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Sandys v. Pincus

Supreme Court of Delaware

October 13, 2016, Submitted; December 5, 2016, Decided

No. 157, 2016

Opinion

 [*126]  STRINE, Chief Justice, for the Majority:

This appeal in a derivative suit brought by a stockholder of Zynga, Inc. turns on whether the Court of Chancery correctly found that a majority of the Zynga board could impartially consider a demand and thus correctly dismissed the complaint for failure to plead demand excusal under Court of Chancery Rule 23.1. This case again highlights the wisdom of the representative plaintiff bar heeding the repeated admonitions of this Court and the Court of Chancery to make a diligent pre-suit investigation into the board's independence so that a complaint can be filed satisfying the burden to plead particularized facts supporting demand excusal. Here, the derivative plaintiff's lack of diligence compounded the already difficult task that the Court of Chancery faces when making close calls about pleading stage independence. Fortunately for the derivative plaintiff, however, he was able to plead particularized facts regarding three directors that create a reasonable doubt that these directors can impartially consider a demand. First, the plaintiff pled a [**3]  powerful and unusual fact about one director's relationship to Zynga's former CEO and controlling stockholder which creates a reasonable doubt that she can impartially consider a demand adverse to his interests. That fact is that the controlling stockholder and the director and her husband co-own an unusual asset, an airplane, which is suggestive of an extremely intimate personal friendship between their families. Second, the plaintiff pled that two other directors are partners at a prominent venture capital firm and that they and their firm not only control 9.2% of Zynga's equity as a result of being early-stage investors, but have other interlocking relationships with the controller and another selling stockholder outside of Zynga. Although it is true that entrepreneurs like the controller need access to venture capital, it is also true that venture capitalists compete to fund the best entrepreneurs and that these relationships can generate ongoing economic opportunities. There is nothing wrong with that, as that is how commerce often proceeds, but these relationships can give rise to human motivations compromising the participants' ability to act impartially toward each other on [**4]  a matter of material importance. Perhaps for that reason, the Zynga board itself determined that these two directors did not qualify as independent under the NASDAQ rules, which have a bottom line standard that a director is not independent if she has "a relationship which, in the opinion of the Company's board of directors, would interfere with the exercise of independent judgment . . . ."1 Although the plaintiff's lack of diligence made the determination as to these directors perhaps closer than necessary, in our view, the combination of these facts creates a pleading stage reasonable doubt as to the ability of these directors to act independently on a demand adverse to the controller's interests. When these three directors are considered incapable of impartially considering a demand, a majority of the nine member Zynga board is compromised for Rule 23.1 purposes and demand is excused. Thus, the dismissal of the complaint is reversed.

The plaintiff alleges two derivative claims, each centering on allegations that certain top managers and directors at Zynga—including its former CEO, Chairman,  [*127]  and controlling stockholder Mark Pincus—were given an exemption to the company's standing rule preventing [**5]  sales by insiders until three days after an earnings announcement. According to the plaintiff, top Zynga insiders sold 20.3 million shares of stock for $236.7 million as part of a secondary offering before Zynga's April 26, 2012 earnings announcement, an announcement that the plaintiff contends involved information that placed downward pressure on Zynga's stock price.2 The plaintiff alleges that these insiders sold their shares at $12.00 per share and that, immediately after the earnings announcement, the market price dropped 9.6% to $8.52. Three months later, following the release of additional negative information, which the plaintiff alleges was known by Zynga management and the board when it granted the exemption, Zynga's market price declined to $3.18, a decrease of 73.5% from the $12.00 per share offering price. In this suit, the plaintiff alleges that the insiders who participated in the sale breached their fiduciary duties by misusing confidential information when they sold their shares while in possession of adverse, material non-public information and also asserts a duty of loyalty claim against the directors who approved the sale.

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152 A.3d 124 *; 2016 Del. LEXIS 627 **

THOMAS SANDYS, Derivatively on Behalf of ZYNGA INC., Plaintiff below, Appellant, v. MARK J. PINCUS, REGINALD D. DAVIS, CADIR B. LEE, JOHN SCHAPPERT, DAVID M. WEHNER, MARK VRANESH, WILLIAM GORDON, REID HOFFMAN, JEFFREY KATZENBERG, STANLEY J. MERESMAN, SUNIL PAUL and OWEN VAN NATTA, Defendants below, Appellees, and ZYNGA INC., a Delaware Corporation, Nominal Defendant below, Appellee.

Subsequent History: Case Closed December 21, 2016.

Prior History:  [**1] Court Below: Court of Chancery of the State of Delaware. C.A. No. 9512-CB.

Sandys v. Pincus, 2016 Del. Ch. LEXIS 43 (Del. Ch., Feb. 29, 2016)

Disposition: REVERSED.

CORE TERMS

reasonable doubt, pleading stage, airplane, oral argument, proxy statement, impartially, allegations, derivative, purposes, plane, pled, particularized, friendship, jet, excusal, Secondary, controlling stockholder, factual allegations, interested party, Offering, Verified, futility, parties, venture, business relationship, act independently, books and records, internet search, partner, co-own

Business & Corporate Law, Standing, Demands, Futility, Business & Corporate Compliance, Corporations, Corporate Governance, Directors & Officers