Delaware Courts and the Validation of Misleading Disclosure: In re Transkaryotic (Friendship Is Not Enough)(Part 3)

We are discussing In re Transkaryotic, a relatively recent Delaware case that contains bad law and reflects the anti-plaintiff bias of the Delaware courts.  

When the Delaware Supreme Court held that friendship with an interested party could result in the loss of independence in Brehm v. Stewart, 845 A.2d 1040 (Del. 2004), we noted that the test was one almost impossible to meet, particularly when coupled with the excessively high pleading standards used by the Delaware courts.  Thus, plaintiffs had to show that “the non-interested director would be more willing to risk his or her reputation than risk the relationship with the interested director.”  And, despite the inherently subjective nature of the test, they had to do so on a motion to dismiss, without the benefit of any discovery.  So the courts would claim that friendship could be a disqualifying relationship in theory but in practice would ensure that it never was.

This case illustrates the point.  In seeking to acquire Transkaryotic, the CEO of Shire, Matthew Emmens, contacted Wayne Yetter, the chairperson of the board.  Plaintiff alleged that the two had a relationship that went back 20 years, that they knew each other "extremely well" and were "very friendly," and that Emmens and Yetter "worked closely together."  At the time when Emmens was using the "back-channel approach" to contact Yetter, Yetter was using Emmen's as a reference for a job as CEO of Odyssey Pharmaceuticals.  The Court treated the reference almost with derision.

• The actual record evidence, however, shows that Yetter merely included Emmen's name on a list of references submitted in connection with an application for a position with Odyssey Pharmaceuticals.  There is no evidence that Emmens was actually contacted by Odyssey or any affiliates.  In fact, there is no evidence whatsoever that Emmens even knew he was listed as a reference.  Moreover, the suggestion that Yetter would sell his vote for a positive job references is belied by the fact that Yetter . .  . voted affirmatively to reject the initial Shire offer of $31 per share.

The Court's explanation is full of assertion and little reasoning.  That Yetter would choose to use Emmens as a reference at the very time Emmens was seeking information on behalf of Shire creates at least the appearance of a conflict of interest.  The fact that there is no evidence that Odyssey contacted Emmens is irrelevant.  Yetter presumably knew that Emmens might be contacted and presumably knew that an unsuccessful interaction in connection with the Shire/Transkaryotic acquisition might impair the value of the reference. 

Moreover, the fact that there was no evidence that Emmens knew he was listed as a reference cuts against the Court's position.  If Yetter included Emmens without informing him, that suggests that he didn't need permission, indicia of a close relationship.  The Court also omitted to mention that Yetter was hired by Odyssey in November 2004, suggesting that the references may have had some value (whether or not actually contacted).  See Wayne Yetter Profile, Forbes.com ("From November 2004 to September 2005, he served as the Chief Executive Officer of Odyssey Pharmaceuticals, Inc., the specialty pharmaceutical division of Pliva d.d.").   

But in addition, there's at least arguable evidence that Emmens and Yetter thought their relationship close.  The proxy statement for the merger disclosed Emmens approached Yetter for the first time in November 2005.  See Proxy Statement, June 27, 2005 ("On November 15, 2004, Mr. Emmens communicated to Wayne Yetter, who was the chairman of our board of directors at the time, Shire’s interest in pursuing an acquisition of our company.").  Plaintiffs alleged that the proxy statement was misleading because it failed to disclose that "Emmens had secretly approached Yetter about the merger in early October 2004."  To the extent true, the failure to disclose the earlier contact could have been accidental.  But it also could have been an effort to hide the preexisting relationship.   

But the ultimate evidence of the importance of the relationship was the board's response.  Plaintiffs assert on brief that, at a board meeting on January 17, 2005: 

• "Yetter was forced to admit generally his 'past association' with Emmens and to acknowledge that 'they were very close . . .  Those admissions fell far short of full disclosure, but they were troubling enough that the board's 'confidence was shaken' by the news.  Even TKT's counsel stated that Yetter was not 'appropriately ' representing TKT and that there was 'ample reason for [the] board to get rid of [Yetter] based on bad judgment alone.'  It therefore agreed that Yetter should step down as Chairman. (citations to record omitted).

The Court acknowledged that Yetter disclosed that "he had a preexisting relationship" with Emmens at the January 17 meeting but did not disclose "the initial October call from Emmens and did not disclose that he listed Emmens as a reference on his resume."  In other words, Yetter did not make full disclosure about the relationship but from what he did say, the information apparently played a role in the decision to have him step down as chairman.  (The Court is unclear on this point, noting only that "the board expressed that its confidence had been shaken in Yetter" but does not specifically relate it to the discovery of the relationship with Emmens).  If so, it would suggest that the board thought that the information was important. 

Plaintiffs don't have to prove a conflict of interest, but need only show the existence of a factual issue requiring resolution by the jury.  The evidence presented by Plaintiffs would seem to suggest at least a jury question over the issue.  There was evidence of a disqualifying relationship.  There was evidence that suggested others thought the relationship significant.  But not in Delaware, where despite protestations to the contrary, friendship does not result in the loss of independence or a finding of a conflict of interest.  It is another reason why the concept of independence in Delaware is flawed. 

We have posted a copy of the opinion and many of the primary documents involved in the case  on the DU Corporate Governance web site.