Mr. Hammerslough used a so-called "proportional decay" model to estimate the number of shares traded during the Class Period for which the class may recover damages. This model appears to assume that all investors are equally likely to trade, so that a "proportional" number of shares are assumed to come from shareholders who are long-term holders and from those who are "in-and-out" traders. Yet a share traded may have a much greater than proportional probability of being re-traded during the Class Period due to the disproportionate influence on trading of short-term traders, arbitrageurs, and similar market participants. Failure to weight the likelihood of trading to reflect the characteristics of trading peculiar to Oracle would likely result in a serious overestimation of aggregate damages. 59 Fordham L Rev at 834-840. Unfortunately, defendants failed to offer a substantial alternative analysis to enable the court to weigh the seriousness of this problem.
While settlement approval does not require aggregate damages to be determined with mathematical precision, the court has numerous questions about the methodology adopted by plaintiffs' damages expert. These questions need not be answered at the moment, however, because of other, and perhaps more serious, difficulties with plaintiffs' case.
In order to prevail on their claims, plaintiffs must, of course, prove that defendants acted with scienter. Ernst & Ernst v Hochfelder, 425 U.S. 185, 208-210, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976). The parties' submissions reveal little evidentiary support for plaintiffs' allegations about how and why defendants inflated the price of Oracle stock. Though there is evidence which suggests that defendant Jeffrey Walker, Oracle's chief financial officer, was concerned about Oracle's prospects for 1Q 1990 and that he might have wanted to shift contract revenue from 4Q 1989 to 1Q 1990, there is no evidence that Oracle's 4Q 1989 report on July 11, 1989, actually understated 4Q 1989 revenues. For example, though Oracle had hoped to finalize a large contract with Bechtel Software, Inc, before May 31, 1989 (the end of 4Q 1989), Oracle properly chose not to recognize revenue from the Bechtel contract until 1Q 1990 because the contract was not signed until June 1990. In fact, plaintiffs have presented no evidence to the court that Oracle improperly moved any contracts from 4Q 1989 to 1Q 1990.
Plaintiffs' allegations concerning Oracle's premature recognition of revenue in 2Q 1990 are similarly unsubstantiated. According to plaintiffs, one middle manager from Oracle claims that defendant Walker instructed him "to manage the P&L results as a first priority in order to support a planned securities offering." Plaintiffs' Memorandum in Support of the Settlement at 22. The offering, however, never took place, and there is no concrete evidence to show that defendants knew about any of the alleged revenue recognition problems. Consequently, even if Oracle did improperly recognize some contracts in 2Q 1990 as a result of employee mistakes or misconduct, plaintiffs would have great difficulty proving that the defendants themselves acted with scienter.
Plaintiffs' general allegations about Oracle's and Arthur Andersen's accounting practices also do not seem to hold much water. Arthur Andersen's expert, Joseph Lhotka, effectively rebuts Mr. Berliner's contention that Oracle's revenue recognition policy violated GAAP. Both accounting experts agree that Oracle and Arthur Andersen should have been guided by Accounting Principles Statement No. 4, which provides that revenue is generally recognized when "(1) the earnings process is complete or virtually complete, and (2) an exchange has taken place." As Mr. Lhotka points out, Oracle complied with this principle because it recognized revenue only after a customer committed to purchase software that Oracle had already developed. When a one-year licensing agreement was signed, the earnings process was virtually complete because Oracle had the software on hand; an exchange too place because the customer agreed to pay the licensing fee in exchange for Oracle's commitment to supply the software. Though defendants concede that Oracle employees did improperly recognize some contracts where software development was not complete or a client's commitment to pay was not legally binding, these instances are few and hardly reflect an intent to manipulate revenue reports.
Mr. Berliner also contends that Oracle and Arthur Andersen should have disclosed the magnitude of Oracle's receivables on long term licensing contracts, but Mr. Berliner cannot point to any accounting principle or law which mandates such disclosure. In the absence of such a requirement, Oracle's failure to disclose its receivables cannot be a basis for liability.
Finally, the evidence shows that Oracle did not hide its revenue recognition practices from the market. Oracle's 1989 10-K report (filed with the Securities and Exchange Commission on August 25, 1989) showed that it recognized revenue from the licensing of its software
either upon shipment of the product or at the time such agreements are effective (which in most instances is the date of the agreement) if the customer is creditworthy and the terms of the agreement are such that the amounts due within one year are noncancellable. The Company recognizes revenue at such time as it has substantially performed all of its contractual obligations.
