In a detailed and thoughtful decision – and one that is
certain to be cited frequently in the months ahead – Judge
William Alsup has dismissed a shareholder derivative
complaint against various officers and directors of CNET
Networks, Inc. based on allegations of options "backdating."
In re CNET Networks, Inc. Shareholder Derivative Litigation,
No. 3:06-cv-03817 (N.D. Cal. April 11, 2007). After carefully
analyzing the specific grants at issue and allegations
relating to individual directors, the Court held that plaintiffs
failed to establish that a majority of CNET's board faced a
substantial likelihood of personal liability or was otherwise
incapable of exercising independent business judgment.
As a result, plaintiffs were unable to show that they have
standing to sue on the company's behalf.
Based largely on the perceived statistical improbability
of CNET's option grant prices, plaintiffs alleged that eight
grants to directors and officers had been backdated,
which they argued rendered CNET's Board incapable of
disinterestedly weighing a shareholder demand to pursue
litigation against the defendants. In rejecting plaintiffs'
arguments, the Court began by scrutinizing their use of price
movements surrounding the option grants to prove their
claims of backdating, and noted their "fail[ure] to plead
where their method came from, whether it was used by
anyone else, or whether it was peer-reviewed or bore other
indicia of academic approval." Accordingly, the Court held
that without establishing that their allegations were based
on "sound analytical methods," an inference of fraud was
"more difficult to support."
Relying heavily on guidance provided by the SEC's Chief
Accountant on September 19, 2006, the Court also explained
that there are a number of non-fraudulent explanations as to
how a Company could use the wrong measurement date for
an option grant. Consequently, the mere conclusion that an
option bore an incorrect measurement date or any resultant
restatement of financial statements would be insufficient by
itself to demonstrate wrongdoing.
The Court also analyzed the facts surrounding each allegedly
improper grant and found in most cases that the plaintiffs
failed to plead sufficient facts to support an inference of
backdating. In particular, the Court did not find an inference
of backdating where:
- The grants were issued pursuant to an overall plan with
a pre-scheduled grant date, such as an annual director
- Form 4s were timely filed within two days of the grant;
- The grants were made to new employees as part of a
publicly disclosed merger;
- The grant was contemporaneous in time with a public
announcement of the new hire who received the grant; or
- The grant was only misdated by "a single day."
The Court ultimately found that plaintiffs adequately alleged
that three grants were backdated. In each instance, specific
facts suggested that the grant was so fortuitously timed
as to raise doubts about its propriety, and defendants
were unable to provide a legitimate, judicially-noticeable
explanation for the timing.
Nonetheless, the Court made clear that the existence of
backdated grants was not sufficient to render the directors
incapable of determining whether litigation was in the
company's best interest. Instead, the Court evaluated each
director's role in the alleged backdating of these options and
whether sufficient facts had been pled to call into question
their independence and disinterestedness.
In so doing, the Court reaffirmed that "mere membership
on a committee or board without specific allegations as to
defendants' roles and conduct, is insufficient to support
a finding that directors were conflicted." The Court found
especially compelling the fact that "plaintiffs [made] no
allegation indicating that [the directors] chose the date on
which the allegedly backdated options were granted or that they knew the grants' true date." Such facts are even more
necessary, the Court explained, in cases where directors
delegated their authority regarding the setting of grant dates
and prices to company executives. The Court also found that
directors who joined the Board or Compensation Committee
after the alleged backdating occurred were disinterested
and could independently evaluate the Company's option
The Court also noted that once CNET's option problems
came to light, the Board appointed a Special Committee to
investigate and apply remedial measures. This ultimately
resulted in a re-pricing of some options and a restatement
of the Company's financials, but the Committee did not find
any intentional wrongdoing. In light of this fact, the Court
would not infer that fraud occurred "absent other facts" to
Because only one director (who received an allegedly
backdated grant) was arguably "interested," plaintiffs
were not entitled to usurp the Board's authority to decide
whether or not to pursue litigation. Although noting that
it was inclined to grant defendants' motion to dismiss with
prejudice, given plaintiffs' repeated amendments to their
complaint, the Court requested additional briefing as to
whether the plaintiffs were entitled to limited discovery
regarding the Compensation Committee members' possible
involvement in alleged backdating.
It is also noteworthy that the Court distinguished the
Delaware Chancery Court's recent opinion in Ryan v. Maxim
Integrated Products, Inc., No. 221-N (Del. Ch. Feb. 6, 2007),
and relied more heavily on Judge Chesney's opinion in In re
Linear Tech. Corp. Deriv. Litig., No. C-06-3290 MMC (N.D. Cal.
Dec. 7, 2006), which also dismissed a derivative backdating
case for failure to plead demand futility.
Kevin P. Muck, Partner, Litigation Group
Felix S. Lee, Associate, Litigation Group
Eric Ball, Associate, Litigation Group
©2007 Fenwick & West LLP. All Rights Reserved.
This update is intended by Fenwick & West LLP to summarize recent
developments in the law. It is not intended, and should not be regarded,
as legal advice. Readers who have particular questions about these
issues should seek advice of counsel.