Pikk v. Pedersen (In re ZAGG Inc.)
| Decision Date | 20 June 2016 |
| Docket Number | No. 15–4001,15–4001 |
| Parties | In re: ZAGG Inc. Shareholder Derivative Action. Albert Pikk; Daniel L. Rosenberg, derivatively and on behalf of ZAGG Inc., Plaintiffs–Appellants, v. Robert G. Pedersen, II; Edward Ekstrom; Randall Hales; Brandon T. O'Brien; Cheryl A. Larabee, Defendants–Appellees, and ZAGG Inc., Nominal Defendant–Appellee. |
| Court | U.S. Court of Appeals — Tenth Circuit |
Albert Y. Chang, Bottini & Bottini, Inc., La Jolla, California (David W. Scofield, Peters Scofield, PC, Sandy, Utah, Francis A. Bottini, Jr., Yury A. Kolesnikov, Bottini & Bottini, Inc., with him on the briefs) for Plaintiffs–Appellants.
Steven M. Schatz, Wilson Sonsini Goodrich & Rosati PC, Palo Alto, California (David J. Berger, Naira Der Kiureghian, and Anne J. Veldhuis, Wilson Sonsini Goodrich & Rosati PC, Palo Alto, California, Gideon A. Schor, Wilson Sonsini Goodrich & Rosati PC, New York, New York, Kevin N. Anderson and Artemis D. Vamianakis, Fabian & Clendenin, Salt Lake City, Utah, Brent R. Baker, D. Loren Washburn, Jennifer A. James, Aaron D. Lebenta, and Shannon K. Zollinger, Clyde Snow
& Sessions, P.C., with him on the briefs) for Defendants–Appellees.
Before HARTZ, BACHARACH, and PHILLIPS, Circuit Judges.
HARTZ
, Circuit Judge.
Plaintiffs, shareholders of ZAGG Inc., a publicly held Nevada corporation, filed a shareholder-derivative action seeking damages, restitution, and other relief for ZAGG. They alleged that past and present officers and directors of ZAGG violated § 14(a) of the Securities Exchange Act of 1934, breached their fiduciary duties to ZAGG, wasted corporate assets, and were unjustly enriched. The district court dismissed the suit on two alternative grounds: (1) Plaintiffs filed suit before presenting the ZAGG Board of Directors (the Board) with a demand to bring suit and they failed to adequately allege that such demand would have been futile, and (2) the complaint failed to state a claim. Plaintiffs appeal the dismissal on both grounds. Because we deny the challenge to the first ground, we need not address the second.
Plaintiffs urge two reasons why demand would have been futile. First, they allege that three of the six board members (Randall Hales, Cheryl A. Larabee, and Edward D. Ekstrom (the Director Defendants)) had a disqualifying interest in the prospective suit because each was threatened with a substantial likelihood of liability. Second, they allege that each of the Director Defendants was compromised by personal and business relationships among themselves and with Robert Pedersen, former ZAGG Chief Executive Officer (CEO) and a codefendant. We reject these arguments. The Director Defendants were not at substantial risk of liability under any of Plaintiffs' claims because the complaint does not adequately allege that any of them knew that he or she was acting wrongfully, as required by a Nevada statute limiting director liability. And at least a majority of the Board was not compromised by personal or business relationships because Plaintiffs do not challenge three of the six directors and they have failed to adequately allege that Director Defendant Larabee had a compromising relationship.
Pedersen, the founder of ZAGG, served as chairman of the Board and CEO until he resigned in August 2012. The reason for the resignation, and the underlying source of the defendants' alleged liability, is the harm to ZAGG from his forced sales of over two million ZAGG shares that secured his margin account with a broker. A margin account is “an extension of credit by a broker that is secured by securities of the customer.” In re Zagg, Inc. Sec. Litig. , 797 F.3d 1194, 1198 (10th Cir. 2015)
(internal quotation marks omitted). To protect the broker, the value of the pledged shares must exceed a threshold set by the broker. If the stock value drops below the threshold, the broker has the right to sell shares to cover the customer's debt. See id. Such sales can cause the supply of shares to far exceed market demand, leading to a sharp drop in share price and the company's market value. Also, the Securities and Exchange Commission (SEC) has recognized that officers and directors who pledge company stock in margin accounts may be subject to improper influences. See SEC Final Rule, Executive Compensation and Related Person Disclosure, 71 Fed. Reg. 53,158, 53,197 (Sept. 8, 2006) ( ). Although these risks from pledging shares have not lead to a prohibition on pledges by corporate officers and directors, the SEC decided in 2006 that the public should be informed when they occur. It amended Item 403(b) of SEC Regulation S–K, 17 C.F.R. § 229.403(b)
, to require that pledges be publicly disclosed in certain company filings, such as proxy statements and Forms 10–K.1
In re Zagg , 797 F.3d at 1198.
