Hearsay OK, gimmicks not, in books and records: Dela. Judge

The seal of the Delaware Supreme Court is seen in Dover, Delaware U.S. REUTERS/Andrew Kelly

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  • Statement by Nvidia Corporation against the City of Westland Police and Fire Department System

  • Statement by Thomas & Betts Corporation v. Leviton Manufacturing Co

(Reuters) – The Delaware Supreme Court this week declined to restrict shareholders’ use of hearsay evidence to justify their demands for access to company books and records – but warned plaintiffs against abusing that latitude by they refused to fairly inform the defendants of their trial plans.

State judges in Nvidia Corporation v. City of Westland Police and Fire Retirement System ruled that Chancellor Kathaleen McCormick of the Delaware Chancery Court made no mistake in allowing shareholders to rely on hearsay evidence — statements contained in her original requests for Nvidia books and records, and plaintiffs’ responses to Nvidia’s interviews rather than giving testimony — to determine their ultimate purpose in locating company records.

In their request, shareholders claimed that they needed the internal records to investigate possible misconduct by the company in Nvidia’s handling of a sudden surge and subsequent decline in demand for graphics processors used by video gamers and cryptocurrency miners.

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Nvidia’s attorneys at Cooley and Richards, Layton & Finger, had argued that no Chancery Court judge had allowed shareholders to rely on hearsay evidence to establish an appropriate purpose for claims for books and records under Section 220 of the Business Code of Delaware without the consent of the defendants. Here, Nvidia argued, there was disagreement that the hearsay evidence was sufficient. In fact, the company said it repeatedly told shareholders prior to the trial, on their 220 demand, that Nvidia wanted an opportunity to challenge the legitimacy of its intentions, either by cross-examining a living witness or challenging the plaintiffs’ affidavits with affidavits Testify.

Delaware justices, in an opinion written by Judge Tamika Montgomery-Reeves, said that as early as 1996 the Supreme Court in Thomas & Betts Corporation v. who was nominated for a seat on the 3rd US Circuit Court of Appeals, said numerous subsequent Chancery Court decisions have relied on the evidence gap found in that ruling.

“It appears to us,” the judge wrote, “that Thomas & Betts has provided an answer to the hearsay question: hearsay is admissible in a Section 220 proceeding if that hearsay is sufficiently reliable.”

As the decision noted, preserving hearsay evidence is a boon to plaintiffs’ attorneys. Claims for books and records have become a fertile arena for litigation in recent years, with shareholders now routinely exercising their right to inspect internal company documents for evidence of derived breach of duty claims. The court’s explicit endorsement of the hearsay evidence exception gives shareholders one less concern in Section 220 litigation.

But the Supreme Court added an important corollary to Nvidia’s ruling: the vulnerability “should not be abused,” Montgomery-Reeves wrote. “Plaintiffs in a Section 220 proceeding must disclose their plans regarding witnesses. Such transparency ensures that companies can choose between issuing shareholders during investigations or calling shareholders as witnesses in court.”

The lawyers for the shareholders in the Nvidia case, the Supreme Court said, fell short in this regard. Prior to the trial, Nvidia asked plaintiffs to disclose whether they intended to subpoena witnesses to establish the purpose of their Section 220 request, according to Delaware judges. Lawyers for shareholders said they are considering affidavits instead.

Nvidia, which chose not to depose plaintiffs, said it needed to see the affidavit in advance to determine if it needed to depose. Shareholders only responded after the deadline for identifying trial witnesses, telling Nvidia they were ready to discuss testimony. Ultimately, the plaintiffs chose not to file an affidavit, instead citing previous court filings.

This tactic, Montgomery-Reeves wrote, deprived Nvidia of its right to question the purported purpose of shareholders. “This type of behavior creates the potential for shenanigans that should be discouraged,” the Supreme Court said. “If shareholders are to provide enough reliable hearsay to establish an appropriate purpose, they must communicate honestly and early on with companies of their intent so that companies can decide whether to remove shareholders or identify their own witnesses at the trial.”

McCormick had ruled that Nvidia was required to issue emails and other communications related to shareholders’ claims that top Nvidia executives benefited from stock sales based on inside information about supply and demand for the GPUs. Because the judges found that Nvidia shareholders were not sufficiently transparent about the evidence on which they relied, the Supreme Court reversed that ruling and remanded the 220 claim to McCormick, allowing Nvidia to deny the legitimacy of the shareholders’ claim can check from the records.

The Supreme Court dismissed several of Nvidia’s other arguments, including its claim that the Chancery Court judge was confused by the ever-changing demands of shareholders and ordered the company to produce documents that do not exist. “The Court of Chancery was far from confused,” the judges said, noting that McCormick’s disclosure order was based on allegations that emerged in a parallel securities class action following shareholders’ original Section 220 request for books and records.

The judges also said they believe the shareholders’ allegations met the lenient standard for determining a reasonable purpose for a Section 220 claim. “While this evidence would likely fall well short of what is required to support an actual claim, we cannot say that it is insufficient to satisfy the lowest possible burden of proof – a credible basis on which the Court of Chancery may be mismanagement that would warrant further investigation,” the court wrote.

Cooley and Richards Layton’s Nvidia attorney did not respond to my query. Nvidia has argued that shareholders’ insider trading allegations are entirely unfounded, as evidenced by the dismissal of the shareholder class action lawsuit in which the claims surfaced. Nvidia also claims that the supply chain issues were a brief setback from which the company — and its stock price — quickly recovered.

Rigrodsky Law shareholder attorney Seth Rigrodsky, who represented the case before the Delaware judges, did not respond to my email. Shareholders are also represented by Hach Rose Schirripa & Cheverie, Levi & Korsinsky, Robbins Geller Rudman & Dowd, Monteverde & Associates and Gainey McKenna & Egleston.

Continue reading:

Chancery’s harsh new message to defendants: ‘Egregious’ Section 220 fights will cost you dearly

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Alison Frankel

Thomson Reuters

Alison Frankel has been a Reuters columnist covering major trade disputes since 2011. A graduate of Dartmouth College, she has been a New York journalist for more than three decades, covering the legal industry and the law. Before joining Reuters, she was a writer and editor at The American Lawyer. Frankel is the author of Double Eagle: The Epic Story of the World’s Most Valuable Coin.

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