Louisiana Municipal Police Employees Retirement System v. Morgan Stanley & Co., Inc., C.A. No. 5682-VCL (Del. Ch. Mar. 4, 2011), read opinion here. This is a decision by the Delaware Court of Chancery which granted in part and denied in part a motion to dismiss a complaint pursuant to DGCL Section 220 in which a shareholder sought books and records regarding the investigation of a board’s special committee and its counsel.
The stated purpose for seeking the inspection of books and records pursuant to Section 220 was to “investigate whether the board of directors of Morgan Stanley & Co. (the “Board”) wrongfully refused an earlier demand by the shareholder that Morgan Stanley must initiate litigation against certain officers and directors for alleged wrongs arising out of the involvement by the company with auction rate securities. The Court granted the motion to dismiss only to the extent that some books and records were not reasonably required to investigate whether the litigation demand was wrongfully refused, but the motion was denied to the extent that Morgan Stanley argued that the shareholder lacked a “proper purpose.”
Notably, the plaintiff shareholder in this case ("LAMPERS") had previously filed a stockholder derivative action against Morgan Stanley without first using Section 220 to obtain books and records, but nonetheless asserted in the derivative action that presuit demand was futile. Cf. overview here of King v. VeriFone, a recent Delaware Supreme Court decision reversing an unrelated Court of Chancery decision and allowing Section 220 claims which were filed after a derivative action.
The plaintiff shareholder in this matter, LAMPERS, in a separate derivative action filed in federal court in New York had its complaint provisionally dismissed for failure to comply with Rule 23.1, but the federal court retained jurisdiction and set a schedule to allow for: (i) the plaintiffs to make a litigation demand on the Board; (ii) the Board to respond; (iii) the plaintiffs to seek any further relief necessitated by the response of the Board. The federal court thereafter stayed the derivative case pending a decision by the Delaware Court of Chancery in the instant Section 220 proceeding.
Eight months after the litigation demand, the Board received a report from the law firm of Simpson Thacher and Bartlett LLP (“Simpson Thacher”) whom the Board had retained to investigate the litigation demand. Based on that report, the Board refused to take any action, and described the process followed by Simpson Thacher in rendering a report and recommendation. However, the Board’s explanatory letter did not provide any “substantive insight” into the reasoning behind the decision to refuse to take action in response to the demand. Very soon after the letter refusing to take action, LAMPERS submitted a demand on May 12, 2010 seeking certain books and records pursuant to Section 220.
In addition to the documents sought relating to the investigation and report by Simpson Thacher, LAMPERS also sought a report prepared by the Skadden Arps firm in connection with the separate investigation it did in 2007 and 2008 into Morgan Stanley’s involvement with auction rate securities.
Short Synopsis of Court’s Legal Analysis
The Court recited the well-established truism that "books and records actions" pursuant to Section 220 are summary proceedings that “are to be promptly tried.” The Court in this instance entertained the motion to dismiss because it appeared that the underlying facts were largely undisputed, although dispositive motion practice may otherwise be inefficient in a summary proceeding which often can be tried within approximately two months of filing.
The Court observed that Section 220(b) requires a proper purpose when a shareholder seeks books and records. A proper purpose has been defined in this context as “a purpose reasonably related to such person’s interest as a stockholder.”
Referring to prior decisions of both the Delaware Supreme Court and the Delaware Court of Chancery, the opinion explained that the stockholder plaintiff does not, by making a pre-suit demand, waive the right to claim that demand has been wrongfully refused (citing Grimes v. Donald (Grimes I), 673 A.2d 1207 (Del. 1996)). In addition, in a later iteration of the dispute between the same parties, the Court of Chancery decided that a request for books and records which are needed to determine whether a special committee complied with Delaware law in their analysis and rejection of a pre-suit demand–was a proper purpose (citing Grimes v. DSC Commc’ns Corp. (Grimes II), 724 A.2d 561, 566 (Del. Ch. 1998)).
The Court also relied on Delaware Supreme Court precedent for the position that a pre-suit demand does not concede the independence or the disinterestedness of the board for purposes of demand refusal analysis (as opposed to demand futility) (citing Grimes I at 1219).
A long list of exemplary “proper purposes” under Section 220 was quoted from a leading treatise on Delaware corporate law. Those recognized proper purposes include the following:
(1) Seeking to investigate allegedly improper transactions or mismanagement; (2) To clarify an unexplained discrepancy in the corporation’s financial statements; (3) To investigate the possibility of an improper transfer of assets out of the corporation; (4) To ascertain the value of stocks; (5) To aid litigation and to contact other stockholders regarding litigation and to invite their association with the case; (6) To inform fellow shareholders of one’s view concerning the wisdom or fairness, from the point of view of the shareholders, or a proposed recapitalization and to encourage shareholders to seek appraisal; (7) To discuss corporate finances and inadequacies of management, and then depending on the response, to determine stockholder sentiment for either a change in management or a sale; (8) To inquire into the independence, good faith and due care of a special committee formed to consider a demand to institute derivative litigation; (9) To communicate with other stockholders regarding a tender offer; (10) To communicate with other stockholders in order to effectuate changes in management policies; (11) To investigate stockholders’ possible entitlement to oversubscription privileges; (12) To determine an individual’s suitability to serve as a director; (13) To obtain names and addressed of stockholders for contemplated proxy solicitation; (14) To obtain particularized facts needed to adequately allege demand futility after the corporation has admitted engaging in backdating stock options. See slip op. at 10-11.
The Court also referred to the recent Delaware Supreme Court decision in City of Westland Police and Fire Retirement Systems v. Axclis Techs., Inc., 1 A.3d 281, 288 (Del. 2010), for the position of Delaware law that books and records may be demanded under Section 220 for the purpose of “evaluating the suitability of directors to serve.” It was further explained that whether or not the Board acted wrongfully in denying and refusing to pursue the claim was not currently at issue. Rather the issue was whether LAMPERS’ purpose for inspection is proper and the Court found that it was.
Scope of Inspection
The scope of inspection in a Section 220 case is limited to “those books and records that are necessary to accomplish the stated purpose.” The core inquiry is whether the requested documents are “reasonably required to satisfy the purpose of the demand” (citations omitted).
In this case, the Court reasoned that LAMPERS stated a valid claim to obtain the information, including the following: (1) The minutes of any meeting of the Board or the Audit Committee where the litigation demand was discussed or evaluated; (2) Simpson Thacher’s written report and presentation to the Audit Committee in connection with the firm’s recommendation to refuse the litigation demand; (3) The Audit Committee’s report and presentation to the Board; and (4) Any documents and other records upon which the Board relied. Moreover, the Court found that LAMPERS stated a claim to obtain the engagement letter of Simpson Thacher so that they could evaluate the scope of the firm’s engagement and its economic incentives. In addition, the Court concluded that LAMPERS had a right to obtain the report prepared by the Skadden Arps firm and those parts of the investigation by Skadden Arps that were considered by Simpson Thacher.
Lastly, the Court granted leave for LAMPERS to pursue a future Section 220 demand in which it was permitted to make arguments based on the materials it obtained through the instant action. Those subsequent demands would need to be considered “in due course.”
In conclusion, the Court determined that if the parties could not resolve the dispute based on this ruling, they were ordered to “negotiate a schedule that will bring this summary proceeding to a final hearing within 60 days.”