On Securities Litigation

By Marie Bafus, Fenwick & West LLP

Marie Bafus
Marie Bafus

Documents obtained pursuant to Delaware’s shareholder inspection statute have become increasingly important in the early stages of fiduciary duty litigation. Section 220 of the Delaware General Corporation Law (“Section 220”) allows shareholders of Delaware corporations to inspect corporate books and records for any proper purpose, including to investigate potential breaches of fiduciary duty by a company’s officers and directors. Because Delaware courts have admonished shareholders to use the “tools at hand” – i.e., documents obtained pursuant to Section 220 – to draft well-plead complaints, shareholders often seek to inspect corporate books and records as a precursor to filing breach of fiduciary duty claims. Recognizing that shareholders might take such documents out of context, Delaware allows companies to require that documents produced pursuant to Section 220 be incorporated by reference in any complaint filed by the shareholder, thereby opening the door to consideration of these materials on a motion to dismiss. What this means on a practical level is that Section 220 documents can be instrumental in either moving the case past the pleading stage or stopping the case in its tracks on a motion to dismiss. Section 220 documents can be especially powerful in alleging or defending against claims that a board failed its oversight duties. The duty of oversight requires directors to ensure reasonable reporting and information systems exist that would allow them to know about and prevent wrongdoing that could cause corporate trauma. Oversight claims – also known as “Caremark” claims – are one of the most difficult claims to plead, requiring a shareholder to allege particularized facts that: (1) the board utterly failed to implement any reporting or information system or controls, or (2) having implemented such a system or controls, consciously failed to address red flags indicating corporate misconduct. Two recent oversight cases – In re the Boeing Co. Deriv. Litig., 2021 WL 4059934 (Del. Ch. Sept. 7, 2021) (“Boeing”) and Firemen’s Ret. Sys. of St. Louis v. Sorenson, 2021 WL 4593777 (Del. Ch. Oct. 5, 2021) (“Sorenson”) – are illustrative of the important role documents obtained pursuant to Section 220 can play in the early stages of board oversight litigation.

In Boeing, the Delaware Court of Chancery sustained an oversight claim at the pleading stage, finding that the complaint alleged particularized facts establishing that a majority of Boeing’s board faced a substantial likelihood of liability with respect to that claim. Boeing arose in the wake of the crashes of two Boeing 737 Max airplanes, which led to the grounding of the Boeing 737 Max fleet and billions of dollars in losses to the company. Plaintiffs alleged that this corporate trauma was caused by Boeing’s prioritization of speed and profit over safety and brought an oversight claim against the directors. Plaintiffs asserted that the board failed to establish a reporting system to ensure that airplane safety issues were raised to the board and later turned a blind eye to red flags suggesting safety problems with the 737 Max following the first crash.

The court found that, although airplane safety was “mission critical” to Boeing’s business, board-level materials obtained by plaintiffs via Section 220 showed that the board: (1) had no committee charged with responsibility to monitor airplane safety; (2) did not regularly monitor, discuss, or address airplane safety; (3) had no protocols requiring management to update the board on airplane safety; (4) never were alerted to red flags that management saw prior to the crashes; and (5) ignored red flags following the first crash that suggested the 737 Max had safety issues. Thus, board level materials obtained via Section 220 were critical in allowing the plaintiffs in Boeing to plead particularized facts to survive a motion to dismiss under the stringent Caremark standard.

The opposite result ensued in Sorenson. There, the Delaware Court of Chancery dismissed plaintiff ’s oversight claim on a motion to dismiss based in part on board-level documents produced pursuant to Section 220. Sorenson arose in the aftermath of a data security breach at Marriott that exposed the personal information of 500 million guests. Plaintiff alleged that Marriott’s board breached its duty of oversight when it ignored red flags about inadequate data protection in its reservation database. In dismissing the oversight claim, the court noted that Section 220 documents demonstrated that the board did not turn a blind eye to red flags indicating that there were cybersecurity risks in the reservation platform; rather, those documents showed that the board had been told that management was addressing the issues, including by hiring audit firms to conduct security assessments, implementing their recommendations, and engaging forensic specialists to investigate once malware was discovered in the database.

Key Takeaways:

• Shareholders who want to bring oversight claims should obtain documents through a shareholder inspection demand prior to filing their complaint. Oversight claims are difficult to plead, but, as illustrated in Boeing, such documents can be key to alleging oversight claims with the particularity necessary to survive a motion to dismiss.

• Companies and their boards should make good faith efforts to implement appropriate processes for board-level
enterprise risk monitoring (especially with respect to “mission critical” risks) to ensure that problems are brought to their attention and timely addressed. Boards should carefully document these processes and their involvement in overseeing and addressing risks in board meeting agendas, minutes, packages, and committee charters in the eventuality that such documents are needed to defend against oversight claims. As seen in Boeing and Sorenson, such materials can be the difference between a case moving forward to discovery or being dismissed at an early stage.

Marie Bafus is a securities litigation partner at Fenwick & West LLP where she represents companies, officers, and directors in shareholder class actions and derivative litigation. mbafus@fenwick.com