Delaware Supreme Court
Delaware Supreme Court

The Delaware Supreme Court reversed the dismissal of a derivative suit for failure to make demand, finding that the complaint alleged particularized facts sufficient to create a reasonable doubt as to the disinterestedness and independence of a majority of directors, in Sandys v. Pincus, No. 157, 2016 (Del. Dec. 5, 2016).  In Sandys, the plaintiff alleged that some top managers and directors at Zynga, Inc. were given an exemption to Zynga’s rule preventing sales by insiders until three days after an earnings announcement.

Because Zynga’s board of directors had nine members, the Court examined whether the complaint had excused a demand as to at least five directors.  Two of the directors (Reid Hoffman, and the controlling stockholder and former CEO, Mark Pincus) had participated in the trades and were considered interested in the transaction.  Another director, Don Mattrick, had been named as the new CEO, and was therefore deemed interested because the corporation’s controlling stockholder was interested in the transaction.  The Court concluded that the complaint alleged reasonable doubt as to the disinterestedness of another three directors (adding up to six of the nine directors).

One director, Ellen Siminoff, was deemed to be potentially interested because she and her husband were co-owners of a private plane with Pincus, which “signaled an extremely close, personal bond” between the two directors and their families because unlike some other assets, a private plane “requires close cooperation in use, which is suggestive of detailed planning indicative of a continuing, close personal friendship.”  The Court noted that at the pleading stage, a plaintiff need not “plead a detailed calendar of social interaction to prove that directors have a very substantial personal relationship rendering them unable to act independently of each other.”

Another two directors, William Gordon and John Doerr, were partners at a prominent venture capital firm, Kleiner Perkins Caufield & Byers, which had interlocking relationships with both directors who traded in Zynga stock.  Specifically, Kleiner Perkins also was invested in a company that Pincus’ wife co-founded, and with a company on whose board Hoffman served as a director.  According to its public disclosures, the Zynga board had determined that Gordon and Doerr did not qualify as independent directors under the NASDAQ listing rules.  The plaintiff’s books and records inspection demand did not inquire as to the board’s NASDAQ determination, and the Court of Chancery found that these directors’ independence had not been sufficiently challenged.  The Delaware Supreme Court disagreed, stating that “to have a derivative suit dismissed on demand excusal grounds because of the presumptive independence of directors whose own colleagues will not accord them the appellation of independence creates cognitive dissonance that our jurisprudence should not ignore.”  While agreeing that “the Delaware independence standard is context specific and does not perfectly marry with the standards of the stock exchange in all cases,” the Court nonetheless identified criteria of the NASDAQ rule that “are relevant under Delaware law and likely influenced by our law.”

The plaintiff had followed the Court’s admonition in other cases to use one of the “tools at hand” – a statutory books and records inspection – to gather facts before filing his complaint.  However, the Court chided him for seeking only books and records relating to the underlying transaction and not those “bearing on the independence of the board,” particularly those relating to the board’s determination of independence under NASDAQ rules.  The Court also advised that “one of the most obvious tools at hand is the rich body of information that now can be obtained by conducting an internet search,” suggesting that the plaintiff had failed to do so and overlooked facts concerning Siminoff available through such an inquiry.  However, the opinion is silent as to whether the Court conducted its own internet search and relied on facts it discovered in its analysis.

Interestingly, both the Court of Chancery and the Supreme Court applied the single-prong standard of Rales v. Blasband (which examines only the disinterestedness and independence of directors, and typically applies when a plaintiff challenges a board’s failure to take action), rather than the two-prong standard of Aronson v. Lewis, which also examines the substance of a decision made by a board.  Neither party contested the applicability of Rales, and therefore the Supreme Court used it in its analysis.

In a dissent, Justice Valihura stated that she would have affirmed dismissal because the plaintiff failed to allege facts showing the materiality of investments made by Kleiner Perkins in other companies and also failed to plead why Gordon and Doerr lacked independence under NASDAQ rules (which are not necessarily coextensive with the Delaware standard for independence).  She also noted that the plaintiff had chosen to plead allegations about Siminoff’s co-ownership of a plane as supporting a business venture and not a close personal relationship, and that those allegations failed to establish the materiality of the venture.