Corporate Governance Group. Client Alert

Transcription

1 February 17, 2012 Corporate Governance Group Client Alert Beijing Frankfurt Hong Kong London Los Angeles Munich New York São Paulo Singapore Tokyo Washington, DC STOCKHOLDER GRANTED ACCESS TO BOOKS AND RECORDS OF COMPANY ACCUSED OF FRAUD Decision continues recent trend of resolving corporate books and records disputes in favor of requesting stockholders In several decisions handed down over the last two years, the Delaware Court of Chancery has demonstrated its willingness to resolve disputes over demands for access to corporate books and records in favor of the requesting stockholder. 1 A decision recently issued in Paul v. China MediaExpress Holdings, Inc. 2 continues this trend. The decision is notable not only because it provides useful rules of the road for stockholders desiring to inspect books and records in anticipation of bringing potential derivative claims against a corporation s directors, but also because it demonstrates the Court s resolve to preserve, as much as possible, the right of stockholders to inspect books and records despite the pendency of federal litigation premised on the same alleged directorial wrongdoing. Background In January 2011, a financial analyst firm issued a report alleging that China MediaExpress Holdings Inc. ( CME ), a Delaware corporation who operates its business of selling television advertising on intercity and airport express buses in China, was engaged in fraudulent accounting practices and that most of CME s business could be a fraud. On February 7, 2011, following the issuance of reports by two shortsellers making similar allegations, CME s Chairman responded by denying any fraud and accusing the shortsellers of promot[ing] their own objective of driving down the Company s stock price. 1 Please see our prior Client Alerts entitled Delaware Courts Permit Stockholders to Pursue Books and Records Inspections in Furtherance of Derivative Claims (dated April 15, 2011), and Delaware Supreme Court Clarifies Standard for Analyzing Books and Records Claims in the context of Plurality Plus Governance Policies (dated September 7, 2010). 2 No VCP, 2012 WL (Del. Ch. Jan. 5, 2012). For further information about this Client Alert, please contact: Alan Stone Partner astone@milbank.com David Schwartz Of Counsel dschwartz@milbank.com Aaron Stine Associate astine@milbank.com You may also contact any member of Milbank s Corporate Governance Group. Contact information can be found at the end of this Client Alert. In addition, if you would like copies of our other Client Alerts, please visit our website at and choose Client Alerts under News. This Client Alert is a source of general information for clients and friends of Milbank, Tweed, Hadley & McCloyLLP. Its content should not be construed as legal advice, and readers should not act upon the information in this Client Alert without consulting counsel Milbank, Tweed, Hadley & McCloy LLP. All rights reserved. Attorney Advertising. Prior results do not guarantee a similar outcome. Editor: Bob Reder

2 The following month, CME s independent auditor Deloitte Touche Tohmatsu resigned, publicly announcing that it was no longer able to rely on the representations of management, that certain issues raised in the audit should be addressed through an independent investigation, and that the issues may have adverse implications for prior periods financial reports. On the heels of Deloitte s resignation, CME requested that the NASDAQ Stock Market temporarily suspend trading in its stock. Next, two CME directors resigned, citing concerns over management s response to the situation. Thereafter, the NASDAQ Stock Market delisted CME s shares. As these events unfolded, Starr Investment Cayman II, Inc., a CME stockholder, sued CME and certain of its directors in the United States District Court for the District of Delaware, alleging various violations of state law and federal securities laws. As required by the Private Securities Litigation Reform Act (the PSLRA ), discovery in this action was automatically stayed pending resolution of a motion to dismiss brought by the defendants. While the federal action was pending, Mark Paul, another CME stockholder, served CME with a voluminous demand for inspection of its books and records, claiming that a series of reports and events, including the resignation of the company s independent auditor, raised suspicions that the company had engaged in fraud and falsified its financial statements. Paul offered two purposes to justify his demand: (1) to investigate possible mismanagement and breaches of fiduciary duties by the directors and officers of the Company, including in connection with the Company s lack of oversight and possible participation in fraudulent conduct ; and (2) to determin[e] whether the Company s directors are independent and have acted, and are capable of acting, in good faith with respect to the Company s potential misconduct. Paul acknowledged that this second purpose was in anticipation of alleging demand futility if he later decides to bring a derivative action on behalf of the Company. When CME failed to respond to this request, Paul brought an action in the Court of Chancery under Section 220 of the Delaware General Corporation Law ( DGCL 220 ) seeking to enforce his inspection rights. The Court of Chancery s Analysis CME attacked Paul s inspection request on two separate grounds. First, CME claimed that Paul had not stated a proper purpose under DGCL 220. Second, CME argued that Paul s action should be stayed pending resolution of the motion to dismiss pending in the federal action. Proper Purpose Under DGCL 220, [a]ny stockholder shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose [t]he corporation s stock ledger, a list of its stockholders, and its other books and records. The Court explained that to take advantage of DGCL 220, a stockholder must prove that he (1) is a stockholder of the company, (2) has made a written demand on the company, and (3) has a proper purpose for making the demand. The Court also noted that a proper purpose is one that is reasonably related to such person s interest as a stockholder. Further, although [t]here is no shortage proper purposes under Delaware law, the purpose asserted by the stockholder should be intended to further[] the interest of all stockholders and should increase stockholder return. Accordingly, the Court turned to an examination of each of Paul s professed purposes for gaining access to CME s books and records. 2

