BOUCHARD, C.
This action involves allegations by a stockholder of Zynga Inc. ("Zynga") that, a few months after the company completed its initial public offering in December 2011, the board of directors waived in a discriminatory manner certain contractual restrictions that had prevented most pre-IPO investors from selling their stock for a designated period. Selectively waiving these "lockup" restrictions permitted some pre-IPO stockholders to sell a portion of their holdings almost two months before other pre-IPO stockholders, at what turned out to be a significantly higher price than was available later. Four of Zynga's eight directors received this opportunity. Plaintiff claims that Zynga's directors breached their fiduciary duty of loyalty by approving a self-dealing waiver of these lockups to the unfair benefit of half the members of the Zynga board (Count I). Plaintiff also claims that two investment banks, whose consent was necessary to waive the lockups, aided and abetted these breaches of fiduciary duty (Count II).
As discussed below, the specific waivers at issue were part of a larger decision by the Zynga board to restructure the lockup restrictions covering approximately 688 million shares of Zynga stock. This figure equates to almost seven times the number of shares (100 million shares) issued in the company's IPO. All of the lockups were set to expire on the same day: May 28, 2012. But, in March 2012, the Zynga board decided to stagger the lockup expirations, which would have the effect of gradually making more stock available to the public.
With their lockups modified, a group of pre-IPO stockholders were thereby able to participate in a secondary offering to the public that closed in early April 2012 at a price of $12.00 per share. Each of the four Zynga directors who received lockup waivers sold millions of dollars of Zynga stock in this secondary offering. Zynga's founder, Chairman, and then-Chief Executive Officer, Mark Pincus, alone received over $192 million in proceeds. The two investment banks that consented to the lockup waivers together made over $10 million in fees by acting as underwriters for the secondary offering. Plaintiff's shares, in contrast to those of the four directors who participated in the secondary offering, remained locked up until May 29, 2012, when the closing price for Zynga's stock was $6.09 per share.
Zynga and the eight director defendants moved to dismiss Count I under (i) Court of Chancery Rule 23.1 for failure to make a pre-suit demand upon Zynga's board or to plead facts excusing such demand and (ii) Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief may be granted. The two underwriter defendants moved to dismiss Count II under Court of Chancery Rule 12(b)(6) for failure to state a claim.
In this opinion, I conclude that plaintiff has stated a claim for breach of fiduciary duty against the director defendants because it is reasonably conceivable that, when the members of the Zynga board restructured the lockup restrictions, half of the directors who approved that decision received an unfair benefit. I also conclude that plaintiff has not stated a claim for aiding and abetting because plaintiff has failed to plead facts from which it is reasonably inferable that the underwriters knowingly participated in a breach of fiduciary duty. Accordingly, the motion to dismiss Count I is denied, and the motion to dismiss Count II is granted.
Defendant Zynga, a Delaware corporation based in San Francisco, California, is in the "social gaming" industry. Zynga produces interactive, online games (think FarmVille) that are accessible through facebook.com and other platforms. It generates income primarily through advertising and selling so-called "virtual goods." Its stock trades on the NASDAQ. Zynga is named as a defendant "solely because it is a party to agreements underlying and relating to the [s]econdary [o]ffering."
Between the company's IPO in December 2011 and the secondary offering in April 2012, Zynga's board consisted of eight individuals: defendants Mark Pincus ("Pincus"), John Schappert ("Schappert"), William Gordon, Reid Hoffman ("Hoffman"), Jeffrey Katzenberg, Stanley J. Meresman, Sunil Paul, and Owen Van Natta ("Van Natta"). All eight individuals had been directors of Zynga since November 2011. Four of these directors received lockup waivers and then sold stock in the secondary offering: Pincus, Schappert, Hoffman, and Van Natta. I refer to the eight individual defendants as the "Director Defendants," and to the Director Defendants and Zynga, collectively, as the "Zynga Defendants."
Defendant Pincus founded Zynga in 2007. Through his ownership of high-voting stock, Pincus controlled 37.4% of Zynga's voting power immediately after the company's IPO, and 36.5% immediately before the secondary offering. He sold 16.5 million shares in the secondary offering and received $192,060,000 in net proceeds, equating to $11.64 per share. Defendants Schappert, Hoffman, and Van Natta together sold approximately 1.5 million shares in the secondary offering, receiving over $17.6 million in net proceeds.
