Every company considering an IPO owes a hearty thanks to U.S. District Judge Robert Sweet of Manhattan for his decision Wednesday to dismiss four shareholder derivative suits against Facebook board members. Sweet’s painstaking 70-page opinion includes holdings that are great for Facebook’s defense of a parallel securities class action over its disclosures to IPO investors, but the judge also reached precedent-setting conclusions on standing and ripeness that will help other derivative defendants ward off IPO-based claims in state court. Facebook’s lead lawyers, Andrew Clubok of Kirkland & Ellis and Richard Bernstein of Willkie Farr & Gallagher, certainly deserve credit for coming up with innovative arguments to establish valuable precedent in IPO cases.
I believe Sweet’s ruling may have application beyond IPO derivative suits, though. The decision could represent a way for defendants to address the proliferation of derivative suits that are inevitably filed in multiple state courts after M&A deals are announced.
First, a refresher on the allegations and procedural background of the Facebook derivative suits. The complaints allege that under the direction of Facebook’s board, the company failed to make adequate disclosures to IPO investors about Facebook’s revenue projections and challenges in adapting to smart device usage. (If those sound an awful lot like securities class action claims, that’s because the derivative suits parallel a securities case against Facebook that is also before Judge Sweet.) Three derivative suits were filed in state courts in California. A fourth was filed in federal court in Manhattan. Defendants removed the three California cases to federal court in San Francisco. Then, before shareholders could litigate motions to remand them to state court, the Judicial Panel on Multidistrict Litigation transferred all of the derivative litigation to Sweet in Manhattan federal court.
Facebook made a number of arguments about why the derivative suits should be dismissed, most of which Sweet agreed with. In findings that will probably turn out to be the most useful for the company, the judge said that Facebook “repeatedly made express and extensive warnings” about the challenge of increased use of mobile devices and that the company was not obligated to disclose internal revenue projections. Sweet’s conclusion about the adequacy of Facebook’s warnings will help the company’s defense in the ongoing securities class action. And according to Facebook defense lawyers Clubok and Bernstein, all IPO issuers should be relieved by Sweet’s strong language on the disclosure of internal projections, in which the judge cited “courts throughout the country” that have “uniformly agreed” such internal calculations aren’t material.
“An opposite ruling on disclosure would have changed at least two decades of IPO practice,” Bernstein told me. “It would have been a revolutionary change.”