Copyright 2008 ALM
Ryan v. Gifford (the "action"), is a derivative action pending in the Delaware Court of Chancery arising from admitted stock option backdating that occurred at Maxim Integrated Products Inc.
In resolving what would appear to be an ordinary discovery dispute in Ryan, the court issued an opinion compelling production of all communications between a special committee and its counsel, arguably rendering a decision with wide-ranging implications. See Ryan v. Gifford, C.A. No. 2213-CC, 2007 WL 4259557 (Del. Ch., Nov. 30, 2007).
Background of the Action
After a March 18, 2006, Wall Street Journal article sparked controversy throughout the investment community by revealing that the practice of backdating was relatively common, Merrill Lynch issued a report demonstrating that officers of numerous companies, including Maxim, had benefited from so many seemingly well-timed stock option grants that backdating was highly likely to have occurred in connection with the grants.
Plaintiff Walter E. Ryan, in part based on the Merrill Lynch report, filed the action on June 2, 2006, alleging that the defendants, certain officers and directors of Maxim, breached their duties of due care and loyalty by approving or accepting backdated options that violated the clear letter of a shareholder-approved stock option plan and stock incentive plan, and unjustly enriched themselves.
Ryan specifically claims that nine specific grants between 1998 and 2002 were backdated because they seem too fortuitously timed to be coincidence and that the backdating has caused Maxim to, among other things, suffer adverse tax and accounting effects and overstate its profits while at the same time unjustly enriching certain recipients of the grants. Cross motions for summary judgment were pending in the action.
After reports of stock option backdating scandals at Maxim and other companies were made public, Maxim formed a special committee, comprised of a single disinterested director, empowered to investigate (but not bring claims in connection with the results of any investigation of) the company's stock option grants and practices. The committee engaged counsel and accounting advisers, who conducted extensive interviews and analyzed significant volumes of electronic and paper material. On Jan. 18 and 19, 2007, at meetings attended by the entire Maxim board and some of the individual directors' personal counsel, the committee and its counsel orally presented its final report to Maxim's full board of directors.
Following this presentation, the board met on several occasions to deliberate and discuss actions in response to the committee's findings and conclusions.
On Feb. 1, 2007, Maxim publicly announced the results of the committee's investigation, noting that there were "deficiencies related to the process for granting stock options to employees and directors" and that, in some instances, the recorded price of those options granted differed from the fair market value on the actual measurement date.
In a non-public report to NASDAQ, the company further reported that the committee found that two employees, John F. Gifford, Maxim's former CEO, and Carl Jasper, Maxim's former CFO, had knowledge of and participated in the selection of grant dates for the disputed options. As a result of the committee's investigation, Maxim terminated Gifford and Jasper's employment, and the company made certain governance changes. Maxim's board, which itself was conflicted, did not take any action to recover the damages Maxim sustained as a result of the backdating scheme.
In addition to providing the results of the committee's work and certain details underlying its findings to the board, Maxim also provided this information to third-parties, including NASDAQ, the SEC, its auditors and the U.S. Attorney's Office. Furthermore, the defendants in the action made use of the committee's findings and conclusions for their own personal benefit, arguing that the committee's exoneration of them should be accorded deference in a number of briefs submitted to the court.
Asserting that the foregoing resulted in a waiver of privilege, the plaintiffs in the action sought discovery of all communication between the committee and its counsel, including counsel's report to the committee, the final report to the full board and counsel's interview notes. The company refused on grounds of privilege and plaintiffs moved to compel.
The Court's Decision
Chancellor William Chandler largely granted plaintiffs' motion, ordering production of all of the requested information except for the interview notes, which the court ordered submitted for an in camera inspection, due to the possibility they contained attorney-work product. Id. at *4. The court grounded its decision on two independent rationales. First, it held that no privilege applied to prevent discovery under Garner v. Wolfinbarger, 430 F.2d 1093, 1103-4 (5th Cir.1970), because plaintiffs pleaded a colorable claim, made specific requests and the information was unavailable from other sources. Thus, plaintiffs had shown good cause for the discovery. Ryan, 2007 WL 4259557 at *3.