Defendant Morgan Stanley & Co. LLC ("Morgan Stanley") is a Delaware limited liability company based in New York. Defendant Goldman, Sachs & Co. ("Goldman") is a New York limited partnership also based in New York. Morgan Stanley and Goldman (together, the "Underwriter Defendants") served as the lead underwriters, and as the representatives for the other underwriters, in Zynga's IPO and the secondary offering.
Plaintiff Wendy Lee ("Lee") has been a Zynga stockholder at all times relevant to this case. She was also a Zynga employee from 2009 until May 2011. On August 2, 2011, pursuant to a Stock Option Exercise Agreement (the "Exercise Agreement"), Lee acquired 30,000 shares of Zynga stock at an exercise price of $3.805 per share. In September 2012, she sold substantially all of her stock at a price of $3.15 per share.
Zynga has three classes of common stock: (i) Class A shares, entitled to one vote per share; (ii) Class B shares, entitled to seven votes per share; and (iii) Class C shares, entitled to seventy votes per share, which "were issued only to Pincus."
On December 16, 2011, Zynga completed its IPO. It sold 100 million shares to the public at $10 per share, raising $1 billion. The offering price implied an enterprise value for the company of over $7 billion.
Before the IPO, the Director Defendants, Zynga's officers and employees, and most other pre-IPO investors (including plaintiff Lee) had agreed to lockup restrictions that prevented them from selling their Zynga stock for a 165-day period after December 15, 2011, i.e., until after May 28, 2012. Collectively, approximately 688 million shares
Morgan Stanley and Goldman acted in the IPO as the lead underwriters and as the representatives for the other underwriters. In its IPO underwriting agreement with Morgan Stanley and Goldman, Zynga had agreed "[n]ot to amend, modify or terminate, or waive any provision of, any of the `lock-up' agreements with [its] officers, directors or stockholders" without the underwriters' prior written consent.
In March 2012, Zynga's directors decided to modify the lockup restrictions to permit certain pre-IPO stockholders to sell some of their shares before the original May 28, 2012, expiration date and the rest of their shares after the original May 28, 2012, expiration date. I infer from the Amended Complaint that all eight of Zynga's directors voted in favor of this lockup restructuring.
First, Zynga's board waived the 165-day lockup restrictions for approximately 49 million shares (inclusive of the underwriters' option to purchase additional shares) held by select investors, including four of Zynga's eight directors: Pincus, Schappert, Hoffman, and Van Natta. For the stock held by these four directors, the board also waived the company's "blackout" policy, which prohibited Zynga employees from selling stock during a designated period around the company's quarterly earnings releases. These waivers were made to facilitate a secondary offering of Zynga stock to the public that closed on April 3, 2012. Director Defendants Pincus, Schappert, Hoffman, and Van Natta would each participate in this secondary offering.
Second, the board waived the 165-day lockup restrictions for approximately 114 million shares held by non-executive employees.
Third, for approximately 325 million shares held by former employees (including plaintiff Lee) and certain institutional investors, the lockups were not modified. Those shares could be sold starting on May 29, 2012, after the 165-day lockup period expired.
Fourth, the board extended the lockup restrictions for the remaining holdings of those stockholders who were permitted to participate in the secondary offering and certain other stockholders. This last group included the rest of the stock held by all eight Zynga directors. In total, approximately 200 million shares were subject to extended lockups. Approximately 50 million shares could be sold on July 6, 2012, and approximately 150 million shares could be sold on August 16, 2012.
On April 3, 2012, the secondary offering closed at a price of $12.00 per share. Pincus sold 16.5 million shares and received net proceeds of $192,060,000, representing nearly 40% of the total proceeds from the offering. Each of Schappert, Hoffman, and Van Natta sold several million dollars' worth of their Zynga stock in the secondary offering. Schappert sold 322,350 shares for net proceeds of $3,752,154. Hoffman sold 687,626 shares for net proceeds of $8,003,967. Van Natta sold 505,267 shares for net proceeds of $5,881,308. Zynga did not sell any shares in the secondary offering.
As they had in the IPO, Morgan Stanley and Goldman acted as the lead underwriters (and as the representatives for the other underwriters) for the secondary offering. For their services, Morgan Stanley and Goldman each received more than $5.3 million in fees and commissions.
After the secondary offering in 2012, Zynga's stock "began a precipitous decline" in value.
