King v. Verifone Holdings Inc

• Citation: 994 A.2d 354
• Decision Date: 12 May 2010
• Docket Number: C.A. No. 5047-VCS.
• Parties: Charles R. KING, Plaintiff,v.VERIFONE HOLDINGS, INC., a Delaware Corporation, Defendant.
• Court: Court of Chancery of Delaware

994 A.2d 354

Charles R. KING, Plaintiff,v.VERIFONE HOLDINGS, INC., a Delaware Corporation, Defendant.

C.A. No. 5047-VCS.

Court of Chancery of Delaware.

Submitted: April 25, 2010.

Decided: May 12, 2010.

David A. Jenkins, Esquire, Michele C. Gott, Esquire, Smith, Katzenstein & Furlow LLP, Wilmington, DE; Judith S. Scolnick, Esquire, Tom Laughlin, Esquire, Scott + Scott LLP, New York City, for Plaintiff Charles R. King.

Raymond J. DiCamillo, Esquire, Kevin M. Gallagher, Esquire, Richards, Layton & Finger, P.A., Wilmington, DE; Robert A. Sacks, Esquire, Sullivan & Cromwell LLP, Los Angeles, CA, for Defendant VeriFone Holdings, Inc.

OPINION

STRINE, Vice Chancellor.

I. Introduction

A plaintiff owning a small number of shares in a corporation rushed off to a federal court to file a derivative suit shortly after the corporation announced that it had to restate its financial statements. The complaint was for money damages, most principally those damages the corporation might suffer if it faced liability in securities suits. There was no basis for exigency and no expedited treatment was sought.

But haste was the order of the day because the plaintiff's lawyers wanted to win the filing Olympics. And they did. The court handling the derivative suit rewarded the plaintiff and his counsel with lead plaintiff status.

But in the lawyers' haste, they did not conduct an adequate pre-suit investigation. And when their complaint was confronted with a motion to dismiss for failure to plead demand excusal, it could not survive that motion.

Fortunately for the plaintiff and his lawyers, the federal court did not dismiss the case with prejudice as to him, and freshen the litigation environment so other plaintiffs whose lawyers had conducted a pre-suit investigation might feel that they could now lead the case. Instead, the court left the gold medal-winning, but dismissal motion-losing, plaintiff in its lead sinecure and encouraged him to file yet another lawsuit-this one-in order to do what he should have done first-obtain books and records in order to determine whether he had grounds for a claim and, as important, whether he had grounds to plead demand excusal as to any such claim.

Thus, the federal court suggested the plaintiff do indirectly what the plaintiff could not do in the derivative suit he filed-obtain information in aid of an already pending derivative suit. Under federal case law interpreting Federal Rule of Civil Procedure 23.1, the plaintiff could not obtain discovery.¹ Without considering that fact, the federal court suggested that the plaintiff file a books and records action to get information to prepare a viable complaint. The plaintiff, with his leadership role intact, happily took up the chance to enmesh the corporation in two lawsuits at once and filed this action.

In the face of that action, the corporation has moved to dismiss, arguing that it is improper for a stockholder to rush to court to file a derivative suit, causing the corporation to expend defense costs in responding to that lawsuit, and then seek to remedy the stockholder's own lack of pre-suit investigation by filing yet another lawsuit, a books and records action, to obtain information to help the stockholder remedy deficiencies that its own self-serving rush to court undoubtedly helped create.

In this decision, I conclude that such a stockholder lacks a proper purpose and may not use § 220 of the Delaware General Corporation Law to rescue him from his own self-interested premature rush to file. Once a plaintiff files a derivative suit, he has made his election. Any informational access granted to a derivative plaintiff from the corporation ought to occur in the forum in which the plaintiff has made the choice to sue the defendant, and under the rules of civil procedure governing the derivative claim. The corporation and, most important, its investors should not suffer the costs of duplicative proceedings. Nor should the judicial system.

As important, to permit a stockholder access to books and records in these circumstances would exacerbate incentives that already work to disadvantage investors. For years, our Supreme Court has made clear that derivative plaintiffs should seek books and records and otherwise conduct an adequate investigation into demand excusal before rushing off to file a derivative complaint.² Likewise, our Supreme Court has made clear that diligent plaintiffs who do so should not be penalized, and thus courts should be careful not to reward counsel who rapidly fire off complaints in order to secure first-filed status.³ Representative litigation plays an important role in protecting the interests of stockholders, but it will not optimally serve investors unless suits are actually filed on the basis of a real concern that wrongdoing has occurred and after a proper investigation.

