Summary
finding a credible basis to suspect wrongdoing based a restatement of financial statements that led to public admissions of accounting irregularities, eight high level executives being terminated or resigning, and the institution of criminal proceedings by federal authorities
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Civil Action No. 18553
Date Submitted: May 7, 2001
Date Decided: July 10, 2001
Pamela S. Tikellis and Robert J. Kriner, Jr., of CHIMICLES TIKELLIS, LLP, Wilmington, Delaware; OF COUNSEL: Robert S. Green and Robert A. Jigarjian, of GIRARD GREEN LLP, San Francisco, California, Attorneys for Plaintiff.
Thomas J. Allingham II, Anthony W. Clark and Paul J. Lockwood, of SKADDEN, ARPS, SLATE, MEAGHER FLOM LLP, Wilmington, Delaware; OF COUNSEL: Jonathan J. Lerner, of SKADDEN, ARPS, SLATE, MEAGHER FLOM LLP, New York, New York, and James E. Lyons, of SKADDEN, ARPS, SLATE, MEAGHER FLOM LLP, San Francisco, California, Attorneys for Defendant.
MEMORANDUM OPINION
The plaintiff, Noel Saito, is currently a shareholder of record of McKesson HBOC, Incorporated ("McKesson HBOC" or "defendant"). Through this action, he seeks, pursuant to 8 Del. C. § 220, court-ordered access to certain books and records of the defendant. A trial was held on May 7, 2001. This Opinion constitutes my decision in the case.
I. FACTS
I limit my recitation to only those facts germane to the present dispute. Thus, some of the details of the transactions and the parties will be discussed in a very abbreviated manner. For a complete and detailed description of the facts, see my discussion in the related case, Ash v. McCall, Del. Ch., C.A. No. 17132, Chandler, C. (Sept. 15, 2000), mem. op. ("Sept. Decision").
A. The Merger
On October 17, 1998, McKesson Corporation ("McKesson"), HBO Company ("HBOC"), and McKesson Merger Sub, Incorporated entered into an Agreement and Plan of Merger that provided for McKesson's acquisition of HBOC in a stock-for-stock transaction. The transaction closed on January 12, 1999, and the name of the combined company was changed to McKesson HBOC, Incorporated ("McKesson HBOC"). The plaintiff purchased his original McKesson shares on October 20, 1998, and continues to hold McKesson HBOC shares today.
B. The Restatement
Three months after the merger, in April 1999, McKesson HBOC publicly announced that its auditors had discovered certain accounting irregularities in HBOC's financial records. Specifically, the auditors found that certain contingent software sales at HBOC had been recorded as revenue despite the contingencies. Ultimately, on July 14, 1999, McKesson HBOC announced that it would have to restate its financial statements in a total amount that exceeded $325 million.
C. The Aftermath
Shortly after the announcement of the restatement, plaintiffs in several jurisdictions filed lawsuits against both McKesson HBOC and its subsidiary HBOC. One such lawsuit is a currently-pending derivative action filed in this Court by the plaintiff and several other plaintiffs. This lawsuit is captioned Ash v. McCall and has been assigned Civil Action Number 17132. On September 15, 2000, this Court issued its Opinion regarding the then-pending motions to dismiss the Ash case. In that Opinion, the Court dismissed all of the plaintiffs' claims but granted leave to amend the complaint to reassert certain claims not dismissed with prejudice. Moreover, the Court invited the plaintiffs to use the "tools at hand . . . to develop additional particularized facts in order to allege properly an oversight claim that will meet the demand futility standard and to avoid the standing requirement of Delaware's continuing ownership rule."
See Ash v. McCall, supra, n. 1.
Id. at 47.
Of the multiple plaintiffs in the Ash case, one chose to heed the Court's advice and demanded access to corporate books and records under 8 Del. C. § 220. After several procedurally deficient attempts, on February 7, 2001, the plaintiff served the defendant with a proper demand letter demanding access to certain of the defendant's books and records.
