The Delaware Court of Chancery, in Desimone v. Barrows, 924 A.2d 908 (Del. Ch. 2007), dismissed a stockholder derivative complaint alleging misconduct in the issuance of stock options by the board of directors of Sycamore Networks, Inc. (“Sycamore”). The Court dismissed the complaint because (i) plaintiff lacked standing to challenge options grants made prior to the time he acquired his shares and (ii) plaintiff failed to satisfy his burden of pleading demand futility. At the outset, the Court thoroughly distinguished the claims before it with those presented in the recent cases of Ryan v. Gifford and In re Tyson Foods, Inc. Cons. S’holder Litig. The Court also clarified the pleading standard required in derivative actions alleging stock option manipulation.

The Court first addressed whether plaintiff lacked standing to challenge any stock options grants made prior to plaintiff acquiring his Sycamore stock in February 2002. All but two of the allegedly improper options grants were made before plaintiff became a stockholder. The only options grants that occurred after plaintiff acquired his stock were a set of officer grants in December 2003. The Court rejected plaintiff’s argument that he had standing because “the conduct alleged in the complaint involved a pattern of ‘continuing wrongs’ persisting into the time period when he was a stockholder.” Thus, the Court concluded that plaintiff lacked standing to challenge any options grants made prior to plaintiff becoming a stockholder in February 2002.

Next, even though the Court held that plaintiff lacked standing to challenge all but two officer options grants, the Court analyzed whether all the claims of stock option manipulation could be dismissed pursuant to Court of Chancery Rule 23.1. In analyzing the viability of options grants claims, the Court categorized the option grants according to the recipients: employees, outside directors, and officers.

With regard to the employee options grants, the Court found that because plaintiff failed to demonstrate that the Sycamore directors were aware that certain options grants to employees were backdated, there was “no basis to conclude that the board faced a substantial threat of liability from claims.” Consequently, plaintiff could not show there was a reasonable doubt as to the board’s ability to consider those claims. The Court also rejected plaintiff’s oversight claim because plaintiff did not allege “any fact to suggest that Sycamore’s internal controls were deficient, much less that the board, the Audit Committee, or Sycamore’s auditors had any reason to suspect that they were or that backdating was occurring.” As a result, plaintiff failed to plead an oversight claim against Sycamore’s directors with particularity, and demand was not excused with respect to the employee options grants allegations.

With regard to the outside director options grants, the Court found that, although plaintiff satisfied his demand futility pleading requirements, plaintiff failed to state a claim under Court of Chancery Rule 12(b)(6) because the outside director options grants were issued in adherence with Sycamore’s stockholder-approved stock option plan. Importantly, the Court noted that, where a stockholder-approved plan permits options to be priced below market, it would be within the board’s exercise of business judgment to issue options at a low point in a trading period (as long as the directors satisfied its disclosure and other regulatory requirements).

With regard to the officer options grants, most of them involved allegedly backdated options, and the Court concluded that plaintiff had failed to allege that any member of the board had knowingly approved backdated options. Plaintiff also alleged, however, that defendants had timed an option grant to benefit from a recent stock price decrease and an expected stock price increase. The Court’s analysis focused on whether, at the time of the issuance of the option grant, the board had material, non-public information. The Court concluded that issuing stock options after negative news is disclosed would not ordinarily state a claim because those options would have been issued “at fair market value reflecting negative information previously disclosed to the public markets.” The same is not true, however, where options are spring loaded (i.e., issued before a positive announcement). Notwithstanding, the Court distinguished the plaintiff’s allegations of a single spring loaded grant from the allegations, made by the plaintiffs in Tyson Foods, of “multi-year pattern of large grants occurring at random times of year that preceded large, market moving announcements.”

The Court concluded that the Sycamore board was not exposed to personal liability regarding plaintiff’s claims. Therefore, because demand was not excused, plaintiff could not pursue such derivative claims.