Delaware Supreme Court
Delaware Supreme Court

The Delaware Supreme Court reversed the dismissal of a derivative suit for failure to make demand, finding that the complaint alleged particularized facts sufficient to create a reasonable doubt as to the disinterestedness and independence of a majority of directors, in Sandys v. Pincus, No. 157, 2016 (Del. Dec. 5, 2016).  In Sandys, the plaintiff alleged that some top managers and directors at Zynga, Inc. were given an exemption to Zynga’s rule preventing sales by insiders until three days after an earnings announcement.

Because Zynga’s board of directors had nine members, the Court examined whether the complaint had excused a demand as to at least five directors.  Two of the directors (Reid Hoffman, and the controlling stockholder and former CEO, Mark Pincus) had participated in the trades and were considered interested in the transaction.  Another director, Don Mattrick, had been named as the new CEO, and was therefore deemed interested because the corporation’s controlling stockholder was interested in the transaction.  The Court concluded that the complaint alleged reasonable doubt as to the disinterestedness of another three directors (adding up to six of the nine directors).

One director, Ellen Siminoff, was deemed to be potentially interested because she and her husband were co-owners of a private plane with Pincus, which “signaled an extremely close, personal bond” between the two directors and their families because unlike some other assets, a private plane “requires close cooperation in use, which is suggestive of detailed planning indicative of a continuing, close personal friendship.”  The Court noted that at the pleading stage, a plaintiff need not “plead a detailed calendar of social interaction to prove that directors have a very substantial personal relationship rendering them unable to act independently of each other.”

Another two directors, William Gordon and John Doerr, were partners at a prominent venture capital firm, Kleiner Perkins Caufield & Byers, which had interlocking relationships with both directors who traded in Zynga stock.  Specifically, Kleiner Perkins also was invested in a company that Pincus’ wife co-founded, and with a company on whose board Hoffman served as a director.  According to its public disclosures, the Zynga board had determined that Gordon and Doerr did not qualify as independent directors under the NASDAQ listing rules.  The plaintiff’s books and records inspection demand did not inquire as to the board’s NASDAQ determination, and the Court of Chancery found that these directors’ independence had not been sufficiently challenged.  The Delaware Supreme Court disagreed, stating that “to have a derivative suit dismissed on demand excusal grounds because of the presumptive independence of directors whose own colleagues will not accord them the appellation of independence creates cognitive dissonance that our jurisprudence should not ignore.”  While agreeing that “the Delaware independence standard is context specific and does not perfectly marry with the standards of the stock exchange in all cases,” the Court nonetheless identified criteria of the NASDAQ rule that “are relevant under Delaware law and likely influenced by our law.”

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Gavel_editFor the first time since 1997, the United States Supreme Court explored the requirements for proving a federal securities fraud claim based on insider trading, in Salman v. United States (Dec. 6, 2016).  The Salman opinion confirms that a factfinder may infer a personal benefit to a tipper from a gift of confidential information to a trading relative or friend, without the added requirement of “proof of a meaningful relationship” that had been imposed by the Second Circuit in United States v. Newman, 773 F.3d 438 (2d Cir. 2015).  Salman thus resolves a circuit split that had developed between the Second and Ninth Circuits.

Historically, individuals have been found to have engaged in securities fraud under “classical” theory or “misappropriation” theory.  Under classical theory, corporate “insiders” (directors, officers, and others deemed to hold a temporary fiduciary status) either trade on inside information or tip the information to someone who does.  Dirks v. S.E.C., 463 U.S. 646 (1983).  Under misappropriation theory, the person trading or tipping inside information need not owe fiduciary duties generally to a corporation and its stockholders, but must violate some relationship of trust and confidence through which she received the information.  United States v. O’Hagan, 521 U.S. 642, 650-52 (1997).  In both cases, then, the person engaging in insider trading has committed an act of deception by violating a relationship of trust and confidence.  Also, in both cases, the actionable deception is to the source of information and not to the other party to the trade or the general trading public, even though the latter may be injured by the trader’s conduct.  See id.  The Supreme Court has not read the federal securities laws as establishing “a general duty between all participants in market transactions to forgo actions based on material, nonpublic information.”  Chiarella v. United States, 445 U.S. 222, 233 (1980).

In the 2015 Newman case, the Second Circuit further limited the ability of the government to bring insider trading cases.  The court acknowledged that language in the Supreme Court’s Dirks opinion could be read as permitting a factfinder to infer that a tipper received a personal benefit by providing confidential information to a trading relative or friend, but added that such an inference “is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”  Newman, 773 F.3d at 452.  The Newman opinion called into question hard-won victories by the federal government against insider trading defendants in the Southern District of New York.

The Ninth Circuit took a different direction in Salman.  In that case, confidential information originally was obtained by an investment banker at Citigroup, Maher Kara, who shared it with his brother Michael.  Unbeknownst to Maher, Michael then shared the information with others including the defendant, Bassam Salman, whose sister was married to Maher.  On appeal, the Ninth Circuit refused to follow Newman,
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