On March 18, 2006, The Wall Street Journal sparked controversy throughout the investment community by publishing a one-page article, based on an academic's statistical analysis of option grants, which revealed an arguably questionable compensation practice. Commonly known as backdating, this practice involves a company issuing stock options to an executive on one date while providing fraudulent documentation asserting that the options were actually issued earlier. These options may provide a windfall for executives because the falsely dated stock option grants often coincide with market lows. Such timing reduces the strike prices and inflates the value of stock options, thereby increasing management compensation. This practice allegedly violates any stock option plan that requires strike prices to be no less than the fair market value on the date on which the option is granted by the board. Further, this practice runs afoul of many state and federal common and statutory laws that prohibit dissemination of false and misleading information.
After the article appeared in the Journal, Merrill Lynch issued a report demonstrating that officers of numerous companies, including Maxim Integrated
Plaintiff Walter E. Ryan alleges that defendants breached their duties of due care and loyalty by approving or accepting backdated options that violated the clear letter of the shareholder-approved Stock Option Plan and Stock Incentive Plan ("option plans"). Individual defendants move to stay this action in favor of earlier filed federal actions in California ("federal actions"). In the alternative, they move to dismiss this action on its merits.
In this Opinion, I grant individual defendants' motion to dismiss all claims arising before April 11, 2001. I deny the remainder of the individual defendants' motion to stay or dismiss.
Maxim Integrated Products, Inc. is a technology leader in design, development, and manufacture of linear and mixed-signal integrated circuits used in microprocessor-based electronic equipment. From 1998 to mid-2002 Maxim's board of directors and compensation committee granted stock options for the purchase of millions of shares of Maxim's common stock to John F. Gifford, founder, chairman of the board, and chief executive officer, pursuant to shareholder-approved stock option plans filed with the Securities and Exchange Commission. Under the terms of these plans, Maxim contracted and represented that the exercise price of all stock options granted would be no less than the fair market value of the company's common stock, measured by the publicly traded closing price for Maxim stock on the date of the grant. Additionally, the plan identified the board or a committee designated by the board as administrators of its terms.
Ryan is a shareholder of Maxim and has continuously held shares since his Dallas Semiconductor Incorporated shares were converted to Maxim shares upon Maxim's acquisition of Dallas Semiconductor on April 11, 2001. He filed this derivative action on June 2, 2006, against Gifford; James Bergman, B. Kipling Hagopian, and A.R. Frank Wazzan, members of the board and compensation committee at all relevant times; Eric Karros, member of the board from 2000 to 2002, and M.D. Sampels, member of the board from 2001-2002. Ryan alleges that nine specific grants were backdated between 1998 and 2002, as these grants seem too fortuitously timed to be explained as simple coincidence. All nine grants were dated on unusually low (if not the lowest) trading days of the years in question, or on days immediately before sharp increases in the market price of the company.
A. Genesis of these Claims
As practices surrounding the timing of options grants for public companies began facing increased scrutiny in early 2006, Merrill Lynch conducted an analysis of the timing of stock option grants from 1997 to 2002 for the semiconductor and semiconductor equipment companies that comprise the Philadelphia Semiconductor Index. Merrill Lynch measured the aggressiveness of timing of option grants by examining the extent to which stock price performance subsequent to options pricing events diverges from stock price performance over a longer period of time. "Specifically, it looked at annualized stock price returns for the twenty day period subsequent to options pricing in comparison to stock price returns for the calendar year in
With regard to Maxim, Merrill Lynch found that the twenty-day return on option grants to management averaged 14% over the five-year period, an annualized return of 243%, or almost ten times higher than the 29% annualized market returns in the same period.
B. Similar Pending Actions
The Merrill Lynch report formed the bases for other derivative lawsuits. Robert McKinney filed a federal action in the Northern District of California on May 22, 2006, three weeks before this action was filed. Eugene Horkay, Jr. followed suit, filing an identical action in the same court two days later. The Northern District of California entered an order on June 14, 2006, consolidating these suits and all subsequently filed suits. Under this order, two more actions were consolidated. All four derivative plaintiffs have stipulated to consolidate and agreed to a lead plaintiff and lead counsel structure. Further, defendants and plaintiffs have entered into a stipulated scheduling order approved by that court.
The federal action is similar to the Delaware action. The federal plaintiffs posit claims of backdating based on the Merrill Lynch report. They specifically challenge ten option grants, alleging that backdating occurred. Further, they contend that this violation of their options plan exposes Maxim to adverse tax consequences.
