Mercury Interactive Corporation v. Klein

• Decision Date: 19 December 2007
• Docket Number: No. H031175.,H031175.
• Citation: 158 Cal.App.4th 60,70 Cal.Rptr.3d 88
• Court: California Court of Appeals Court of Appeals
• Parties: MERCURY INTERACTIVE CORPORATION, Plaintiff and Appellant, v. Kenneth KLEIN et al., Defendants and Appellants; The Recorder, et al., Movants and Respondents.

70 Cal.Rptr.3d 88

158 Cal.App.4th 60

MERCURY INTERACTIVE CORPORATION, Plaintiff and Appellant, v. Kenneth KLEIN et al., Defendants and Appellants; The Recorder, et al., Movants and Respondents.

No. H031175.

Court of Appeal, Sixth District.

December 19, 2007.

Sara Beth Brody, Norman J. Blears, Heller Ehrman, San Francisco, for Plaintiff and Appellant Mercury Interactive Corporation.

Cheryl W. Foung, Jared Kopel, Thomas Martin, Christina Costley, Jacob T. Veltman, Wilson Sonsini Goodrich & Rosati, Palo Alto, for Defendant and Appellant Kenneth Klein.

M. Todd Scott, James N. Kramer, Sylvia E. Cedial, Orrick Herrington & Sutcliffe, San Francisco, for Susan Skaer.

C. Brandon Wisoff, Douglas R. Young, James C. Mann, Farella Braun & Martel, San Francisco, for Sharlene Abrams.

Karl Olson, Levy Ram & Olson, San Francisco, for Movants and Respondents.

DUFFY, J.

Eight years ago, our Supreme Court held that the right of public access to court proceedings under the First Amendment of the United States Constitution applied to civil as well as criminal proceedings. (See NBC Subsidiary (KNBC-TV), Inc. v. Superior Court (1999) 20 Cal.4th 1178, 86 Cal.Rptr.2d 778, 980 P.2d 337 (NBC Subsidiary).) Chief Justice George, writing for a unanimous court, addressed the propriety of excluding the public and press from certain trial proceedings in a civil suit involving prominent entertainment figures and concluded "that, in general, the First Amendment provides a right of access to ordinary civil trials and proceedings...." (Id. at p. 1212, 86 Cal.Rptr.2d 778, 980 P.2d 337.) The court also made the point in a footnote that courts have generally held that there is "a First Amendment right of access to civil litigation documents filed in court as a basis for adjudication ... [¶] ... [but] that the First Amendment does not compel public access to discovery materials that are neither used at trial nor submitted as a basis for adjudication." (Id. at pp. 1208-1209, fn. 25, 86 Cal.Rptr.2d 778, 980 P.2d 337.)

Based upon this footnote in NBC Subsidiary, the Judicial Council in 2001 adopted two rules concerning the sealing of trial court records that are presently rules 2.550 and 2.551 of the California Rules of Court (collectively, the sealed records rules, or rules).¹ Those rules create a presumption of public access to some, but not all, court-filed documents. The sealed records rules "do not apply to discovery motions and records filed or lodged in connection with discovery motions or proceedings. However, the rules do apply to discovery materials that are used at trial or submitted as a basis for adjudication of matters other than discovery motions or proceedings." (Rule 2.550(a)(3).)

The main issue presented by this appeal is whether the rules' presumption of public access applies to discovery documents produced and designated confidential pursuant to a protective order, where the records are later attached to a court-filed pleading that is not used at trial or to adjudicate a material controversy. The resolution of that issue turns, in substantial part, on the meaning of the limiting phrase "as a basis for adjudication" found in footnote 25 of the NBC Subsidiary decision, in the sealed records rules, and in an advisory committee comment to the rules.

This shareholder derivative action was brought on behalf of the corporation, Mercury Interactive Corp. (Mercury), to recover damages to the corporation resulting from the alleged backdating of stock options by several former Mercury executives. (See generally In re Zoran Corp. Derivative Litigation (N.D.Cal.2007) 511 F.Supp.2d 986, 996-997 [discussing history and mechanics of stock options backdating].) Representatives of the media, respondents herein (collectively, the media),² sought an order unsealing an amended and consolidated complaint (Complaint) and 17 exhibits thereto. That pleading had been filed with the court below under seal pursuant to a stipulated protective order agreed to by the parties and entered by the court; the reason for the sealed filing was that the exhibits had been previously produced by Mercury in discovery with a confidentiality designation. The media's motion was opposed by defendants Kenneth Klein, Susan Skaer, Sharlene Abrams (hereafter, collectively, defendants), by defendant Douglas Smith, and by Mercury. The court granted the motion. The action, however, was dismissed shortly after the records were ordered unsealed, based upon the court's conclusion that the plaintiffs lacked standing to bring a derivative suit.

