A recent ruling by Vice Chancellor Donald F. Parsons, Jr. caused me to ponder why a case involving alleged misstatements in a proxy statement filed with the Securities and Exchange Commission wasn’t immediately tossed out on jurisdictional grounds. Pfeiffer v. Leedle, 2013 Del. Ch. LEXIS 272 (Del. Ch. Nov. 8, 2013) is a derivative suit alleging that the defendant directors breached their fiduciary duties by approving stock option grants to a company executive that exceeded the maximum number of stock options that could be granted to that individual under the corporation’s stock incentive plan. Unsurprisingly, the defendants moved to dismiss for both failure to make a demand and failure to state a claim. Here’s the statement that set me to thinking:

[Pfeiffer, the plaintiff] has stated a claim with respect to the Board’s alleged dissemination of a misleading Proxy Statement. Pfeiffer has pled particularized facts that the Board clearly violated the Plan. At this stage of the proceedings, those alleged facts support an inference that the Board knowingly or intentionally violated the Plan. Drawing all reasonable inferences in favor of Pfeiffer, as the nonmoving party, therefore, I conclude that it is reasonably conceivable that the Board knowingly or intentionally caused the Company to issue a Proxy Statement containing misleading statements that Leedle’s Stock Option grants were Performance Awards that were consistent with the Plan’s requirements. Accordingly, I decline to dismiss Pfeiffer’s claim that the Board breached its fiduciary duties by causing the Company to issue a materially misleading Proxy Statement

Why? I recalled that Section 27 of the Securities and Exchange Act of 1934 is very explicit on jurisdiction:

“The district courts of the United States … shall have exclusive jurisdiction of violations of [the Exchange Act] or the rules and regulations thereunder, and of all suits in equity and actions at law brought to enforce any liability or duty created by [the Exchange Act] or the rules and regulations thereunder.”

15 U.S.C. § 78aa. What could be more clear? Violations of the proxy rules, which are rules under the Exchange Act, must be pursued in the U.S. District Court. I did a little more digging and discovered that Vice Chancellor J. Travis Laster had addressed roughly the same question not quite four years ago in NACCO Indus. v. Applica Inc., 997 A.2d 1 (Del. Ch. 2009). That case involved allegedly false filings under Section 13 of the Exchange Act. The Vice Chancellor noted that Section 28 of the Exchange Act, which conveniently follows Section 27, provides that “[T]he rights and remedies provided by [the Exchange Act] shall be in addition to any and all other rights and remedies that may exist at law or in equity . . . .” 15 U.S.C. § 78bb. He also noted the Delaware Supreme Court had previously said “the federal statutory remedies of the Act over which the federal courts have exclusive jurisdiction are intended to coexist with claims based on state law and not preempt them.” Rossdeutscher v. Viacom, Inc., 768 A.2d 8, 17 (Del. 2001). After discussing cases dealing with removal to the federal courts and the federal courts’ exercise of jurisdiction under 28 U.S.C. § 1367, the Vice Chancellor concluded:

If a Delaware entity engages in fraud or is used as part of a fraudulent scheme, that entity should expect that it can be held to account in the Delaware courts.

But where is the line? Vice Chancellor Laster readily acknowledged in his opinion that a claim seeking to enforce Section 13 of the Exchange Act or asserting a claim for a violation of Section 13 could be heard only by a federal court and the Court of Chancery could not consider it. 997 A.2d at 25. The Vice Chancellor draws this line very narrowly, however. It seems that a claim will only be out of bounds if it is based on a “line item” requirement.