The Advisors' Blog

– Liz Dunshee

Shareholders are increasingly sending a Section 220 “books & records” demand as a first step in derivative complaints – and companies need to tread carefully when responding. A recent opinion from the Delaware Court of Chancery lays out some good techniques.

In Pennsylvania Transportation Authority v. Facebook, the court denied two books & records demands where the shareholders were seeking to investigate whether Facebook’s board breached its fiduciary duties by overcompensating executives. The shareholders also said they wanted the info to inform themselves about a say-on-pay vote, communicate with directors & other shareholders about pay issues and assess director independence, which didn’t fly with the court.

This Wilson Sonsini memo explains:

Vice Chancellor Slights explained that because duty of care claims were barred by Facebook’s customary exculpatory charter provision, the plaintiffs had to demonstrate a credible basis to infer a potential breach of the board’s duty of loyalty. The plaintiffs did not claim the directors were conflicted or lacked independence, and therefore they had to argue bad faith: that Facebook’s executive compensation decisions were so “inexplicable… that bad faith—a motive other than the interest of the Company—must be at work.”

The shareholders didn’t meet that standard – in part because the directors had reviewed peer data & received “expert guidance” from a compensation consultant. The memo continues:

The court also found that, even if the plaintiffs had stated a proper purpose to investigate mismanagement, Facebook had already produced all “necessary and essential” records to fulfill that purpose. Before the lawsuit, Facebook had voluntarily produced certain board materials (minutes and presentations) relevant to the advertising metric errors, which showed that Facebook’s audit committee had discussed those errors and taken measures to address them. But Facebook otherwise stipulated that the directors did not consider the advertising metric errors when setting executive compensation. Vice Chancellor Slights concluded that the plaintiffs therefore had “the information they need[ed]” to decide whether to bring a duty of loyalty claim.

Finally, the court found that none of the plaintiffs’ secondary purposes for the demands was proper. The court rejected the stated purpose of contacting directors and stockholders about compensation decisions, explaining that “a conclusory statement that plaintiffs wish to discuss compensation issues with the board and/or stockholders is not a key to unlock more information than the company has already provided.”

The purpose of deciding how to vote on “Say on Pay” was also improper because the 2019 vote had passed and it was unclear what issues would be relevant for future votes. On the plaintiffs’ request for director independence questionnaires to assess board independence, the court explained, “[b]ecause there is no credible basis to suspect wrongdoing, Plaintiffs are not entitled to determine whether the Board is independent for purposes of considering a demand to bring claims related to such wrongdoing.”