Carrie Cope on Ryan v. Gifford: Delaware Delivers an Unexpected Setback to Backdating Defendants by Allowing Companies' Internal Investigations to Be Discoverable
Until now, the only substantive stock options backdating decisions have addressed motions to dismiss based on demand futility. This left open a key question: how would courts react to discovery disputes in the backdating context?
In this Expert Commentary, insurance specialist attorney Carrie Cope, a partner in the Chicago office of Tressler, Soderstrom, Maloney & Priess, LLP, discusses Ryan v. Gifford, the first decision to tackle these questions. In this landmark decision, the influential Chancellor Chandler of the Delaware Court of Chancery has ruled that a company’s internal investigation is discoverable because the special committee conducting the investigation waived the attorney-client privilege.
The author writes: “Over the last year, the insurance industry has been coping with the fallout of the stock options backdating scandal. As is now well known, it appears that for many years directors and officers of corporations from across the business spectrum engaged in the backdating of executive stock option grants. Essentially, these individuals retrospectively chose grant dates of their stock options, picking dates at which the stock price was lower than the date of the grant. This resulted in an instant paper profit to the recipients of the grant. After the scandal broke, derivative lawsuits were filed against scores of companies’ directors and officers alleging breaches of fiduciary duty, fraud, and related counts. Although backdating is not in itself illegal so long as the backdated grants are properly expensed, the defendants in backdating cases allegedly backdated options for their own benefit without following the proper accounting procedures.”
Cope also explains that “In Ryan v. Gifford, the plaintiffs filed numerous motions to compel after the defendants failed to produce various documents. The most important of these motions, however, concerned a production request by the plaintiffs asking for all communications that occurred between the special committee and the special committee’s attorneys, as well as communications between Maxim and the special committee’s attorneys. Specifically, the plaintiffs sought discovery concerning the communications between the attorneys and the special committee throughout the special committee’s investigation and the attorneys’ presentation of their final report to the special committee and Maxim’s board.”
Cope concludes that “The potential impact of the Chancellor’s decision is difficult to underestimate. The standard procedure for many companies implicated in the stock options backdating scandal has been to create a special committee to investigate the company’s historical options granting process. These special committees retain their own, independent attorneys to assist with the investigation. At the conclusion of the investigation, the special committee reports to the board regarding its findings. While the special committees’ general findings are often made public, the specific evidence they rely upon to reach those findings remains confidential and has not been accessible by derivative plaintiffs. Although much of the underlying evidence would likely be discoverable from other sources, the plaintiffs will now be able to examine how the special committees and their attorneys scrutinized and interpreted the evidence. In addition, there is always the possibility that the special committees may have uncovered evidence that would not have otherwise been revealed during discovery.”