In September 2009, Dell Inc. (“Dell”) agreed to settle a shareholder derivative action claiming breach of fiduciary duties by certain past and present Dell officers, employees and directors. As part of that settlement, which followed an investigation into its past accounting and financial reporting practices, Dell agreed to institute certain corporate governance reforms, including agreeing that its board of directors would be comprised of at least a substantial majority of independent directors.
Background to Litigation
In August 2006, Dell announced that the U.S. Securities and Exchange Commission (“SEC”) had commenced an investigation into certain of Dell’s accounting and financial reporting practices in August 2005, and that, as a result of SEC’s investigation, Dell’s Audit Committee had commenced its own investigation into such practices.
In August 2007, Dell announced that the Audit Committee investigation had been completed, and that Dell would be restating financial results for 2003 through to 2007 after the investigation found that Dell had overstated sales by US$359 million and profit by US$92 million during that period (the “Restatement”).
The Audit Committee’s investigation referenced numerous accounting issues, most of which involved adjustments to various reserve and accrued liability accounts. The investigation identified evidence that certain adjustments, that sometimes involved senior executives, may have been motivated by the objective of attaining financial targets, and that such activities typically occurred at the close of a quarterly period. The investigation found that, in some cases, incorrect or incomplete information about these activities was deliberately provided to internal or external auditors.
Shareholder Derivative Action and Settlement
In 2006 and 2007, after Dell’s announcement of the SEC investigation, certain shareholders of Dell (the “Plaintiffs”) commenced shareholder derivative actions in Texas that were consolidated into one action. The Plaintiffs alleged that certain of Dell’s past and present officers, employees and directors (the “Defendants”) breached their fiduciary duties by (i) engaging in insider trading, (ii) failing in their oversight responsibilities, and (iii) making or permitting material, false, and misleading statements to be made concerning Dell’s business prospects, financial condition and expected financial results which allegedly inflated Dell’s stock price. On September 11, 2009, Dell and the Defendants agreed to a settlement of all claims. Dell also agreed to pay the Plaintiffs’ legal fees and expenses of US$1.75 million. Despite the settlement, the Defendants denied all claims made against them.
After the action was commenced, but before settlement was agreed to, Dell instituted certain remedial measures and corporate governance reforms. These reforms included (i) developing and implementing a remediation plan directed at the material weaknesses reported for Dell’s 2007 financial year, (ii) adopting an executive compensation recoupment policy, (iii) enhancing the finance function and establishing separate accounting and planning/forecasting functions, (iv) increasing the focus on review and monitoring by Dell’s accounting, internal audit and disclosure review functions, (v) enhancing recording procedures in connection with accrued liability and reserve accounting, (vi) establishing a global team of accountants for complex revenue recognition matters, and developing an accounting code of conduct and a global accounting training initiative, (vii) improving information systems, (viii) enhancing ethics and compliance training, resources and communication, (ix) enhancing its internal misconduct reporting and investigation process, (x) enhancing its Audit Committee charter to allow for anonymous employee complaints regarding internal controls or auditing matters, (xi) enhancing and clarifying the general qualifications each member of its board of directors should possess and the scope of responsibilities for various board committees, (xii) instituting ongoing selective training on insider trading and misuse of Dell information, and (xiii) adopting a new securities trading policy. Dell agreed to maintain the above reforms for at least four years, unless a majority of Dell’s independent directors voted otherwise.
Dell also agreed to adopt additional corporate governance reforms, including (i) amending its corporate governance principles to provide that its board of directors must consist of a substantial majority (at least 60%) of directors meeting Dell’s standards for director independence, (ii) permitting Dell directors to attend, at Dell’s expense, an accredited director education program each calendar year, (iii) amending its corporate governance principles to provide that executive sessions of the independent directors must be held any time that an independent director requests and, in any case, during at least 60% of regularly scheduled board meetings, and (iv) amending its corporate governance principles to provide each director with complete and open access to Dell employees and eliminating the requirement to coordinate such access with the chairman of the board or Dell’s board liaison office.
Dell agreed to maintain the above additional reforms for at least four years from the date that they are adopted, unless a majority of the Dell’s independent directors voted otherwise.
The settlement’s instigation of the above-referenced corporate governance reforms appears to be a unique feature of this litigation, which took the form of a shareholder derivative action. These developments serve as a further reminder for issuers to ensure that they monitor compliance with internal controls and disclosure controls and procedures on an ongoing basis. As evidenced by the reforms in question, policies such as corporate codes of conduct, securities trading policies and whistleblower policies can be important tools in monitoring such compliance. Given the evolving nature of an issuer’s business and markets in general, issuers should review the adequacy of such policies regularly.