Thursday, October 25, 2007

More (and More) Options Backdating Dismissals

For those keeping track, the options backdating-related securities class action lawsuit filed against Hansen Natural can be added to the list of options backdating-related securities class action dismissals. (Refer here regarding prior dismissals.) Hansen announced in its 8-K dated October 23, 3007 (here) that the court granted the defendants’ motion to dismiss the plaintiff’s complaint, without leave to amend.

In its October 16, 2007 opinion (here), the court granted the Hansen Natural defendants’ motion on several grounds. The court found that the complaint failed to allege fraud with particularity, and that the complaint failed to allege facts sufficient to give rise to a strong inference that the defendants acted with scienter. In particular, the court found that none of the plaintiff’s allegations of a backdating scheme, accounting fraud, lack of internal controls, corporate authority, or insider trading gave rise to a strong inference of scienter. The court also found that the plaintiff failed to sufficiently plead either materiality or loss causation.

The court clearly was not impressed with the plaintiff’s argument, based upon a comparison of the company’s stock price graph and the option grant dates, that the defendants "must have engaged in backdating." The court declined to draw any inferences from the plaintiff’s analysis, which, as the court noted, "is no analysis at all, but simply a series of charts and graphs comparing Hansen’s stock price on the date of each of the stock option grants with the stock price on the tenth day after the stock option grant day." The court noted that between 1997 and the end of 2005, Hansen’s stock price increased about 15,000 percent, so "it is not surprising that Hansen’s stock price would have risen following the twelve stock grants."

As readers will recall, there was a stir (refer here) as the options backdating story unfolded last year about the fact that many companies apparently were late in filing their Form-4s (as was detailed in a well-publicized Glass Lewis report). The notion at the time was that perhaps the late Form-4 filing indicated (or at least facilitated) backdating. The Hansen Natural court specifically considered and rejected this argument, in part because the Form-4s by themselves showed nothing other than they were late, and in part because the company’s Special Committee had specifically found that the Form-4s did not support a finding of backdating.

The court’s perspective on the case was clearly influenced by external events surrounding the backdating allegations, particularly the Special Committee’s findings that there was no willful or intentional misconduct in connection with stock option grants; and that the company’s outside auditor's conclusion that the needed options-related accounting adjustments were not material. The court took judicial notice of a wide variety of documents and materials outside the complaint. While the plaintiffs did not object to some of the items of which the court took judicial notice, the court’s ultimate conclusions do have an air of factual determination about them. The Tellabs decision’s requirement that courts weigh competing inferences puts them squarely in the business of making assessments. But reasonable minds might ask at what point the development and consideration of a voluminous record outside the complaint, supporting evaluations of factual allegations, is entirely consistent with the court’s limited role at the motion to dismiss stage.

Nevertheless, the Hansen Natural court’s categorical rejection of the plaintiff’s complaint may foreshadow developments in other pending backdating cases that depend upon the plaintiffs’ contention that there must have been backdating. For courts in the post-Tellabs business of weighing competing inferences, stock graphs overlain with option grant dates may simply not be enough to create a strong inference of scienter – as further corroborated below in the discussion of the Delta Petroleum options backdating-related shareholders’ derivative case.

Two More Backdating Derivative Lawsuit Dismissals: In separate decisions, two courts recently granted motions to dismiss in options backdating related derivative lawsuits. There are some features of these two dismissals that are particularly noteworthy.

The first dismissal involves the shareholders derivative lawsuit brought against Delta Petroleum, as nominal defendant, and several of its directors and officers. The court’s September 26, 2007 opinion dismissing the Delta Petroleum case can be found here. The second dismissal came in the derivative lawsuit filed against Glenayre Technologies, as nominal defendant, and several directors and officers. The court’s October 9, 2007 dismissal opinion can be found here.

The two cases raised both raised allegations (pled derivatively) under both the federal securities laws and under applicable state law. The Delta Petroleum court dismissed the federal securities law allegations on the grounds that the plaintiffs had not stated a claim, because they had not made sufficient allegations that the options were, in fact, backdated. The plaintiffs relied on the standard litany of sources: the March 2006 Wall Street Journal article, the May 2006 research of the Center for Financial Research and Analysis, and the supposed suspicious timing of the stock options grants. The court found these references "insufficiently specific," noting that

The Plaintiffs have repeatedly alleged that the odds of there being so many option grants near the monthly low were "remote." However, they allege no facts to support this conclusion, not do they explain why they believe this to be the case.
The court did allow the plaintiffs leave to attempt to replead; as of today, however, they have not yet filed an amended complaint.

The Glenayre Technologies court dismissed the federal securities laws allegations on the basis of the statute of limitations. The plaintiffs in the federal court case, faced with a competing state court case involving the same company and the same allegations, sought to secure their federal court case by alleging that the individual defendants violated the federal proxy solicitation statute and rules by filing false and misleading proxies. The court found that none of the proxy-related allegations were timely and dismissed the case on the basis of the statute of limitations applicable to claims alleging proxy solicitation violations.

Both the Delta Petroleum court and the Glenayre court, having dismissed the federal claims, declined to exercise jurisdiction over the remaining state law claims and dismissed those claims as well. In the Glenayre case, that is perhaps easier to understand, given the existence of the parallel state court action involving the same defendants and the same essential claims. But both courts had supplemental jurisdiction over the state law claims under 28 U.S.C. 1367, and while the statute says courts"may" dismiss supplemental jurisdiction claims when the original jurisdiction claims have been dismissed, the courts had discretion to retain the state law claims. (The existence of the parallel state court proceedings in the Glenayre case gets into complicated principles under the abstention doctrine and the application of the Colorado River abstention criteria, but the bottom line is that the federal courts both had the discretion to retain jurisdiction over the state law claims.) The alacrity with which the federal courts declined to retain supplemental jurisdiction over the state law claims suggest an earnest wish to banish to state court those annoying state corporate law issues.

While there have to date been some options backdating settlements, some quite substantial, and there have been some impressive decisions (particularly out of Delaware) denying motions to dismiss, there is an increasingly impressive list of options backdating cases where the motions to dismiss have been granted. For all of the options backdating sound and fury, in the end, the whole scandal may not signify all that much, even given the settlements so far, if most cases wind up getting dismissed. Certainly, the disdain of the courts cited above for the "must have been backdating" theory is a dark portent for the plaintiffs’ prospects in many of the pending backdating cases.

Special thanks to Adam Savett of the Securities Litigation Watch (here) for copies of the Delta Petroleum and Glenayre opinions.

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