In the demand letter, the plaintiff stated the purpose for making the demand as follows:
The examination and inspection of the books and records demanded herein is requested for the purpose of enabling Mr. Saito, through his duly empowered attorneys: (1) to further investigate breaches of fiduciary duties by the boards of directors of HBO Co., Inc., McKesson, Inc., and/or McKesson HBOC, Inc. related to their oversight of their respective company's accounting procedures and financial reporting; (2) to investigate potential claims against advisors engaged by McKesson, Inc. and HBO Co., Inc. to the acquisition of HBO Co., Inc. by McKesson, Inc.; and (3) to gather information relating to the above in order to supplement the complaint in Ash v. McCall. et al., C.A. No. 17132 in accordance with the September 15, 2000[,] Opinion of the Court of Chancery of Delaware.
Pl.'s Trial Ex. 6.
To foster those three purposes, the plaintiff seeks access to the following eleven categories of books and records:
1. All sales agreements and documents related to sales agreements (including documents, which have been referred to as "side letter," containing terms and conditions of any agreements not included within the agreement itself) between HBO Co. ("HBOC") or [McKesson HBOC, Inc.] and [33 certain specified entities identified in actions filed by the Securities Exchange Commission and the Department of Justice.]
2. All documents evidencing communications between the following persons and entities or representatives thereof regarding: (i) "side letters"; (ii) backdating of sales contracts; (iii) sales contingent upon terms not contained within the main sales contract; or (iv) accounting practices at HBOC, McKesson HBOC, or HBOC and the post-merger subsidiary of the Company ("HBOC sub"):
a. HBOC or HBOC sub and any [of the 33 entities identified in the first request]; b. Arthur Andersen and any entities identified in [Request No. 1] above; c. Bear Sterns and any entities identified in [Request No. 1] above; d. Arthur Andersen and [B]ear Steams; e. Arthur Andersen and Deloitte Touche; f. Bear Steams and HBOC or HBOC sub; g. Arthur Andersen and HBOC or HBOC sub; and h. Deloitte Touche and HBOC or HBOC sub.
3. All documents concerning Arthur Andersen's pre-merger review of the internal controls of HBOC.
4. All documents concerning verification by Arthur Andersen of any representations about revenues and/or expenses made by HBOC management during the due diligence process in preparation for or in connection with HBOC's merger with McKesson, Inc. (McKesson").
5. All documents related to or reflecting the verification by McKesson, its employees, directors or advisors that the revenues and/or expenses reported in the financial statements of HBOC that were incorporated by reference in the amended joint proxy statement, issued in connection with the merger between McKesson and HBO Co., were properly and accurately reported.
6. All documents reflecting the reaction of an [sic] discussions among or communications with any members of the Board of Directors of HBOC, McKesson or McKesson HBOC concerning (i) reports dated April 14, 19997 [sic] and August 19, 1998[,] by the Center for Financial Research and Analysis (CFRA); (ii) any other published public analysis of the accounting practices of HBOC prior to and following HBOC's merger with McKesson; (iii) any public response to such published reports by any employee of HBO Co.; or (iv) any HBOC, McKesson or McKesson HBOC shareholder reaction to such published reports.
7. All documents relating to or reflecting communications among of [sic] between members of HBOC management and/or HBOC's board of directors concerning HBOC's purpose in pursuing a merger with McKesson or any other entity between January 1, 1997[,] and October 17, 1998.
8. All documents concerning the decision to change the structure of the merger of HBOC and McKesson from a "merger of equals" to an acquisition of HBOC by McKesson.
9. All documents, including board minutes or other documents evidencing any communications with or among HBOC's or McKesson HBOC's Board of Directors related to the termination or resignation of the following individuals: Jay Gilbertson, Albert Bergonzi, Charles W. McCall, Mark A. Pulido, David Held, Jay Lapine, Michael Smeraski and Dominick DeRosa.
10. All documents concerning SEC, Department of Justice or any other governmental agency investigation of any individual listed in Request No. 9 above, or any other employee of HBOC, McKesson, McKesson HBOC or HBO sub between January 1, 1997 and the present.
11. All documents reflecting discussions among or communications with McKesson HBOC's management or members of its Board of Directors about whether to initiate litigation against any past or present employee of HBOC, McKesson HBOC or HBO sub or against any advisor to or auditor of any of the foregoing entities in connection with the restatements of HBOC's and/or the Company's financial results for fiscal year 1997, 1998 and 1999.
Id.
