Vice Chancellor Strine of the Delaware Court of Chancery recently issued a significant decision, Desimone v. Barrows,C.A. No. 2210-VCS, 2007 WL 1670255 (Del. Ch. June 7, 2007) (Sycamore Networks), which clarifies that shareholders alleging wrongful backdating of stock options are required to plead both substantive wrongdoing and individual participation with a high degree of particularity. The opinion also suggests that claims based on "spring loading" (granting options just before the company releases positive information that will likely increase the stock price) and "bullet dodging" (granting options just after the company releases negative information so that the recipient benefits from a lower exercise price) may not survive unless the company made fairly explicit statements suggesting that it would not engage in such practices. Vice Chancellor Strine dismissed the complaint in its entirety.

Because Sycamore Networks was brought as a derivative action, plaintiff was required to demonstrate why it would have been futile to make a demand on the board before bringing suit. Plaintiff argued that a majority of the board faced a substantial likelihood of personal liability and therefore could not impartially consider a demand.

Plaintiff argued that members of the compensation committee were likely to be held liable because the committee was charged with administering the option plan. The court rejected this theory, finding that plaintiff failed to plead facts from which it could be inferred that any director "knowingly" engaged in wrongdoing, or any facts "about whether and to what extent any director was involved in the mechanics by which options were issued, or the dates on which administrative tasks were carried out." This pleading burden may be read as a departure from another recent backdating case, Ryan v. Gifford,918 A.2d 341 (Del. Ch. 2007), which many plaintiffs have read to suggest that merely pleading membership on the compensation committee is sufficient to show a substantial likelihood of liability.

Plaintiff also argued that the audit committee was likely to be held liable because it was at least negligent in failing to uncover backdating or prevent it from occurring. But the court was unimpressed by plaintiff's allegation that it was "apparently fairly widely known within the Company" that the directors were backdating. The court found that plaintiff failed to plead any "red flags" from which it could be inferred that any director had any reason to suspect backdating, or any facts to suggest any deficiency in Sycamore's internal controls.

With respect to plaintiff's "spring-loading" allegation, the court dismissed the claim, noting that "if directors consciously granted options in advance of the issuance of positive information as a bonus, disclosed their motivations candidly, and accounted for the options in good faith reliance on experts, it is difficult to perceive the existence of a fiduciary duty claim other than for excess compensation." The court also dismissed plaintiff's "bullet dodging" claim, noting that it was "skeptical that a bare allegation that a board of directors made a discretionary issuance of stock options at the market stock price after releasing negative information can ever be sufficient in itself to state a claim of director disloyalty, even when a stockholder-approved option plan requires fair-market-value grants." The court found that "there is no obvious reason why a company that wishes to grant its officers and employees stock options as an incentive to align the employee's interests with those of the company, cannot wait until after the company releases negative news to the market to grant the options."

In sum, Sycamore Networks is important because it suggests that Delaware will carefully scrutinize allegations of stock option manipulation to ensure that plaintiffs are describing conduct that, indeed, could be found wrongful or fraudulent, if proven; that plaintiffs state such claims with particularity; and that plaintiffs plead specific facts from which it might be inferred that each defendant knowingly participated in the fraud. The opinion is likely to have widespread impact, given that stock option lawsuits against Delaware corporations have been filed throughout the United States and those courts, charged with applying Delaware law, have been struggling to predict how the Delaware courts might resolve these issues.