Desimone, Backdating, and the Use of Bench Trials on Motions to Dismiss

Vaughn Marshall has written posts on the three backdating cases that have come down from the Delaware Court of Chancery.  The most recent,Desimone v. Barrows, 2007 Del. Ch. Lexis 75 (Del. Ch. June 7, 2007), deserves some commentary not because of its holding (questionable enough) or its length (77 double spaced pages) but the obvious way the opinion makes factual findings on a motion to dismiss to the disadvantage of the plaintiff. 

We have observed on this Blog that the Delaware Courts sometimes dismiss cases after making their own factual findings, without allowing shareholders a similar opportunity or an opportunity for discovery.  See #6 of the Top 10 Reasons Why Independent Directors are not Independent.  This topic is also discussed in my article here.  That more or less occurred in Desimone. 

First, despite its stance as a demand excusal case, to be decided on the pleadings, the court relied extensively on materials outside the complaint, including:

• a proxy statement, see Opinion at 20 n. 11  (facts about chairman's stock ownership taken from proxy statement); 
• assorted public disclosures", see Opinion:

• at 21 n. 13 ("According to its public disclosures, Sycamore does not provide any compensation other than stock option grants to its directors for serving on the board.");
• at 35 ("According to Sycamore's recent public disclosures, the improperly-accounted-for grants included six new employee options grants in which employment start date records were deliberately modified to provide lower exercise prices and six existing stock options grants that were deliberately cancelled and reissued to provide for lower exercise prices."),
• stock option plans, see opinion at 22-23 n. 15 ("Although the stock option plans are not attached to the complaint, the complaint relies heavily on these documents and indeed (mis)quotes them. They are incorporated by reference into the complaint and are properly before me on this motion.");
• a current report on Form 8-K, see opinion, at 36 n. 35 ("On December 29, 2006, Sycamore announced that Kevin Oye, an Officer Grant recipient, had agreed to re-price 166,667 of the 1 million options he received in April 2002. Sycamore Networks, Inc., Current Report (Form 8-K) (December 29, 2006).").  

How about credibility determinations, the quintessential function for the jury?  Plaintiff relied extensively on a memorandum provided by Stephen Landry, the Director of Human Resources, who left the firm and later filed suite.  As plaintiff described, Landry filed suit claiming "that Sycamore replaced him after he refused to manipulate the dates of stock options grants."  In other words, Landry was a hero, ethically resigning rather than participate in improper behavior.  Here is how Chancellor Strine characterized Landry.  

• "In late 2004, after Jewels had left Sycamore's employ, Landry wrote a letter to defendant Deshpande, Sycamore's Chairman, hoping  to renegotiate the severance agreement. Landry succeeded in getting a meeting with Sycamore's new CFO and tried to use his knowledge of Sycamore's options backdating practices as leverage. Landry told a story in which Jewels was the boss and he was an underling in a conspiracy to backdate options grants. Jewels allegedly instructed Landry repeatedly to alter and falsify human resources documents in order to corroborate falsified options grant dates. Often, this was accomplished by forging personnel file documents to change a newly-hired employee's start date to correspond to the date on which Jewels had determined to backdate the Employee Grant."

No hero, the court seemed to treat Landry as something akin to a blackmailer.  The characterization, of course, was intended to discredit the value of his allegations and was not consistent with what plaintiff alleged. 

Then there is the conclusion about the role of the compensation committee.  Critical to the case was the board's involvement in granting the backdated options.  Plaintiff alleged that the committee "administered" the option plans, something Chancellor Strine interpreted to mean having no involvement in the awards. 

• "I accept this allegation as true, as I must. Nonetheless, that vague and conclusory statement does not suggest in any way that the Compensation Committee was involved in or had knowledge of any backdating. With respect to rank-and-file Employee Grants, the Compensation Committee is most likely to have administered the Incentive Plan by delegating options-granting responsibility to executive officers. Indeed, it defies logic to infer that these two Outside Directors were constantly present at Sycamore to sign off on each of these small options Grants, and the complaint does not allege that they did."

In other words, Chancellor Strine made findings that the committee did not approve the options, but delegated the responsibility to others.  Perhaps that is what happened, but that is not what the complaint says.   The complaint merely stated that the compensation committee administered the plans and that "the Company, through the actions of its Board of Directors and its Compensation Committee, granted stock options for the purchase of millions of shares of the Company's common stock to the Executive Office Defendants."   

It is another phenomena that often occurs in shareholder litigation in the Delaware courts, as I have discussed in my article, Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty  It is not a motion to dismiss but a bench trial only the plaintiffs are not allowed to participate.  It is another way to dismiss cases without giving shareholders the benefit of discovery.