Saturday, August 18, 2007

Delaware Chancery Court Reexamines, Allows Springloading Claim to Proceed

In an August 15, 2007 opinion (here), Delaware Chancery Court Chancellor William B. Chandler III reexamined his February 6, 2007 refusal to dismiss plaintiffs’ claim involving stock option springloading against directors and officers of Tyson Foods, Inc. In his earlier opinion (here), Chandler had held, in response to the defendants’ motion to dismiss, that the board’s authorization of springloaded options may, in certain circumstances, constitute a breach of a director’s fiduciary duties.

In his August 15 opinion, Chandler considered defendants’ motion for judgment on the pleadings, in which the defendants argued that the supposedly springloaded options were in fact authorized under the company’s shareholder approved stock option plan.

The defendants probably sensed that their motion’s prospects for success were dim when they read how Chandler characterized the circumstance that could be inferred from the consolidated complaint:

On three separate occasions between 2001 and 2003, defendants suspected that Tyson’s share price would climb once the market learned what the board already knew. Armed with this knowledge, members of the Compensation Committee granted non-qualified stock options to select Tyson employees, ensuring that these options would shortly be in the money. When the option grants were later revealed to shareholders, however, defendants did not straightforwardly describe such strike-price prestidigitation. Rather, they provided minimal assurances to investors that these options rested within the limits of the shareholder-approved plan. The crux of defendants’ argument is that a scheme that relies upon bare formalism concealed by a poverty of communication somehow sits within the scope of reasonable, good faith business judgment.
In analyzing the issues before him, Chandler first reviewed the legal standards governing directors’ conduct, which he summarized as follows:

Loyalty. Good faith. Independence. Candor. These are words pregnant with obligation. The Supreme Court did not adorn them with half-hearted adjectives. Directors should not take a seat at the board table prepared to offer only conditional loyalty, tolerable good faith, reasonable disinterest or formalistic candor. It is against these standards, and in this spirit, that the alleged actions of spring-loading or backdating should be judged.
The defendants argued that because the company’s Stock Incentive Plan allowed options to be granted at any price, the shareholders had authorized grants of the type at issue. The Company’s SEC disclosures revealed to investors only that the stated strike price on the options had to be the market price on the day of the grant. The SEC disclosures did not reveal the springloading, leading Chandler to observe that the disclosures “display an uncanny parsimony with the truth.” Chandler said that at the pleading stage, taking the inferences in the plaintiffs’ favor, the Court “may further infer that grants of spring-loaded stock options were both inherently unfair to shareholders and that the long-term nature of the deceit involved suggests a scheme inherently beyond the bounds of business judgment.” Chandler added that “where I may reasonably infer that a board of directors later concealed the true nature of a grant of a stock options, I may further conclude that those options were not granted consistent with a fiduciary’s duty of utmost loyalty.”

In summarizing the reasons for his denial of the defendant’s motion, Chandler stated that:

What the defendants here fail to confront is that their disclosures regarding the options under attack do nothing to rebut the pleading stage inference that the defendants intended to conceal a pattern of unfairly stocking up insiders’ larders with option grants shortly before the announcement of events likely to increase the Company’s stock price. In fact, the magnitude and timing of the grants, when accompanied with no disclosure of the reasons motivating the grants, is suggestive, at the pleading stage, of a purposeful subterfuge. Put simply, the pleadings support an inference not only that the defendants engaged in self-dealing, but that they attempted to hide their conduct from the stockholders.

While a variety of courts have now weighed in on the backdating issue, the Delaware courts’ statements on these issues remain the most important, because of the prominence and influence of Delaware law and the Delaware courts themselves. Chandler’s views of backdating and springloading in the Tyson Foods case and Ryan v. Gifford (here), the Maxim Integrated Products case, have not prevented other courts from dismissing other cases, and in fact Chancery Court Vice Chancellor Leo Strine distinguished Chandler’s prior opinions in granted the dismissal motion in the Sycamore Networks case (here). But Chandler’s refusal to dismiss the springloading allegations in the Tyson Foods case -- essentially because the options related disclosures were inconsistent with the level of disclosures required by directors’ fiduciary duties -- could have an important impact, precisely because of its insistence that the directors' fiduciary duties require completely candid disclosures to shareholders about all the benefits from an options grant. Certainly his perception that the imbedded profit potential inherent within a springloaded option grant is a benefit of a kind that fiduciary duties require to be disclosed to shareholders will be an important point of view for future courts reviewing springloaded option grants.

The Delaware Corporate and Commercial Litigation Blog also has a post on Chandler's recent opinion in the Tyson Foods case (here). Very special thanks to Francis Pileggi, who maintains the DCCL blog, for providing a copy of the opinion.

"Seven Ways Counsel Can Help Clients With D & O Claims": In an August 16, 2007 post, here, I reviewed seven ways counsel can aid their clients in connection with D & O claims. Due to a snafu at my feed syndication service, no email went out to most of my subscribers about this post, so I just making sure that all readers are aware of the post.

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