Defendants have also submitted copies of investment analysts' reports which show that the investment community was aware of Oracle's revenue recognition practices even before the Class Period. Thus, even if plaintiffs could show that Oracle's revenue recognition practices violated GAAP, plaintiffs would have difficulty proving that they suffered any injury from these practices. See In re Apple Computer Securities Litigation, 886 F.2d 1109, 1115 (9th Cir 1989) ("in a fraud on the market case, the defendant's failure to disclose material information may be excused where that information has been made credibly available to the market by other sources").
As for the claims against Arthur Andersen, plaintiffs' evidence, at best, shows that the firm may have been lax in its auditing of Oracle. For instance, perhaps Arthur Andersen should not have permitted Oracle to recognize the $ 15 million in contracts in 2Q 1990, or should have forced Oracle to disclose earlier its August 27, 1990, financial restatement. There is no proof however, that Arthur Andersen deliberately or recklessly violated any duty it owed to the plaintiffs. In the absence of such proof, it is unlikely that plaintiffs could sustain their claims against Arthur Andersen. Ernst & Ernst v Hochfelder, 425 U.S. 185, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976). See also DiLeo v Ernst & Young, 901 F.2d 624 (7th Cir 1990).
Given the apparent dearth of evidence to support plaintiffs' claims, class counsel's decision to settle cannot be said to be unreasonable. Although Mr. Hammerslough opined that damages could exceed $ 200 million, the parties have presented virtually no evidence to support the liability theories upon which his estimate is based and plaintiffs' method of calculating damages appears wildly unreliable. Of course, a basic problem in any class action settlement approval process is that both sides are trying to support the settlement. Consequently, courts are frequently faced with the situation, such as this, in which one or both sides have little incentive to put forth their best case. Class counsel's memoranda in support of the settlement, for example, are replete with concessions about the weakness of their case. Given that the lawyers have taken such a non-adversarial posture, it is difficult for the court to perceive the true merits of each side's potential arguments. As there is no manifest indication that the parties have not dealt with the court in good faith, however, the court has no choice but to evaluate the evidence as it has actually been presented. Given the record before the court, the court can only find that the settlement is a reasonable, if not generous, one.
The derivative settlement is much more problematic. This stems in large measure from the inherent conflict between the interests supposedly protected by the class action and those benefitted by the derivative action. Beneficiaries of the former are persons who bought Oracle stock or call options during the Class Period, while beneficiaries of the latter are the current shareholders of Oracle. Because many of those who bought Oracle stock or options during the Class Period may very well have sold some or all of their Oracle shares, the two groups are by no means identical and their interests not coextensive. Inasmuch as almost all of the class settlement is to be funded by Oracle, it is the current shareholders who are paying to settle the class action; most of them will likely receive none of the proceeds of the class settlement and those who do will indirectly pay far more than they receive because of the legal fees and litigation and administrative expenses of the class action. In short, settlement of the class action results in a redistribution of wealth from Oracle's current shareholders to certain buyers of Oracle stock and options and, most especially, the lawyers for both the plaintiffs and defendants in the class action. In theory, settlement of the derivative suit should benefit the current shareholders. It is necessary, therefore, to inquire whether the current shareholders benefit from these interrelated settlements.
The sole benefit which the derivative settlement confers upon Oracle's current shareholders is a termination of the expenses associated with these lawsuits. As noted above, the settlement itself also mentions various administrative changes which the derivative litigation has supposedly spurred Oracle to undertake:
Oracle, the Derivative Plaintiffs, and Derivative Counsel agree that the Derivative Actions have conferred a real and substantial benefit upon Oracle. Since March 1990, when the Derivative Actions were first filed, Oracle has implemented important enhancements to its internal policies, systems, and controls in part because of the prosecution of the Derivative Actions, which enhancements address specific issues raised in the Derivative Actions. Among the enhancements are improvements to oracle's insider trading policy and improvements to Oracle's revenue recognition policies and practices.
