Home -> Law Blog Directory -> Corporate & Securities Law Blogs -> The Corporate Counsel.net Blog

Corporate & Securities Law

: The Corporate Counsel.net Blog

The Latest Developments for Special Litigation Committee Practice

By broc

The Latest Developments for Special Litigation Committee Practice

As Travis Laster notes, a recent decision has significant implications for special litigation committee practice:

In Sutherland v. Sutherland, C.A. No. 2399 (Del. Ch. May 5, 2008), Vice Chancellor Lamb denied a motion to terminate filed by a single-member SLC, despite finding that the SLC member was disinterested and independent, on the grounds that the SLC did not conduct an adequate investigation. By my count, this is only the fourth Delaware decision to reject an SLC's motion to terminate and only the second to do so on the basis of an inadequate investigation, as opposed to on the basis of lack of independence.

Key practice points include:

1. Vice Chancellor Lamb rejected the argument that the SLC member was not independent because he was paid his hourly rate for conducting the investigation. Questions about SLC member compensation frequently arise, and the Sutherland decision indicates that paying an hourly rate should be acceptable.

2. Vice Chancellor Lamb was not troubled by the fact that the SLC's counsel and the SLC did not retain their notes from witness interviews. Prior SLC rulings differed on whether notes of interviews should be retained and whether they would be subject to production during discovery, although at least one decision supported the general practice of not retaining notes. The Sutherland case upholds the general practice in this area. However, because the failure to retain interview notes potentially implicates spoliation issues, practitioners should continue to be cautious, particularly if their actions will be reviewed by courts in jurisdictions other than Delaware.

3. Despite his ruling on the underlying interview notes, Vice Chancellor Lamb appeared quite troubled by the cursory nature of the interview memoranda prepared by the SLC's counsel. The Court noted that the summaries were "perfunctory" and typically recorded only the questions or topics of discussion, but not the interviewee's answers. The Court remarked that "Without this information, the Court is unable to ascertain the reasonableness of the SLC's investigation."

4. Vice Chancellor Lamb reiterated his concern, expressed in an earlier opinion, that the SLC's report was "wholly devoid of citations to key documents or interview summaries." (18 n.34). The Court also noted that "the SLC did not enter any of the underlying documents, interview summaries, affidavits, or deposition transcripts into the record until it filed its reply [brief]. ... Needless to say, these facts do not enhance the court's confidence in the SLC. Not only does the lack of a record hinder the court's, and the plaintiff's ability to scrutinize the SLC's good faith, independence, and reasonableness, it also suggests that the SLC has not taken its obligation seriously and has not acted in
good faith."

5. Vice Chancellor Lamb expressed concern that the SLC report referred to exculpatory evidence for certain expenses that were the subject of the investigation but did not mention other, problematic evidence. The Vice Chancellor noted that the SLC member and SLC counsel both stated that they were aware of the expenses, yet they were not addressed in the report. In the Court's words, "[t]he incongruity between omitting analysis of the large, possibly suspicious payments, yet referencing the innocent, generally available discount, raises significant questions as to the good faith of the SLC's work."

Practitioners advising or considering the use of an SLC should pay careful attention to the Sutherland case. Most significantly, the opinion indicates that interview summaries should contain significant detail and that the SLC report should cite to evidence and underlying documents, and not merely provide an unsupported narrative.

Even More on Special Litigation Committee Practice

More from Travis Laster:

In the wake of Vice Chancellor Lamb's Sutherland decision rejecting a special litigation committee's motion to terminate a derivative action, the SLC moved for reconsideration, and the Vice Chancellor denied the motion in this new decision.

Two points are worth noting for practitioners who advise SLCs:

First, the Court stated that "the touchstone of good faith in the context of a special litigation committee report is its demonstrated willingness to deal openly and honestly with all relevant information." The Court found that the destruction of interview notes by the SLC, after using the notes to prepare cursory and incomplete interview summaries, undermined the Court's confidence in the SLC's actions.

In his prior decision, Vice Chancellor Lamb held that it was not improper to destroy interview notes. Nevertheless, the clear lesson is that if an SLC decides not to retain interview notes, the interview summaries should be considerably more detailed than might otherwise be required if notes are retained and produced. This ruling dovetails with Chancellor Chandler's holding in Ryan v. Gifford, where he required an investigative committee to produce its interview summaries, notes, and communications with counsel where the committee had not prepared a report and there was no other factual record of what the committee did.

Second, the Court stated that "the SLC was required to investigate the claims in the case, not merely the specific allegations [the plaintiff] made in her complaint." This is significant because it makes clear that an SLC investigation cannot stop with the allegations of the complaint, but must explore more broadly into the merits of the underlying claims. This may require the SLC to investigate issues that the plaintiff did not identify. Although parsing the complaint can be a way to sidestep difficult issues, the Sutherland decision indicates that the Court of Chancery will not look kindly on such an approach.

The fact that an SLC will have a duty to explore beyond the narrow allegations of the complaint reinforces the need for a board of directors to think carefully before creating an SLC. Put simply, it is not always clear when an SLC is created where its investigation will lead or end. While an SLC can be a powerful device to address derivative litigation, it should not be the knee-jerk response to the denial of a motion to dismiss.

The Perils of Naked Short Selling

As Dave recently blogged, the SEC proposed an anti-fraud rule for naked short selling a few months ago. In this podcast, Dave Patch, Founder of InvestigatetheSEC.com, discusses naked short selling, including:

- What do you see as the most important short issues that we face today?
- How is the SEC addressing those issues?
- What do you think the SEC should be doing?

- Broc Romanek

Full post as published by The Corporate Counsel.net Blog on June 11, 2008 (boomark / email).