responding to a pre-suit demand. The Court characterized one director, Ellen Siminoff, as a “close family friend of the CEO” relying almost entirely on the fact that Siminoff co-owned a private plane with the CEO. The Court analogized this co-ownership to family ties that, as a part of human nature, would call into question Siminoff’s independence and disinterestedness because jointly owning an airplane was an uncommon relationship with high expenses requiring a great deal of cooperation between Siminoff and the CEO. The Court also found that there was a reasonable doubt that directors John Doerr and William Gordon were independent or disinterested. This determination was based in part on the fact that Doerr and Gordon were partners in a venture capital firm that owned 9.2% of Zynga and that also invested in a company co-founded by the Zynga CEO’s wife. The Court, however, focused most heavily on the fact that Zynga did not consider Doerr or Gordon to be independent directors under the NASDAQ listing rules.
While the Court acknowledged that characterization for the NASDAQ listing rules is not dispositive in every case, the Court afforded great weight to Zynga’s determination that Doerr and Gordon lacked independence. While the Delaware Supreme Court reversed the Court of Chancery’s dismissal under Rule 23.1, the Delaware Supreme Court highlighted that the plaintiff had made the demand excusal determination more difficult by not conducting more pre-suit investigation or pleading more particularized facts as to the directors’ lack of independence. In particular, the Delaware Supreme Court emphasized that, while plaintiff made a pre-suit books and records request, the plaintiff had only sought books and records relating to the transaction he sought to redress. The Court said that plaintiff should have also used the books and records request to investigate the independence of the board. Companies should, therefore, expect prospective shareholder derivative plaintiffs to make greater use of books and records requests to inquire as to the independence of directors prior to filing.
Sandys was a derivative action filed by shareholders of Zynga, Inc. The complaint asserted the CEO and other managers and directors were granted an exception to a company rule preventing insider sales of shares until three days after an earnings announcement. Taking advantage of this exception, insiders sold 20.3 million shares at $12 per share. Immediately after the earnings announcement, the price dropped to $8.52 per share. Within three months after the earnings announcement, the share value had fallen to $3.18 per share. The complaint alleged wrongdoing by the directors who approved this exception.
The Court of Chancery dismissed the complaint for failure to adequately plead demand excusal under Rule 23.1. In evaluating the independence and disinterestedness of Zynga’s nine directors, the Court of Chancery found that only two of those directors, the two who sold shares under the exception, were interested.
The Delaware Supreme Court reversed. In its opinion, the Court analyzed the independence and disinterestedness of three additional directors and determined that when looking at the real-world implications of their relationships to the Zynga CEO, who benefitted greatly from this exception, there was a reasonable doubt that these directors could have properly exercised independent and disinterested business judgment in responding to a pre-suit demand. The Court characterized one director, Ellen Siminoff, as a “close family friend of the CEO” relying almost entirely on the fact that Siminoff co-owned a private plane with the CEO. The Court analogized this co-ownership to family ties that, as a part of human nature, would call into question Siminoff’s independence and disinterestedness because jointly owning an airplane was an uncommon relationship with high expenses requiring a great deal of cooperation between Siminoff and the CEO. The Court also found that there was a reasonable doubt that directors John Doerr and William Gordon were independent or disinterested. This determination was based in part on the fact that Doerr and Gordon were partners in a venture capital firm that owned 9.2% of Zynga and that also invested in a company co-founded by the Zynga CEO’s wife. The Court, however, focused most heavily on the fact that Zynga did not consider Doerr or Gordon to be independent directors under the NASDAQ listing rules.
While the Court acknowledged that characterization for the NASDAQ listing rules is not dispositive in every case, the Court afforded great weight to Zynga’s determination that Doerr and Gordon lacked independence. While the Delaware Supreme Court reversed the Court of Chancery’s dismissal under Rule 23.1, the Delaware Supreme Court highlighted that the plaintiff had made the demand excusal determination more difficult by not conducting more pre-suit investigation or pleading more particularized facts as to the directors’ lack of independence. In particular, the Delaware Supreme Court emphasized that, while plaintiff made a pre-suit books and records request, the plaintiff had only sought books and records relating to the transaction he sought to redress. The Court said that plaintiff should have also used the books and records request to investigate the independence of the board. Companies should, therefore, expect prospective shareholder derivative plaintiffs to make greater use of books and records requests to inquire as to the independence of directors prior to filing.
No comments:
Post a Comment
Note: Only a member of this blog may post a comment.