Proposed Derivative Settlement Agreement, § 5.1. At the settlement approval hearing, the court commented that this description, standing alone as it did, provided no explanation of the nature of these "improvements" and no basis to determine whether these changes conferred any benefit upon Oracle. Accordingly, in their supplemental memorandum in support of the settlement, derivative plaintiffs' counsel provided the court with evidence that in 1991, Oracle amended its insider trading policy to discourage trading in Oracle stock by Oracle employees' family members, as well as by employees themselves. Furthermore, on more than one occasion since the derivative litigation began, Oracle has altered its revenue recognition policies. Principal changes that oracle has adopted include the following rules which apparently did not exist previously: (1) recognition is permitted only if contracts are received at Oracle headquarters before a quarter ends, rather than within four days of the end of a quarter; (2) shipment is required before revenue from long term software licenses can be recognized; and (3) contracts may only be recognized if they are free of contingencies or significant uncertainties. Derivative plaintiffs' counsel also retained an investment banker, Edward Elliott, who opined that, while the benefit created by the change in the insider trading policy is negligible, the accounting changes increased investor confidence in Oracle and conferred on Oracle and its shareholders an economic benefit in terms of increased share price which "vastly exceeds" the $ 750,000 fee request submitted by derivative plaintiffs' counsel.
Unfortunately, the record contains no evidence to support derivative plaintiffs' counsel's argument, and Mr. Elliott's assumption, that their lawsuit, rather than some other stimulus, actually caused Oracle to make these changes. In fact, the investment analysts' reports submitted by the parties show that the need to improve investor confidence in Oracle was itself a primary motivator behind Oracle's decision to change its revenue recognition policies. Fear of further class actions, such as the potentially costly one involved here, must also have provided Oracle with good reason to change its business practices.
Notably, the corporation itself has not offered an independent analysis of these issues. Consequently, the court still has only a murky understanding of the benefit which the derivative litigation has conferred upon Oracle. It is clear, however, that, at the same time that it denies Oracle any financial award, the settlement calls for Oracle to pay derivative counsel up to $ 750,000 and releases the individual defendants from any claims it might have against them. The derivative settlement thus confers a substantial benefit on the individual defendants and derivative plaintiffs' counsel. As with the class settlement, the brunt of the derivative settlement falls upon Oracle and indirectly, therefore, on its current shareholders.
The parties argue that the settlement is reasonable because derivative plaintiffs' claims are virtually meritless.
The record before the court supports the parties' contentions, as it contains little evidence to support plaintiffs' claims. Like those of the class plaintiffs, the derivative plaintiffs' mismanagement claims against the individual defendants seem dubious. The parties have also identified a number of faults with derivative plaintiffs' insider trading claims. First, while some of the individual defendants did sell their stock during the Class Period, the foregoing assessment of the class settlement shows that it is unlikely that Oracle's shares were in fact fraudulently inflated during this time. Second, none of the inside sales occurred when Oracle stock neared a peak price. Third, none of the sales amounted to more than a small fraction of each inside seller's total Oracle holdings. Based on this presentation of the evidence, the derivative plaintiffs appear extremely unlikely to prevail on their claims against the individual defendants, and the proposed settlement and dismissal of the derivative action would seem appropriate.
The court's analysis of the proposed settlement cannot end here, though, for the court is well aware that it has not received an unbiased portrayal of the merits of the derivative claims. The presentation of plaintiffs' counsel is biased because the settlement offers them a substantial fee, regardless of the benefit conferred on the corporation and its shareholders. See R. Clark, Corporate Law, § 15.7 at 657-659 (1986) (explaining that because settlement assures them a fee, derivative plaintiffs' attorneys generally have a strong incentive to settle even where the settlement is not in the corporation's best interest); Note, Independent Representation for Corporate Defendants in Derivative Suits, 74 Yale L.J. 524, 532 (1965) ("at settlement the probability that [derivative] plaintiff's counsel will be interested only in obtaining a lucrative fee may undermine his capacity to represent adequately the corporation' s shareholders").
The presentation on behalf of the individual defendants is similarly biased in favor of settlement, because the settlement absolves them of liability without requiring them to part with any return consideration. See W. Haudek,The Settlement and Dismissal of Stockholders' Actions - Part II: The Settlement, 23 Sw. L.J. 765, 770 (1969) (in a stockholder's derivative action, "the directors will * * *, as a rule, be hostile to the suit and cannot be effective champions of the corporate interests in the settlement talks"). The pressure on the individual defendants to settle is particularly strong because settlement ensures that the corporation may indemnify their litigation expenses, whereas a final adjudication of malfeasance would likely preclude indemnification. 8 Del C § 145(b); see J. Bishop, Sitting Ducks and Decoy Ducks: New Trends in the Indemnification of Corporate Directors and Officers, 77 Yale L.J. 1078, 1082-1083 (1968).
