INSIDE THIS ISSUE
On August 10, 2010, Scott+Scott LLP client Brockton Contributory Retirement System filed a shareholder derivative lawsuit in California Superior Court on behalf of Hewlett-Packard Company (“HP”) and its shareholders. The lawsuit charges recently-resigned CEO Mark Hurd and the HP board of directors with gross mismanagement, waste of corporate assets, violation
the California Corporations Code, misappropriation of information, and unjust enrichment.
The lawsuit stems from severance compensation lavished on disgraced CEO Hurd in connection with his August 6, 2010 resignation from HP. As widely reported in the media, Hurd resigned from all of his positions at the company following the discovery of inappropriate conduct on his part during an investigation into a sexual harassment claim against the former HP CEO and chairman. The confidential internal probe concluded that Hurd violated the company’s standards of business conduct, finding, among other things, that Hurd had a personal relationship with an HP contractor who received numerous inappropriate payments from the company.
Upon the disclosure of the probe and Hurd’s resignation, HP has lost significant credibility. The market punished the company, slashing its stock rating. HP investors have absorbed tremendous losses as over $9 billion in market capitalization was been erased. In stark contrast, in exchange for his releasing HP from future litigation, Hurd received $12.2 million in severance, plus vested options and restricted stock for an estimated total of $40 million.
The Scott+Scott complaint charges that Hurd’s severance package could have been significantly smaller if HP's board had followed their duty to the company to fire Hurd with cause. Among other things, the suit aims to reclaim Hurd's severance package for HP. The suit also seeks to impose corporate governance changes on the HP board, which is alleged to have violated corporate law by failing to inform shareholders of the investigation into the sexual harassment allegations against Hurd.
HP, founded in 1939, has long espoused the guiding principle known as "the HP Way." "We work together to create a culture of inclusion built on trust, respect and dignity for all," according to a statement on the company's website about HP's corporate objectives, which "have guided the company in the conduct of its business since 1957, when first written by co-founders Bill Hewlett and Dave Packard." The code also promises "uncompromising integrity."
HP, as of late, has found itself in the headlines for serious acts undermining these principles. Not long ago, Hurd, then chairwoman Patricia Dunn, and several board members were embroiled in litigation connected to HP's notorious "pretexting" scandal of 2006. The 2006 matter involved HP's use of outside investigators who impersonated board members and journalists, including reporters from CNET, the New York Times and the Wall Street Journal, seeking to get their phone records in a search for leaks that showed up in a CNET story on HP's business strategy.
HP settled a related case by the California Attorney General in December 2006, by agreeing to pay a $14.5 million civil penalty and to injunctive relief. In addition in connection with this settlement and the settlement of a related shareholder derivative action, HP agreed to adopt a series of corporate governance reforms, including revisions to its Standards of Business Conduct, which HP shareholders were assured would restore credibility to the oversight of the HP board of directors. The reforms included that HP would implement majority voting, create a new lead independent director position, create a new board position of “Independent Director for Compliance and Ethical Requirements Related to Investigations,” create a new senior management position of “Chief Ethics and Compliance Officer,” and re-staff the HP board’s Ethics and Compliance Committee.
It has now come to light that these measures went largely unimplemented by the company, and to the extent they were adopted at all, failed grossly. Specifically, the HP board of directors failed to hold its highest executive, Hurd, to its Standards of Business Conduct. Instead, Hurd was permitted to run HP as his own private fiefdom — free from board oversight.
New Charges Against the Board
Hurd resigned as chief executive officer and chairman of the board after it was disclosed that he had a personal relationship with a contractor who received numerous inappropriate payments from the company. HP has stated that Hurd approved paying the contractor, Jodie Fisher, anywhere from$1,000 to $10,000 per event. HP initiated a confidential investigation on June 29 after Ms. Fisher made a claim of sexual harassment against Hurd. It was later revealed that the board investigation uncovered misconduct on the part of Hurd, including failing to disclose a personal relationship with an HP contractor—which HP defines as a conflict of interest—and filing expense reports that the company determined were intended to conceal the relationship.
