Chancery Court Rejects Trading Restriction as Condition of Receipt
Under 8 Del. C. Section 220, stockholders of Delaware companies are entitled to inspect certain books and records of the company upon stating a proper purpose. A long-recognized proper purpose for a books-and-records demand is an interest in valuing one's stock. In The Ravenswood Investment L.P. v. Winmill & Co., C.A. No. 7048-VCN (Del. Ch. May 30, 2014), the Court of Chancery decided the "novel" issue of whether a company, in response to a books-and-records demand, may condition the provision of nonpublic financial information on a trading restriction. Finding that the trading restriction would "inappropriately frustrate a fundamental stockholder right" to value its stock, the court held that the company could not require an agreement on the part of the requesting stockholder not to trade its stock for a certain period of time after receipt of the requested information.
The plaintiff, The Ravenswood Investment Co. L.P., held 10,000 shares of nonvoting stock in defendant Winmill & Co. Inc., a holding company for various investment securities. Although Winmill's stock trades on the over-the-counter market, it is not a reporting company under the federal securities laws. As a result, current financial information was not publicly available, and the last time the company released financial information was Feb. 17, 2010, for the nine months ending Sept. 30, 2009.
In September 2011, Ravenswood demanded to inspect the following books and records: (1) quarterly and annual financial statements for the previous two years and for all subsequent periods to the date of production; (2) compensation records for the company's directors, officers and voting stockholders; (3) a stockholder list; and (4) a list of trading in Winmill stock and options by the company's directors, officers and voting stockholders. Ravenswood's stated purpose for inspecting the company's financial information was to determine "the value of its investment in and the economic performance of Winmill."
Winmill responded to Ravenswood's demand by offering to provide the compensation and stockholder list information upon execution of an appropriate confidentiality stipulation. Winmill refused, however, to produce the requested financial statements and trading information in the absence of an agreement by Ravenswood not to trade in Winmill's stock for a certain period of time after receiving the requested information. In support of the trading restriction, Winmill claimed that Ravenswood had requested material, nonpublic information and that, if Ravenswood intended to trade on such information, it could potentially implicate "tipper" liability under federal securities laws. The company concluded that trading on such material, nonpublic information was not a proper purpose for Ravenswood to inspect Winmill's books and records.
To address this purported concern, the company asked Ravenswood to agree to the following provision: "'The requesting parties [i.e., Ravenswood] agree not to trade in Winco's [i.e., Winmill's] stock until the sooner of (a) three business days after the financial information received by them as part of the documents becomes publicly available or (b) one year from the date they receive the documents. Notwithstanding the foregoing sentence, the requesting parties may trade in Winco's stock at any time with a sophisticated person who has received the documents pursuant to a signed undertaking. ... The requesting parties acknowledge that they are aware of the restrictions imposed by federal and state securities laws on a person possessing material nonpublic information about a company.'"
Ravenswood declined to enter into the trading restriction, and Winmill refused to produce the requested books and records.
In response to Winmill's refusal to satisfy Ravenswood's demand, Ravenswood initiated a books-and-records action under 8 Del. C. Section 220. During the course of litigation, Winmill produced, upon Ravenswood's execution of a confidentiality agreement, the requested information other than the financial information, as Ravenswood continued in its refusal to accept the trading restriction. Thus, the sole issue before the court was whether Winmill validly conditioned the provision of material, nonpublic financial information on an agreement by Ravenswood not to trade in Winmill's stock. The court found that it did not.
In support of its trading-restriction requirement, Winmill argued that the agreement was necessary to avoid potential liability under the federal securities laws. According to Winmill, tipper liability may arise where material, nonpublic information is disclosed to a recipient who in turn trades on that information. Winmill supported its position with testimony from its senior associate general counsel. Winmill also argued that the trading restriction is an extension of its internal "insider trading policies," which are intended "to ensure that material, nonpublic information is not misused by the company and its affiliates or their directors, officers, or employees."
The court noted that Winmill cited "considerable federal case law" discussing tipper liability under Section 10(b) of the Securities Exchange Act of 1934. The court also noted, however, that Winmill "noticeably" failed to cite Delaware case law—either from the Delaware Supreme Court or the Court of Chancery—endorsing a trading restriction for the purpose of protecting the corporation from tipper liability as a lawful prerequisite for a stockholder to access financial books and records pursuant to Section 220.
Ravenswood rejected Winmill's position and contended that Delaware law does not, and should not, support the trading-restriction scheme contemplated by the company.
After analyzing the parties' respective positions, the court ruled that Winmill's arguments in support of the trading restriction were unpersuasive. The court began by finding that Delaware law has long recognized that valuing stock is a proper purpose to support a stockholder's request for financial information under 8 Del. C. Section 220. As such, the purpose stated by Ravenswood in support of its demand was "clearly proper." The court further found that Winmill was a thinly traded company that did not regularly release its financial information, which left few options for Ravenswood to obtain financial information for purposes of fulfilling its proper purpose. As Ravenswood established a proper primary purpose, the court found that "any secondary purpose or ulterior motive" was irrelevant. The court determined that the company's "unsupported speculation that Ravenswood may unlawfully trade based on the company's material, nonpublic financial information," did not "sufficiently establish" an improper, actual purpose contrary to its stated purpose of valuing its stock.
The court next addressed the effect the requirement of a trading restriction would have on a stockholder's right to access the company's financial information. As the "whole point" of valuing one's stock is "to buy, sell or use the value for some other appropriate purpose," and stock that cannot be traded for a year may not have a readily ascertainable value, the court found that Winmill's trading restriction "would inappropriately frustrate a fundamental stockholder right." Additionally, the court was "unwilling to incorporate such an inequitable notion into Delaware's Section 220 jurisprudence." The court, thus, held that the proposed trading restriction was contrary to Delaware law.
The opinion in Ravenswood emphasizes the important rights afforded stockholders under 8 Del. C. Section 220. As in previous decisions, the court sought to determine the primary purpose underlying the demand and would not assume that the stockholder harbored an improper ulterior motive for seeking the requested information. Accordingly, in responding to a books-and-records demand, a company should think twice before seeking to impose conditions or restrictions on the stockholder's receipt of properly requested information. Although a confidentiality agreement is appropriate, and would be expected, restrictions that impact the use of the requested information in furtherance of the properly stated purpose likely will not withstand scrutiny.