Under FRCP 23.1, the court has a duty to determine whether the settlement reasonably protects the interests of the corporation and its shareholders. Mathes v Roberts, 85 F.R.D. 710, 713 (SDNY 1980). Because of the absence of a disinterested presentation on behalf of the corporation, it is impossible for the court to perform this duty. As the record now stands, the court has before it only presentations from parties which have a vested interest in settlement.
In fact, when the settlement was first proposed to the court, the parties did not even mention Oracle's participation in the settlement approval process. After an inquiry from the court on June 16, 1993, Oracle's general counsel and the law firm of Morrison & Foerster, who together represent Oracle and the four insider defendants,
provided copies of a December 22, 1992, written consent to the derivative settlement. The four members of Oracle's seven member board who are not named defendants in the derivative action apparently approved the settlement. In response to the June 16 order, Morrison & Foerster and the general counsel also informed the court that Oracle's directors had decided to appoint the four non-defendant directors to a special settlement committee to decide whether to approve the settlements. On June 24, 1993, Morrison & Foerster and the general counsel forwarded to the court copies of a new written consent to the derivative settlement, dated June 23, 1993, and signed by the same four non-defendant directors on behalf of the special settlement committee.
In essence, then, Oracle's board terminated the derivative litigation in accordance with procedures similar to those discussed by the Delaware Supreme Court in Zapata Corp v Maldonado, 430 A.2d 779 (Del 1981), by establishing a committee of purportedly disinterested directors to ratify the settlement. In Zapata, the court sanctioned the assignment of disinterested board members to a special litigation committee, which has the power "to dismiss derivative litigation that is believed to be detrimental to the corporation's best interest." Id. at 786. Unlike Zapata, Oracle's special committee has not presented the court with a motion to dismiss, and the proposed derivative settlement is not an attempt by the board to deprive derivative plaintiffs of an action that they believe is worth carrying forward. But the proposed settlement does take the derivative claims away from Oracle, which is the real party in interest. As the Zapata court recognized, a special litigation committee's motion to dismiss is "analagous to a settlement in that there is a request to terminate litigation without a judicial determination of the merits." 430 A.2d at 787. See also Kaplan v Wyatt, 484 A.2d 501, 506-507 (Del Ch 1984), aff'd, 499 A.2d 1184 (Del 1985) (a special litigation committee's motion to dismiss "is a hybrid one, derived by analogy to a motion to dismiss a derivative suit based upon a voluntary settlement"). Oracle's special settlement committee, like the special litigation committee in Zapata, has decided to withdraw Oracle's claims against the individual defendants without receiving any return consideration. Although derivative plaintiffs' counsel have assented to this settlement, this fact does not materially distinguish the settlement from a Zapata-style termination because, as noted above, the fee offered to derivative plaintiffs' counsel renders their support of the settlement virtually meaningless for analytical purposes.
Zapata bears particular relevance because Oracle is a Delaware corporation. In Burks v Lasker, 441 U.S. 471, 486, 60 L. Ed. 2d 404, 99 S. Ct. 1831 (1979), the Supreme Court held that courts, when deciding whether to allow a corporation's independent directors to discontinue a derivative action, must apply the law of the state of incorporation. See also Johnson v Hui, 811 F. Supp. 479, 483 (ND Cal 1991). As in Zapata, then, this court must assess whether the special committee's decision to terminate the derivative action adequately protects the interests of the corporation and its shareholders.
The Zapata court established a two-part test for courts to determine whether to approve the termination of a derivative suits by a special committee:
First, the Court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. Limited discovery may be ordered to facilitate such inquiries. The corporation should have the burden of proving independence, good faith and a reasonable investigation, rather than presuming independence, good faith and reasonableness. If the Court determines either that the committee is not independent or has not shown reasonable bases for its conclusions, or if the Court is not satisfied for other reasons relating to the process, including but not limited to the good faith of the committee, the Court shall deny the corporation's motion. If, however, the Court is satisfied under Rule 56 standards that the committee was independent and showed reasonable bases for good faith findings and recommendations, the Court may proceed, in its discretion to the second step.
