Delaware Courts and Backdating: A Summary

Over the last week or more, we’ve seen how Delaware Courts have considered allegations of backdating, spring loading, and bullet dodging. From the three cases we’ve looked at, a framework has begun to emerge.

In Chancellor Chandler’s opinions in Ryan and Tyson Foods, the stage was set for shareholders to be able to bring claims of improper option granting against boards of directors. However, it is clear that those decisions were narrow. The Chancellor stated in Ryan: "plaintiff may survive a motion to dismiss where the complaint relies on empirical data to support claims of: 1) specific instances of backdating; 2) violations of shareholder-approved plans or some other legal obligation; and 3) fraudulent disclosures regarding compliance with that plan."

For allegations of spring loading and bullet dodging, the Chancellor articulated a similar test: “First, a plaintiff must allege that options were issued according to a shareholder-approved employee compensation plan. Second, a plaintiff must allege that the directors that approved spring-loaded (or bullet-dodging) options (a) possessed material non-public information soon to be released that would impact the company’s share price, and (b) issued those options with the intent to circumvent otherwise valid shareholder-approved restrictions upon the exercise price of the options.”

The decisions nonetheless suggested limited patience for backdating and spring loaded options.  The decision in Desimone set an entirely different tone.  That decision more or less suggested that these types of practices were just another form of compensation.  Only if the board violated a plan and affirmatively lied about it would a breach of fiduciary duties occur. 

Nonetheless, Desimone was viewed by commentators with relief.  Jones Day wrote that the decision "takes much of the sting out of his colleague Chancellor Chandler's previous Tyson and Ryan decisions." Professor Stephen Bainbridge criticized Chancellor Chandler for not simply invalidating the board’s decision in Ryan since it violated a shareholder approved plan. He sees the application of the duty of loyalty to backdating allegations as a mistake. Professor Larry Ribstein agrees  found the opinion a palliative from the press.  "In general, Strine’s opinion strikingly contrasts with the murky thinking that has characterized the press’s condemnation of backdating."

The Chancery Court's view in Desimone can be contrasted with what is going on at the federal level.  With recent guilty pleas accepted in the case of Take-Two andMonster, Inc., the ongoing criminal trial of the former CEO of Brockade, indictments recently set down in connection with Engineered Support Systems, and the SEC aggressively pursuing a large number of cases, it seems as if Delaware and the federal government are at odds over the consequences of backdating.  It is clear that the problem of backdating will largely have to be addressed at the federal level.  Ironically, one would suspect that most officers and directors would have preferred to deal with the matter as a potential breach of fiduciary duties, a non-criminal offense.  The Delaware courts, however, are apparently not cooperating.