(Article from Securities Law Alert, February 2015)
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On February 4, 2015, the First Circuit affirmed dismissal of a shareholder derivative suit against Smith & Wesson’s officers and directors on the grounds that an independent special litigation committee (“SLC”), acting in good faith and with a reasonable basis for its conclusions, had recommended against filing any claims. Sarnacki v. Golden, 2015 WL 467547 (1st Cir. 2015) (Lynch, C.J.). The court rejected plaintiff’s contention that two of the three SLC members “could not be independent” because they were named as defendants in the derivative suit, and also because they had “reviewed and approved many of the allegedly misleading statements” at issue. The First Circuit determined that “[t]here are no per se rules holding that” the independence of an SLC member “is destroyed by either naming [that] member as a defendant” in a derivative action, or by virtue of the SLC “member’s past approval of a disputed statement.”
The First Circuit explained that “[t]here are good reasons to reject such per se rules.” The court reasoned that “[i]f an SLC member’s status as a defendant in the litigation categorically subverted the independence of the committee, a shareholder would be able to manipulate the process: he or she would be able to name SLC members as defendants after the committee’s formation, thereby undercutting the legitimacy of its conclusions.” The First Circuit further observed that “[t]he realities of corporate governance, in which some corporations have small boards, suggest that an SLC will frequently include at least one director who also approved the relevant transaction.”
The First Circuit acknowledged that its rejection of such “per se rules” does not necessarily “mean that there is no cause for concern” when an SLC member is either a defendant in the action or approved the statements at issue. The court recognized that “[t]hose who are asked to evaluate conduct which they have approved may have a tendency not to find fault.” However, the First Circuit explained that under Delaware law, “a director is [considered] independent when he is in a position to base his decision on the merits of the issue rather than being governed by extraneous considerations or influences” (quoting Kaplan v. Wyatt, 499 A.2d 1184 (Del. 1985)). In the case before it, the First Circuit found that plaintiff had “offer[ed] no evidence of actual bias affecting any [SLC member] or of extraneous considerations having motivated either the [SLC’s] process or [its] ultimate recommendation.” The court also found it significant that the SLC had “not use[d] in-house counsel, a disapproved practice, but [instead had] chose[n] independent counsel.”
As to the scope of the SLC’s investigation, the First Circuit determined that there was “inadequate evidence to permit a reasonable finder of fact to conclude that [the] SLC counsel [had been] conflicted, that the SLC members [had] read too few discovery materials, or that the SLC’s involvement [had been] merely perfunctory.” To the contrary, the court found that “the SLC [had] relied on experienced independent counsel, reviewed relevant discovery materials, and released a lengthy final report, all indicia of a reasonable process and good faith.” The First Circuit held that Smith & Wesson had proved both the SLC’s independence as well as the SLC’s good faith and reasonable bases for its conclusions, and therefore affirmed dismissal of plaintiff’s derivative suit.