(Reuters) - In a pair of bare-knuckled briefs made public on Tuesday, two shareholder groups led by major pension funds told Vice Chancellor Joseph Slights of Delaware Chancery Court why he should pick them – and should definitely not pick the other guys – to lead shareholder derivative litigation accusing Facebook Inc’s officers and directors of failing to protect Facebook users’ privacy and data.
The competing shareholder groups filed separate behemoth complaints earlier this month: a 389-page tome by the California State Teachers’ Retirement System (known as CalSTRS) and several other Facebook shareholders; and a comparatively sleek 219-page complaint by two Rhode Island pension funds. Broadly speaking, the complaints allege that even after Facebook entered a 2012 agreement to resolve the U.S. Federal Trade Commission’s investigation of its user privacy protections, the company's board failed to safeguard user data, which was notoriously harvested by the political consulting firm Cambridge Analytica in the 2016 presidential campaign.
Moreover, according to the complaints, the board compounded that breach of duty when it negotiated a record-setting $5 billion follow-up deal with the FTC in 2019, allegedly overpaying the government in order to shield CEO Mark Zuckerberg from individual liability.
Facebook’s lawyers at Gibson, Dunn & Crutcher and Ross Aronstam & Moritz have argued that there’s no evidence the board acted in bad faith. They have also said shareholders cannot stand in the shoes of the corporation to bring a derivative claim because they cannot show the board is too conflicted to act independently. Facebook counsel Orin Snyder of Gibson Dunn and David Ross of Ross Aronstam did not respond to my emails.
Lead counsel fights in shareholder litigation are nothing new, of course, but this one is based on an particularly robust record, in which both of the contenders litigated for years to obtain documents to inform their complaints. Both pension fund groups offered procedural reasons why Slights should select them: The CalSTRS group said its coalition owns vastly more shares than the Rhode Island funds; the Rhode Island funds said two of CalSTRS’ proposed lead law firms are conflicted because they’re already representing clients with direct claims against Facebook. But the groups' competing briefs also highlight the different theories they've pursued.
The Rhode Island funds, represented by Block & Leviton and Heyman Enerio Gattuso & Hirzel, have long been chasing a theory that after the FTC began investigating Cambridge Analytica’s harvesting of data from Facebook users, Facebook paid the FTC vastly more than it should have in order to squelch an inquiry into Zuckerberg. That allegation was at the heart of the Rhode Island funds’ lawsuit in Chancery Court to obtain Facebook’s corporate books and records. The funds also brought a Freedom of Information Act suit against the FTC to obtain documents about the commission’s negotiations with Facebook after the Cambridge Analytica scandal broke.
In a nutshell, the Rhode Island funds contend that Facebook’s maximum corporate exposure to the FTC for allegedly failing to safeguard user data was only about $105 million — and that the most compelling explanation for why the company agreed to pay $5 billion was to shield its CEO and controlling shareholder, Zuckerberg, from testifying in the FTC’s investigation and, perhaps, being personally named as a defendant in an FTC suit.
The Rhode Island funds argued in their lead plaintiffs brief that there is another key reason to focus on the FTC overpayment theory.
Breach of duty suits against corporate officers and directors are evaluated under either the extremely stringent business judgment standard or the more lenient entire fairness standard. The Rhode Island funds maintain that because Facebook directors were allegedly acting in the interest of controlling shareholder Zuckerberg when they agreed to overpay the FTC by billions of dollars, Chancery Court should use the entire fairness standard to judge the board's actions. The FTC deal, they maintain, was akin to an M&A deal in which board members failed to adopt precautions to avoid a controlling shareholder's conflicts. Under Delaware precedent, those directors are not entitled to business judgment deference — and nor should Facebook directors be, the Rhode Island funds argued.
That theory seems to have some initial support from the judge. At a June 2020 hearing in the Rhode Island funds’ suit to obtain Facebook books and records, Slights said the controlling shareholder scenario “sounds like a prima facie, at least, breach of fiduciary duty.”
The shareholders led by CalSTRS, on the other hand, have focused more tightly on the board’s alleged failure to assure that the company complied with the 2012 FTC agreement and protected users’ data. The group’s latest complaint, which unites several shareholder contingents that were previously litigating separately against Facebook, includes allegations that the company overpaid in the 2019 FTC deal.
But some of the shareholders in the CalSTRS coalition began litigating to see Facebook books and records before that deal was even struck – and they allege that the crux of the case is an overarching theory that board members breached their fiduciary duties by allowing Facebook to engage in illicit privacy violations.
The CalSTRS group’s complaint, filed by shareholder lawyers from Scott + Scott, Kaplan Fox & Kilsheimer and Prickett, Jones & Elliott, goes to great lengths to show that it would have been futile for shareholders to demand that the board take action against officers and directors because board members were not independent. The CalSTRS lead plaintiff motion argued that the Rhode Island funds simply failed to offer adequate allegations that individual board members were conflicted and took specific actions that breached their duties.
The CalSTRS group said its pre-suit investigation was more thorough and its complaint was more comprehensive. The Rhode Island funds said its rivals were latecomers (after previously espousing skepticism) to the controlling shareholder theory, which is the shareholders’ best shot because of the entire fairness standard. Both sides insisted that their litigation strategy is the best way to prevail against Facebook.
I emailed CalSTRS coalition lawyers Geoffrey Johnson of Scott + Scott and Frederic Fox of Kaplan Fox but didn’t hear back. Rhode Island fund counsel Joel Fleming of Block & Leviton declined to provide a statement.
Both groups have already invested years of effort in the Facebook derivative litigation. When Delaware judge Slights makes his choice, someone is going to be very unhappy.
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