Corporate Governance

The Race to the Bottom and Shareholder Accessibility to Information: Norfolk County Retirement v. Jos. A Bank Clothier (Part 3)

By J. Robert Brown

The case involves a derivative suit involving behavior that was also subject to a federal securities suit.  The Special Litigation Committee found that the derivative claims and the securities claims had no merit.  Nonetheless, the federal court hearing the securities suit declined to dismiss the case, concluding that plaintiffs had met the high pleading standards for scienter set out in the PSLRA.

In Norfolk, plaintiff sought to inspect records in order to look into the possibility of mismanagement by officers and directors.  In meeting the credible evidence standard, plaintiff relied extensively on the complaint in the securities case and the two opinions by the federal district court declining to dismiss the case.  As the brief for summary judgment noted:  "The Securities Action complaint likewise pleads specific and compelling facts leading to a strong inference that the defendants made these multiple, material misstatements with the intent to defraud."  Brief, at p. 6.

The Chancery Court refused to allow the inspection of records.  First, the court found that in fact "credible evidence," the so called standards articulated by the courts under Section 220, was, in fact, not enough.

• Delaware courts have held that even with a credible showing of wrongdoing, a plaintiff still may not be entitled to books and records where the circumstances indicate that the request is burdensome or opportunistic. See, e.g., Trial Tr., Parfi Holding, AB v. Mirror Image Internet, Inc., No. 18457, at 6-9 (Del. Ch. Mar. 23, 2001) (denying demand for books and records where a court in a different jurisdiction already granted a stay of discovery, and the same plaintiff came before the court to compel a corporate defendant to produce documents according to a Section 220 action).

The finding was necessary because there was little doubt that the plaintiff had met the credible evidence standard.  Thus, the court had to prepare for another basis for denying access to the records.  Instead, the plaintiff had to present a "reasonable basis" for challenging the special litigation committee process.

• In that  context, Norfolk has not demonstrated a reasonable basis for believing that Jos. A. Bank was not adequately represented by the prior derivative plaintiff or the SLC. As in Grimes, Norfolk has received documents that “should suffice for the purposes of establishing or raising reasonable grounds for suspicions about a special committee’s independence, good faith and due care.” Under the low burden imposed by Delaware courts in § 220 actions, such a showing could entitle Norfolk to inspect additional documents beyond what the Company voluntarily provided. Yet, Norfolk has made no meaningful attempt to question the adequacy of the SLC’s process or the reasonableness of its investigation and conclusions.

The court concluded this despite the fact that the SLC had already issued a report concluding that the securities claims lacked merit, a decision that at least on the pleading, was rejected by the federal district court.  In other words, there was prima facie evidence that the conclusions of the SLC were wrong.  That, however, was not enough to establish the requisite reasonable basis.  Somehow the court concluded that the evidence in the securities class action might have been enough but not under the facts of this case.

• In the absence of contrary evidence, such as the SLC Report, the decisions in the Securities Class Action might have been sufficient to carry Norfolk’s burden. Having waited as long as it did while the Company responded to actions of other shareholders, however, Norfolk cannot ignore the other facts of record here. Norfolk was at least on inquiry notice in 2006 that the Maryland Derivative Action proceeded in the absence of a Section 220 action. Yet, Norfolk did not seek books and records from the Company until after the Maryland Derivative Action had already been dismissed, a demand made, and an SLC formed.

In other words, the decision of the SLC was held to negate any other evidence possessed by plaintiff suggesting wrong doing and otherwise meeting the applicable "credible evidence" standard.  This was despite the fact that the decision in the securities case already raised significant issues with the credibility of the SLC's determination.

Plaintiff had "credible" evidence of wrong doing.  A companion securities case survived a motion to dismiss and was in the discovery phase.  The company formed an SLC that found no merit to either case, a conclusion potentially in conflict with the decisions of the federal district court.  The facts suggest at least the possibility of mismanagement and wrong doing.  Yet despite these allegations, the Chancery Court has denied the owners of the company access to the records that are needed to determine whether in fact mismanagement occurred.

It is, in short, an example of the race to the bottom, the practice of Delaware courts to diminish the rights of shareholders.  Decisions like this explain why there is a need for significant federal preemption of the standards used by Delaware courts.

For primary materials on this case and on the securities case, go to the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on February 17, 2009 (boomark / email).