Second, the court further held that, even if the privilege did apply, the committee had waived it because:
(i) the committee was not a "special litigation committee" under the framework of Zapata v. Maldonado,480 A.2d 779 (Del. 1981), because it had not been delegated the power to assert claims on behalf of the company and, therefore, it did not possess a privilege independent of the company;
(ii) it reported its findings to the full board, including directors who had been the target of the investigation and did not have a common interest with the committee;
(iii) the target directors had their personal counsel present at the board meetings where the committee's findings were presented and as a result they were present in their individual, and not fiduciary, capacities; and
(iv) the director defendants and the company relied extensively on the committee's findings as exculpatory evidence in the action and thus attempted to use privileged information as both a sword and a shield.
Denial of Maxim's Appeal
While the court's decision arguably creates a novel doctrine that must be considered any time a committee is investigating potential misconduct by directors or officers, the court in its Jan. 2, 2008, decision denying Maxim's motion for an interlocutory appeal of the Nov. 30 decision suggests that this is not the case. Ryan v. Gifford, C.A. No. 2213-CC, 2008 WL 43699 (Del. Ch., Jan. 2, 2008). In this opinion, the court explained that its decision ordering the discovery did not decide an issue of first impression under Delaware law. Rather, as the court explained, its opinion was grounded on a "bedrock principle of waiver" contained in numerous cases and codified in the Delaware Rules of Evidence. See D.R.E. 510.
The court also explained that its Nov. 30 decision would not, as Maxim argued, "affect Delaware corporate customs and longstanding principles of good corporate governance," stating that "[n]ot only are such dire consequences exaggerated, but fears thereof are also misplaced." Id. at *5.
Rather, the court made clear that "[t]he decision was the result only of the application of well-settled precedent to a set of particular and specific facts" and it "would not apply to a situation ... in which board members are found to be acting in their fiduciary capacity, where their personal lawyers are not present, and where the board members do not use the privileged information to exculpate themselves." Id.
Nor would the decision "affect the privileges of a Special Litigation Committee formed under Zapata or any other kind of committee that ... has the power to take actions without approval of other board members." Id.
Lessons Learned
The court's decision, especially when viewed in light of the limitations expressed in its subsequent denial of Maxim's motion for an interlocutory appeal, provides some practical lessons for future committees and their counsel:
- "A committee formed to investigate potential
wrongdoing should be delegated power to institute litigation
or take actions without the approval of other board
members.
- An investigative committee needs to be careful when
communicating findings with the board of directors, and focus
on communicating findings only to those individuals who
genuinely need to know the information and are not implicated
in the investigation.
- Counsel for a committee should proactively assess whether
the common interest doctrine will apply to each member of the
board prior to sharing privileged information with the
board.
- Named or targeted individuals, and their counsel, should
be excluded from presentation of any investigative
committee's report and findings.
- " To the extent such individuals are allowed access
to that information, it should be provided to them merely in
their role as corporate fiduciaries (and access to it by
their personal counsel should be restricted or narrowly
constrained).
- To the extent privileged company information is shared
with defendants or targets, those individuals should sign
confidentiality agreements committing not to use the
information provided to them for any reason other than in
connection with their role as corporate fiduciaries.
- Counsel should document the limitations and conditions
placed on the sharing of any privileged company information
with defendants or targets, and the fact that such sharing of
information is not intended to be a waiver of privilege in
board minutes and/or resolutions, where appropriate.
- Because there is always a risk of waiver even if
protective measures are taken, counsel conducting an
investigation should defensively plan the process and any
documents created in the course of the investigation with an
eye toward disclosure so that if the privilege is lost, the
record revealed is both clean and consistent.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.