First Backdating Lawsuit Ends In Whimper

One of the first shareholder lawsuits seeking restitution from corporate executives over backdated stock options fizzled late last month with no damages going to the plaintiffs, a heartening sign for the legions of companies now tarred by backdating allegations.

The shareholders had sued JDA Software Group, a $215 million software concern in Scottsdale, Ariz., accusing several current and former directors and officers of backdating option grants from 1996 to 2002. The complaint was filed in August in Maricopa County Superior Court, but the plaintiffs agreed to dismiss it last month; two weeks before a scheduled hearing for JDA’s motion to dismiss. The plaintiffs, led by John Liu, are not receiving compensation to dismiss the case.

The dismissal could be an early barometer of how courts will handle the inevitable slew of derivative litigation that will spring from the backdating scandal. Hundreds of companies are now under some sort of probe—by the Justice Department, the Securities and Exchange Commission, or internal investigators—and some experts claim that in severe cases, backdating plundered huge sums of shareholder value.

Robert Brownlie, a partner at the law firm DLA Piper, which represented JDA, hopes his client’s victory will set a standard. “If more cases are challenged immediately, you could see more civil cases dismissed,” he says.

Lawler

Brownlie’s views, however, may be in the minority. Most attorneys stress that each case is very fact specific. “I haven’t seen a pattern of cases withdrawn en masse in the face of a motion to dismiss,” says Richard Lawler, a partner with the Winston & Strawn law firm. “It is hard to believe this is part of a wider trend.”

Even Brownlie concedes that one major reason the plaintiffs folded their suit was the relatively flimsy set of facts in the JDA case relative to other backdating cases.

The Allegations Explored

The suit alleged that executives and directors colluded to backdate dozens of grants of JDA options to a number of officers, including current Chief Executive Officer Hamish Brewer. The suit also alleged that JDA produced and disseminated false financial statements and other SEC filings that improperly recorded and accounted for the backdated options grants and concealed the improper backdating of stock options.

The suit then identified 12 different occasions when stock options were granted just before a substantial rise in JDA’s stock price, calling it “a striking pattern that could not have been the result of chance.” The suit also claimed that JDA’s five-member board was not capable of engaging in an objective assessment of the grants due to conflicts of interest, including one board member receiving backdated options.

THE DEFENSE

Below is an excerpt of JDA Software's amended motion to dismiss the complaint from its shareholders.

Without first making a demand on its board of directors, plaintiff filed this stockholder derivative suit on behalf of JDA, a Scottsdale-based technology company, claiming that certain stock option grants from 1996 to 2002 were backdated. This claim is based solely on the price of JDA’s stock 10 trading days before the option grant date and 10 trading days after those dates, a mystery “statistical analysis” and plaintiff’s rank speculation that the recipients of the options and the board members who approved them must have colluded to backdate the options. The boilerplate amended complaint does not allege a single fact to support plaintiff’s assertions.

JDA is a Delaware corporation. A plaintiff may not proceed with a derivative suit on behalf of a Delaware corporation unless he alleges (1) he made a demand on the corporation’s board to bring suit and that demand was wrongfully refused; or (2) reasons why the making of a demand should be excused. Plaintiff did not make a demand on JDA’s board. Thus, he must show that demand should be excused. To do this, Plaintiff must allege particular facts that (1) a majority of JDA’s board is legally incapable of deciding whether this case should be brought because they are not independent or disinterested or (2) the challenged transaction was not the product of a valid exercise of business judgment. Plaintiff’s conclusory allegations fail to meet this standard. Moreover, Plaintiff blatantly admits that he did not even consider making a demand. Indeed, he pleads that there were five directors at the time he should have made a demand, when in fact there were six. Without knowing the total number of directors, Plaintiff could not have made an informed decision as to whether a majority of the directors were interested or lacked independence and whether demand was excused.

Plaintiff also fails to sufficiently plead his cause of action. He alleges Defendants breached their fiduciary duties because they “colluded” or “conspired” to backdate options, but fails to plead the most basic element of a conspiracy—that defendants entered into an agreement. With respect to the unjust enrichment claim, Plaintiff also fails to plead the most basic facts indicating that Defendants where enriched.

Finally, almost all of Plaintiff’s claims are barred by the applicable two-year statute of limitations. With only a few exceptions, the challenged option grants and public statements were made and publicly disclosed well outside of the statute of limitations period. All claims based on such grants and statements, and the defendants who received or made them, therefore, must be dismissed as time barred.

Source

Superior Court of Arizona, Maricopa County (Oct. 30, 2006)

In subsequent court filings, however, JDA countered that the two-year statute of limitations to bring this sort of case had expired and that the plaintiffs failed to allege that they had made a pre-suit demand on JDA’s board of directors. Defense attorneys also argued that the plaintiffs failed to present sufficient facts to constitute a valid cause of action for breach of fiduciary duty or unjust enrichment, the only causes of action listed in the complaint.

Brownlie

Two other critical factors worked in JDA’s favor, Brownlie says. First, it is not currently among the scores of companies under formal investigation for backdating; and in the rush to get to the courthouse first, the lawsuit was not well planned. The latter can a big issue in state court cases, Brownlie says, since derivative litigation suits are not subject to the Private Securities Litigation Reform Act, which states that the lead plaintiff in a securities class action is the group that has the largest financial interest.

He also believes that the plaintiffs knew that in Arizona, if they didn’t drop the case, they faced the possibility of picking up the defendants’ legal tab.

Eric Zagar, an associate with the law firm Schiffrin & Barroway, who represented the plaintiffs, disputed Brownlie’s analysis, but declined to discuss the specifics of the case, only saying, “A lot more goes into a decision like this than what he mentioned.” Zagar says the plaintiffs do not plan to refile their complaint at some future date.

Zagar

Zagar also challenges Brownlie’s assertions that the case could sway the dozens of others derivative suits related to options backdating. Since the charges were dropped, the case has no effect on the standard of proof that plaintiffs must bring in cases that do go to trial.

What Does It All Mean?

“There is no effect at all,” says Zagar, whose firm has filed dozens of shareholder derivative actions in what the firm calls “an extensive campaign” against options backdating. “This case has no value as a precedent.”

Other plaintiff lawyers agree. “Not one of my cases has been dismissed,” sniffs Darren Robbins, a founding partner with Lerach Coughlin Stoia Geller Rudman & Robbins—a firm that has tied many companies in knots over the years with class-action suits.

Robbins

Robbins says his firm currently has 14 suits related to backdating: 13 of them are derivative suits. In 10 cases, he says he has refused to engage in settlement discussions because the defendants are not prepared to make fundamental changes in the way they are governed or to make certain financial contributions. He is in talks with the other four.

The only case that isn’t a derivative suit involves UnitedHealth, the poster child for errant corporate behavior when it comes to backdating. Last year, Lerach Coughlin announced that its client—the mighty California Public Employees’ Retirement System—was appointed lead plaintiff in the options backdating securities class-action suit against the health-care giant. Robbins boasts of CalPERS’ recent request for a judge to freeze the assets of outgoing UnitedHealth CEO William McGuire, who is sitting on hundreds of millions of dollars worth of stock options.

The pension giant is also seeking non-monetary relief, including corporate-governance reforms and forcing the corporate insiders to bear their own legal fees arising out of the stock option backdating scandal—demands that more resemble those in derivative suits.