3 Investigating Waste and Management The Court began this portion of its analysis by stating that it is well-established that a stockholder s investigation of wrongdoing or mismanagement at a company is a proper purpose for a 220 action. However, a stockholder seeking to inspect corporate books and records must make more than mere conclusory statements that waste and mismanagement have occurred or are occurring. Rather, the stockholder must present some credible basis through documents, logic, testimony or otherwise from which the Court can infer wrongdoing, even if such evidence may ultimately fall well short of demonstrating that anything wrong occurred. Based on the record before it, the Court concluded that Paul had in fact established a credible basis to warrant suspicion of waste and mismanagement at CME, citing numerous third-party media reports alleging fraudulent conduct at CME, the resignation of Deloitte as CME s auditor, the noisy resignations of two CME directors and the actions taken by the NASDAQ Stock Market in response. While [e]ach of these items arguably provides [the requisite] credible basis, in the Court s view, taken together they convince me that Paul has presented a credible basis for suspecting wrongdoing on the part of CME s directors in breach of their fiduciary duties. In this connection, the Court explained that, at least for purposes of a DGCL 220 action, so-called hearsay statements that are nonetheless sufficiently reliable, may be considered in determining whether a credible basis exists to conclude that waste and mismanagement may have occurred. Determining Director Independence With respect to Paul s second stated purpose, CME argued that Paul s desire to investigate director independence and the ability of the directors to act in good faith, in anticipation of bringing a derivative claim against CME s directors, was negated by the fact that he continued to buy shares of CME stock after the release of negative third-party reports. The Court rejected this line of argument, stating that Paul need not prove that he would qualify as a representative plaintiff in a later class or derivative action to show a proper purpose under 220. Instead, what matters in proving a proper purpose under 220 is that he would have standing to bring either direct or derivative claims against CME following the requested inspection. Because Paul had been a CME stockholder during the relevant period, the Court concluded that he presumably will have standing to bring either direct or derivative claims against CME and had, therefore, demonstrated the existence of a proper purpose to investigate demand futility. Scope of the Investigation On this basis, the Court granted Paul s request for inspection, subject to Paul signing a confidentiality agreement. The Court did, however, limit the scope of Paul s inspection to books and records of CME that were necessary, essential and sufficient to Paul s stated purposes. Of particular note in this regard is the Court s outright rejection of Paul s demand for all s [and] notes created by, distributed to, or reviewed by or on behalf of CME s Board or any committee thereof, concerning [well over two dozen subjects]. In the Court s view, this aspect of Paul s demand reads much more like a sweeping discovery request than a narrowly focused 220 demand. 3

