New York’s First Department recently issued a decision refusing to revive a stock-option backdating shareholder derivative lawsuit against Bed Bath & Beyond (“BB&B”) based upon the immediate remedial action taken by the directors of the home décor company. Wandel et al. v. Eisenberg et al., No. 4008, 2009 WL 6435 (N.Y. App. Div., 1st Dept . Jan. 13, 2009). The derivative plaintiff alleged that BB&B executives unfairly benefited from receiving undisclosed profits from stock options based on award dates that were dialed back to low points in the company’s stock history.
The Trial Court’s Dismissal
In March 2006, BB&B was identified by two securities analysts, Merrill Lynch and Deutsche Bank, for backdating stock-option grants. In response, BB&B’s board of directors appointed a special committee to conduct an investigation of the backdating allegations. In October 2006, BB&B publicly published the special committee’s findings, which “identified differences in the process of granting and documenting stock options,” in addition to finding that the people responsible for the accounting and disclosure functions at BB&B were unaware of the improper selection practices.
Following the issuance of the report, BB&B adopted new controls in its stock option awards process and reset the prices of unvested options to the appropriate levels, among employing other remedial efforts. Approximately nine days after BB&B published the special committee’s findings, BB&B investor, Arnold Wandel, along with other shareholders, brought a derivative action against the company. The defendant-directors successfully moved to dismiss the action for failure to adequately plead the demand futility. The plaintiff appealed that decision.
The First Department’s Decision
The appellate court agreed with the trial court’s conclusion that dismissal of the action was appropriate because the plaintiff failed to clear a preliminary hurdle with respect to the shareholder derivative action: the “pre-suit demand” test. This test, used by New York courts and courts in most other states, require that plaintiff-shareholders must give their directors the opportunity to review the allegations and take up the suit on behalf of the company. If the plaintiff declines to pursue a pre--suit demand, the plaintiff must be ready to show that the directors lacked independence, objectivity or information to give the allegations fair consideration.
The First Department concluded that the plaintiff’s amended complaint lacked the particularity required to support a finding of demand futility. Specifically, the complaint failed to allege a purposeful and egregious backdating scheme where the directors failed to question or investigate the company’s stock option issuance process and failed to do so. Most significantly, BB&B remedied the error by resetting the price of invested options and adopted other new controls recommended by its special committee and thus, the court found that there was a lack of evidentiary support for plaintiff’s claim.