Litigation Update Royse Law April 19, 2017

Greetings all. The following is a link to the April 19, 2017, Litigation Update for Royse Law of which I am the editor, http://conta.cc/2p46oKU

I primarily practice out of the Menlo Park office. We also have offices in San Francisco, Los Angeles and Brea. My practice includes civil litigation (business, real estate, D&O, professional responsibility, employment, IP, insurance, etc.) and trust, estate and elder litigation and contentious administrations. You can email me at dtate@rroyselaw.com, or call me at (650) 813-9700 extension 233. Best, David Tate

Evaluating Director Independence – Zynga Shareholder Derivative Suit

Thomas Sandys Derivatively on Behalf of Zynga, Inc. v. Pincus, et al., Delaware Supreme Court, Case No. 157,2016, December 5, 2016, highlights the sometimes difficulty, and the importance of evaluating director independence in the circumstance of a shareholder derivative suit.

In Zynga the plaintiff filed his shareholder derivative suit without first making a demand upon the board that the Company sue Company insiders that were alleged to have improperly sold Company stock. Instead of first making the demand upon the board, plaintiff argued that such a demand would have been futile because a majority of the nine person board members lacked independence.

In summary, the plaintiff alleged two derivative claims based on allegations that certain top managers and directors at Zynga were given an exemption to the Company’s standing rule preventing sales of stock by insiders until three days after an earnings announcement, and that the insiders who participated in the sale breached their fiduciary duties by misusing confidential information when they sold their shares while in possession of adverse, material non-public information. And plaintiff also asserted a duty of loyalty claim against the directors who approved the sale.

The holding in Zynga is that at the pleading stage there was sufficient evidence to suggest that a majority of the board did lack independence so as to excuse not making the demand upon the board. The holding is primarily interesting for the Court’s discussion about three particular board members, and the reasons why the Court determined that there was evidence to sufficiently suggest that those three directors did in fact lack independence to impartially consider a demand that the Company bring suit against the selling insiders, which resulted in a majority of the board also lacking independence, so as to excuse making the pre-suit demand upon the board.

To plead demand excusal the plaintiff must plead particularized factual allegations that create a reasonable doubt that, as of the time the complaint was filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand. At the pleading stage, a lack of independence turns on whether the plaintiff has pleaded facts from which the director‘s ability to act impartially on a matter important to the interested party can be doubted because that director may feel subject to the interested party‘s dominion or beholden to that interested party.
With respect to one of the directors in question, the Court found troubling for the purpose of independence or lack thereof that the particular board member and her husband co-owned an unusual asset, an airplane, with Zynga’s former CEO and controlling stockholder, which the Court found was suggestive of an “extremely intimate personal friendship between their families.”

And with respect to the other two directors, the Court found troubling for the purpose of independence or lack thereof that the directors are partners at a prominent venture capital firm and that they and their firm not only controlled 9.2% of Zynga‘s equity as a result of being early-stage investors, but have other interlocking relationships with the controller and another selling stockholder outside of Zynga. More specifically the Court stated “Although it is true that entrepreneurs like the controller need access to venture capital, it is also true that venture capitalists compete to fund the best entrepreneurs and that these relationships can generate ongoing economic opportunities. There is nothing wrong with that, as that is how commerce often proceeds, but these relationships can give rise to human motivations compromising the participants’ ability to act impartially toward each other on a matter of material importance. Perhaps for that reason, the Zynga board itself determined that these two directors did not qualify as independent under the NASDAQ rules, which have a bottom line standard that a director is not independent if she has ―a relationship which, in the opinion of the Company‘s board of directors, would interfere with the exercise of independent judgment . . . .[Footnote #1: NASDAQ Marketplace Rule 5605(a)(2)] Although the plaintiff’s lack of diligence made the determination as to these directors perhaps closer than necessary, in our view, the combination of these facts creates a pleading stage reasonable doubt as to the ability of these directors to act independently on a demand adverse to the controller‘s interests. When these three directors are considered incapable of impartially considering a demand, a majority of the nine member Zynga board is compromised for Rule 23.1 purposes and demand is excused. Thus, the dismissal of the complaint is reversed.”

As you might correctly assume, board member independence can arise as an issue in several different corporate and governance related circumstances.

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NEW NINTH CIRCUIT CASE – PLAINTIFF CANNOT BRING A SECURITIES CASE FOR BREACH OF THE CORPORATE CODE OF ETHICS . . . WELL, NOT SO FAST . . . .