The second step provides, we believe, the essential key in striking the balance between legitimate corporate claims as expressed in a derivative stockholder suit and a corporation's best interests as expressed by an independent investigating committee. The Court should determine, applying its own independent business judgment, whether the motion should be granted.
430 A.2d at 788-789. The proposed derivative settlement fails at the first step of the Zapata test, because the record does not show that the directors who approved the settlement acted with the requisite independence and good faith.
Morrison & Foerster and Oracle's general counsel argue together that the disinterested directors' approval of the settlements meets the business judgment rule and adequately protects the interests of the corporation. As counsel point out, courts generally respect the business judgment of a disinterested majority of directors. See, e.g., Republic National Life Insurance Co v Beasley, 73 F.R.D. 658, 668 (SDNY 1977) ("the business judgment of an independent, disinterested board of directors that settlement * * * of a derivative action is in the best interests of the company and its shareholders is respected by the Courts"). Still, the "requirement of director independence inhers [sic] in the conception and rationale of the business judgment rule." Aronson v Lewis, 473 A.2d 805, 816 (Del 1984). Independence is not established by the fact that directors are no defendants in the derivative action. Thus, in Zapata, the court noted that:
Notwithstanding our conviction that Delaware law entrusts the corporate power to a properly authorized committee, we must be mindful that directors are passing judgment on fellow directors in the same corporation and fellow directors, in this instance, who designated them to serve both as directors and committee members. The question naturally arises whether a "there but for the grace of God go I" empathy might not play a role.
430 A.2d at 787 ; see also G. Dent, The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit?, 75 NW U L Rev 96, 111-114 (1980) (outlining how "the independence of [non-defendant] directors * * * may be compromised in many ways").
Since "independent" directors are often beholden to the defendant directors who appointed them, the retention of independent counsel by these directors provides one of the few safeguards to ensure the legitimacy of their acts and to aid the court in assessing the reasonableness of a derivative settlement or termination. See Messing v FDI, Inc, 439 F. Supp. 776, 782 n 8 (D NJ 1977). There is no indication, however, that any of the supposedly disinterested directors on Oracle's settlement committee ever conferred with independent counsel to discuss whether the proposed derivative settlement was in Oracle's best interests. Instead, the written consents indicate that these directors were advised by Oracle's own general counsel.
The role played by Oracle's general counsel in this litigation is distressingly ambiguous. Early submissions to the court, including the joint answer to the derivative complaint filed by Oracle and three of the insider defendants, indicated that the general counsel represented the insider defendants while Morrison & Foerster represented the corporation. More recently, all of the memoranda submitted on behalf of the corporation and the insider defendants in connection with the class and derivative settlements have listed Morrison & Foerster and the general counsel as jointly representing the corporation and the insider defendants. On July 19, 1993, the court issued an order querying the effect of the apparent sharing of counsel among the corporation and the insider defendants. In a marked change of tune, Morrison & Foerster and the general counsel jointly responded that the general counsel has represented only the corporation in the class and derivative actions. The response explained further that Morrison & Foerster has represented the insider defendants in both actions and Oracle in the class action. Morrison & Foerster and the general counsel aver that the appearances on the answer to the derivative complaint were inadvertently reversed and that the memoranda submitted in connection with the settlements listed Morrison & Foerster and the general counsel together merely "in order to shorten lawyer listings." Thus, counsel argue, Oracle has been represented by independent counsel - its own general counsel - throughout the derivative litigation.
Though the court's research revealed no cases which deal specifically with this circumstance, there is a substantial body of authority proscribing dual representation of corporate and individual defendants in a derivative action. See, e.g., Cannon v US Acoustics Corp, 398 F. Supp. 209 (ND Ill 1975), aff'd in part, rev'd in part, 532 F.2d 1118 (7th Cir 1976); Lewis v Shaffer Stores Co, 218 F. Supp. 238 (SDNY 1963); Messing v FDI, Inc, 439 F. Supp. 776 (D NJ 1977); Murphy v Washington American League Base Ball Club, Inc, 116 U.S. App. D.C. 362, 324 F.2d 394 (DC Cir 1963); Garlen v Green Mansions, Inc, 9 A.D.2d 760, 193 N.Y.S.2d 116 (1959); Dukas v Davis Aircraft Products Co, Inc, 129 Misc. 2d 846, 494 N.Y.S.2d 632 (Sup 1985); Essential Enterprises Corp v Dorsey Corp, 40 Del. Ch. 343, 182 A.2d 647 (1962).