4 Deference to the Federal Proceeding While recognizing that the district court may have authority to stay this action if it determines that [Paul s books and records] inspection would interfere with the automatic stay in the Federal Action, the Court nevertheless refused to stay the books and records action of its own accord. The Court explained that federal courts are granted discretion by the PSLRA to stay discovery in concurrent state law proceedings (i) where there is a risk that the federal plaintiffs will obtain the state plaintiff s discovery, (ii) if the underlying facts and legal claims in the state and federal actions overlap and (iii) in light of the burden that the state court discovery proceedings will impose on the federal defendants. In fact, the Court took pains to explain why it believed that the District Court should not stay the Delaware books and records proceeding. Among the factors cited by the Court for this view are: Paul neither is the plaintiff in the federal action nor has any relationship with the actual plaintiff in that action. Paul s signing of a confidentiality agreement with respect to any information learned as a result of his DGCL 220 inspection will make it unlikely that further proceedings in this case will result in some form of discovery inadvertently reaching the federal plaintiffs. The respective claims made in the books and records litigation and in the federal litigation involve entirely different legal claims, the actual judgments entered in 220 cases are much more limited in scope and, from a timing point of view, it still is unlikely that any judgment will issue from a future derivative action [in Delaware court] before the district court has an opportunity to decide the motion to dismiss. I do not expect complying with the production ordered in this action to be overly burdensome for CME. Conclusion The Court of Chancery s decision in Paul v. China MediaExpress Holdings demonstrates the Court s continued desire to protect the fundamental right of stockholders under DGCL 220 to inspect a corporation s books and records. This decision is noteworthy in two regards. First, the decision provides a clear and helpful explanation of how a stockholder who may be contemplating derivative litigation against directors alleged to have engaged in wrongdoing or to lack independence may demonstrate the proper purpose required to gain access to corporate books and records under DGCL 220. Second, it gives the Court an opportunity to plead its case to the federal courts as to why the automatic stay of discovery in federal securities law litigation triggered by a motion to dismiss should not necessarily interfere with a stockholder s right to inspect books and records under DGCL 220 in anticipation of bringing state law fiduciary duty claims.. 4

5 Please feel free to discuss any aspect of this Client Alert with your regular Milbank contacts or with any of the members of our Corporate Governance Group, whose names and contact information are provided below. Beijing Units 05-06, 15th Floor, Tower 2 China Central Place, 79 Jianguo Road, Chaoyang District Beijing , China Anthony Root aroot@milbank.com Edward Sun esun@milbank.com Gary Wigmore gwigmore@milbank.com Frankfurt Taunusanlage Frankfurt am Main, Germany Norbert Rieger nrieger@milbank.com Hong Kong 3007 Alexandra House, 18 Chater Road Central, Hong Kong Anthony Root aroot@milbank.com Gary Wigmore gwigmore@milbank.com Joshua Zimmerman jzimmerman@milbank.com London 10 Gresham Street London EC2V 7JD, England Stuart Harray sharray@milbank.com Los Angeles 601 South Figueroa Street, 30 th Floor Los Angeles, CA Ken Baronsky kbaronsky@milbank.com Neil Wertlieb nwertlieb@milbank.com Munich Maximilianstrasse 15 (Maximilianhöfe) Munich, Germany Peter Nussbaum pnussbaum@milbank.com New York One Chase Manhattan Plaza New York, NY Scott Edelman sedelman@milbank.com Roland Hlawaty rhlawaty@milbank.com Thomas Janson tjanson@milbank.com Joel Krasnow jkrasnow@milbank.com Alan Stone astone@milbank.com Douglas Tanner dtanner@milbank.com Paul Wessel pwessel@milbank.com São Paulo Rua Colombia, 325 Jardim América São Paulo, SP Andrew Janszky ajanszky@milbank.com Singapore 30 Raffles Place, #14-00 Chevron House Singapore David Zemans dzemans@milbank.com Naomi Ishikawa nishikawa@milbank.com Tokyo 21F Midtown Tower, Akasaka, Minato-ku Tokyo Japan Mark Plenderleith mplenderleith@milbank.com Washington, DC International Square Building, 1850 K Street, NW Suite 1100 Washington, DC Glenn Gerstell gerstell@milbank.com 5