Defendants and Mercury appeal from the order unsealing the records.³ We conclude that the trial court erred when it found that there was a presumption of public access to the exhibits to the Complaint under NBC Subsidiary, supra, 20 Cal.4th 1178, 86 Cal.Rptr.2d 778, 980 P.2d 337 and under the sealed records rules. The court therefore incorrectly imposed upon the parties who sought to keep the records sealed a significant burden of showing that there was an overriding interest in keeping them sealed, and that this overriding interest would have been substantially prejudiced by granting the media's request. Because of the erroneous application of this legal standard, the court erred in unsealing the exhibits to the Complaint.⁴ Accordingly, we will reverse the order and remand the case for further proceedings.

PROCEDURAL BACKGROUND

I. The Pleadings and Motion to Unseal

This action commenced on or about October 14, 2005, with the filing by plaintiff Charles Conrardy of a shareholder derivative complaint on behalf of Mercury. Plaintiff Paul Morillo filed a similar suit on November 5, 2005. The two suits were ordered consolidated in December 2005. (Conrardy and Morillo are hereafter collectively referred to as plaintiffs.) Following Mercury's motion for partial termination of the derivative litigation, the court entered an order dismissing the case as to certain individual defendants, staying the litigation as to another individual defendant, and ordering the filing of a consolidated complaint by plaintiffs. Pursuant to that order, plaintiffs filed their consolidated Complaint on September 22, 2006.

Plaintiffs—both shareholders of Mercury—alleged in the Complaint filed under seal that the action was being prosecuted against defendants at the request of a special litigation committee of Mercury's board of directors.⁵ In the time period from 1996 to 2002, defendants below⁶— former Mercury officers and directors— allegedly "engaged in an unlawful stock option backdating scheme whereby they grossly enriched themselves at the expense of Mercury by granting themselves (and their colleagues) millions of underpriced options to purchase Mercury stock." According to the Complaint, defendants granted themselves backdated stock options that had an aggregate excess value (i.e., increased value by backdating the option grant date, as compared with the actual option grant date) of over $54,000,000. In addition to defendants receiving this "immediate paper gain," plaintiffs alleged that defendants received an aggregate of nearly $88,000,000 in proceeds from their stock sales that were improper because they were made at a time they possessed material inside information concerning their own backdating scheme and the consequent overstatement of Mercury's net income.

Plaintiffs alleged that defendants' actions resulted, inter alia, in the overstatement of Mercury's net income by nearly $570,000,000 from 1992 through March 2005, which required the company to file a restatement in July 2006; Mercury's incurring $70,000,000 in attorney fees for the investigation of the backdating; the company's being delisted from the NASDAQ stock exchange; and Mercury's being investigated by the Securities Exchange Commission (SEC). Defendants' conduct allegedly caused damage to Mercury in excess of $100,000,000. Plaintiffs alleged in the Complaint that Mercury's special litigation committee concluded in June 2006 that defendants had breached their fiduciary duties to the company by backdating stock options, and that the lawsuit should continue against defendants, "thus transforming the derivative nature of this action into a direct action by Mercury...."

On September 29, 2006, the media made a request by letter to the court that the Complaint that had been filed under seal be ordered unsealed. The court issued an order directing the parties to show cause why the Complaint should remain under seal. The parties thereafter entered into a stipulation that resulted in a continuance of the hearing on that request and established a briefing schedule for a formal motion to unseal by the media.

On October 26, 2006, the media filed a formal motion to unseal the Complaint. They argued, inter alia, that civil litigation documents filed with the court are presumptively public, the Complaint concerned a matter of great public interest (alleged stock option backdating), and there was no overriding interest here that overcame the public's right of access to the pleading. Separate oppositions to the media's motion were filed by defendants and Mercury on November 6, 2006.

On December 8, 2006, defendants filed a demurrer to the Complaint, contending that the action was not maintainable because plaintiffs lacked standing. They argued that because of a merger consummated in November 2006 in which all of Mercury's stock—including shares previously owned by plaintiffs—was acquired by Hewlett-Packard Company (HP), plaintiffs did not have standing to bring a shareholder derivative suit. The demurrer was noticed for hearing on January 19, 2007.

On January 3, 2007, defendants and Mercury each filed formal applications to seal (1) the Complaint and its exhibits, and (2) plaintiffs' opposition to the demurrer. That application was prompted by the court's interim order observing that no party had filed an application to seal the Complaint, and that the sealed records rules did not permit the...