Direct Shareholder Claims Allowed in Apple Stock Backdating Scheme–but No Remedy

In New York City Employees’ Retirement System v. Jobs, a stock backdating scheme by Apple CEO Steve Jobs (and others) allegedly caused a 20% dilution in the issued shares of Apple, Inc., not authorized by shareholder vote. 

A shareholder class action lawsuit alleged a related proxy statement did not adequately disclose the backdated options.  The class action case sought (a) rescission of management’s vote for the backdated options and (b) compensatory damages to shareholders for the resulting 20% share dilution.

The Ninth Circuit Court of Appeals allowed direct class claims against Steve Jobs (and others) holding: ”Where a shareholder has been denied one of the most critical rights he or she possesses—the right to a fully informed vote—the harm suffered is almost always an individual, not corporate, harm.”

But the Ninth Circuit Court rejected any remedy for rescission of the vote or for compensatory damages for the 20% share dilution under the Private Securities Litigation Reform Act (PSLRA).

Shareholders argued for rescission of the backdated options in an effort to plead around the narrow economic loss rule of the PSLRA.

The Ninth Circuit Court rejected this distinction, holding: “the PSLRA does not differentiate between plaintiffs seeking legal and equitable remedies, and thus, without an allegation of economic loss, no remedy, equitable or otherwise, is available.”

It is becoming vanishingly difficult to plead ANY claim under the PSLRA.

Direct Claims Allowed

In the option backdating scheme, Steve Jobs allegedly acquired 630,000 extra shares, valued at over $50 million.  Other managers and employees also received backdated options.  The scheme allegedly caused 20% dilution in Apple stock not approved by shareholder vote.

The district court characterized the shareholder claims as derivative of the rights of the corporation, and dismissed the shareholders’ direct claims.

The Ninth Circuit Court reversed, ruling that a claim under Securities Exchange Act § 14(a) may be brought either as a direct or a derivative claim.

Whether a claim is direct or derivative is governed by the law of the state of incorporation, and “must be based solely on the following questions: Who suffered the alleged harm—the corporation or the suing stockholder individually —and who would receive the benefit of the recovery or other remedy?”

”Where a shareholder has been denied one of the most critical rights he or she possesses—the right to a fully informed vote—the harm suffered is almost always individual, not corporate, harm.”

But Remedies Rejected

Treating the claim as a direct claim under SEA §14(a) shareholders needed to allege loss causation.  Loss causation under the PSLRA requires a showing that the defendant “caused the loss for which the plaintiff seeks to recover damages.” 15 U.S.C. § 78u-4(b)(4).

The Supreme Court ruled in Dura Pharmceuticals that the loss causation rule of the PSLRA requires a plaintiff to prove both economic loss and proximate causation.  In well-pleaded § 14(a) claims, loss causation connects the proxy misstatements with an actual economic harm.

 In Dura Pharmaceuticals, the Supreme Court ruled under the PSLRA, an “artificially inflated purchase price is not itself a relevant economic loss.”

In the instant case, shareholders argued their economic loss was a diluted stock price that could be remedied by recission of management’s vote for the backdated options.  Therefore, shareholders argued, their claims should not be controlled by the Dura Pharmaceuticals ruling that rejected claims based on an inflated stock price. 

The Ninth Circuit Court rejected this distinction, holding: “the PSLRA does not differentiate between plaintiffs seeking legal and equitable remedies, and thus, without an allegation of economic loss, no remedy, equitable or otherwise, is available.”

While the Ninth Circuit Court gave plaintiff leave to allege claims under SEA §10(b) it is difficult to see how economic loss can be pled under SEA §10(b) that would show proper loss causation under the PSLRA, where loss causation could not be pled under SEA §14(a).

The net effect: a wrong without a remedy.

See a related discussion of Hemi Group, LLC v. City of New York regarding RICO damages causation.

Prevailing counsel was George Riley.

The Ninth Circuit panel included: Judge David R. Thompson, Judge Sidney R. Thomas and Judge Ann Aldrich, District Court Judge, District of Ohio.