The federal action differs in some respects, however. First, that action alleges that other officers, in addition to Gifford, benefited from backdated options. Further, the federal action names more director defendants. In addition to breach of fiduciary duty claims, the federal plaintiffs assert claims for aiding and abetting breach of fiduciary duty, abuse of control, gross mismanagement, constructive fraud and corporate waste. The federal plaintiffs also allege violations of sections 10(b) and 14(a) of the Securities Exchange Act of 1934 and of Rules 10b-5 and 14a-9.
In addition to the Delaware action and the federal action, Louisiana Sheriff's Pension & Relief Fund filed a derivative action in California state court that makes similar allegations as the federal derivative action and this action. The California state court action, filed on June 16, 2006, names sixteen defendants, including all defendants in the Delaware action. The judge in the state court action granted a stay in that proceeding.
Plaintiff contends that all defendants breached their fiduciary duties to Maxim and its shareholders. The shareholder-approved 1983 Stock Option Plan and 1999
Defendants respond with a motion asserting three theories under which this Court should stay this action in favor of the federal action or, in the alternative, numerous theories under which this Court should dismiss this action. First, defendants move to stay this action pursuant to the Supreme Court of Delaware's ruling in Mc Wane Cast Iron Pipe Corp. v. McDowell-Wellman Engineering Co.
Defendants also seek dismissal under numerous theories. First, defendants allege that plaintiff fails to meet his burden of pleading demand futility with particularity because plaintiff does not show that the companies' directors were incapable of making an impartial decision regarding litigation. Second, defendants state that plaintiff lacks standing to assert seven of his nine claims because he was not a shareholder when those challenged transactions occurred. Third, defendants assert that plaintiff fails to state a claim for breach of fiduciary duty because plaintiff fails to rebut the business judgment rule. Fourth, defendants contend that the statute of limitations bars plaintiff's claims and that plaintiff cannot save his claims by relying on any tolling doctrines because all relevant information was public. Finally, defendants assert that plaintiff's unjust enrichment claim fails because plaintiff does not allege the manner in which Gifford was unjustly enriched. Ryan never suggests that Gifford has exercised any of the allegedly backdated options or sold any stock. Thus, defendants argue, there is no enrichment.
I will address these assertions in turn.
III. MOTION TO STAY
A. McWane Doctrine
Defendants move to stay this action pursuant to the McWane doctrine, arguing
The Supreme Court of Delaware strongly encourages this Court to freely exercise its discretion "in favor of the stay when there is a prior action pending elsewhere, in a court capable of doing prompt and complete justice, involving the same parties and the same issues."
A shareholder plaintiff does not sue for his direct benefit. Instead, he alleges injury to and seeks redress on behalf of the corporation. Further, the board or any shareholder with standing may represent the injured party. Thus, this Court places less emphasis on the celerity of such plaintiffs and grants less deference to the speedy plaintiff's choice of forum. Because the plaintiff is not the directly injured party, this Court proceeds cautiously when faced with the question of whether to defer to a first-filed derivative suit, "examin[ing] more closely the relevant factors bearing on where the case should best proceed, using something akin to a forum non conveniens analysis."
For example, in Biondi v. Scrushy, Vice Chancellor Strine declined to stay a later-filed Delaware action where he determined that the first-filed Alabama complaint was substandard compared to the Delaware action.
A similarly important factor in determining whether a stay is appropriate in a derivative action is a court's ability to render justice. Rendering justice necessarily entails accurately applying controlling law, in this case Delaware law. In many instances, this Court has recognized without hesitation that sister state courts and federal courts are capable of applying Delaware law and providing complete justice to parties.
The allegations in this case involve backdating option grants and whether such practice violates one or more of Delaware's common law fiduciary duties. This question is one of great import to the law of corporations. It encompasses numerous issues, including the propriety of this type of executive compensation, requisite disclosures that must accompany such compensation, and the legal implications of intentional non-compliance with shareholder-approved plans (if such practices are deemed noncompliant), to name only a few. Investors are challenging this very practice in many courts throughout the United States, including this Court.
B. Forum Non Conveniens
Defendants also seek a stay pursuant to the doctrine of forum non conveniens. Specifically, they contend that the pendency of the first-filed federal derivative action warrants a stay because "`it makes little sense to duplicate the efforts of the federal court.'"
This Court examines six factors when assessing whether stay or dismissal is appropriate under a forum non conveniens analysis: "1) the applicability of Delaware law, 2) the relative ease of access of proof, 3) the availability of compulsory process for witnesses, 4) the pendency or non-pendency of a similar action or actions in another jurisdiction, 5) the possibility of a need to view the premises; and 6) all other practical considerations that would make the trial easy, expeditious, and inexpensive."
