Securities Snapshot
August 10, 2021

Northern District of California Kicks Shareholder Derivative Suit Against Alphabet, Inc. for Failing to Allege Demand Futility

Northern District of California Kicks Shareholder Derivative Suit Against Alphabet, Inc. For Failing to Allege Demand Futility; Rare Securities “Holder’s Claim” Trial Results in Jury Verdict for Defendants; Delaware Court of Chancery Permits Dismissed Defendant to Be Added Back to Case; Ninth Circuit Tells District Court to Redo Lead Plaintiff Selection Process; New Suit Claims McDonald’s Directors Failed to Exercise Oversight and Investigate Misconduct.

On July 30, 2021, in In Re Alphabet Inc. Stockholder Derivative Litigation, Judge Richard Seeborg of the U.S. District Court for the Northern District of California dismissed a derivative suit by Alphabet, Inc. shareholders asserting breach of fiduciary duty and unjust enrichment claims against Alphabet directors. The court held that the shareholders failed to sufficiently allege demand futility.

The case stems from a Federal Trade Commission investigation into compliance by YouTube (which is indirectly owned by Alphabet through its Google LLC subsidiary) with the Children’s Online Privacy Protection Act (“COPPA”), which prohibits operators of websites “directed to children” from collecting children’s personal information without parental consent. In response to the investigation, Alphabet asserted that YouTube was a “general audience site” and thus not subject to COPPA. On September 4, 2019, however, a lawsuit by the FTC and the New York Attorney General against YouTube and Google was both filed and settled, with settlement terms including a civil penalty and no admission of liability.

Alphabet shareholders subsequently filed derivative suits, claiming that Alphabet directors knew that YouTube was violating COPPA and failed to act. Defendants moved to dismiss, arguing that plaintiffs failed to sufficiently allege that a demand that the Alphabet board pursue plaintiffs’ claims would have been futile. Under Delaware law, in a case targeting a board’s supposed oversight failure, pleading demand futility requires alleging particularized facts creating a reasonable doubt that a majority of the board would be disinterested with respect to the underlying claims or independent of any interested directors.

Agreeing with defendants, the court dismissed the case in its entirety. Addressing the Alphabet board’s disinterestedness, the court concluded that plaintiffs’ allegations failed to show that the directors faced a substantial likelihood of liability because “[w]hereas plaintiffs charged the board with manufacturing a narrative of oblivion to skirt their fiduciary duties, even the most charitable reading of the complaint points to something less sinister: an earnestly fought legal dispute” regarding COPPA’s applicability to YouTube. The court explained that “plaintiffs attempt to attach the legal significance of ‘known violations’ to what were then — and, consistent with the non-admission of liability aspect of the settlement, still remain — known accusations.” Addressing the Alphabet board’s independence, the court concluded that plaintiffs’ allegations necessarily failed in light of plaintiffs’ failure to adequately allege interestedness. The court granted plaintiffs leave to amend, though noted that “it is far from clear how plaintiffs might cure the pleading deficiencies.”

Rare Securities “Holder’s Claim” Trial Results in Jury Verdict for Defendants

On July 29, 2021, in Hussein v. Razin et al., a California Superior Court jury found that NextGen Healthcare Inc. and certain of its executives did not make false or misleading statements that induced a shareholder to hold (i.e., not sell) his NextGen stock. While permitted under California law, such a “holder’s claim” is not permitted under the federal securities laws, which generally require a plaintiff to have engaged in a purchase or sale to pursue a claim. According to defendants’ counsel, this case is the first holder’s claim to reach trial in 86 years.

Plaintiff alleged that defendants fraudulently induced him to hold his NextGen stock by issuing positive projections and making statements confirming the projections. Plaintiff claimed that the projections were subsequently retracted and that the announcement of disappointing financial results caused NextGen’s stock price to drop and Plaintiff to suffer more than $400 million in damages. Defendants argued that they reasonably believed that the positive projections were achievable and that their statements regarding the projections were neither false nor misleading. Defendants further argued that plaintiff did not take sufficient preparatory action toward selling his shares and therefore could not show that he had been induced to retain his shares.

At the conclusion of a 14-day trial, the jury found that the statements at issue were neither false or misleading.

Delaware Court of Chancery Permits Dismissed Defendant to be Added Back to Case

On July 23, 2021, in In re Mindbody, Inc., Stockholder Litigation, Chancellor Kathaleen McCormick of the Delaware Court of Chancery allowed plaintiffs to amend their complaint to reassert claims against a defendant previously dismissed from the case. The court found that discovery taken after the dismissal lent support to plaintiffs’ allegations that directors of MindBody, Inc., were conflicted in approving Mindbody’s 2019 sale to Vista Equity Partners.