On December 21, 2011 (nine days after Defendant Hales, who was already a member of the Board, had been named as ZAGG's president and chief operating officer (COO)) a margin call on Pedersen's account forced the sale of 345,200 shares. Pedersen reported the sale to the SEC. By December 24, ZAGG's share price had dropped from $8.65 to $6.73. After that sale more than 1.7 million of Pedersen's shares still remained pledged.
On March 15, 2012, ZAGG filed a Form 10–K for fiscal year 2011, and on April 27 it filed a proxy statement soliciting votes for re-election of five board members. Neither the 10–K nor the proxy statement disclosed any pledged shares of Pedersen, as required by § 229.403(b)
.
On August 14, 2012, a second margin call on Pedersen's account forced the sale of an additional 515,000 shares. This caused Pedersen to resign as Chairman and CEO, as announced in a press release issued August 17. The press release also announced that Larabee was the new Board Chair, that ZAGG would conduct a search for a new permanent CEO, and that Hales would serve as interim CEO. ZAGG stock fell 13% the next trading day. On an August 28 conference call with analysts, Hales stated that Pedersen's departure “was entirely related to the margin call situation that started last December and unfortunately surfaced again two weeks ago.” Complaint, Aplt. App. at 42 ¶ 86 (internal quotation marks omitted). On that same call Pedersen—who had satisfied all his margin obligations after a third margin call on August 24—assured investors that “[b]y completely deleveraging my ZAGG stock, I have removed the element of uncertainty around future unwanted sales and have taken a step towards building investor confidence in ZAGG.” Dist. Ct. Mem. Decision and Order, Feb. 5, 2014 at 5, (Order), Aplt. App., Vol. 1 at 239. ZAGG also implemented a new policy prohibiting officers and directors from pledging ZAGG shares in margin accounts. A month later, ZAGG signed Pedersen to a one-year, $910,000 consulting agreement. On December 10, 2012, nearly four months after Pedersen resigned, ZAGG appointed Hales as permanent CEO.
Plaintiffs filed the shareholder-derivative complaint at issue in this appeal on June 5, 2013. The complaint alleged that the defendants had failed to disclose Pedersen's “margin call situation” to the public and had executed a “secret succession plan” to replace Pedersen with Hales, Aplt. App., Vol. 1 at 22 ¶ 14, thereby violating § 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a)
, and breaching their fiduciary duties as directors and officers. Plaintiffs also asserted claims of unjust enrichment and corporate waste based on Pedersen's consulting agreement and the Director Defendants' continued receipt of director compensation even after their alleged transgressions.2 Plaintiffs did not make a presuit demand on the Board to bring this action, alleging that demand should be excused as futile.
Plaintiffs argue that our review of the futility issue is de novo. But, citing deHaas v. Empire Petroleum Co. , 435 F.2d 1223, 1228 (10th Cir. 1970)
, the defendants argue that we review the district court's ruling only for abuse of discretion. We need not resolve the dispute because we can affirm the district court's dismissal upon de novo review.
Plaintiffs' claims arise under federal statutory law (§ 14(a) of the Exchange Act) and the common law (of some jurisdiction, not specified in the complaint). It is not obvious, however, what law should govern the standards for determining whether Plaintiffs were required to demand that ZAGG's directors bring suit before Plaintiffs filed suit themselves. The Federal Rules of Civil Procedure require all shareholder-derivative complaints filed in federal court to “state with particularity: (A) any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members; and (B) the reasons for not obtaining the action or not making the effort.” Fed. R. Civ. P. 23.1(b)(3)
. But the federal procedural rules cannot establish substantive law. As the Supreme Court wrote in a shareholder-derivative suit bringing claims under § 20(a) of the Investment Company Act of 1940, 15 U.S.C. § 80a–20(a) (ICA) :
[A]lthough Rule 23.1
clearly contemplates both the demand requirement and the possibility that demand may be excused, it does not create a demand requirement of any particular dimension. On its face, Rule 23.1 speaks only to the adequacy of the shareholder representative's pleadings. Indeed, as a rule of procedure issued pursuant to the Rules Enabling Act, Rule 23.1 cannot be understood to “abridge, enlarge or modify any substantive right.” 28 U.S.C. § 2072(b).... [T]he function of the demand doctrine in delimiting...
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