Securities Snapshot
December 2, 2020

Delaware Court of Chancery Rules Against Gilead in Books and Records Action

Delaware Court of Chancery Rules Against Gilead in Books and Records Action; Second Circuit Reverses Dismissal of Securities Fraud Suit Alleging Chinese Education Company Engaged in Sham Transactions; Third Circuit Grants Writ of Mandamus Vacating District Court’s Denial of Motion to Transfer Securities Case Against 3M Company; Delaware Court of Chancery Denies Motion to Dismiss Breach of Fiduciary Duties Claims Against GPB Capital and its Officers.

On November 24, 2020 following a trial and post-trial briefing, Vice Chancellor McCormick issued a blistering, 69-page decision in Deborah Pettry, et al. v. Gilead Sciences, Inc., granting stockholders’ request under Delaware General Corporation Law Section 220 to inspect books and records of Gilead Sciences, Inc. (“Gilead”). Vice Chancellor McCormick held that the plaintiffs had clearly established a “credible basis” for their request, the “lowest possible burden of proof under Delaware law,” and chided Gilead for its “overly aggressive defense strategy.” Vice Chancellor McCormick further gave plaintiffs leave to file a motion for expenses, including attorneys’ fees.

These Section 220 actions, consolidated by stipulation, arose out of scrutiny of Gilead’s development, marketing, and sale of its tenofovir disoproxil fumarate (“TDF”) drug,  used to treat HIV. In recent years, Gilead has been the subject of lawsuits and investigations regarding TDF, including allegations of antitrust violations, mass torts, patent infringement, and False Claims Act violations. In 2019, five Gilead stockholders separately made written demands upon Gilead to inspect certain books and records relating to TDF, claiming that the aforementioned investigations and lawsuits gave them a “credible basis to suspect” that Gilead had engaged in wrongdoing “in its efforts to protect the TDF market.” Gilead refused to allow inspection, and each plaintiff filed suit to enforce their inspection rights under Section 220. 

In opposing the lawsuits, Gilead argued that the plaintiffs lacked proper purposes and had failed to justify the scope of their requests. Gilead asserted that plaintiffs failed to demonstrate a credible basis to suspect wrongdoing and that “each plaintiff was acting as a Manchurian candidate for a law firm such that none of Plaintiffs’ stated purposes [were] their own.” Gilead took issue with plaintiffs’ reliance on “unsubstantiated allegations” in various TDF-related complaints filed in courts across the country, arguing that such allegations, absent substantive evidence, “cannot supply a credible basis to suspect possible wrongdoing.” Gilead also argued that plaintiffs lacked standing because they could not overcome defenses to anticipated derivative claims even if their requests were granted. Specifically, Gilead claimed that plaintiffs did not own shares at the time of the alleged wrongdoing and that any subsequent derivative claims would be time-barred and barred by an exculpatory charter provision (eliminating fiduciary duty liability for directors in certain circumstances).

Vice Chancellor McCormick examined the evidence proffered by plaintiffs in support of each category of alleged wrongdoing by Gilead, and held that plaintiffs had clearly established a credible basis to infer wrongdoing, and therefore that they stated a proper purpose for inspection. The Vice Chancellor held that while the unverified allegations in various lawsuits cited by plaintiffs may not be “substantiated or even probable,” they were sufficient to meet plaintiffs’ low burden of demonstrating a credible basis for their investigation.

Vice Chancellor McCormick also rejected Gilead’s remaining arguments, i.e., that the purposes alleged were not the stockholder plaintiffs’ own, and that inspection was inappropriate because plaintiffs would lack standing in any derivative action. With respect to plaintiffs’ purposes, the Court distinguished Wilkinson v. A. Schulman, Inc., a case decided upon “extreme facts” in which the plaintiff played no meaningful role in the demand or litigation and the attorneys “disregarded their client’s objectives entirely and pursued their own.” Here, the Vice Chancellor held, plaintiffs’ general understanding of the dispute was sufficient to demonstrate that “their purpose was their own” despite the “dominant role” played by the lawyers. With respect to the standing argument, the Vice Chancellor held that success in a Section 220 proceeding does not necessarily depend upon the viability of “causes of action that have not yet been asserted and might have never been asserted,” unless the plaintiff “identifies pursuing a derivative claim as its sole purpose” in making the demand. Here, because the plaintiffs expressly identified “multiple potential end-uses for the information obtained through their investigation,” the Vice Chancellor held that potential defenses to theoretical subsequent derivative claims were irrelevant.

Gilead argued in the alternative that if inspection were ordered, plaintiffs should only be permitted to review formal board materials, and should be denied access to five additional categories of documents they requested. Vice Chancellor McCormick rejected this argument, again finding that plaintiffs had “demonstrate[ed] a credible basis to suspect wide-ranging misconduct and wrongdoing.” Thus, the Vice Chancellor ordered that Gilead give plaintiffs access to all of the books and records requested.

