Opinion ID: 3214863
Heading Depth: 3
Heading Rank: 1

Heading: Failure to Disclose Pedersen’s Margined Stock

Text: SEC regulations require a company’s proxy statements to “indicate, by footnote or otherwise, the amount of shares that are pledged as security” by its officers and directors. 17 C.F.R. § 229.403(b); see id. § 229.10(a)(2). And it is a violation of Exchange Act § 14(a) to solicit a proxy in violation of SEC regulations, including § 229.403(b). See 15 U.S.C. § 78n(a)(1). ZAGG’s April 27 proxy statement did not report Pedersen’s margined stock, and Plaintiffs assert that this violation of § 14(a) exposed the Director Defendants to a substantial likelihood of liability. We can assume without deciding that Plaintiffs adequately pleaded that the Director Defendants knew of Pedersen’s margin pledges. What is missing, however, is an adequate basis in the complaint for an inference that the violation was knowing or intentional—that is, that the Director Defendants knew that such pledges had to be disclosed. Plaintiffs urge that such knowledge is reasonably inferred from the pleaded facts that all three Director Defendants “reviewed, approved, and signed [ZAGG’s] filings with the SEC,” Aplt. App., Vol. 1 at 61 ¶ 154, and that Larabee and Ekstrom, as members of the audit committee, were “responsible for overseeing the integrity of ZAGG’s financial statements,” id. at 59 ¶ 149. The district court properly refused to infer knowledge from these allegations. We doubt that board members are expected to know the minutiae of SEC regulations. We think it significant that the Delaware courts, whose experience and expertise in such matters is widely recognized, see Delaware Coal. for 20 Open Gov’t, Inc. v. Strine, 733 F.3d 510, 524 (3d Cir. 2013); Swope v. Siegel-Robert, Inc., 243 F.3d 486, 496 (8th Cir. 2001), do not think they are. Delaware cases do not infer knowledge of detail (factual or legal) merely from committee membership or execution of SEC filings, but require specific allegations from which one can infer knowledge. For example, in Guttman v. Huang, 823 A.2d 492 (Del. Ch. 2003), the plaintiffs alleged that the board knew of the company’s improper accounting practices. See id. at 496–97. The court refused to infer such knowledge because the complaint did not contain “well-pled, particularized allegations of fact detailing the precise roles that these directors played at the company, the information that would have come to their attention in those roles, and any indication as to why they would have perceived the accounting irregularities.” Id. at 503. In Wood, 953 A.2d at 139, plaintiffs alleged that defendant board members breached their fiduciary duty to value certain assets properly, in violation of the company’s internal policies, accounting standards, and federal law. To support the claim that the defendants knew their actions to have been wrongful, the plaintiffs alleged that the defendants had executed the company’s financial reports and served on its audit committee. See id. at 142. The court, however, ruled that the complaint did “not plead with particularity the specific conduct in which each defendant ‘knowingly’ engaged, or that the defendants knew that such conduct was illegal.” Id. It said that “Delaware law on this point is clear: board approval of a transaction, even one that later proves to be improper, without more, is an insufficient basis to infer culpable knowledge or bad faith on the part of individual directors.” Id. It could not infer knowledge from the plaintiffs’ allegations because “[t]he Board’s execution of [the 21 company’s] financial reports, without more, is insufficient to create an inference that the directors had actual or constructive notice of any illegality.” Id. In particular, it held that to infer knowledge from membership on an audit committee would run “contrary to wellsettled Delaware law.” Id. In short, “[a]s numerous Delaware decisions make clear, an allegation that the underlying cause of a corporate trauma falls within the delegated authority of a board committee does not support an inference that the directors on that committee knew of and consciously disregarded the problem.” South v. Baker, 62 A.3d 1, 17 (Del. Ch. 2012). Plaintiffs quote the ZAGG audit committee charter, but fail to explain how it compels a conclusion of knowledge. To be sure, one quoted provision states that “[t]he Audit Committee shall comply with the relevant rules and regulations of the SEC.” Complaint, Aplt. App., Vol. 1 at 35 ¶ 51. But it would be too much of a stretch to read this as requiring the committee members to have detailed knowledge of all SEC regulations. Corporations have lawyers and accountants for that purpose. Who would take on that responsibility as a board member? As was true in Wood, 953 A.2d at 142, “the Complaint alleges . . . violations of federal securities . . . laws but does not plead with particularity the specific conduct in which each defendant ‘knowingly’ engaged, or that the defendants knew that such conduct was illegal.” 4 4 Plaintiffs argued to the district court that the secret succession plan was itself evidence that the Director Defendants knew of the “illicit nature” of Pedersen’s pledges. They have dropped this argument on appeal, which is just as well, as the allegation of a secret succession plan is implausible. 22 Plaintiffs’ pleadings likewise fail to show that the Director Defendants knew that nondisclosure of the pledges violated a common-law fiduciary duty. Indeed, that may have been an impossible task, given the apparent lack of support for the existence of any such duty. The only case in point that we have found states the contrary. See Burekovitch v. Hertz, No. 01-cv-1277 (ILG), 2001 WL 984942, at  (E.D.N.Y. July 24, 2001) (“While a controlling shareholder’s decision to commit large quantities of his stock as security in margin trading undoubtedly has the potential to affect the price of that stock, plaintiff has not and cannot allege an affirmative duty imposed by common law to keep the public appraised of such a decision.”).