Based on Lee's calculations, had the four Zynga directors who sold stock in the secondary offering at $12.00 per share instead sold those shares on May 29 at $6.09 per share, they would have received approximately $100 million less in proceeds. This calculation is the basis of Lee's allegation that the lockup waivers received by the four Zynga directors were "worth" approximately $100 million.
On April 4, 2013, Lee commenced this action against defendants. On May 10, 2013, defendants filed a notice of removal from the Court of Chancery to the United States District Court for the District of Delaware. On December 23, 2013, the District Court granted Lee's motion for remand to this Court for lack of federal jurisdiction.
On January 17, 2014, Lee filed the Amended Complaint, asserting two causes of action. Count I asserts that the Director Defendants breached their fiduciary duty of loyalty by waiving the lockup restrictions to favor the Director Defendants at the expense of other pre-IPO stockholders. Count II asserts that the Underwriter Defendants aided and abetted those breaches of fiduciary duty.
On March 6, 2014, the Zynga Defendants moved to dismiss Count I of the Amended Complaint under Court of Chancery Rules 12(b)(6) and 23.1. Also on March 6, 2014, the Underwriter Defendants moved to dismiss Count II of the Amended Complaint under Court of Chancery Rule 12(b)(6).
In Count I, Lee alleges that the Director Defendants breached their fiduciary duties by "selectively releasing the [l]ockups, selectively waiving the [b]lackout [p]olicy, and authorizing the [s]econdary [o]ffering to benefit themselves."
The Zynga Defendants raise three arguments in support of their motion to dismiss Count I. First, they contend that the cause of action is derivative and that Lee failed to satisfy the pleading requirements of Court of Chancery Rule 23.1. Second, they assert that Lee's claim sounds in contract law and thus does not state a claim for breach of fiduciary duty. Third, they argue that, even if fiduciary duty principles govern the claim, it must be dismissed because Lee has failed to rebut the business judgment rule. These issues are considered, in turn, below.
Lee seeks to bring this action on behalf of a class consisting of all Zynga stockholders, excluding defendants and their affiliates, who "were subject to the [l]ockups, and who were not permitted to sell shares in the [s]econdary [o]ffering."
Despite how Count I is pled, the Zynga Defendants argue that the claim is derivative in nature on the theory that it is based on a "devaluation in stock resulting from [their] alleged breach of fiduciary duty."
In opposition, Lee asserts that Count I does not fit within the framework of a traditional derivative claim. For example, she does not contend that the Director Defendants breached their fiduciary duties by selling stock in the secondary offering based on confidential information, which would give rise to derivative harm.
The Delaware Supreme Court articulated the test for determining whether a stockholder plaintiff's claim is direct or derivative in Tooley v. Donaldson, Lufkin & Jenrette, Inc.
The parties have not cited any Delaware case squarely addressing whether the claim advanced as Count I may be asserted directly.
The Zynga Defendants' primary authority in support of their position, Feldman v. Cutaia,
Unlike the plaintiff in Feldman, Lee alleges no harm to the corporation or to all stockholders because the lockup waivers did not harm Zynga or the liquidity of all Zynga stockholders but only that of the putative class of pre-IPO stockholders. Lee is thus not "restating a derivative claim under the guise of a direct claim."
The Zynga Defendants assert that their obligations to Lee and the putative class with respect to the lockup restrictions are limited exclusively to those set forth in the agreements providing for the lockups. That is, they disclaim that the Director Defendants owed any fiduciary duties to the pre-IPO stockholders regarding any modification to any contractual lockup restrictions, including to their own lockups. They argue that Lee was not harmed by the lockup restructuring because she "received exactly what she was entitled to under her contract—she was permitted to sell her Zynga stock without restriction beginning on May 29, 2012."
Lee insists that her claim is governed by fiduciary duty principles, not by contract law, because her Exercise Agreement did not "expressly address" the possibility that the Director Defendants could modify the lockups covering the stock they owned to the detriment of Lee and other members of the class.
Directors of Delaware corporations owe fiduciary duties to the corporation and to the stockholders.
In Nemec, former stockholders alleged that the directors unfairly caused the corporation to redeem their stock pursuant to the plan by which they received their shares. The Supreme Court concluded that the stockholders' breach of fiduciary duty claim was "foreclosed as superfluous" because the "dispute relat[ed] to the exercise of a contractual right."
