Equitable Tolling and Insider-Trading Claims
Although the statute of limitations does not automatically bar an equitable claim in the Delaware Court of Chancery, the court will apply the relevant statute of limitations by analogy. Equitable tolling will toll the three-year statute of limitations for wrongful self-dealing claims if a plaintiff reasonably relies on the competence and good faith of a fiduciary. In the recent decision in In re Primedia Shareholders Litigation, Consol. C.A. No. 6511-VCL (Del. Ch. Dec. 20, 2013), the court addressed the doctrine of equitable tolling in the context of insider-trading claims.
The plaintiffs were stockholders of defendant Primedia Inc., which was acquired by TPG Capital L.P. in a reverse triangular merger. Defendant Kohlberg Kravis Roberts & Co. was the controlling stockholder of Primedia from its inception until the merger and had several directors on the Primedia board. During the 1990s, Primedia raised capital by issuing preferred stock. Following the bursting of the technology bubble, the stock price of Primedia's common and preferred stock dropped dramatically. The Primedia board authorized the company to use common stock to repurchase up to $100 million of preferred stock in December 2001. The exchanges began in March 2002. On May 16, 2002, the board authorized exchanges for another $100 million. Five days after this authorization, on May 21, 2002, two of the Primedia directors designated by KKR prepared a memorandum for KKR's investment and portfolio committees. The May 21 memo contained positive, nonpublic information about Primedia's performance for the second quarter of 2002 and the year as a whole. The memo recommended that KKR purchase Primedia preferred stock before the market became aware of Primedia's improving performance.
To address usurpation of corporate opportunity concerns, KKR told Primedia it would defer to Primedia if Primedia wished to acquire preferred stock. By July 12, 2002, all of the Primedia directors executed a written consent providing that KKR entities would not usurp a corporate opportunity of Primedia by acquiring preferred stock. An entity created by KKR, referred to in the opinion as ABRA, began buying preferred stock July 8, 2002. The exact dates of the July purchases and an Aug. 8, 2002, purchase were disclosed in Form 4s filed by KKR with the Securities and Exchange Commission on Aug. 9, 2002, and Sept. 10, 2002.
On Sept. 26, 2002, the board approved the sale of Primedia's American Baby Group assets to a third party for $115 million in cash. Three KKR directors participated in the board meeting. The sale was not publicly announced until Nov. 4, 2002. ABRA purchased preferred stock Sept. 26, 2002—which was disclosed in a Form 4 filed Sept. 30, 2002—and Oct. 7, 2002—which was disclosed in a Form 4 filed Oct. 9, 2002. After these purchases and the announcement of the American Baby sale, the trading price of Primedia's common stock and preferred stock rose. Primedia began redeeming the preferred stock in 2005. As a result of the redemptions and the payment of dividends on the preferred stock, KKR earned profits of $190 million on its $76 million investment in Primedia's preferred stock.
After the filing of a derivative action in 2005 and investigation by a special litigation committee (SLC), the plaintiffs received a small document production, including the May 21 memo, in September 2007. The plaintiffs believed that the May 21 memo supported an insider-trading claim against KKR under Brophy v. Cities Service, 70 A.2d 5 (Del. Ch. 1949). The SLC disagreed and moved to dismiss the derivative action. On June 16, 2010, the Court of Chancery dismissed the derivative action and the decision was appealed to the Delaware Supreme Court. While the appeal was pending, the board approved a merger agreement with TPG. Primedia stockholders filed class actions challenging the merger. The Supreme Court reversed the dismissal of the derivative action, but the closing of the merger extinguished the plaintiffs' standing to pursue the derivative action. On Dec. 12, 2011, the plaintiffs filed the operative class complaint alleging that the merger was not entirely fair because the merger consideration did not include any value for the derivative claims. After the court denied the defendants' motion to dismiss, the defendants answered the complaint and moved for judgment on the pleadings on the grounds that the insider-trading claim was barred by laches.
Because the insider-trading claims accrued in the summer and fall of 2002 when KKR purchased Primedia preferred stock and the first derivative complaint was filed in November 2005, the plaintiffs had to rely on equitable tolling to save their insider-trading claims. Equitable tolling applies to a wrongful self-dealing claim (like insider trading) when the plaintiff relies on the competence and good faith of a fiduciary. Equitable tolling will toll the statute of limitations until the plaintiff is on inquiry notice of his or her claim. If there is not sufficient information to arouse a reasonable stockholder's suspicions and a stockholder could not obtain information necessary to file a complaint that would survive a motion to dismiss, a stockholder may continue to rely on the competence and good faith of a fiduciary. The plaintiffs' insider-trading claims fell into two categories that the court addressed separately: (1) ABRA's purchase of preferred stock allegedly based on inside information about the American Baby sale; and (2) ABRA's purchase of preferred stock allegedly based on inside information about Primedia's improving finances.
According to the court, the Form 4s filed in September 2002 and the public announcement of the American Baby sale put the plaintiffs on inquiry notice of their insider-trading claim by Nov. 4, 2002. A reasonable stockholder would have been suspicious of the timing of the purchases and could have made a books-and-records demand for Primedia board minutes concerning the American Baby sale. The minutes disclosed that KKR directors were present for approval of the sale. A reasonable stockholder would have understood that a KKR affiliate, ABRA, purchased preferred stock while KKR directors knew of the American Baby sale and before public announcement of that sale. With this information, a stockholder could have pleaded an insider-trading claim that would survive a motion to dismiss within the three-year statute of limitations. Thus, the court concluded that this claim was not equitably tolled and was barred by laches.
The court reached a different conclusion with respect to ABRA's purchase of preferred stock in the summer of 2002 while KKR possessed inside information about Primedia's improving finances. Although the court believed that a reasonable stockholder would be suspicious of the purchases in the weeks before the announcement of favorable quarterly results, it concluded that such a stockholder would not have been able to obtain sufficient information to draft a complaint that would survive a motion to dismiss. The court viewed the May 21 memo as the critical piece of evidence that a stockholder would need to successfully plead an insider-trading claim. Unlike the board minutes relating to the American Baby sale, a Primedia stockholder could not obtain the May 21 memo in a books-and-records demand because the memorandum was in the possession of KKR, not Primedia. The court concluded that the statute of limitations was tolled until the discovery of the May 21 memo in September 2007. The plaintiffs filed their original complaint challenging Primedia's redemption of preferred stock in November 2005 and their second amended complaint challenging KKR's purchase of preferred stock as a usurpation of corporate opportunity in August 2007. Regardless of whether the insider-trading claim related back to the November 2005 complaint or the August 2007 complaint, the court found that the insider-trading claims based on the July 2002 purchases were filed within the tolling period.
As this decision reflects, plaintiffs can successfully invoke the doctrine of equitable tolling to preserve an insider-trading claim if they can show that it is unlikely they would have been able to plead a claim that would survive a motion to dismiss within the statute of limitations. While the court concluded that a reasonable stockholder would have been suspicious of the timing of all of the purchases within the statute of limitations, the court decided that a stockholder would not have been able to obtain sufficient information to plead a viable insider-trading claim based on the summer 2002 preferred stock purchases. The existence of the May 21 memo and its production in 2007 tolled the statute of limitations until 2007.
This decision illustrates how important it can be for a stockholder plaintiff to obtain books and records to plead a claim that accrued more than three years prior to the filing of a complaint. This decision also illustrates, however, the limits of a books-and-records demand when the stockholder does not own shares in a company possessing key evidence.