In the midst of the investigation, Hurd settled the sexual harassment claim with Fisher for an undisclosed sum and promptly resigned. Early in the investigation, the HP board had seen enough evidence of misconduct by Hurd to see that he was no longer fit to serve as CEO and to terminate him with cause. Despite this knowledge, the HP Board wasted tens of millions of dollars worth of HP assets through their authorization of unwarranted severance benefits to Hurd. Among other things, Hurd received a severance payment of $12.2 million, plus other benefits that include a prorated vesting settlement of 330,177 restricted HP shares. Hurd's severance package also gave the former CEO until September 7, 2010 to exercise options to buy 775,000 common shares. Hurd has notified the Securities and Exchange Commission that he intends to sell all of these shares. Compensation experts question the board’s decision to pay Hurd at all, given that lying on expense reports is a firing offense for employees. Frank Glassner of Veritas told CNBC it's "a huge lapse in thought and judgment by the board."
The Scott+Scott complaint alleges, among other things, that the sitting board of HP is not fit to right the ship at HP, because, among other things, the Audit Committee failed to oversee HP’s compliance with legal and regulatory requirements or to perform adequate risk assessment and risk management function. Specifically, the Audit Committee failed to detect and remediate repeated fraudulent expense account claims made by Hurd over a two-year period. The action, Brockton Contributory Retirement System v. Andreessen, et al., No. 10 Civ. 179356, is being litigated in California Superior Court in Santa Clara County.
On August 18, 2010, Senior Judge Harrington of the United States District Court for the District of Massachusetts issued a Memorandum and Order granting, in part, plaintiffs’ motion
to proceed to what is being called “phase two” discovery in Dahl v. Bain Capital Partners, LLC, et al., No. 07-12388-EFH (the “Private Equity Litigation”). The Court’s Order represents the latest development in what is currently one of the largest, most complex federal antitrust class actions pending in the federal court system.
The Private Equity Litigation concerns allegations that the largest private equity firms in the United States, including, among others, KKR and Blackstone, conspired to suppress prices paid to shareholders for tendering their shares in multi-billion dollar leveraged buyouts (“LBOs”) of publicly-traded companies between 2003 and 2006. In their Third Amended Complaint, plaintiffs specifically identified the AMC Theatres, Aramark, Freescale Semiconductors, HCA, Kinder Morgan, Michaels Stores, Neiman Marcus, PanAmSat, and SunGard Data Systems LBOs as having been affected by defendants’ conspiracy.
The defendants moved to dismiss plaintiffs’ claims in mid-2008. On December 15, 2008, the Court denied defendants’ motions to dismiss, in part, and allowed plaintiffs to conduct discovery limited to the nine LBOs specifically identified in their Third Amended Complaint. From January 2009 until April 2010, plaintiffs conducted discovery into the nine LBOs, including reviewing numerous documents and conducting over 30 depositions.
Pursuant to the Court’s December 15, 2008 Order, on April 28, 2010, Plaintiffs moved the Court for permission to conduct discovery outside of the nine LBOs specifically identified in their Third Amended Complaint, arguing phase one discovery had revealed “sufficient evidence of collusion” on the part of defendants to warrant additional discovery beyond the original nine LBOs. Defendants opposed the motion in July, and plaintiffs filed reply papers in the beginning of August.
Without oral argument, which all parties had requested, the Court quickly decided plaintiffs had set forth sufficient evidence to warrant discovery into eight additional target companies identified by plaintiffs in their motion papers. The Court’s August 18 Order allows plaintiffs 30 days to move to amend their complaint to include the eight additional deals. Defendants then have 14 days to answer Plaintiffs’ amended complaint. The parties will then have nine months to conduct phase two discovery relating to the eight additional deals.
The Court’s Order represents a substantial victory for plaintiffs as defendants had sought to bring discovery in the Private Equity Litigation to an end with one defendant even cross-moving for summary judgment. Instead, plaintiffs will have the opportunity to conduct discovery of eight additional target companies.
District Court Judge Jay A. Garcia-Gregory of the U.S. District Court of Puerto Rico denied certain Popular, Inc. director and officer defendants’ motion to dismiss the breach of fiduciary duty claims in a Scott+Scott shareholder derivative action. In allowing the shareholder’s breach of fiduciary claims to proceed, Judge Garcia-Gregory determined that the shareholder complaint successfully demonstrated that making a presuit demand on Popular’s Board of Directors to bring this action on the company’s behalf would have been futile. As a result of this ruling, discovery will now proceed in the case.
