In recent days, there has been extensive media attention (here and here) focused on the fact that plaintiffs’ lawyers seeking to exploit the options backdating scandal are filing shareholders’ derivative suits in preference to securities fraud class action lawsuits. Indeed, The D & O Diary’s running tally of options backdating lawsuits (here) shows that only 16 companies have been named in securities fraud lawsuits, but over 70 companies have been named as nominal defendants in shareholders’ derivative lawsuits. But while the observation that plaintiffs’ lawyers are preferring shareholders’ derivative lawsuits appears to be valid, this observation does not explain why plaintiffs’ lawyers are so eager to file derivative lawsuits. Traditionally, derivative lawsuits have not been nearly as lucrative for plaintiffs’ lawyers as securities fraud suits. So why are plaintiffs’ lawyers preferring derivative lawsuits in connection with the options backdating scandal?

It may be supposed that recent trends in other recent derivative lawsuits’ recoveries makes these suits more attractive to plaintiffs’ lawyers now than perhaps they were in the past. The derivative lawsuit filed against the Hollinger board resulted in a $50 million settlement (here) – funded entirely by D & O insurance – and the Oracle derivative settlement resulted in Larry Ellison’s payment of $100 million to charity, as well as his payment of the company’s $22 million attorneys’ fees. In addition, the existence of a derivative lawsuit was a "substantial factor" in the payment of $200 million in settlement of various litigation against AOL Time Warner. But there need to be numerous caveats around the purported value of the AOL Time Warner derivative settlement (see the prior D & O Diary post concerning the AOL Time Warner settlement here) and the Oracle settlement with its payment to charity rather than to the company requires a very big asterisk (and is probably a worthy topic of a separate post). The Hollinger settlement may be more apposite, but it may also represent an extreme case.

Whether or not these other settlements represent a trend that might be increaing plaintiffs’ lawyers interest in filing shareholder derivative suits, the derivative lawsuits brought in connection with options timing allegations appear subject to numerous defenses or other practical limitations. To name but a few of the defenses and limitations:

Standing: For many of the companies involved in the backdating scandal, the period during which the alleged misdating took place covers a large swath of time, in some cases going back to the early or mid 90’s. In order to have sufficient standing to pursue the derivative suit, a shareholder plaintiff will have to show continuous share ownership, at the time of the alleged wrongdoing as well as the at the time of the lawsuit. Some putative plaintiffs may satisfy this requirement, but not many, and most of the plaintiffs in whose name the options lawsuits have been brought lack the requisite standing (and for an additional comment about standing, see the note below about the Mercury Interactive shareholders’ derivative lawsuit);

Statute of Limitations: The statute of limitations under Delaware law for shareholder derivative suits is three years. Shareholders’ claims for alleged options timing misconduct more than three years’ prior to the spring or summer 2006 (when most of the lawsuits were filed) may well be time barred. Plaintiffs’ lawyers undoubtedly will seek to circumvent this bar by alleging concealment or some other excuse to stay of the limitations bar, but the whole point of a limitations statute is to avoid trying events from the distant past. The limitations period may well prove a substantial bar to many of the plaintiffs’ claims.

Demand Requirement: In the race to the courthouse that followed the media frenzy surrounding the options backdating scandal, many of the plaintiffs’ lawyers disregarded the derivative lawsuit filing prerequisite that the plaintiffs first demand that the board pursue the lawsuit on the corporations’ behalf or present allegations to show why demand would be futile. The demand requirement is substantial and cannot be circumvented by mere conclusory allegations of futility; the plaintiff must plead with particularity why a majority of the board lack sufficient disinterest to consider the demand. This should be a particular burden in the many cases where the directors did not themselves benefit from the options timing. Moreover, where (as in most cases) the plaintiffs filed their suits without first pursuing a books and records request to obtain requisite factual information as a basis for their claim, a
dismissal based a failure to meet the demand requirement will be with prejudice;

Exculpatory Clause: Most corporations have adopted an exculpatory clause in their corporate charter, as permitted under Delaware law, precluding liability against the directors for breach of fiduciary duty except upon a showing of bad faith or disloyalty. Liability for mere breaches of the duty of care is waived under these exculpatory provisions. In most cases, the boards of directors of companies caught up in the backdating scandal were simply unaware of the backdating, and therefore allegations of wrongdoing amount to no more than alleged breached of the duty of care, the liability for which is precluded under the exculpatory clause.