In general, the defendant objected to producing most, if not all, of the categories of documents and records the plaintiff seeks. Despite the continuing objections, it did eventually supply the plaintiff with approximately 1000 pages of documents to which it believed the plaintiff was entitled had he a proper purpose (which the defendant argues he does not). The documents produced consisted of: (1) certain minutes from the meetings of the McKesson HBOC Board; (2) certain minutes from the meetings of the McKesson HBOC audit committee; (3) tolling agreements between McKesson HBOC and numerous third parties that protect McKesson HBOC's litigation rights; (4) employment and termination agreements between McKesson HBOC and former employees identified in the demand; (5) correspondence relating to McKesson HBOC's retention of its auditors; and (6) reports to the McKesson HBOC Board regarding auditing or accounting issues.
The defendant argues that the plaintiff is not entitled to other books and records because they are beyond the scope of his asserted purposes; the plaintiff is not entitled to documents relating to claims which he has no standing to pursue; the plaintiff is not entitled to documents from the wholly-owned, and legally distinct, subsidiary HBOC; and, the plaintiff is not entitled to records of third parties that the defendant has in its possession as a result of formal and informal discovery in various lawsuits.
The parties have fully briefed their respective arguments and the matter was tried before the Court on May 7, 2001. This is my post-trial decision.
II. ANALYSIS
The Delaware General Corporation Law expressly provides shareholders with the right to inspect the books and records of the corporations in which they have an ownership interest. This right, however, is not absolute. A shareholder seeking access to the corporation's books and records must demonstrate (1) that the shareholder has demanded inspection of the records in the proper form and manner, and (2) that the shareholder has a proper purpose for making such a demand. A "proper purpose" means "a purpose reasonably related to such person's interest as a stockholder."
8 Del. C. § 220(b) provides in pertinent part that:
Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose the corporation's stock ledger, a list of its stockholders, and its other books and records, and to make copies or extracts therefrom. A proper purpose shall mean a purpose reasonably related to such person's interest as a stockholder.
See 8 Del. C. § 220(c). See also Security First Corp. v. U.S. Die Casting and Dev. Co., Del. Supr., 687 A.2d 563, 566-67 (1997).
If the Court finds that the shareholder has a proper purpose for making such a demand, the Court must determine the scope of the relief that shall be granted. "In determining the scope of inspection relief, the overriding principle is that only those records that are "essential and sufficient' to the shareholder's purpose will be included in the court-ordered inspection." The plaintiff bears the burden of meeting this standard. The scope of inspection afforded shareholders under this statute is narrowly tailored and is less far-reaching than typical discovery under Court of Chancery Rules.
Helmsman Management Services, Inc. v. A S Consultants, Inc., Del. Ch., 525 A.2d 160, 167 (1987). See also Security First Corp., 687 A.2d at 570.
Thomas Betts Corp. v. Leviton Mfg. Co., Inc., Del. Supr., 681 A.2d 1026, 1035 (1996).
See Carapico v. Philadelphia Stock Exchange, Inc., Del. Ch., C. A. No. 16764, Lamb, V.C. (Sept. 27, 2001), mem. op. at 10, n. 13.
After some initial skirmishes concerning the form and manner of the demand, there are no longer disputes as to the procedural propriety of the present demand. Rather, the defendant primarily challenges the plaintiff's purported purposes and the scope of relief to which he is entitled, if any.
The plaintiff has asserted three purposes for his demand. All three center around investigating and "ferreting out" allegations of wrongdoing regarding the merger of HBOC and McKesson. While there is one central theme to the three purposes, the plaintiff directs the inquiry towards two different groups: the various boards of directors and the advisors to those boards.
The defendant has expended great energy in arguing that the plaintiff, at deposition, has disavowed his proffered purposes in his demand letter. I find that defendant's narrow reading of his deposition testimony is unwarranted and somewhat misleading. Reading his deposition as a whole, I find that the plaintiff was, and is, concerned by the possible wrongdoing that might be the cause for the restatements. Thus, reading the record as a whole, I am convinced that the plaintiff has not disavowed the purposes set forth in the demand letter. See Security First Corp., 687 A.2d at 567-68 ("The failure of plaintiff's key witness to articulate certain "magic words' while testifying at trial is not fatal. . . . [W]e understand that the trial court considered the totality of the trial record in making its findings. Accordingly, we find that the Court of Chancery properly relied on all of the evidence adduced at trial" in determining whether the plaintiff had a proper purpose for making a demand.)