The shareholder complaint was filed by Scott+Scott on behalf of Popular and its shareholders and alleged that the director and officer defendants breached their fiduciary duties to the company by allowing Popular to file numerous false and misleading financial statements with the Securities and Exchange Commission in violation of federal securities laws and Generally Accepted Accounting Principles (“GAAP”). Specifically, the complaint alleges that Popular, a publicly owned bank holding company and the largest financial institution based in Puerto Rico with operation in the U.S., inappropriately accounted for nearly $1 billion in deferred tax assets, thereby inflating the company’s earnings by hundreds of millions of dollars and providing the appearance that Popular was “well-capitalized.” Once Popular revealed the truth about the accounting for the deferred tax assets and its overall financial conditions, Popular lost hundreds of millions of dollars in shareholder equity, delisted two classes of preferred stock, sold off numerous assets, slashed its dividend 75% and was forced to seek $950 million from the U.S. Department of the Treasury’s Capital Purchase Program under the Troubled Assets Relief Program.
Defendants’ primary argument, in seeking to dismiss the shareholder complaint, was based on their claim that plaintiffs failed to make a pre-suit demand on the Board. Plaintiff is not required to demand action from the Board when there is a reason to doubt that the majority of the Board (at least 50% of the Board) could have properly exercised its independent and disinterested business judgment in responding to a demand. Plaintiff’s allegations, however, set forth reasonable doubt that a majority of Popular’s nine-person Board was capable of impartially considering a demand to initiate a suit. Indeed, plaintiff alleged that the majority of the Board was interested and thus not independent because each member faces a substantial likelihood of personal liability for abdicating their oversight duties to the company and causing Popular to violate securities laws and GAAP.
In his August 11, 2010, Judge Garcia-Gregory agreed with the shareholder plaintiff and found that the pre-suit demand was excused. Judge Garcia-Gregory recognized that a Board member “cannot act loyally as a corporate director by causing the corporation to violate the positive laws it is obliged to obey.” This duty of “legal fidelity” is built in as a “subsidiary element of the fundamental duty of loyalty.” Based on the plaintiff’s specific allegations, Judge Garcia-Gregory concluded that there was a “reason to doubt” the legality Popular’s accounting of its deferred tax assets. This apparent breach of loyalty, according to the court, rebutted the presumption that the Board took a valid business judgment and showed that the Board faced a substantial likelihood of liability, thereby making the majority of the Board interested and excusing the pre-suit demand requirement. Judge Garcia-Gregory also stated that the shareholder complaint “certainly contains sufficient particularity to survive a Motion to Dismiss against this heightened standard.”
On August 20, 2010, Magistrate Judge Kevin F. McDonald for the U.S. District Court for the District of South Carolina (the “District Court”) agreed with arguments set forth by Scott+Scott on behalf of plaintiffs and the investor class and denied defendants’ motion to enforce the Private Securities Litigation Reform Act of 1995 (“PSLRA”) stay of discovery. Judge McDonald’s ruling allows discovery to proceed in the securities class action against Signalife and five of its executives.
Defendants’ motion relied on the PSLRA’s automatic stay provision, which requires that discovery in securities class actions be stayed (or put on hold) until the court has decided any pending motions to dismiss the action. Once the court decides a motion to dismiss in a plaintiff’s favor, discovery may proceed. The PSLRA stay provision is straight forward when a case involves only one defendant or only one motion to dismiss, but the provision does not expressly address when a case involves multiple defendants bringing multiple motions to dismiss, which occurred in the case against Signalife and the executive defendants.
In this case, Signalife and five of the executive defendants filed separate motions to dismiss at the same time. On September 4, 2009, the District Court issued an order denying their motions to dismiss. Typically, this would lift the PSLRA stay and discovery would proceed; however, the District Court also ordered the entire case stayed until after the United States Supreme Court ruled on a case whose outcome could cause the District Court to reconsider its decision to dismiss certain aspects of the plaintiffs’ case. While the case was stayed, a sixth executive defendant filed his motion to dismiss, which is still pending before the District Court. As this latest motion to dismiss was pending, the Supreme Court issued its ruling, thereby lifting the stay in the Signalife case. After the Supreme Court’s ruling, plaintiffs filed a motion to reconsider, asking the District Court to reevaluate its previous decision in light of the Supreme Court’s ruling. Plaintiffs also requested that discovery proceed against Signalife and the five executive defendants whose motions to dismiss were already denied.
Even though the previous motions to dismiss were already denied, defendants’ filed a motion seeking to delay discovery by extending the PSLRA’s stay provision to all defendants pending the outcome of the sixth defendants’ motion to dismiss and plaintiffs’ motion for reconsideration. In denying defendants’ motion to extend the PSLRA stay, Judge McDonald found that the purpose of the PSLRA stay (to prevent frivolous lawsuits) had already been served in the case and that discovery as to Signalife and the five other executives would go ahead regardless of the outcome of the sixth executive's motion to dismiss and plaintiff’s motion to reconsider.