Finally, Vice Chancellor McCormick took the unusual step of inviting plaintiffs to file a motion for attorneys’ fees. The Vice Chancellor viewed Gilead’s failed arguments as an indication that “Gilead’s real goal in this litigation is not to protect its interests but, rather, to make the process of investigating wrongdoing as difficult as possible for its shareholders.” Vice Chancellor McCormick observed that Gilead’s behavior “exemplified the trend of overly aggressive litigation strategies by blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs’ statutory rights.” Under these circumstances, the Vice Chancellor believed that the extraordinary remedy of fee shifting could be appropriate, and invited further briefing on that question.


On November 25, 2020, a three-judge panel of the Second Circuit Court of Appeals overturned a district court order dismissing the plaintiffs’ securities fraud claims in Lea v. TAL Education Group. The panel held that the complaint sufficiently alleged that TAL Education Group (“TAL”) and its directors engaged in “sham transactions” in order to fraudulently inflate its income, resulting in false and misleading statements in TAL’s financial disclosures and other public statements.

Defendant TAL provides education-related services in China through various subsidiaries and affiliates. Plaintiffs, shareholders of TAL, brought suit in June 2018 alleging that TAL misled investors, first by executing a “sham sale and repurchase” of one of its subsidiaries, GZ1-1, in order to realize a $50 million pre-tax gain, and second by improperly recognizing a profit of $25.2 million from shares in Shunshun, a company TAL allegedly controlled through its CEO, a long time TAL associate who owned 49% of Shunshun. 

Defendants moved to dismiss the complaint, arguing that plaintiffs had failed to plausibly allege that the GZ1-1 transactions were a sham or that TAL controlled Shunshun. With respect to the GZ1-1 transaction, the complaint included extensive allegations of circumstantial evidence that TAL never actually transferred control of GZ1-1 to its purported buyer, including allegations that key contracts were never transferred, that employees’ salaries continued to be paid by TAL after the transaction, and that financial disclosures by both TAL and the buyer did not align with TAL’s public statements. Defendants’ motion to dismiss pointed to legitimate, nonfraudulent business reasons that would account for the circumstances alleged, including the possibility of different accounting standards in China and the fact that “corporate reorganizations can take time and are not seamless.” 

With respect to TAL’s allegedly improper recognition of profit from its ownership of Shunsun shares, plaintiffs alleged that TAL exercised de facto control over Shunshun prior to its 2016 acquisition of a majority interest in the company, and that TAL’s recognition of a $25.2 million gain on its prior minority interest therefore violated GAAP accounting standards. The complaint alleged that TAL controlled Shunshun through its CEO, Yang Zhang, a long time TAL associate who allegedly held 49% of Shunshun and coordinated with TAL to inflate the value of his own shares. In their motion to dismiss, defendants argued that the complaint failed to plausibly allege that TAL controlled Shunshu and therefore that the company had violated GAAP standards. Among other things, defendants pointed out that the complaint did not allege any specific substantive contact between TAL executives and Zhang, and that in an interview cited in the complaint Zhang had stated that TAL “fully respect[s] [Shunshun’s] independence, so that we have complete operational control.” The district court agreed with defendants and dismissed the complaint for failure to state a claim.

The Second Circuit reversed, holding that plaintiffs’ allegations, “taken together, are sufficient to plausibly allege falsity, as well as to provide a strong inference of scienter that meets the standard articulated in Tellabs [Inc. v. Makor Issues & Rts., Ltd.].” The Court disagreed with the lower court’s conclusion that the plaintiffs allegations had “alternative explanations so obvious that they render plaintiff’s inferences unreasonable,” and emphasized that the allegations “should not be considered one by one, but rather must be ‘taken collectively’ to determine whether they ‘give rise to a strong inference of scienter.’” In light of the numerous accounting irregularities detailed in the complaint, the Court found that the “cogent allegations regarding the GZ1-1 transaction in the amended complaint, taken together, are sufficient to plausibly allege falsity as well as to provide a strong inference of scienter.” The Court also found that the allegations regarding TAL’s supposed collusion with Zhang “sufficiently plead material misrepresentations or omissions regarding the Shunshun transactions” and that “the amended complaint pleads sufficient facts to support the reasonable inference of knowledge by the senior executives.”


On November 18, 2020, the Third Circuit Court of Appeals granted 3M Company’s petition for a writ of mandamus in In re 3M Company, vacating the District of New Jersey’s denial of 3M’s motion to transfer plaintiffs’ securities fraud claims to the District of Minnesota. The Court acknowledged that issuing a writ was an “extraordinary remedy,” but held that it was appropriate in this case because District Judge Cecchi’s analysis of the motion to transfer contained “several errors.”