To be consistent with these important public policy interests, stockholders who seek books and records in order to determine whether to bring a derivative suit should do so before filing the derivative suit. Once a plaintiff has chosen to file a derivative suit, it has chosen its course and may not reverse course and burden the corporation (and its other stockholders) with yet another lawsuit to obtain information it cannot get in discovery in the derivative suit.

II. Factual Background ⁴

In November 2006, VeriFone Holdings, Inc., a Delaware corporation that designs and markets secure electronic payment systems, acquired Lipman Electronic Engineering Ltd. Shortly after the acquisition, on December 3, 2007, VeriFone announced that it would restate its financial statements for the first three quarters of fiscal year 2007 due to accounting errors arising from the integration of Lipman's inventory systems with VeriFone's.⁵ These accounting errors had led to an SEC investigation, which culminated in the SEC filing a civil complaint against VeriFone.⁶

As soon as VeriFone announced on December 3, 2007 that it would restate its financial statements, lawyers sped to the court and filed a number of putative class actions and purported derivative actions. The rush to the courthouse is noteworthy.

The underlying securities suits sought relief for investors who purchased VeriFone shares before the restatement at an arguably inflated price and who allegedly suffered damages when VeriFone's stock price dropped after the announcement of the restatement.⁷ Therefore, as is typical in a stock-drop situation, there was no reason beneficial to investors for complaints to be filed hastily and without a period of investigation and reflection. The securities complaints appear to have sought no expedited treatment or injunctive relief, they simply sought monetary damages for the consequences of past events.⁸

Critically, the lack of an investor-beneficial reason for urgent filing was especially absent as to the derivative suit filed by plaintiff Charles R. King (“King”), who owns 3,000 shares of VeriFone common stock. Why? Because the major category of damages sought by King on VeriFone's behalf was to hold certain directors and officers liable to indemnify VeriFone for any damages or costs it would incur in resolving the securities suits addressing the restatement.⁹ Thus, the derivative suit could not rationally proceed ahead of the securities suits.

But of course there was a rational reason for the haste, albeit one that has nothing to do with the best interests of VeriFone, its stockholders, or its prior stockholders who had bought and sold during the relevant time frame. That reason is related to the self-interest of the lawyers jockeying for position as lead counsel. In King's case, his counsel admits that she rapidly filed the complaint on his behalf, and eschewed seeking books and records at that time, in order to have the first derivative complaint on file and therefore to be the winner in the lead counsel Olympics race.¹⁰ To that end, King's complaint was filed on December 14, 2007, a mere eleven days after VeriFone's announcement.

Counsel's sense of the incentive system at work was vindicated. All of the federal securities and derivative suits relating to the VeriFone stock drop were consolidated before a single judge of the United States District Court for the Northern District of California (the “Federal Court”).¹¹ King and his counsel were crowned as lead plaintiff and lead counsel in the derivative action because they won the race to file first.

But winning that race came at an eventual price. Perhaps in large measure because King and his counsel did not undertake any responsible pre-suit investigation, the complaint was soon challenged on demand excusal grounds. This challenge was especially formidable because the central claim that King asserted in the derivative suit is that VeriFone's board of directors failed to comply with their duty of oversight under Caremark¹² in managing the integration process following the merger with Lipman. In other words, King did not allege that the independent board majority at VeriFone had purposely committed accounting fraud, but that they were so indolent in their monitoring of management that they should be held responsible for the accounting problems. ¹³ Because of the stringency of the Caremark standard and the presence of an exculpatory charter provision, King faced a difficult pleading burden. After his initial complaint, King amended his complaint almost eleven months later in October 2008.¹⁴ To aid him in amending that complaint, King did not seek discovery from the defendants in the derivative action.

The reason, his counsel explained at argument, is that such discovery would not have been granted by the Federal Court if the defendants had objected. ¹⁵ As King's counsel admits, there is abundant federal authority implementing Federal Rule of Civil Procedure 23.1 that holds that a derivative plaintiff cannot obtain discovery until it meets its pleading burden to show grounds for demand excusal.¹⁶ King therefore...