The Delaware Court of Chancery recently granted a motion to dismiss a shareholder derivative action involving Sycamore Networks, Inc. that alleged misconduct in the issuance of stock options. Desimone v. Barrows, 2007 WL 1670255 (Del. Ch. June 7, 2007). The court dismissed the action, in relevant part, on grounds of failure to adequately plead demand futility and failure to state a claim. The court’s detailed opinion is the third significant backdating decision to emerge out of the Delaware courts (see EAPD’s analysis of the other two decisions, Maxim and Tyson Foods, here). The decision provides litigants some assurance that Delaware courts will examine the often complex factual details alleged in backdating cases, and will likely be highly influential in other jurisdictions.
The Chancery Court noted the fact-specific nature of its analysis, indicating that, given the complex legal framework governing corporate directors, it is critical in deciding stock option cases to closely examine the board’s alleged conduct. Thus, after providing an extensive review of Maxim and Tyson Foods, and describing in detail a number of illustrative hypothetical situations, the court stated that: “Those examples, which present only a few of the many plausible scenarios in which interesting questions about stock option grants could arise, highlight the need for judicial caution. Lumping context-specific behavior involving varying motivations into generic categories such as backdating, spring loading and bullet dodging, and driving results by such labeling seems unlikely to do justice.”
The court then categorized the Sycamore stock option grants according to the recipients: employees, outside directors, and officers. With regard to the employee option grants, the court held that plaintiffs failed to sufficiently allege demand futility because there was “no basis to conclude that the Sycamore board faces a substantial threat of liability,” in investigating improper grants to employees. With respect to the outside director grants, the court found that, although the plaintiffs satisfied their demand futility pleading requirements (the outside directors comprised a majority of the board), the plaintiffs failed to state a claim under 12(b)(6) because the outside director grants had been made in strict accordance with the shareholder-approved stock option plan.
The court’s analysis of the officer grants was more complicated. Most of the officer grants involved allegedly backdated options, and the court concluded that plaintiffs had failed to allege that any member of the board had knowingly approved backdated options. However, plaintiffs also alleged that defendants had timed an options grant to benefit from a recent stock price drop and an expected stock price jump. The court’s analysis focused on whether, at the time of the issuance of this option grant, the board had material, non-public information.
Issuing stock options after negative news is disclosed would not ordinarily state a claim because those options would have been issued “at a fair market value reflecting negative information previously disclosed to the public markets.” However, the same is not true where options are spring loaded, i.e., issued before a positive announcement. Nevertheless, the court distinguished the plaintiffs’ allegations of a single spring loaded grant from the allegations, made by plaintiffs in Tyson Foods, of “a multi-year pattern of large grants occurring at random times of year that preceded large, market moving announcements.”
Given this distinction, the court concluded that the Sycamore board was not exposed to personal liability. Therefore, because demand was not excused, plaintiffs could not pursue these derivative claims.
A copy of the Chancery Court’s opinion is available here.
