Statistical Evidence and A "Barely Sufficient" Basis for Inspecting Records Under Delaware Law

In Louisiana Municipal Police Employees’ Retirement System v. Countrywide Financial Corp., No. 2608-VCN, 2007 Del. Ch. LEXIS 138 (Del. Ch. Oct. 2, 2007), Plaintiff, Louisiana Municipal Policy Employees’ Retirement System (LAMPERS) filed an action under Del. Code Ann. tit. 8, § 220 to inspect the corporate books and records of the defendant, Countrywide, for potential corporate misconduct regarding executive stock option grants. The court granted LAMPERS limited access to Countrywide’s corporate books and records to investigate possible wrongdoing by Countrywide in issuing stock options to executives. Before bringing their claim, LAMPERS hired an expert to conduct a statistical analysis of Countrywide’s stock price movements after it granted options to executives. The expert determined through his analysis that Countrywide’s stock increased by an abnormal amount after the date it granted options to executives.

Delaware General Corporation Law § 220 gives shareholders a right to inspect corporate books and records for any proper purpose reasonably connected to the shareholders interests. The court noted that “it is well settled under Delaware law that an investigation of corporate mismanagement, waste or wrongdoing is a proper purpose for § 220 inspection.” It is insufficient, however, merely to state a purpose of investigating potential wrongdoings. Following the holding in Seinfeld v. Verizon, 909 A.2d 117 (Del. 2006), the court held that a plaintiff seeking relief under § 220 must meet its minimal burden to establish a “credible basis," by presenting “some evidence,” from which the court can infer possible issues of corporate misconduct warranting further inquiry. The Delaware Supreme Court in Seinfeld, noted that § 220’s “credible basis” standard “sets the lowest possible burden of proof” and this court expressed that it is “far cry” from requiring proof that corporate misconduct actually occurred.

This § 220 hearing involved a battle of expert witnesses. LAMPERS’ expert provided statistical data and testimony suggesting that some type of option manipulation may have occurred. Rebutting these assertions, Countrywide’s expert contended that the statistical methodology used by LAMPERS’ expert was flawed. The court referred to this case as a “close call,” concluding that while LAMPERS’ expert’s testimony may be unpersuasive as to whether misconduct actually occurred, his statistical data and credible testimony was sufficient to clear § 220’s “credible basis” hurdle. Thus, the court granted LAMPERS access to Countrywide’s books, but limited access to information regarding grants to executives because LAMPERS’ expert only used grants to executives, not directors, in his analysis.

The court emphasized its role as gatekeeper in § 220 actions. Assessing whether a plaintiff provided a credible basis for inferring possible corporate wrongdoings required a careful weighing of the facts on a case-by-case basis. The court warned of “indiscriminate fishing expeditions by shareholders,” and noted that any abuse of the § 220 process should not be tolerated. In addition, once a right to inspect the corporate books has been established, as gatekeeper, the trial court had to tailor the inspection to the shareholder’s stated purpose.

As a policy matter, the court acknowledged that Delaware has encouraged shareholders to use § 220 before filing a derivative suit to meet the heightened pleading requirements applicable to such a suit. Congress created the heightened pleading requirements of the PSLRA to prevent plaintiffs from filing weak claims of securities fraud against defendants who may be forced to settle rather than incur discovery litigation costs. The PSLRA created a problem for plaintiffs who needed discovery to meet the heightened pleading requirements, but could not get past a defendant’s pre-discovery motion to dismiss because of these same heightened pleading requirements. Section 220 appears to alleviate this problem to some extent.

The opinion in this case may be found on the DU Corporate Governance website.