To be sure, there are some companies with respect to which more substantial or active wrongdoing is alleged, and with to respect to which the derivative claim may be more substantial and perhaps potentially more lucrative for the plaintiffs’ lawyers. But these claims amount to no more than a very small handful; almost all of the derivative complaints that have been filed are subject to the above defenses and other substantial defenses and limitations. It remains to be seen whether the flood of derivative lawsuits raising options timing allegations produces substantial value for the corporations on whose behalf the lawsuits have been filed, or for the plaintiffs’ lawyers who filed the lawsuits. But the number and strength of the potential defenses makes the D & O Diary wonder: why are the plaintiffs lawyers filing all these derivative suits?

The D & O Diary is interested in readers’ comments about the potential merits of the shareholders’ derivative options backdating lawsuits.

Unique Standing Defenses in the Mercury Interactive Derivative Lawsuit: Among the companies involved in the options backdating scandal is Mercury Interactive, which also was named as the nominal defendant in a shareholders’ derivative lawsuit brought by the Lerach Couglin firm. On July 25, 2006, while the derivative lawsuit was pending, Mercury Interative announced its acquisition by Hewlett-Packard. According to a September 11, 2006 story on entitled "H-P Deal May Kill Mercury Suit" (here), one of the individual defendants (who is represented by the Wilson Sonsini firm) has filed a motion to dismiss based on the argument under Delaware law that as a result of the H-P acquisition, the plaintiffs lack standing to assert the claim against the individual defendants. The only way the case can continue is if H-P decides to take it up on its own. The story has a definite "clash of the titans" feel to it, because the Lerach firm’s response to the motion to dismiss is to contend that because of the Wilson Sonsini’s firm’s alleged involvement in the H-P board’s brouhaha about its own Board investigation, Wilson Sonsini is or ought to be precluded from being involved in the Mercury Interactive lawsuit. Lerach’s arguments based on the Wilson Sonsini firm’s role with H-P probably indicates nothing so much as that the motion to dismiss is almost certainly meritorious, as mergers of this type generally divest plaintiffs of standing under Delaware law.

Thanks to Adam Savett of the Lies, Damn Lies blog (here) for the link to the article. (The comments about the case are strictly my own.)

Options Backdating Litigation Tally Update: The D & O Diary has updated its options backdating litigation tally (here) to add the new securities fraud class action lawsuit that has been brought against Aspen Technology (here). The addition of the Aspen Technology lawsuit brings the number of securities fraud lawsuits based on options timing allegations to 16. In addition, the number of companies sued in shareholders’ derivative lawsuits is now stands at 71, with the addition to the lawsuit against Home Depot (here), THQ (here), and Witness Systems (here).

Request for Information: As previously noted on The D & O Diary (here), Lynn Turner, the former Chief Accountant at the SEC and now a managing director at Glass Lewis, testified on Capitol Hill on September 6, 2006. As part of his written testimony (here), Turner attached an appendix that listed the companies involved in the options backdating investigations. A column on the appendix purported to identify the companies that have been named in options backdating shareholder suits (but not differentiating between securities fraud suits and shareholders’ derivative suits). There were some companies that were not identified in Turner’s exhibit as having shareholder suits that have in fact been sued (e.g., Mattel), and there were others identified as having been sued that The D & O Diary simply cannot independently corroborate as having been sued. The companies that Turner lists as having been sued for which The D & O Diary can find no corroboration are: Amkor, Blue Coat, Boston Communications, Dot Hill, Molex, and Newpark Resoureces. Most if not all of these six companies have shown up on various plaintiffs’ law firms’ press releases as being "under investigation" but as far as I have been able to determine they have not actually been sued. The D & O Diary would greatly appreciate it if its readers could provide any further corroboration about the existence of lawsuits against these companies — or any others that do not appear on The D & O Diary’s list of options backdating lawsuits.

Special thanks to Michael Miraglia for a link to the Turner testimonial exhibit and to Bill Ballowe for his help in locating options backdating lawsuits.