Southeastern Pennsylvania Transportation Authority v. Facebook, Inc., C.A. No. 2019-0228-JRS (Del. Ch., Oct. 29, 2019) (Slights, V.C.)
In this memorandum opinion, the Delaware Court of Chancery denied Plaintiffs’ demands to inspect certain books and records of Facebook, Inc. (“Facebook”) pursuant to 8 Del. C. § 220 (“Section 220”). The Court denied the demands because Plaintiffs failed to demonstrate a proper purpose to investigate possible breaches of fiduciary duty in connection with the compensation of Facebook executives during a time when Facebook’s revenue growth declined. In particular, the Court found that Plaintiffs failed to establish a credible basis to suspect that the Facebook board’s compensation determinations were motivated by bad faith. The Court also rejected the demands because Plaintiffs already had all the information necessary and essential to file a complaint to assert any claims.
Facebook generates almost all of its revenues through advertising sales, and, in connection with such sales, provides potential advertisers with certain metrics about advertisements on its platforms. In September 2016, Facebook publicly announced that it had overestimated the time its users spent watching video advertisements. News stories after that announcement indicated that some advertisers may reduce their advertising spending. Some advertisers also initiated lawsuits against Facebook because of the errors. In July 2018, Facebook publicly announced that it anticipated that its revenue growth rate decreased by 7 percent in the second quarter of 2018 and that it expected further decreases in both the third and fourth quarters of 2018. Despite the expected decreases in revenue growth rate, Facebook’s actual advertising revenue was still increasing. The next day, Facebook’s stock price dropped 19%, resulting in a $119.1 billion decrease in market value.
Soon after the stock price drop, Plaintiffs made their demands for inspection pursuant to Section 220, seeking to inspect documents relating to the Facebook board’s consideration of the advertising metric errors in connection with its executive compensation determinations. Facebook initially refused the demands, but ultimately agreed to produce board-level materials related to the advertising metric errors. Facebook later confirmed that it had produced all board-level materials and that the Facebook board’s compensation committee (the “Compensation Committee”) did not consider advertising metrics when making compensation decisions. Plaintiffs then brought this suit, seeking the Compensation Committee’s documents relating to advertising growth rates, as well as director independence questionnaires.
While Plaintiffs stated four purposes for their demands, the Court found that Plaintiffs’ primary purpose was to investigate possible breaches of fiduciary duty related to the compensation of executives. In determining whether that purpose was proper, the Court first explained that, because Facebook’s charter contained an exculpatory provision under 8 Del. C. § 102(b)(7), Plaintiffs would need to establish a credible basis to suspect a breach of the duty of loyalty. Plaintiffs did not assert that the Compensation Committee members were conflicted or did not act independently. Accordingly, Plaintiffs would need to demonstrate a credible basis to infer that the Compensation Committee acted in bad faith. The Court found that Plaintiffs could not meet that burden.
The first flaw the Court found was that Plaintiffs did not demonstrate a credible basis to infer that Facebook overcompensated its executives. The Court did not find any evidence that suggested that any salaries Facebook paid to its executives were inconsistent with Facebook’s goal to incentivize revenue growth.
Second, the Court found that Plaintiffs did not demonstrate a credible basis to support an inference that the stock price drop that occurred in July 2018 was related to the advertising metric errors that were announced in 2016. Plaintiffs argued that the two events were linked because a 2016 Wall Street Journal article stated that some advertisers had reduced advertising spend after disclosure of the errors. The Court found there was no evidence that suggested that the stock drop (preceded by a decrease in revenue growth rate that Facebook attributed to other factors) resulted from the advertising metric errors, particularly in light of the near two-year gap between the events.
Lastly, the Court found that Plaintiffs had not demonstrated a credible basis to infer bad faith. Plaintiffs claimed that the Compensation Committee acted in bad faith because it did not explore any link between reductions in revenue growth and the advertising metric errors while it awarded and increased compensation based on advertising revenue growth. The Court rejected this argument, stating that “[t]he fundamental flaw with Plaintiffs’ stated purpose is that their theory of wrongdoing strikes directly at the heart of the Board’s business judgment.” The Court held that not considering the advertising metrics when making compensation decisions did not imply bad faith. In reaching its decision that Plaintiffs failed to demonstrate a credible basis to infer bad faith, the Court also noted the following: (i) the Compensation Committee considered peer compensation and expert advice in making its compensation decisions, (ii) news stories proffered by Plaintiffs indicated that the advertising metric errors did not have a significant financial impact, and (iii) Facebook’s advertising revenues increased significantly during the relevant time period.
The Court also rejected Plaintiffs’ demands because they already had the information necessary and essential to assert any claims they may have, as Facebook had already stipulated that it did not consider advertising metrics when determining executive compensation.
The Court then proceeded to briefly address Plaintiffs’ three other stated purposes for inspection, rejecting all three. First, the Court found that any additional documents were not necessary and essential to Plaintiffs’ stated purpose of communicating with Facebook’s board or other stockholders because they already were aware of the following facts: (i) the amount of the Facebook executives’ compensation, (ii) the Board’s failure to consider the advertising metric error in determining the executives’ compensation, and (iii) Facebook’s performance during the relevant time period. Second, the Court held that Plaintiffs’ purpose to obtain information to determine how to vote on Facebook’s “Say On Pay” vote was not proper because the 2019 vote had already occurred, and the Court could not determine what would be relevant to the next scheduled vote in 2022. Finally, the Court held that the request for director questionnaires, which Plaintiffs made for the purpose of investigating demand futility, failed because there was no credible basis to suspect wrongdoing.