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Chancery Denies Section 220 Bid for Executive Compensation Records Involving Facebook

Southeastern Pa. Trans. Auth. v. Facebook, Inc., C.A. No. 2019-0228-JRS (Oct. 29, 2019)

Shareholders of a Delaware corporation have a qualified right to access corporate books and records for a “proper purpose.” One such proper purpose is to investigate potential mismanagement or fiduciary wrongdoing. Indeed, Delaware law encourages shareholders to use this “tool at hand” prior to bringing a derivative action. But this type of inspection has an important precondition: the shareholder must advance some evidence to suggest a “credible basis” from which the Court can infer actionable wrongdoing. As this decision involving Facebook illustrates, the credible basis standard is lenient but not meaningless, and may turn on, among other things, the potential for monetary damages arising out of the alleged wrongdoing. After a trial on a paper record, the Court of Chancery denied an attempt by two stockholders of defendant Facebook, Inc. to obtain additional documents related to the company’s executive compensation practices.

In 2016, Facebook disclosed that it had artificially inflated a key advertising metric—the amount of time that users spent watching advertisers’ videos—and, in 2018, Facebook’s stock value tumbled after Facebook announced that its growth rate had decelerated. Plaintiffs questioned why, despite these events, Facebook continued to increase executive compensation. Plaintiffs issued a Section 220 demand, and Facebook asserted that plaintiffs had not stated a proper purpose and that the requested records were not necessary and essential to plaintiffs’ stated purpose. After negotiations, Facebook produced records related to advertising metrics, but resisted producing minutes of certain committees and director independence questionnaires.

In a thorough post-trial decision, the Court of Chancery agreed with Facebook. The Court explained in detail the context of the 2016 advertising metric miscalculations and the 2018 stock value decrease, as well as Facebook’s executive compensation practices. Against this context, the Court concluded that although plaintiffs had stated four separate purposes, the plaintiffs’ primary purpose was to investigate potential wrongdoing related to executive compensation.

The Court explained that while investigating wrongdoing is a proper purpose under Section 220, a shareholder is only entitled to books and records if the shareholder can show “some credible basis from which the court can infer that waste or mismanagement may have occurred.” Moreover, if a corporate charter, like Facebook’s, limits director liability “to the fullest permitted by law” consistent with Section 102(b)(7) of the DGCL, then “a purpose aimed at investigating and exposing breaches of the Board’s duty of care will not support a demand for inspection.” To be proper in that circumstance, the purpose must implicate the duty of loyalty.

Plaintiffs argued that the Facebook board had overcompensated executives and given the advertising miscalculations and declining revenue, that the overcompensation could only be explained by bad faith. But the Court concluded that plaintiffs failed to prove a credible basis for any part of its theory. That is, there was no credible evidence for the assertion that the executives were overcompensated, nor was there a credible evidence linking the revenue declines in 2018 to the advertising metric errors from 2016. Even if there had been credible evidence for those assertions, the plaintiffs failed to identify any credible evidence that the directors’ executive compensation decisions were motivated by bad faith. Accordingly, the Court concluded that the plaintiffs had not stated a proper purpose for inspecting the books and records they sought.