It is well settled that the investigation into corporate waste and mismanagement is a proper purpose for a books and records inspection under § 220. Moreover, "a stockholder may demonstrate a proper demand for the production of corporate books and records upon a showing, by a preponderance of the evidence, that there exists a credible basis to find probable corporate wrongdoing. The stockholder need not actually prove the wrongdoing itself by a preponderance of the evidence." The plaintiffs request will fail to meet this standard if it evinces a "mere curiosity or desire for a fishing expedition. But the threshold may be satisfied by a credible showing, through documents, logic, testimony, or otherwise, that there are legitimate issues of wrongdoing."
Security First Corp., 687 A.2d at 567.
Id. at 565.
Id. at 568. See also Thomas Betts, supra, showing that this purpose must be supported by credible record evidence.
I find that the record in this case evinces credible evidence of possible wrongdoing. McKesson HBOC was forced to restate its financial statements to reflect accounting irregularities totaling $325 million. This led to the public admission of the irregularities, the termination of certain high-ranking executives, and the institution of criminal proceedings by federal authorities. While the ultimate involvement or culpability, if any, of the defendant in this wrongdoing is unclear on this record, the plaintiff has met his burden at this stage to gain access to books and records to examine the defendant's conduct. Thus, to the extent that the plaintiff seeks access to the books and records of the defendant to foster this purpose, in general, I find that he has set forth a proper purpose for a demand. The full breadth of my finding, however, is limited.
First, for reasons discussed below, I find that this plaintiff has asserted a proper purpose for examining potential wrongdoing only as to the McKesson board, and the resulting McKesson HBOC board, from the time he purchased his stock. Thus, the plaintiff has not asserted a proper purpose for examining potential wrongdoing by the HBOC board or the McKesson board prior to the purchase of his shares. Moreover, for reasons also discussed below, I am not persuaded that this books and records action against McKesson HBOC is the appropriate vehicle for examining potential claims against non-party advisors involved in counseling the boards involved in the merger, and, thus, he is not entitled to books and records solely designed for that purpose.
For reasons unknown, this plaintiff, Saito, is the only plaintiff from the Ash case to file a books and records action. This is important because the original Ash plaintiffs counted among their number shareholders of all the various companies involved in this litigation. Saito, however, only purchased his shares three days after the acceptance of the merger agreement and, thus, held shares originally in McKesson and now in McKesson HBOC. He was never a shareholder of HBOC.
As I noted in the Ash opinion:
Section 327 of Delaware's General Corporation Law requires a shareholder plaintiff asserting derivative claims to allege that he was a stockholder of the corporation at the time of the transaction of which he complains. In addition to this statutory requirement, it is also settled law in Delaware that a derivative plaintiff must be a stockholder at the time he commences suit and must maintain such stockholder status throughout the course of litigation. This is known as the continuous ownership requirement.
Ash v. McCall, Del. Ch., C.A. No. 17132, Chandler, C. (Sept. 15, 2000), mem. op. at 31 (internal citations omitted).
Because this plaintiff, as the sole plaintiff in this action, cannot satisfy the continuous ownership requirement for bringing and maintaining a derivative suit against either HBOC or McKesson for conduct occurring before his purchase of McKesson shares, he has not shown that he has a proper purpose for investigating acts prior to that time and is not entitled to books and records designed to examine that pre-purchase conduct.
Accord, Landgarten v. York Research Corp., Del. Ch., C.A. No. 8417, Berger, V.C. (Feb. 3, 1988).
Moreover, plaintiff has offered no affirmative authority that would sanction the use of a § 220 action against a company to attempt to develop a separate and distinct cause of action against financial advisors to that company during a transaction. As noted above, I have found that the investigation of possible wrongdoing is a proper purpose. It is also well settled that a secondary "improper" purpose is generally irrelevant and not fatal. Here, however, rather than seeking documents for a proper purpose that might also happen to support an improper purpose, the plaintiff seeks categories of documents that go directly towards examining the conduct of certain advisors with the purported intent of developing claims against them. In this fashion, plaintiff has invoked his books and records statutory right as a vehicle for obtaining discovery implicating potential claims against third parties. Plaintiff offers nothing to support this use of § 220.
See Carapico v. Philadelphia Stock Exchange, Inc., Del. Ch., C.A. No. 16764, Lamb, V.C. (Sept. 27, 2000); Skouras v. Admiralty Enterprises, Inc., Del. Ch., 386 A.2d 674 (1978).