First, Delaware law controls. Thus, the applicability of Delaware law clearly favors denial of the motion. Second, most corporate litigation in the Court of Chancery involves companies with documents and witnesses located outside of Delaware. Defendants point to no documents they will be unable to produce and no witnesses who will be subjected to overwhelming hardship by testifying in Delaware. While it is true that California might provide a more convenient location, motions to dismiss a plaintiff's choice of forum are not granted for defendants' mere convenience. Thus, there is no showing that the "ease of access of proof" standard supports a stay or dismissal. Third, "the availability of compulsory process of witnesses" while convenient in California, is not determinative. Defendants fail to identify necessary witnesses not subject to process; nor will this Court presume that such witnesses exist. Fourth, while a separate pending action exists, defendants provide no evidence that litigating both matters will cause the type of overwhelming hardship necessary under the forum non conveniens doctrine. Fifth, there is no indication that a view of any premises will be necessary. Nor do defendants assert any other considerations that would make trial in Delaware a real hardship, let alone a substantial and overwhelming hardship. Therefore, the doctrine of forum non conveniens does not require that I grant a stay in favor of the first-filed action.
C. California Actions Will Render Delaware Actions Moot
In a final effort to convince this Court to stay this action, defendants state that adjudication of the California actions will render the Delaware action moot. Defendants fail, however, to provide any explanation as to why they make this assertion. Without more, I cannot hold that this action should be stayed. Thus, I deny a motion to stay on the grounds that adjudication of the California actions will render the Delaware action moot.
IV. MOTION TO DISMISS
A. Futility of Demand Under Rule 23.1
Defendants state that plaintiff has failed to make demand or prove demand futility.
When a shareholder seeks to maintain a derivative action on behalf of a corporation, Delaware law requires that shareholder to first make demand on that corporation's board of directors, giving the board the opportunity to examine the alleged grievance and related facts and to determine whether pursuing the action is in the best interest of the corporation. This demand requirement works "to curb a myriad of individual shareholders from bringing potentially frivolous lawsuits on behalf of the corporation, which may tie up the corporation's governors in constant litigation and diminish the board's authority to govern the affairs of the corporation."
This Court has recognized, however, that in some cases demand would prove futile. Where the board's actions cause the shareholders' complaint, "a question is rightfully raised over whether the board will pursue these claims with 100% allegiance to the corporation, since doing so may require that the board sue itself on behalf of the corporation."
The analysis differs, however, where the challenged decision is not a decision of the board in place at the time the complaint is filed. In Rales v. Blasband, the Supreme Court of Delaware held that "[w]here there is no conscious decision by the corporate board of directors to act or refrain from acting, the business judgment rule has no application."
Here, the compensation committee, not the board, approved the challenged option grants. Plaintiff concedes that the option plans provided the board with express authority to delegate to a committee its power to grant options according to the plans. Additionally, 8 Del. C. § 141(c) provides that the board of directors may designate committees and "[a]ny such committee . . . shall have and may exercise all powers and authority of the board of directors in the management of the business and affairs of the corporation." Further, "a member of the board of directors . . . shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon any such information, opinions, reports or statements presented . . . by committees of the board of directors."
The spirit of Rales, if not the letter, supports this conclusion. In Rales, the current board was not the same board that originally made the decision on which the action was based. Consequently, the Supreme Court of Delaware held that the usual test for determining a derivative plaintiff's compliance with the demand obligation did not apply. Because the current board did not make the underlying challenged decision, it became impossible to test whether the current directors acted in conformity with the business judgment rule in approving the challenged transaction.
Because the compensation committee attacked by plaintiff constitutes a majority of the board, the business judgment analysis under the second prong of Aronson may be readily applied. Plaintiffs may prove demand futility by raising a reason to doubt whether the challenged transactions were a valid exercise of business judgment.
Plaintiff alleges that the challenged transactions raise a reason to doubt whether the option grants were a valid exercise of business judgment. Specifically, plaintiff states that the terms of the stock option plans required that "[t]he exercise price of each option shall be not less than one hundred percent (100%) of the fair market value of the stock subject to the option on the date the option is granted."
