Securities Snapshot October 06, 2021

Delaware Court of Chancery Finds that Director’s Email on Outside Email System Remains Confidential

IN THIS ISSUE

Delaware Court of Chancery Finds that Director’s Email on Outside Email System Remains Confidential; Delaware Supreme Court Overrules Longstanding Precedent Regarding Derivative Versus Direct Standing; SEC Files Crowdfunding Suit Against Cannabis-Related Companies; Delaware Supreme Court Reframes Test for Demand Futility; New Jersey Federal Court Dismisses Class Action Against Becton Dickinson Regarding FDA Approval.

IN THIS ISSUE
IN THIS ISSUE
IN THIS ISSUE

Delaware Court of Chancery Finds that Director’s Email on Outside Email System Remains Confidential

On September 17, 2021, the Delaware Court of Chancery denied an effort to obtain emails that a Dell Technologies Inc. outside director, the former chairman and CEO of Accenture PLC, maintained on his accenture.com email account. The outside director is among the defendants in an ongoing lawsuit related to Dell’s redemption of stock in connection with its 2016 acquisition of EMC Corporation.

At the time of the emails at issue, the outside director, who did not have a Dell email account, was retired from Accenture but the company had approved his continued use of his accenture.com email account for personal matters and he used it for Dell-related matters. Plaintiff argued that because Accenture’s policies permitted Accenture to monitor and review accenture.com email accounts, the outside director lacked any reasonable expectation of confidentiality with respect to his accenture.com email account and therefore had waived the attorney-client privilege as to the Dell-related emails it contained. In opposing the motion, the outside director argued that although Accenture had the ability to monitor his email account, there was no evidence that Accenture had ever done so (beyond collecting emails in connection with the litigation) and thus his expectation of privacy as to the emails at issue was reasonable.

Vice Chancellor J. Travis Laster concluded that Accenture’s general email practices and approval for personal use post-retirement were “sufficient to create a reasonable expectation of privacy for [the outside director’s] email account.” While he denied plaintiff’s request for the emails, Vice Chancellor Laster nonetheless warned that the use of outside email accounts is not “without risk” to waiving the attorney-client privilege and that a “strong argument can be made that the better course for outside directors is to have an email account that they can be confident is not subject to a potential for monitoring.”

Delaware Supreme Court Overrules Longstanding Precedent Regarding Derivative Versus Direct Standing

On September 20, 2021, the Delaware Supreme Court overturned a 15-year-old precedent, Gentile v. Rossette. While dilution claims are generally considered derivative, Gentile had created an exception that permitted minority stockholders to bring both direct and derivative claims if a controlling stockholder diluted the minority’s financial and voting interests. In overruling Gentile, the Delaware Supreme Court held that such claims are now solely derivative. This decision will limit the ability of minority shareholders to bring dilution claims following a consummated merger because a merger typically extinguishes derivative standing.

The case arose from a private placement in which Brookfield Asset Management, Inc. and its affiliates increased their controlling ownership of TerraForm Power, Inc. TerraForm minority shareholders brought direct and derivative claims, alleging that Brookfield had caused TerraForm to issue stock for inadequate consideration and thereby diluted the minority stockholders’ financial and voting interests. After the litigation was filed, Brookfield acquired the remainder of TerraForm’s stock in a merger. Defendants then moved for dismissal, arguing that plaintiffs’ claims were solely derivative and that plaintiffs lacked derivative standing following the merger. The Delaware Court of Chancery denied the motion, concluding that pursuant to the Gentile exception plaintiffs could bring both direct and derivative claims. 

On interlocutory appeal, the Delaware Supreme Court unanimously reversed the Court of Chancery’s decision and explicitly overruled Gentile. The Supreme Court concluded that Gentile, which had created an exception to the relatively straightforward test for derivative and direct standing established by the Supreme Court’s earlier decision in Tooley v. Donaldson, Lufkin & Jennette, Inc., was “analytical[ly] [in] tension” with Tooley’s holding that “economic and voting dilution was an injury to stockholders independent of any injury to the corporation.” The Supreme Court further concluded that there was “no practical need for” Gentile’s “carve-out” from Tooley because “[o]ther legal theories . . . provide a basis for a direct claim for stockholders to address fiduciary duty violations in a change of control context.” Finally, the Supreme Court concluded that “the practical and analytical difficulties courts have encountered in applying [] reflect fundamental unworkability and not growing pains.”