On January 19, 2017, the Ninth Circuit dismissed a securities fraud case holding that the claim could not legally be brought where shareholders of Hewlett-Packard Company (“HP”) alleged that the Company CEO and Chairman violated Hewlett-Packard’s Corporate Code of Ethics after publicly touting the Company’s high standards for ethics and compliance while at the same time himself violating the provisions in the Code of Ethics. The case is Retail Wholesale & Department Store Union Local 338 Retirement Fund v. Hewlett-Packard Co. and Mark A. Hurd, Ninth Circuit Case No. 14-16433 and District Court Case No. 3:12-cv-04115-JST (Northern District of California) and you can view the case at http://cdn.ca9.uscourts.gov/datastore/opinions/2017/01/19/14-16433.pdf.

Plaintiffs’ claim was brought under §10 and Rule 10–b of the Securities Exchange Act of 1934. The Court’s decision is helpful from a defense viewpoint, but the decision shouldn’t be viewed too broadly. In summary, the Court held as follows (note: the below quotes from the case are not necessarily in the exact order in which they appeared in the Court’s decision):

“Retail Wholesale argues that the SBC [HP’s Standards of Business Conduct], bolstered by Defendants’ express promotion of corporate ethics, gives rise to a finding of material misrepresentation. Its claim is based in three factual allegations: (1) HP and Hurd actively promoted the SBC and stated that HP had zero tolerance for SBC violations; (2) Hurd’s SBC violations led to his resignation; and (3) Hurd’s resignation caused HP’s stock price to drop. The Court cannot agree that, under the facts alleged in the complaint, Defendants’ representations about ethics were materially misleading.”

“Defendants made no objectively verifiable statements during the Class Period. As one court has aptly written, a code of conduct is “inherently aspirational.” Andropolis, 505 F. Supp. 2d at 686. Such a code expresses opinions as to what actions are preferable, as opposed to implying that all staff, directors, and officers always adhere to its aspirations. See id.”

“Similarly, Hurd’s comments prefacing the SBC are not objectively verifiable. In the 2008 preface to the SBC, Hurd stated, in part,

We want to be a company known for its ethical leadership . . . .

We know actions speak louder than words. We must make decisions and behave in ways that we can be proud of, that reflect our commitment to doing the right thing . . . .

. . . . Let us commit together, as individuals and as a company, to build trust in everything we do by living our values and conducting business consistent with the high ethical standards within our SBC.”

“The aspirational nature of these statements is evident. They emphasize a desire to commit to certain “shared values” outlined in the SBC and provide a “vague statement[] of optimism,” not capable of objective verification. See Or. Pub. Emps., 774 F.3d at 606. A contrary interpretation—that statements such as, for example, the SBC’s “we make ethical decisions,” or Hurd’s prefatory statements, can be measured for compliance—is simply untenable, as it could turn all corporate wrongdoing into securities fraud.”

However, and equally important, the Court also stated:

“We note that the case may have been closer had Hurd’s sexual harassment and false expenses scandal involved facts remotely similar to those presented by the 2006 scandal [i.e., an earlier unrelated ethics problem at HP in which “A few years earlier, in 2006, a major scandal erupted when a whistleblower informed several government agencies that HP had hired detectives to monitor the phone records and email accounts of HP directors, HP employees, and journalists to find the sources of leaks of company information to the press”], as the ethical code could then have been understood as at least promising specifically not to do what had been done in 2006. Here, however, the context does not make HP’s promotion of business ethics any less subjective or vague. Further, Retail Wholesale cites to no case law suggesting that context may operate to allow a plaintiff to import an out-of-Class-Period statement into the Class Period. The strongest statement alleged in the complaint—the suggestion of a zero tolerance policy for SBC violations—was made outside of the Class Period.”

“In sum, we conclude that as there was no statement during the Class Period that was capable of being objectively false, there was no affirmative misrepresentation.”

It could be easy to read the case too broadly, and to conclude that a securities fraud claim cannot be brought for violation of the company’s code of ethics. Whether such a claim can be brought really depends on the facts and circumstances of the case. Further, and depending on the facts of each case, it might be possible that such a claim could be brought under a different legal theory such as, for example, the Foreign Corrupt Practices Act.

Thus, companies, and their officers, managing agents and directors still must be advised to know the company’s Code of Ethics, to follow the Code, and to be careful about making specific representations about following, satisfying or complying with the Code.

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Royse Law Firm/David Tate – Legal Updates in Litigation, Liability, Governance & Risk Management (March 10)

Below I have provided a link to the Royse Law Firm Legal Updates in Litigation, Liability, Governance & Risk Management, of which I am the Editor. The Update is litigation and dispute targeted, primarily covering business, IP, employer and employee, D&O, founder/owner/shareholder/investor, M&A, and trust and estate litigation and disputes, and also including governance, administrations, and risk management. The Updates include the Firm’s attorney written articles and updates, videos and presentations, and also from time to time select resources by other outside third parties with comments added.