In Sanders v. Wang,
The situation here closely mirrors that in Sanders v. Wang. Plaintiff supports his claim that backdating occurred by pointing to nine option grants over a six-year period where each option was granted during a low point. That is, every challenged option grant occurred during the lowest market price of the month or year in which it was granted. In addition to pointing specifically to highly suspicious timing, plaintiff further supports his allegations with empirical evidence suggesting that backdating occurred. The Merrill Lynch analysis measured the extent to which stock price performance subsequent to options pricing events diverged from stock price performance over a longer period of time to measure the aggressiveness of the timing of option grants and found that Maxim's average annualized return of 243% on option grants to management was almost ten times higher than the 29% annualized market returns in the same period. This timing, by my judgment and by support of
Plaintiff supports his breach of fiduciary duty claim and his assertion that demand is futile by pointing to the board's decision to ignore limitations set out in the company's stock options plans. The plans do not grant the board discretion to alter the exercise price by falsifying the date on which options were granted. Thus, the alleged facts suggest that the director defendants violated an express provision of two option plans and exceeded the shareholders' grant of express authority.
Plaintiff here points to specific grants, specific language in option plans, specific public disclosures, and supporting empirical analysis to allege knowing and purposeful violations of shareholder plans and intentionally fraudulent public disclosures. Such facts, in my opinion, provide sufficient particularity in the pleading to survive a motion to dismiss for failure to make demand pursuant to Rule 23. 1.
2. Demand is Futile Under Rales
Even if the decision by the compensation committee was not imputable to the entire board, thereby implicating Aronson, demand would remain futile under the Rales test. Where the board has not yet made a decision, demand is excused when the complaint contains particularized facts creating a reason to doubt that a majority of the directors would have been independent and disinterested when considering the demand. Directors who are sued have a disabling interest for pre-suit demand purposes when "the potential for liability is not a mere threat but instead may rise to a substantial likelihood."
A director who approves the backdating of options faces at the very least a substantial likelihood of liability, if only because it is difficult to conceive of a context in which a director may simultaneously lie to his shareholders (regarding his violations of a shareholder-approved plan, no less) and yet satisfy his duty of loyalty. Backdating options qualifies as one of those "rare cases [in which] a transaction
B. Failure To State a Claim Upon Which Relief Can Be Granted
Defendants assert that plaintiff fails to state a claim for breach of fiduciary duty. This defense, stripped to its essence, states that in order to survive a motion to dismiss on a fiduciary duty claim, the complaint must rebut the business judgment rule. That is, plaintiff must raise a reason to doubt that the directors were disinterested or independent. Where the complaint does not rebut the business judgment rule, plaintiff must allege waste. Plaintiff here, argue the defendants, fails to do either. Further, there is no evidence that the defendants acted intentionally, in bad faith, or for personal gain. Therefore, so the argument goes, plaintiff fails to plead facts sufficient to rebut the business judgment rule and cannot maintain an action for breach of fiduciary duties.
Plaintiff responds that the same facts that establish demand futility under the second prong of Aronson v. Lewis — that is, the directors' purposeful failure to honor an unambiguous provision of a shareholder approved stock option plan — also rebuts the business judgment rule for the purpose of a motion to dismiss for failure to state a claim upon which relief can be granted.
1. Rule 12(b)(6) v. Rule 23.1
This Court follows well-settled standards governing motions to dismiss for
2. The Business Judgment Rule and Bad Faith
Even if this were not the case, the complaint here alleges bad faith and, therefore, a breach of the duty of loyalty sufficient to rebut the business judgment rule and survive a motion to dismiss. The business affairs of a corporation are to be managed by or under the direction of its board of directors.
In Stone v. Ritter, the Supreme Court of Delaware held that acts taken in bad faith breach the duty of loyalty.
Based on the allegations of the complaint, and all reasonable inferences drawn
I am unable to fathom a situation where the deliberate violation of a shareholder approved stock option plan and false disclosures, obviously intended to mislead shareholders into thinking that the directors complied honestly with the shareholder-approved option plan, is anything but an act of bad faith. It certainly cannot be said to amount to faithful and devoted conduct of a loyal fiduciary. Well-pleaded allegations of such conduct are sufficient, in my opinion, to rebut the business judgment rule and to survive a motion to dismiss.
Defendants move to dismiss seven of the nine claims asserted in plaintiff's complaint on the grounds that plaintiff lacks standing to assert these claims. According to defendants, plaintiff must have continuous ownership from the time of the transaction in question through the completion of the lawsuit in order to sustain a derivative action. It is unchallenged that plaintiff never owned stock in Maxim before 2001, and plaintiff acquired his stock through a merger, not by operation of law. Only two of the nine challenged transactions occurred while plaintiff held shares. Accordingly, defendant argues that dismissal of all claims arising before April 11, 2001, is proper pursuant to 8 Del. C. § 327.