SEC Files Crowdfunding Suit Against Cannabis-Related Companies

On September 20, 2021, the SEC filed a complaint against two cannabis-related real estate companies and the crowdfunding platform they used to allegedly sell nearly $2 million in unregistered securities. The complaint is noteworthy because it is the SEC’s first enforcement action involving Regulation Crowdfunding, which permits eligible issuers to offer and sell securities through crowdfunding.

The complaint alleges that those behind the crowdfunding offerings made numerous material misleading statements and omissions to investors, including concealing past criminal behavior. The complaint further alleges that offering proceeds were diverted for personal use, rather than used for acquiring real estate to be leased to cannabis growers, and that none of the investors have received any return on their investment and few have recovered their invested funds. Finally, the complaint alleges that the crowdfunding platform used to conduct the crowdfunding offerings ignored red flags and otherwise failed to reduce the risk of fraud.

The complaint charges the issuers and those behind the crowdfunding offerings with violating the antifraud and registration provisions of the Securities Act of 1933 and Securities Exchange Act of 1934, and charges the crowdfunding platform and its CEO with violating the crowdfunding rules of the Securities Act of 1933.

Delaware Supreme Court Reframes Test for Demand Futility

On September 23, 2021, the Delaware Supreme Court adopted a new demand futility standard in affirming the Delaware Court of Chancery’s dismissal of stockholders’ claims against Facebook, Inc. CEO Mark Zuckerberg. The case stemmed from earlier class action litigation concerning a stock reclassification that would have permitted Zuckerberg to sell most of his shares while maintaining control of Facebook. After Facebook abandoned the reclassification, having spent more than $20 million to defend the litigation and more than $68 million to settle it, new stockholder derivative litigation was filed that sought to recoup those costs.

The Court of Chancery dismissed the derivative complaint, concluding that plaintiff failed to show that demand on Facebook’s board was futile. Finding that the traditional demand futility tests were difficult to apply in light of director turnover and a director’s decision to abstain from voting on the reclassification, Vice Chancellor J. Travis Laster took a new approach in which he “ask[ed] for each director (i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand, (ii) whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand, and (iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.”

On appeal, the Delaware Supreme Court adopted Vice Chancellor Laster’s “three-part test as the universal test for assessing whether demand should be excused as futile.” The Delaware Supreme Court explained that “[i]f the answer to any of the questions is ‘yes’ for at least half of the members of the demand board, then demand is excused as futile.” Applying the test, the Delaware Supreme Court concluded that plaintiff had not plead particular facts establishing demand futility under any of the three prongs and therefore affirmed the dismissal based on lack of demand futility.

New Jersey Federal Court Dismisses Class Action Against Becton Dickinson Regarding FDA Approval

On September 15, 2021, a New Jersey federal judge dismissed a putative securities fraud class action alleging that Becton, Dickinson and Company (BD) and certain of its executives failed to disclose that BD’s infusion pumps were defective and that BD had modified them without obtaining 510(k) clearance from the FDA. 

Plaintiff alleged that because BD had attempted to correct defects in the infusion pumps without FDA clearance, BD was at risk of adverse FDA action but had nonetheless failed to publicly disclose that the FDA would require 510(k) clearance before BD could continue to market and sell the infusion pumps and that BD had determined that such clearance was required. In February 2020, BD disclosed that the FDA was requiring BD to obtain 510(k) clearance for past modifications to the infusion pumps before it could continue to sell them.

In dismissing the complaint, the court concluded that “[a]bsent a demonstration that the FDA had in some manner or other made clear that it would require a new 510(k) application for [the] products, and that BD would be required to stop marketing [the infusion pumps] until that application was successfully resolved, the mere possibility of administrative action is not enough to require disclosure.” The court further concluded that “[t]he allegations are insufficient to establish that [d]efendants knew or even believed that the FDA was going to require a 510(k) application for [the infusion pumps] prior to the continued marketing of the devices, nor were they obligated to predict the regulatory action that the FDA would ultimately take.” The court also found that the statements defendants had made were not misleading because, among other things, they “must be evaluated in the context of all available information” and that “[c]onsidering the available information, no reasonable investor could bury their head in the sand to avoid the potential risks of regulatory action.” Finally, the court found that the complaint failed to allege defendants’ scienter because it did not establish personal knowledge by the individual defendants, whose positions at BD and stock trading also failed to support an inference of scienter.

The decision underscores that a company’s disclosure obligations do not include predicting uncertain regulatory action.

EDITORIAL BOARD
Ezekiel L. Hill
Kate E. MacLeman

CONTRIBUTORS
Christopher Herbert
Dylan Schweers
Batoul Husain
Emily Notini