Plaintiffs initially alleged that Mindbody stockholder Institutional Venture Partners was motivated to complete a quick sale to exit its Mindbody investment and that Eric Liaw, a Mindbody outside director appointed by IVP, “used his directorship and IVP’s clout” to do just that. In dismissing the claims against Liaw, the court concluded that the then-operative complaint did not “support a reasonable inference that Liaw took any action to tilt the process toward his personal interest.” The court’s dismissal noted, however, that it was a prejudgment order that could be revisited if discovery revealed a “compelling reason” to do so.

After the close of fact discovery, plaintiffs moved to amend their complaint to reassert claims against Liaw, arguing that discovery supported plaintiffs’ allegations that Liaw and Mindbody’s CEO allied to complete a transaction within IVP’s desired timeframe. The court granted plaintiffs’ motion, noting that where discovery reveals that a dismissed defendant had “a more significant and compromising role” than previously shown, “the plaintiffs can seek to revisit” the dismissal “should future developments provide a compelling reason for doing so.” Specifically, the court concluded that certain text messages and deposition testimony “provide[d] support for the contention” that Liaw took efforts to push “a quick private equity sale and communicated with [Mindbody’s CEO] in the process.” The court noted that those text messages and testimony did not prove plaintiffs’ theories but nonetheless justified the sought amendment.

Ninth Circuit Tells District Court to Redo Lead Plaintiff Selection Process

On July 23, 2021, in In re George Mersho, the U.S. Court of Appeals for the Ninth Circuit held that the district court’s order appointing a lead plaintiff in a securities fraud putative class action was in error because it did not give effect to the presumption governing the lead plaintiff selection process under the Private Securities Litigation Reform Act (“PSLRA”).

Plaintiffs allege that Nikola Corporation and certain of its officers, directors, and employees made false and misleading statements regarding the prospects for Nikola’s zero-emissions vehicle technology that caused plaintiffs to purchase Nikola stock at inflated prices. The district court consolidated the various securities fraud putative class actions and undertook the PSLRA’s lead plaintiff selection process to determine which plaintiff would serve as lead plaintiff. The PSLRA creates a presumption that the lead plaintiff should be the plaintiff seeking appointment as lead plaintiff who has the largest alleged loss and makes a prima facie case that (1) they will adequately represent the putative class and (2) their claims are typical of those in the putative class.

Six plaintiffs or plaintiff groups sought appointment as lead plaintiff, including Nikola Investor Group II, which was comprised of three individuals. While the district court concluded that Nikola Investor Group II had the largest alleged loss and had made a prima facie showing of adequacy and typicality, the district court nonetheless rejected Nikola Investor Group II, concluding that the presumption had been rebutted because the district court had “misgivings about the cohesion of Nikola Investor Group II and its ability to control the litigation without undue influence from counsel” because the district court did not know if the individuals comprising Nikola Investor Group II had a “pre-litigation relationship.”

Nikola Investor Group II petitioned the Ninth Circuit to vacate the district court’s order and appoint Nikola Investor Group II as lead plaintiff and the Ninth Circuit granted the petition in part. The Ninth Circuit held that the district court erred in finding the PSLRA’s presumption rebutted based “only on the absence of proof by Group II regarding a pre-litigation relationship.” The Ninth Circuit noted that pursuant to the PSLRA’s presumption, “competing movants must convince the district court that the presumptive lead plaintiff would not be adequate, not merely that the district court was wrong in determining that the prima facie elements of adequacy were met.” The Ninth Circuit thus vacated the district court’s order and remanded the case to the district court for redetermine the lead plaintiff.

New Suit Claims McDonald’s Directors Failed to Exercise Oversight and Investigate Misconduct

On July 23, 2021, a McDonald’s shareholder filed a derivative suit captioned Gianotti v. Dean et al. in the Delaware Court of Chancery against certain McDonald’s directors and officers and McDonald’s outside counsel, Morgan Lewis & Bockius LLP. The suit arises from the officers’ supposed misconduct, the directors’ supposed inadequate oversight of sexual harassment and racial discrimination reporting, and Morgan Lewis’s supposed inadequate investigation into supposed misconduct by former McDonald's CEO Steve Easterbrook.

The suit alleges breaches of fiduciary duty against the directors due to their decision to terminate Easterbrook “without cause” in November 2019 despite allegedly knowing of his violation of McDonald’s “anti-dating policy.” In so doing, the board approved a severance package for Easterbrook purportedly worth approximately $47.5 million, which allegedly would not have been provided had he been terminated “for cause.” The board’s determination was based in part on an eight-day investigation conducted by Morgan Lewis, which supposedly was rushed and improperly limited in scope by Easterbrook’s allegedly false representations as to the breadth of his misconduct.

The suit also alleges that the directors further breached their fiduciary duties by failing to properly oversee sexual harassment and racial discrimination claim reporting by filtering the reporting of all such claims through the CEO and effectively delegating oversight to management. Finally, the suit alleges that the officers breached their fiduciary duties by exercising inadequate oversight over sexual harassment and racial discrimination claims and directly engaging in related misconduct.

Morgan Mordecai

Dylan Schweers