Section 327 of the DGCL exists to prevent the purchasing of shares in order to maintain a derivative action attacking transactions that occurred before the purchase.
In most instances, Delaware courts have strictly construed this statute. Dispositive in this case is this Court's holding in Saito v. McCall.
Plaintiff here faces the same problem. He became a shareholder on April 11, 2001, by way of a merger, not by operation of law. Therefore, he lacks standing to assert claims arising before April 11, 2001. The cases where this Court has applied section 327 with some leniency are not applicable here. For example, in the case of Helfand v. Gambee, plaintiff lost standing by virtue of reorganization.
D. Statute Of Limitations
Defendants contend that the statute of limitations of 10 Del. C. § 8106 bars plaintiff's claims because none of the challenged transactions occurred within the past three years. Further, defendants assert that plaintiff cannot save his claims by relying on any tolling doctrines since the information was publicly available. Plaintiff concedes as much by relying on the Merrill Lynch report as the basis of his claims, which was prepared using publicly disclosed information and historical stock prices. Thus, defendants argue, the statute of limitations bars all claims asserted in this complaint.
This Court applies a three-year statute of limitations to equitable claims only by analogy. The statute of limitations begins to run at the time the alleged harmful act is committed, regardless of plaintiff's knowledge of the act. Plaintiff, however, may toll the limitations period by specifically alleging that the facts were "so hidden that a reasonable plaintiff could not have made timely discovery of an injury necessary to file a complaint."
Plaintiff asserts that the doctrine of fraudulent concealment tolls the statute
The allegations in the complaint satisfy the requirements of the doctrine of fraudulent concealment. Defendants allegedly caused Maxim to falsely represent that the exercise price of all the stock options it granted pursuant to its stock option plans was no less than the fair market value of Maxim's common stock, measured by the publicly traded closing price for Maxim stock on the date of the grant. To the extent that the date on which the grant was issued is not the same as the date that the defendants, in public filings, represented that the grant was issued, defendants affirmatively acted to conceal a fact that prevented plaintiff from gaining material relevant knowledge in an attempt to put plaintiff off the trail of inquiry. Plaintiff may rely on public filings and accept them as true, and need not assume that directors and officers will falsify such filings. Accordingly, where plaintiff alleges that defendants intentionally falsified public disclosures, defendants may not rely on the statute of limitations as a defense until plaintiff is placed on inquiry notice that such filings were fraudulent.
Defendants argue that there is no fraudulent concealment since Merrill Lynch based its report on public disclosures and plaintiff bases his complaint on the Merrill Lynch report. That is, defendants insist that Ryan, through investigation, could have discovered the same information that Merrill Lynch discovered. This defense is unconvincing. Shareholders may be expected to exercise reasonable diligence with respect to their shares, but this diligence does not require a shareholder to conduct complicated statistical analysis in order to uncover alleged malfeasance.
Finally, defendants contend that plaintiff's claim for unjust enrichment fails because there is no allegation that Gifford exercised any of the alleged backdated options and, therefore, Gifford did not obtain any benefit to which he was not entitled to the detriment of another. This defense is contrary both to the normal concept of remuneration and to common sense.
Unjust enrichment is "the unjust retention of a benefit to the loss of another, or the retention of money or property of another against the fundamental principles of justice or equity and good conscience."
At this stage, I cannot conclude that there is no reasonably conceivable set of circumstances under which Gifford might be unjustly enriched. Gifford does retain something of value, the alleged backdated options, at the expense of the corporation and shareholders. Further, defendants make no allegations that Gifford is precluded from exercising these options or that the options have expired. Thus, one can imagine a situation where Gifford exercises the options and benefits from the low exercise price. Even if Gifford fails to exercise a single option during the course of this litigation, that fact would not justify dismissal of the unjust enrichment claim. Whether or not the options are exercised, the Court will be able to fashion a remedy. For example, this Court might rely on expert testimony to determine the true value of the option grants or simply rescind them. Either way, Gifford's alleged failure to exercise the options up to this point does not undermine a claim for unjust enrichment Thus, I deny the motion to dismiss the unjust enrichment claim.
For the foregoing reasons, I grant defendants' motion to dismiss all claims arising before April 11, 2001. I deny defendants' motion to stay or dismiss with respect to all other claims.
IT IS SO ORDERED.
This concern is not implicated where the board has delegated decision-making authority to a committee comprising one half or more of its members and a shareholder seek to challenge an action taken by that committee. Where half or more of the board has already approved a corporate action, even acting through a committee, there is no need for a shareholder to give the entire board a second bite at the apple.