Del. Supreme Court Finds Demand Excused and Revives 'Zynga' Derivative Claim
The derivative complaint alleged that Zynga's CEO, Chairman and controlling stockholder Mark Pincus, along with certain other top managers and directors were given an exception from the company's standing rule preventing insider sales until three days after an earnings announcement. The exception permitted the insiders to sell 20.3 million shares of stock for $236 million as part of a secondary offering. The insiders sold their shares for $12/share. Following the earnings announcement the market price dropped to $8.52 and following more negative news three months later dropped to $3.18, a 75 percent decrease from the offering price. The complaint alleged wrongdoing by the directors who approved the exception and those who participated in the sales. Of the company's nine directors, the Court of Chancery found that only the two directors who participated in the sale, Pincus & Hoffman, were interested and therefore could not impartially consider a demand. The Chancery Court rejected the argument that the facts alleged in the complaint were sufficient to create a reasonable doubt about the independence of director Siminoff because of an allegation that she was a "close family friend" of Pincus and had a business relationship with Pincus as co-owners of a private plane. The Chancery Court also rejected the argument that directors Doerr and Gordon lacked independence because of investment relationships they had with Zynga and Hoffman and Pincus.
The Supreme Court agreed that Pincus and Hoffman were interested but disagreed with the lower court's conclusion of independence respecting Siminoff, Doerr and Gordon. Finding that five of the nine directors were not disinterested and independent, the Supreme Court reversed. It ruled that the plaintiff actually had met its pleading burden of raising a reasonable doubt that a majority of the board could act impartially in considering a demand in this case.
As to Siminoff, the Supreme Court ruled that co-ownership of a private plane is uncommon and that the expense and cooperation involved in owning such an asset suggests that the Pincus and Siminoff families had a continuing close personal relationship analogous to family ties that one would expect to heavily influence a human's ability to exercise impartial judgment. At a pleadings stage, these facts were sufficient to "create a reasonable doubt" about Siminoff's ability to consider impartially the demand in the complaint.
With respect to directors Doerr and Gordon, both were partners at Kleiner Perkins Caufield & Byers which controlled 9.2 percent of Zynga's equity. Kleiner Perkins also invested in a company co-founded by Pincus' wife, and it, along with Hoffman, had investments in another company where Hoffman served on the board with another Kleiner Perkins partner. Beyond that, the board of directors of Zynga had determined that Doerr and Gordon did not qualify as independent directors under the NASDAQ Listing Rules. The basis for the board's conclusion about their independence qualifications, however, had not been disclosed. The Supreme Court was critical of the plaintiff's failure to discover such information in a pre-suit books and records demand. Acknowledging that the stock exchange rules regarding director independence are not controlling of the demand excusal issue, the court nevertheless accorded weight to the determination of the other independent directors who concluded that Doerr and Gordon were not independent directors in a company controlled by Pincus. To the argument that Kleiner's investments ran one way toward Pincus making him beholden to them and not vice versa, the Supreme Court said " ... the reality is that firms like Kleiner Perkins compete with others to finance talented entrepreneurs like Pincus, and networks arise of repeat players who cut each other into beneficial roles in various situations." That factor combined with the close investment relationship existing between Doerr and Gordon and Pincus and Hoffman raised a reasonable doubt about their ability to consider impartially the demand in the complaint.
The Supreme Court acknowledged this was a close case and that demand excusal determinations are fact-specific. Justice Karen Valihura's dissent from the opinion authored by the chief justice further evidences the closeness of the question. The opinion, however, reflects a willingness at the pleadings stage to consider how the real-life dynamics of human nature and human interaction operate and the constraint such relationships may impose on one's ability to act adversely toward another in the relationship. Moreover, the Supreme Court evidenced the importance of such relationships to its independence analysis even in the absence of any direct evidence of material financial coercion or advantage.
Finally, to the extent uncertainty has lingered in Delaware law about a stockholder's ability under 8 Del. C. Section 220 to seek books and records concerning director independence, the Supreme Court squarely removed any such doubt. The court admonished the plaintiff for lack of diligence in failing to request information in its books and records demand concerning the directors' independence.