Steinhardt, Chen, et al. v. Occam Networks, Inc., C.A. No. 5878 (Del. Ch. Jan. 6, 2012) (Laster, VC)
Michael Steinhardt (“Steinhardt”) and Herbert Chen (“Chen” and collectively with Steinhardt, the “Plaintiffs”) traded shares of Occam Networks, Inc. (“Occam”) while serving as representative plaintiffs in a class action challenging the merger of Occam with and into Calix, Inc. (“Calix”). Vice Chancellor Laster granted defendants’ motion for sanctions with respect to Steinhardt, who actively traded on confidential information obtained from Chen, but denied the motion with respect to Chen, who inadvertently traded a small amount of Occam stock but had otherwise proven himself to be an effective class representative. The Vice Chancellor dismissed Steinhardt and his funds as class representatives, barred them from recovery in this litigation, required self-reporting to the Securities and Exchange Commission (the “SEC”), directed disclosure of their improper trading upon any future application to act as lead plaintiff, and ordered disgorgement of related illicit profits.
On September 16, 2010, Occam and Calix announced that the parties had entered into a merger agreement pursuant to which each share of Occam common stock would be converted into the right to receive $3.8337 in cash and 0.2925 shares of Calix common stock. The Plaintiffs wrote to the Occam board of directors setting forth their objections to the merger, and, in particular, the merger consideration. On October 6, 2010, the Plaintiffs commenced this action in the Court of Chancery, alleging that the Occam directors breached their fiduciary duties by approving the merger at an unfair price. Between October 29 and November 2, 2010, Chen sold 31,000 Occam shares at less than the announced merger price in an effort to generate liquidity in anticipation of entering into a confidentiality order that would limit his ability to trade. On November 12, 2010, the Vice Chancellor approved a stipulation and order requiring that confidential discovery material be used only for purposes of this litigation, and restricting the purchase, sale, or trades in the securities of any company, including but not limited to Occam and Calix, on the basis of confidential information contained in the confidential discovery material. Shortly thereafter, the Plaintiffs amended their complaint to include disclosure claims and moved to preliminarily enjoin the consummation of the merger. Thereafter, document production and depositions commenced. On December 28, 2010, when the defendants had nearly completed their document productions, Steinhardt began short selling his Calix common stock to both exit his position in Occam stock, and take advantage of the arbitrage spread that existed between Calix and Occam at the time. In total, he sold 589,097 shares of Calix common stock, which equated to selling 2,014,007 shares of Occam common stock based on the exchange ratio set forth in the merger agreement.
Steinhardt testified that he based his decision to short sell his shares of Calix common stock on his view that the hype surrounding Calix common stock from its IPO had inflated its share price and was unsustainable. However, at the time he decided to sell, Steinhardt was also receiving non-public information regarding the litigation from Chen. Because of his extensive knowledge and investment in Occam, Chen became actively involved in the document production, from which he learned information about the status of the litigation that he communicated to Steinhardt both orally and through written summaries. Chen was aware that Steinhardt was selling Calix shares short and disagreed with his decision to do so, but Chen did not inform Plaintiffs’ counsel about the short sales. On January 24, 2011, the Vice Chancellor held a hearing in open court and granted Plaintiffs’ motion to enjoin the merger pending the issuance of supplemental disclosures and the deposition of one of the lead bankers.
On January 25, 2010, Chen sold 2,500 shares of Occam stock to satisfy a margin call on his brokerage account. Chen testified that he accidentally sold Occam shares, which amounted to less than 0.5% of his holdings in Occam, because he was multi-tasking while executing the trade. He further testified that when he discovered that he had sold Occam shares by mistake, in violation of the confidentiality order, he chose not to violate it a second time by buying shares back. However, he failed to inform Plaintiffs’ counsel of the sale. Occam convened and adjourned its stockholder meeting, disclosed additional information, and, on February 22, 2011, obtained stockholder approval of the merger at the reconvened meeting. Thereafter, defendants requested discovery regarding the Plaintiffs’ trading activities. Steinhardt sought to avoid the requests by offering to step down as class representative, but defendants declined the offer and Chen moved for class certification without Steinhardt.
Vice Chancellor Laster first analyzed the motion for sanctions against Steinhardt by noting that when a stockholder of a Delaware corporation files suit as a representative plaintiff he voluntarily assumes the role of fiduciary for the class, thereby making it unacceptable for the plaintiff-fiduciary to trade on the basis of non-public information obtained through litigation. The Court found that Steinhardt sold Calix shares short with the benefit of information he received from Chen, whose insights were based on the discovery record and discussions with counsel, which allowed Steinhardt to conclude that the merger would be consummated without a change in the merger consideration. Thus, the Court concluded that Steinhardt used non-public information for his personal benefit, actions which constituted a breach of this fiduciary obligations as a representative plaintiff and in violation of the terms of the confidentiality order. The Court further determined that Steinhardt’s offer to step down as class representative did not moot the breaches. Consistent with prior rulings, the Vice Chancellor dismissed Steinhardt and his funds, barred them from receiving any recovery in the litigation, required them to self-report to the SEC, directed their disclosure of improper trading in any future application to serve as lead plaintiff, and ordered them to disgorge trading profits. The Vice Chancellor noted that while he could order disgorgement of all profits from trading on Occam and Calix shares, based on the facts of this case, that would constitute a disproportionate and punitive sanction. Thus, he limited the sanction to any advantage gained by Steinhardt’s position as representative plaintiff and trading before the injunction hearing, and calculated the amount to be disgorged by subtracting the merger cash consideration from the profits on trading on Occam and Calix shares and ordered Steinhardt to disgorge $534,071.45 as a sanction for the improper trades.
The Court found Chen’s trades to be materially different than Steinhardt’s trades. Chen first traded Occam shares before execution of the confidentiality order and before the defendants produced any non-public information. He later accidentally traded a small fraction of Occam shares by “fat finger error” soon after the preliminary injunction hearing which eliminated the principal benefit Chen obtained from accessing confidential discovery information. The Vice Chancellor further stated that he was troubled by Chen’s decision to continue providing Steinhardt with confidential information despite knowing that Steinhardt was shorting the Calix stock, but found that Chen had become very knowledgeable about Occam and the merger and had proven himself to be a motivated and effective representative plaintiff, and thus removing him from the litigation would significantly harm the class.