In summary, I conclude that this plaintiff has demonstrated a proper purpose in seeking to investigate corporate wrongdoing by the then-McKesson and now McKesson HBOC boards for acts or conduct by them following the purchase of his shares on October 20, 1998.
Having found that the plaintiff has identified a proper purpose for an inspection of the corporate books and records, the Court must now determine the scope of the relief that shall be granted. "In determining the scope of inspection relief, the overriding principle is that only those records that are `essential and sufficient' to the shareholder's purpose will be included in the court-ordered inspection." The plaintiff bears the burden of meeting this standard.
Helmsman, 525 A.2d at 167. See also Security First Corp., 687 A.2d at 570.
Thomas Betts Corp., 681 A.2d at 1035.
Because the scope of this plaintiffs "proper purpose" is limited as noted above, the scope of the examination to which he is entitled will similarly be quite limited. The plaintiff is effectively limited to examining conduct of McKesson and McKesson HBOC's boards following the negotiation and public announcement of the merger agreement. Thus, the scope of the examination will be limited to only those documents, or categories of documents, "necessary and sufficient" to foster that purpose. By this, I mean that the plaintiff, regardless of the denominated categories in his demand letter, is entitled to examine any books and records of McKesson and McKesson HBOC designed to ferret out possible wrongdoing by the boards of these two companies. This inspection, however, is temporally limited to those books and records reflecting the boards' conduct following his purchase of McKesson stock on October 20, 1998.
The scope of the plaintiffs Court-awarded inspection of books and records is also limited to those books and records of the company in which he owns, or owned, shares, here McKesson and McKesson HBOC. HBOC and HBOC sub are separate, subsidiary corporations from the parent McKesson HBOC. I do not find that the plaintiff has provided any evidence that the subsidiary was created to perpetrate fraud or that it is a mere alter ego of the parent, thus warranting disregard for its existence as a separate legal entity. Ultimately, while McKesson HBOC, as the parent, may have certain books and records of its subsidiaries in its custody or control, the plaintiff's inspection is limited to the books and records of the parent, McKesson or McKesson HBOC.
See Carpico, supra, mem. op. at 11; Skouras, 386 A.2d at 681; Landgarten, supra. The defendant, in its brief, argues that this Court's recent decision in Salovaara v. SSP, Inc., Del. Ch., C.A. No. 18903, Chandler, C. (Jan. 10, 2001), let. op., changes the law in this area by focusing on who, the parent or the subsidiary, has possession, custody, or control of the subsidiary's records. This misreads the Salovaara decision. There, the nature of the relationship among the parties was such that a finding that the subsidiaries were "alter egos" or instrumentalities of the parent was justified. There, the "parent" corporation was the general partner of an intermediate layer of limited partnerships that were, in turn, the general partners of the target "subsidiaries" (also limited partnerships). Of this three-tiered structure, only the target subsidiaries were operating entities. The "parent" and middle layer were both created primarily to build and support the structure involved. Thus, to the extent that the parent corporation had custody or control of financial records of these "subsidiaries," a shareholder of the parent could inspect the books and records of the subsidiary. The present action is different; HBOC had a completely separate existence prior to the merger with a separate board and separate books and records. Thus, there is no evidence that HBOC is so closely related to the parent that ignoring its separate corporate existence is appropriate.
III. CONCLUSION
I find that the plaintiff's proffered purpose for his demand, to examine allegations of corporate misconduct, is a proper purpose. That finding, however, is limited to the plaintiff's examination of corporate conduct following the purchase of his McKesson shares. Moreover, because he would lack standing to challenge the conduct of the HBOC and McKesson boards prior to his stock ownership, he has not shown that he has a proper purpose for investigating that same conduct. Plaintiff also has failed to persuade the Court that using a § 220 action against a company in which he owns shares is a proper vehicle for examining the conduct of third-party advisors to the company with the ultimate view of filing separate actions against the third-party advisors.
Finally, the scope of plaintiffs Court-ordered inspection is limited to those books and records of McKesson or McKesson HBOC designed to investigate conduct by the respective boards following the purchase of his shares. The parties are to work together, as best possible, to identify those records that are responsive to the scope identified above. To the extent those records have not previously been provided to the plaintiff, the defendant is hereby ordered to provide access to the books and records.
IT IS SO ORDERED.