My practice continues in civil and trust and estate litigation and disputes and administrations, and other related areas. The Royse Law Firm offers very experienced, appropriately priced corporate, IP, employment, D&O, M&A, founder/owner/shareholder/investor, estate planning and litigation legal services and representation for established and new businesses, and people, in Northern and Southern California. Please contact me if you or other people who you know have legal needs. You can contact me at (650) 813-9700, extension 233. The Firm’s website is http://rroyselaw.com/

Click on the following link to Legal Updates in Litigation: Royse Legal Updates in Litigation, Liability, Governance & Risk Management (March 10, 2017)

Updated Tate’s Excellent Audit Committee Guide (02172017) – Please Use, And Pass To Others

Below I have provided a link to my updated (02172017) Tate’s Excellent Audit Committee Guide. Please use it, and tell other people who would be interested. Best to you, David Tate, Esq., Royse Law Firm, Northern and Southern California, 149 Commonwealth Drive, Ste. 1001, Menlo Park, CA 94025, (650) 813-9700, Extension 233, http://www.rroyselaw.com

Here’s the link to the updated guide tates-excellent-audit-committee-guide-02172017-with-appendix-a

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Audit Committee 5 Lines of Defense 07182016

When should you take your internal accounting error/mistake or irregularity/fraud investigation outside?

Most every audit committee member, in-house counsel, other board member, CEO, CFO, risk officer, and chief internal auditor will at some time consider whether an accounting related investigation that is being done internally should be taken outside. The decision to stay inside or to go outside isn’t necessarily clear, and there certainly could be differing opinions depending on the facts and circumstances of the situation. The following isn’t a formal or legal discussion, but below are at least some of the factors that I would consider and that you might consider. Every situation is different at least to some extent.

  1. Is there really the expertise in-house to do the investigation? This is an important consideration that I will have more to say about in other posts – however, consider whether it is important for the primary investigator to not only have a legal background in the subject matter, but also accounting or auditing backgrounds. Whereas an accounting or auditing firm might also be retained to assist with the investigation, you might well also find that it would be helpful for the primary investigator to be able to understand the accounting, internal control and auditing or auditor issues, and that the primary investigator might need those backgrounds to better lead the investigation and make decisions or evaluations.
  2. Is there really the time availability to handle the investigation in-house?
  3. Is the dollar amount involved sufficiently large to warrant going outside for the investigation?
  4. Are the qualitative natures of the issues sufficiently important to warrant going outside, such as because of possible public relations, ethics, fraud, or other considerations?
  5. Does it warrant going outside because of the possible people who might be interviewed, questioned or involved including their office or stature in the organization, and their relationships with the people who are investigating, the board, the audit committee, the executive officers and other people?
  6. For whatever reasons, is it warranted or required that the investigation be independent, or more independent in nature.
  7. If the initial investigation began in-house (which is entirely possible), has it for whatever reason now become more prudent to go outside?

That’s it for now. Just some thoughts. I’m sure that you can come up with additional thoughts – the above discussion isn’t all encompassing.

Dave Tate, Esq. (San Francisco and California)

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Audit Committee 5 Lines of Defense 07182016

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Completed (mostly) a will contest and trust real property percentage trial on Friday – read more

I have been away from the blog for a while, preparing for a very contentious and time-consuming trial.

This past week I was in trial on a will contest action, and also on related but separate real property ownership and trust beneficiary percentage ownership claims. The witnesses and experts included my client who was the named beneficiary, the contestant(s), documents in which the decedent expressed her wishes including a police report and APS records in addition to other documents, forensic document examiners, forensic psychiatrists, and third party witnesses including a very spry 102 year old woman who was a friend of the decedent (the decedent executed the will at age 103, and passed away approximately 9 months later at age 104). Issues also involve the validity of a power of attorney that the decedent executed in June 2015 (she died one month later in July 2015), mental capacity, undue influence, elder abuse, trust and power of attorney accountings, costs and attorneys’ fees, and other issues.

As you may be aware, issues of mental capacity and undue influence are not the same for wills, powers of attorney, and trusts, variously including California Probate Code §§810, etc., and 6100.5, etc., and California Welfare and Institutions Code §15610.70, and various other statutes and case law.

The will contest was denied, and my client will receive what the decedent wished and intended.

So . . . I will be back on this blog and other networking, and also on my other blog http://californiaestatetrust.com

Best to you, and thank you for following my blogs and posts. Dave Tate, San Francisco Bay Area and California.