This Court has identified a similar principle in several recent decisions analyzing in what contexts, and to what extent, the fiduciary duties owed by directors to preferred stockholders may be preempted by the contractual rights set forth in the preferred stock's certificate of designation. For example, in LC Capital Master Fund, Ltd. v. James,
The Zynga Defendants argue that the principle animating Nemec and LC Capital applies with equal force here. In particular, they contend that, in the same way that the conversion ratios in the certificate of designation defined the board's obligations to preferred stockholders with respect to the merger consideration in LC Capital, the lockup provision in the Exercise Agreement exclusively defined their obligations to Lee with respect to the lockup restrictions. That is, the Zynga Defendants maintain that they "did not owe [Lee] (or her proposed class) a fiduciary duty to provide her with different terms from those contained in her contract."
I disagree. The core issue in this case is whether the existence of the Exercise Agreement, and the company's rights under that agreement, superseded the Director Defendants' general fiduciary obligations to Lee as a Zynga stockholder. In my view, the fact that the putative class members' shares were governed by contracts containing lockup restrictions does not eliminate the fiduciary duties of the Director Defendants to act loyally to all Zynga stockholders—especially when the challenged action did not involve the exercise of any contractual right governing Lee's shares but instead involved modifications to the contractual provisions governing their own shares.
This case is thus distinguishable from Nemec and LC Capital. Unlike in Nemec, where the company exercised a redemption right governing the shares at issue, this case does not involve any action that was taken under the terms of the contracts governing the putative class members' shares.
The Zynga Defendants' contention that "the staggered release had no effect on the liquidity or transferability of [Lee's] shares"
A motion to dismiss under Rule 12(b)(6) for failure to state a claim for relief must be denied unless, assuming the well-pled allegations to be true and viewing all reasonable inferences from those allegations in the plaintiff's favor, there is no "reasonably conceivable set of circumstances susceptible of proof" in which the plaintiff could recover.
When a stockholder plaintiff claims that the directors breached their fiduciary duties, Delaware courts review the alleged misconduct through a doctrinal standard of review.
A plaintiff may rebut the business judgment standard by alleging that at least half of the directors who approved the decision at issue are not entitled to its protection.
Lee's main theory for rebutting the business judgment standard of review is that four of the eight Zynga directors had a personal financial interest in the lockup restructuring because they received a benefit not shared with all pre-IPO stockholders: the opportunity to participate in the secondary offering.
As support for their arguments, the Zynga Defendants cite In re Paxson Communication Corp. Shareholders Litigation
A director may be interested in a transaction if, as a result of the business decision at issue, the director receives a "personal financial benefit . . . as opposed to a benefit which devolves upon the corporation or all stockholders generally."
Before the lockup restructuring, the Director Defendants and the putative class of Zynga stockholders were similarly situated: all of their lockups were to expire on May 28, 2012. Through the restructuring, four of the Director Defendants received lockup waivers allowing them to sell earlier than May 28; the putative class did not. Affording plaintiff all reasonable inferences, as I must at this procedural stage, it is reasonably conceivable that, as of the time when the decision was made to restructure the lockups,
Despite their arguments to the contrary, the Zynga Defendants have not demonstrated why it is unreasonable to infer at this stage that the overall lockup restructuring may have conferred a benefit to the directors. The calculations the Zynga Defendants have offered comparing the average market prices at which the Director Defendants and Lee could sell their pre-IPO stock appear to suffer from at least two infirmities. First, these calculations are entirely hypothetical. No record exists concerning any actual sales the Zynga directors made after the extended lockups expired.
Unlike here, the Court in Robotti, the primary decision on which the Zynga Defendants rely, was able to conclude definitively at the pleadings stage that the challenged transaction did not confer a benefit upon the directors. In Robotti, the plaintiff alleged that the directors breached their fiduciary duties because a stockholder rights offering unfairly adjusted the conversion ratio of the directors' stock options pursuant to the anti-dilution provisions of those options. The Court rejected the plaintiff's argument that the additional stock to be issued when the directors exercised their adjusted options "would be issued for free" because the plaintiff "failed to account for the exercise price of the options."
As discussed above, the facts here do not warrant the same conclusion. The lockup waivers the Zynga directors received were not granted by operation of some pre-existing contractual rights, and it is not self-evident that the directors received no net benefit from their being able to participate in the secondary offering while extending the lockups on their remaining shares.
