Michael Clyde Partner

In 2006 a record number of unhappy shareholders fought in Delaware courts to enforce their demands to inspect corporations' books and records. What caused this dramatic increase? Delaware courts frequently chastised shareholders for failing to use this powerful fact-gathering tool before bringing derivative suits. Many states, including Washington and Delaware, also recently expanded shareholders' statutory inspection rights.

In this Update we highlight two recent Delaware cases, Polygon and Shamrock, that identify important defenses available to corporations responding to inspection demands, and provide practical advice.

The Department of Justice recently announced that it will revise some controversial policies outlined in a document known as the Thompson Memorandum. The new policies will place procedural limits on attempts by the Department of Justice to require companies under investigation to waive the attorney-client privilege. The policies will also bar federal prosecutors from considering as a factor in charging decisions whether a company is advancing attorneys' fees to employees or other corporate agents. These widely anticipated changes respond to strong criticism of the Thompson Memorandum from many sources and are designed to preempt legislation introduced by Arlen Specter, the outgoing chair of the Senate Judiciary Committee.

In a decision generally protective of directors and officers, a Seattle federal district court recently held that shareholders who seek to bring derivative claims under Washington law must meet requirements similar to those imposed under Delaware law. In re Cray, Inc., 431 F. Supp. 2d 1114 (W.D. Wash. 2006).

In a significant decision favorable to defendants in securities fraud lawsuits, Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 126 S. Ct. 1503 (2006), the United States Supreme Court has unanimously decided to close a loophole that plaintiffs' lawyers have used to bring securities fraud lawsuits in state court. This loophole existed as a result of how some appellate courts had interpreted the language of the Securities Litigation Uniform Standards Act of 1998 (SLUSA).

In recent years the SEC has dramatically increased the size of civil penalties it seeks from companies accused of violating the federal securities laws. Critics questioned the SEC's lack of standards for determining such penalties and argued that the SEC's approach simply heaped additional punishment on the very same shareholders who were victimized by the company's violations.

In the first case to directly address the question, a federal district court has held that private parties have no right to enforce Section 304 of the Sarbanes-Oxley Act of 2002. Neer v. Pelino, No. 04-CV-04791-SD (E.D. Pa. Sept. 27, 2005). Instead, the court held that only the SEC can enforce Section 304.

A judge in the U.S. District Court for the Southern District of New York recently dismissed the SEC's first Regulation FD enforcement action to be tested in federal courts. In dismissing the action against Siebel Systems and two of its officers, the Court took the SEC to task for its overly aggressive enforcement of Regulation FD.

In early August 2005, the Delaware Court of Chancery issued its opinion after a widely publicized three-month trial in In re The Walt Disney Company Derivative Litigation, absolving Disney's directors of liability in connection with the 1995-1996 hiring and firing of former Disney president Michael Ovitz. Ovitz received a severance package of approximately $140 million after his unsuccessful 14-month tenure at Disney.

The pattern is familiar. A public company makes some positive announcements about a product. After some time passes, the company announces bad news about the product, leading to a decline in the stock price.