Steinhardt v. Howard-Anderson: Court of Chancery Sanctions Representative Plaintiffs for Improper Trading Practices
March 2, 2012
In Steinhardt v. Howard-Anderson, C.A. No. 5878-VCL (Del. Ch. Jan. 6, 2012), the Court of Chancery imposed sanctions on representative plaintiffs for improper trading by plaintiff-fiduciaries. Michael Steinhardt and two funds managed by him filed suit as representative plaintiffs on behalf of stockholders of Occam Networks, Inc. (“Occam”) challenging the acquisition of Occam by Calix, Inc. (“Calix”). Steinhardt short-sold shares of Calix stock after the Court entered a confidentiality order restricting trading on the basis of confidential information obtained in the lawsuit and after Steinhardt had received information about the lawsuit from another representative plaintiff. The Court sanctioned Steinhardt and the funds by (i) dismissing them from the case with prejudice, (ii) barring them from recovering anything from the litigation, (iii) requiring them to self-report to the SEC, (iv) directing them to disclose the Court’s opinion in any future application to serve as lead plaintiff, and (v) ordering disgorgement of profits in the amount of $534,071.45.
Steinhardt and other representative plaintiffs filed suit on October 6, 2010, alleging that Occam directors breached their fiduciary duties in approving the merger at an unfair price. The merger agreement provided that Occam would merge with an acquisition subsidiary of Calix, with Occam stockholders receiving $3.8337 in cash and 0.2925 shares of Calix stock for each share of Occam common stock. On November 12, 2010, the Court entered a confidentiality order, which explicitly prohibited persons receiving confidential discovery information from trading in securities of Calix or Occam on the basis of such information, and document production began on December 1, 2010. Another representative plaintiff, Herbert Chen, worked out of Steinhardt’s offices. Chen had pre-merger holdings of Occam stock amounting to approximately 20 to 25% of his net worth and was deeply involved in the case. Although Steinhardt was not as deeply involved in the prosecution of the action, Chen provided Steinhardt with regular updates concerning the litigation. Despite the confidentiality order, Steinhardt began short-selling Calix common stock on December 28, 2010.
The Court explained that, when a stockholder files a representative action, the plaintiff voluntarily assumes the role of fiduciary for the putative class and that it is unacceptable for a plaintiff-fiduciary to trade on the basis of nonpublic information obtained in the litigation, as such trading undermines the integrity of the representative litigation process. According to the Court, the fact that a representative plaintiff does not have direct access to confidential information produced in discovery is not determinative. While Steinhardt did not speak directly with plaintiffs’ counsel until two days before his deposition in May 2011 and did not have direct access to discovery, Steinhardt nevertheless received regular written and oral updates about the litigation from Chen, whose insights in turn were based on discussions with counsel and the discovery record. The Court therefore held that by trading after receiving information from Chen, which was derived from confidential discovery material, Steinhardt and the funds breached their fiduciary obligations as representative plaintiffs and violated the confidentiality order.
The defendants also sought sanctions against Chen. Chen sold Occam shares between October 29 and November 2, 2010, but the Court did not find these trades improper because the defendants had not yet produced nonpublic information and the Court had not yet entered the confidentiality order. Chen also sold Occam shares on January 25, 2011, but the Court found that trade to have been inadvertent. Additionally, Chen’s January 25 trade came a day after the Court’s preliminary injunction ruling, which, according to the Court, eliminated the principal benefit Chen obtained from the confidential information by making it reasonably clear to the public that the merger was highly likely to close after the issuance of supplemental disclosures. The Court also found Chen to be a highly motivated and effective representative plaintiff and stated that Chen’s removal would harm the class. The Court accordingly declined to impose sanctions on Chen.