Two years after plaintiffs filed their first complaint, discovery may now proceed because of Judge McDonald’s ruling. The case was filed on behalf of investors who purchased Signalife (now known as HeartTronics, Inc.) stock between February 10, 2004 through April 14, 2008. Plaintiffs allege that the top executives at Signalife knowingly participated in a fraudulent scheme to artificially manipulate and inflate Signalife’s stock price by issuing false and misleading statements about the commercial viability of Signalife’s flagship product. The plaintiffs claim that despite four years of positive statements about its product, Signalife had virtually no sales and never had a product that was commercially viable. The truth about Signalife and its product emerged on April 14, 2008 when the market learned that Signalife had not earned any revenues from reported sales. As a result, the price of Signalife’s stock fell significantly and was later delisted
In a decision issued on August 17, 2010, the Superior Court of New Jersey's Appellate Division interpreted the New Jersey Business Corporations Act as permitting shareholders to inspect the meeting minutes of a board of directors and its committees. In this case, Schering-Plough Corporation shareholders were allowed to inspect the minutes of the company’s Board of Directors and Executive Committee. The plaintiffs, represented by Scott+Scott LLP, had previously filed a shareholder derivative complaint in federal court on behalf of Schering against its board and certain executives, alleging that the directors and executives breached their fiduciary duties by allowing the company to significantly delay the results of a high-profile clinical trial called ENHANCE. Separately, the shareholders also sent a written demand to Schering to inspect the books, minutes and records that were relevant to their interests in how the company was being managed. The demand was made pursuant to New Jersey statute 14A:5-28, which provides shareholders the right to inspect a corporation’s books and records if the shareholders meet certain requirements.
Schering rejected the shareholders’ request stating that New Jersey statute 14A:5-28 does not allow a shareholder to inspect board minutes. The shareholders then launched a separate lawsuit in state court requesting that Schering be ordered to produce its books and records, specifically the minutes of the Board of Directors and the Executive Committee meetings from April 2006 to the present. The trial court decided to allow the plaintiffs’ application for an examination of the minutes, and directed Schering to produce any nonprivileged portions of the minutes.
In its August 17, 2010 ruling, the appeals court held that while New Jersey law will allow shareholders to inspect minutes of board of directors and executive committee meetings, it will only allow access when the stockholder can show that the inspection of the minutes is related to a proper purpose—in this case a credible claim of mismanagement. The appeals court concluded that shareholder plaintiffs showed a proper purpose for those portions of the minutes
that address the ENHANCE trial.
As discussed in previous newsletters, shareholders are often unaware that they have the right to inspect a corporation’s books and records. Indeed, most states have enacted statutes based on longstanding common law that entitle shareholders to inspect books and records, including a corporation's stock ledger, a list of its stockholders, board of director and committee minutes and the like, for a proper purpose. Even corporate charters, or bylaw provisions, often bestow such an inspection right to shareholders.
Federal courts encourage shareholders to seek books and records of a corporation to support their claims in a derivative action and investigate waste and mismanagement. Shareholders are empowered to this right to protect their investments and ensure that the corporation is not being mismanaged.
3- 5, 2010
Global Asset Allocation Summit
Las Vegas, NV
Opal Financial Group is presenting this conference to address asset allocation strategies relative to Public Pensions, Endowments, Foundations and Taft Hartley Funds.
9- 14, 2010
National Council on Teacher Retirement Annual Convention
The Westin La Cantera Resort
San Antonio, TX
This year marks the 88th year for the NCTR convention. The seminars will cover topics including real estate trends, global investing alternatives and legal issues affecting public plans.
+ October 16-
NPEA- National Pension Education Association
Hyatt Regency Hotel
Lake Tahoe, NV
NPEA has provided education and networking opportunities for its member systems for over 30 years. This seminar will share information on technology, education as well as trends and legislative issues in the pension industry.
18- 20, 2010
Northeast Public Employee Retirement Systems Forum
Seaport World Trade Center
The 6th annual NEPA Conference will bring together public pension funds and investment consultants from all over the northeast region of the United States to provide a forum for sharing experiences.
Government Finance Officers Association Conferences
3- 6, 2010
6- 8, 2010
Baton Rouge, LA
6- 8, 2010
7- 8, 2010
13- 15, 2010
Overland Park, KS
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