Plaintiffs filed the case in the District of New Jersey in July 2019, alleging claims under the Securities Exchange Act of 1934 based on allegations that 3M misled investors regarding the extent of legal liabilities stemming from its manufacture and distribution of certain chemicals that allegedly caused environmental harm. Defendants filed a motion to transfer the case to the District of Minnesota, where the company is headquartered, under the federal venue transfer statute, 28 U.S.C. § 1404. The district court considered the relevant factors and denied the transfer motion, and defendants petitioned the Third Circuit for a writ of mandamus. The Third Circuit held that the lower court’s analysis improperly considered the impact on New Jersey citizens of the environmental harms caused by 3M’s chemicals, when the proper consideration was instead the impact of the resulting legal liabilities on 3M investors, and plaintiffs themselves were not New Jersey citizens. The lower court also had not given proper consideration to the fact that 30 of the 31 allegedly misleading statements made by 3M were issued from 3M’s headquarters in Minnesota, while only one of the statements was made outside of Minnesota, and none was made in New Jersey. Finally, plaintiffs failed to identify any witness that would be unavailable to testify in Minnesota, while defendants identified at least one third-party witness in Minnesota that would be beyond a New Jersey court’s subpoena authority.

The Third Circuit held that these errors “considered as a whole” met the high bar for issuing for a writ of mandamus, i.e., that the errors “approach the magnitude of an unauthorized exercise of judicial power, or a failure to use that power when there is a duty to do so.” The Third Circuit directed the District of New Jersey to transfer the case to the District of Minnesota.


On November 18, 2020, in Lipman v. GPB Capital Holdings LLC, the Delaware Court of Chancery declined to dismiss investors’ derivative complaint asserting breach of fiduciary duty claims against GPB Capital Holdings LLC (“GPB Capital”), its controller, and two of his associates, on behalf of limited partnerships that GPB Capital controls as their general partner. Vice Chancellor Glasscock held that plaintiffs were excused from making a demand upon the general partner GPB Capital, given the apparent threat of liability to the general partner’s controller. The Vice Chancellor further held that plaintiffs sufficiently alleged that GPB Capital’s controller caused the general partner to breach its fiduciary duties, and that the other individual defendants aided and abetted those breaches.

GPB Capital acted as general partner of the limited partnerships, which purported to invest in automotive dealerships. Plaintiffs, who were investors in the limited partnerships, brought suit on January 28, 2020 against GPB Capital, its controller, David Gentile, and two of Gentile’s associates, one former employee of GPB Capital and one unaffiliated business associate of Gentile, alleging self-dealing and misappropriation of partnership assets, including by paying “consulting fees” to entities owned by the defendants or their relatives and operating the partnerships as a Ponzi scheme by paying investors out of other investor’s funds while failing to actually invest in automotive businesses. The complaint incorporated allegations from several related suits in other jurisdictions. The court denied the motion to dismiss, after the court had previously rejected defendants’ motion to stay pending the outcomes in the related suits.

The court first rejected defendants’ argument that the complaint failed to plead that a demand by plaintiffs would have been futile. Under Delaware law, a limited partner seeking to sue derivatively on behalf of a partnership must ordinarily first make a demand upon the general partner to take up the prosecution of the lawsuit. This requirement is excused if there are sufficient allegations in the complaint that the general partner faces “substantial likelihood” of liability and thus cannot impartially exercise its business judgment regarding whether to pursue the case. Here, the court held that even though the allegations were sparse regarding the likelihood that GPB Capital itself – the general partner – would face liability, the court held that the demand requirement was excused due to the substantial likelihood of liability for Gentile, GPB Capital’s sole member. The court reasoned that the personal liability risk for Gentile “makes prosecution of this matter by a Gentile-controlled entity problematic.”

Finding demand excused, the court then turned to defendants’ motion to dismiss. The court held that the complaint’s allegations of self-dealing by Gentile and his associates were sufficient to state a claim against all defendants. First, the court held that GPB Capital may have breached its fiduciary duties by failing to provide audited financial statements to investors of the limited partnerships, because this failure was alleged in the complaint to be part of an effort to cover up a “left-handed Ponzi scheme of paying contributions out of the limited partners’ capital account to preserve the façade of profitability.” Second, plaintiffs had sufficiently stated a claim against Gentile by alleging that, through GPB Capital, he exercised control over the limited partnerships’ assets and engaged in self-dealing. Lastly, the court held that plaintiffs’ allegations made it “reasonably conceivable” that defendants Lash and Schneider, associates of Gentile, knowingly participated in Gentile’s breach of fiduciary duties. Schneider was alleged to have been “heavily involved in the marketing of GPB’s [automotive] dealerships,” and Lash was directly employed by GPB while he allegedly “funneled nearly $2,000,000 in revenue to entities [Gentile and Lash] controlled.” Accordingly, the court denied the motion to dismiss in full.

John A. Barker