Strine on backdating and springloading

Delaware’s VC Leo Strine issued a very interesting opinion in Desimone v. Barrows (thanks to Francis Pileggi for the tip and the link), regarding backdating, springloading and bullet-dodging allegations at Sycamore Networks. Strine dismissed a hastily filed complaint, comparing it unfavorably to the complaints in Ryan and Tyson complaints Chancellor Chandler opined on in previous backdating and springloading cases (discussed here and here).

[As I’ve noted, Strine is on something of a compaign against these hasty complaints. He characterized this complaint as

rushed into court, making generalized charges of wrongdoing unaccompanied by fact pleading about the involvement of the directors in the improprieties he contends occurred. Perhaps as a result, [the] complaint must be dismissed.]

Strine had some very interesting comments on backdating and springloading specifically, and Delaware corporate jurisprudence in general. I can’t do the 77-page opinion justice here, but I’ll try to hit some highlights.

Brief summary:  The complaint was based largly on a Sycamore internal report concerning grants beginning in 2000. Since the plaintiff held stock only since 2002, he lacked standing as to most of the claims. As to grants to rank-and-file employees and officers, the complaint was dismissed for lack of demand under Rule 23.1 because the board members neither received grants nor faced a substantial likelihood of personal liability for knowing misfeasance or defective controls. Although the grants were backdated and their backdated nature was concealed, the complaint lacked allegations that the misbehavior was known by anybody other than a single executive, who hid facts from the board and Sycamore’s auditors. (Interestingly, senior officers owning over 30% of the company’s stock received no disputed options.) These facts of non-involvement, Strine stressed, contrasted with the allegations in Ryan and Tyson. A majority of the board did get some of the options. But Strine dismissed those allegations under Rule 12(b)(6) because the grants were awarded pursuant to a disclosed and approved schedule.

Most importantly for future cases in Delaware, Strine emphasized the need to make careful distinctions in backdating/springloading cases. He noted the arguments of “distinguished scholars” (here he cites me and Steve Bainbridge) that the backdating cases should emphasize the board’s authority rather than its fiduciary duties.

Actually, I'd characterize that as more Steve’s argument than mine. I have emphasized disclosure, including in the post Strine cites. That is precisely Strine’s emphasis as well, characterizing Chancellor Chandler as reasoning in Ryan and Tyson that “deception is itself a disloyal act.” Thus, Strine suggests that directors who tell the shareholders the truth about the backdating are off the hook. As I said last September, "let's be clear. Backdating is not about greedy overpaid executives. It's only about disclosure." And I emphasized last June that there’s no insider trading liability for spring-loading if the board is informed. Strine takes the identical position in n. 98.

To be sure, Strine also says (p. 42): "Although directors have wide authority to take lawful action on behalf of the corporation, they have no authority knowingly to cause the corporation to become a rogue, exposing the corporation to penalties from criminal and civil regulators." So the board can't disclose illegality and get off the hook. But this seems a fanciful scenario.

Strine also has some comments on Stone, Caremark and good faith, emphasizing that good faith is not a potential escape hatch form exculpation under 102(b)(7) because it requires scienter (see n. 97).

In general, Strine’s opinion strikingly contrasts with the murky thinking that has characterized the press’s condemnation of backdating. As Strine says:

Lumping context-specific behavior involving varying motivations into generic categories such as backdating, spring loading, and bullet dodging, and driving results by such labeling, seems unlikely to do justice.

We’ve had the reporting and the Pulitzer. Now it’s time for the courts to carefully decide what actually happened.