Finally, the Zynga Defendants argue that the lockup waivers were not a "material" benefit, which they contend is necessary to render a director interested for standard of review purposes.
Here, the Zynga board at the time of the lockup restructuring consisted of eight directors, and it is reasonably conceivable for the reasons explained above that four of them received a benefit in the lockup restructuring. Under the familiar definition of self-dealing as a transaction in which a fiduciary stands "on both sides,"
For the reasons stated above, Lee has pled facts sufficient to rebut the business judgment standard of review because the lockup restructuring was not approved by a majority of disinterested and independent directors. Further, it is reasonably conceivable that the benefit the Director Defendants received in the lockup restructuring was not entirely fair. Accordingly, the Zynga Defendants' motion to dismiss Count I for failure to state a claim for relief is denied.
In Count II, Lee alleges that the Underwriter Defendants aided and abetted the Director Defendants' breach of fiduciary duty. Under Delaware law, a claim for aiding and abetting includes four elements: "(i) the existence of a fiduciary relationship, (ii) a breach of the fiduciary's duty, (iii) knowing participation in the breach by the non-fiduciary defendants, and (iv) damages proximately caused by the breach."
To demonstrate the "knowing participation" element of an aiding and abetting claim, it must be reasonably conceivable from the well-pled allegations that "the third party act[ed] with the knowledge that the conduct advocated or assisted constitute[d] . . . a breach [of fiduciary duty]."
Here, the Amended Complaint alleges that the Underwriter Defendants "profited" from the secondary offering, which was only possible after they "waiv[ed] the [l]ockups to which the participants in the [s]econdary [o]ffering were subject," through the "receipt of over $10.6 million in fees and commissions."
In my opinion, the allegations of the Amended Complaint do not support a reasonable inference of knowing participation by the Underwriter Defendants. Critically, plaintiff has failed to plead any facts from which it is reasonably inferable that the Underwriter Defendants knew when they provided their consent to modify the lockup restrictions that such action would facilitate a breach of fiduciary duty by the Director Defendants. The fact that the Underwriter Defendants' consent was necessary for the Director Defendants to waive a lockup restriction, without more, is insufficient to demonstrate that the Underwriter Defendants gave their consent with the knowledge that the Director Defendants were treating Lee and the putative class unfairly.
The Amended Complaint, moreover, does not allege that the amount of fees the Underwriter Defendants received in connection with the secondary offering were unreasonable for the services performed.
In support of her aiding and abetting claim, Lee relies primarily on Chancellor Chandler's decision in In re eBay Inc. Shareholders Litigation.
In sum, the allegations of knowing participation in the Amended Complaint are conclusory and fall short of those that Delaware courts routinely conclude do not substantiate a claim for aiding and abetting.
For the foregoing reasons, the Zynga Defendants' motion to dismiss Count I of the Amended Complaint under Court of Chancery Rule 23.1 and Rule 12(b)(6) is DENIED. The Underwriter Defendants' motion to dismiss Count II of the Amended Complaint under Court of Chancery Rule 12(b)(6) is GRANTED.
Am. Compl. ¶ 37; see also id. ¶ 38.
Separately, the Zynga Defendants complain that Lee should not be permitted to "win a race to judgment and capture the disgorgement remedy for herself" ahead of the derivative actions filed in California and in this Court that seek disgorgement from certain Director Defendants. Zynga Defs.' Reply Br. 23-24. Underlying this contention is the general principle, which Lee acknowledges, Pl.'s Ans. Br. 22, that a given dollar can be disgorged only once. See, e.g., Litton Indus., Inc. v. Lehman Bros. Kuhn Loeb Inc., 734 F.Supp. 1071, 1076 (S.D.N.Y. 1990). This concern of the Zynga Defendants is not a basis in my view for dismissing Count I, which otherwise states a claim for breach of fiduciary duty. Rather, this concern speaks to the appropriate remedy to be awarded if liability is established on the theory plaintiff has espoused, and bears on the question whether prosecution of this case should be coordinated somehow with the other actions going forward.
Rohrer Decl. Ex. 1, § 7. The Exercise Agreement was not attached to the Amended Complaint, but it is plainly integral to Lee's claims. Thus, I may consider it at this procedural stage. See Santa Fe, 669 A.2d at 69-70.