The derivative action exists, after all, to benefit the corporation, not derivative plaintiffs' counsel or the individual defendants. See Cannon v US Acoustics Corp, 398 F. Supp. at 213. Dual representation is impermissible, particularly at the settlement stage, because:
If the same counsel represents both the corporation and the director and officer defendants, the interests of the corporation are likely to receive insufficient protection. An increased recovery for the corporation is wholly incompatible with the goal of limiting the defendants' liability. Defendants' counsel is thus placed in an untenable position, and more often than not he will succumb to the pressure to approve any settlement between the shareholder and his individual clients.
Note, Independent Representation for Corporate Defendants in Derivative Suits, 74 Yale L.J. 524, 532 (1965). See also New York City Bar Association Committee on Professional and Judicial Ethics, Opinion 842, 15 Record of NYCBA 80 (1960).
Contrary to the assertions of defense counsel, representation of the corporation's interests by in-house counsel does not ameliorate this conflict, for in-house attorneys are inevitably subservient to the interests of the defendant directors and officers whom they serve. See G. Dent, The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit?, 75 NW U L Rev 96, 117 n 113 (1980) ("the corporation's house counsel or regular outside counsel * * * are too financially dependent on the board to be disinterested"); Note, Developments in the Law - Conflicts of Interest in the Legal Profession, 94 Harv L Rev 1244, 1342 (1981) ("while the inhouse attorney is nominally the representative of the corporation, his personal loyalties will inevitably be to the individual executives who hired him"). Corporate representation by in-house counsel in derivative litigation involving a public corporation also creates an appearance of impropriety which casts a shadow over the entire proceeding, particularly where corporate counsel advocates a settlement that is highly favorable to the individual defendants who are his superiors. See Rowen v Le Mars Mutual Insurance Co of Iowa, 230 N.W.2d 905, 915-916 (Iowa 1975); Note, Derivative Actions - Rowen v Lemars Mutual Insurance Co - Disqualification of Corporate Counsel and Appointment of Independent Counsel, 2 J. Corp. L. 174, 180 (1976).
The cases on dual representation recognize these problems and require corporations involved in derivative suits to retain counsel with no prior ties to the individual defendants or the corporation. Garlen v Green Mansions, Inc, 9 A.D.2d 760, 193 N.Y.S.2d 116, 117 (1959) (appearance by a corporation in a derivative suit "must be by independent counsel whose interests will not conflict with those of the individual defendant"); Lewis v Shaffer Stores Co, 218 F. Supp. 238, 240 (SDNY 1963) ("it would be wise for the corporation to retain independent counsel, who have had no previous connection with the corporation, to advise it as to the position which it should take in this controversy"); Messing v FDI, Inc, 439 F. Supp. 776, 782 (D NJ 1977) ("Independent counsel for the corporation, unshackled by any ties to the directors, would be in the unique position of having only the corporation's interest at stake"); see also Note, Independent Representation for Corporate Defendants in Derivative Suits, 74 Yale L.J. 524, 534-535 (1965). Compare Schmidt v Magnetic Head Corp, 97 A.D.2d 151, 468 N.Y.S.2d 649 (1983) (denying motion to disqualify corporate counsel in dispute over board membership where counsel had no prior connection with corporation or its directors). It is also clear that an inanimate corporate entity, which is run by directors who are themselves defendants in the derivative litigation, cannot effectively waive a conflict of interest as might an individual under applicable professional rules such as Cal R Prof Conduct 3-600(E) and 3-310. Note, Independent Representation for Corporate Defendants in Derivative Suits, 74 Yale L.J. 524, 534-535 (1965); New York City Bar Association Committee on Professional and Judicial Ethics, Opinion 842, 15 Record of NYCBA 80 (1960); Note, Disqualification of Corporate Counsel in Derivative Actions: Jacuzzi and the Inadequacy of Dual Representation, 31 Hastings L.J. 347, 360 (1979).
In the matter before the court, the conflict of interest could not be stronger. The general counsel, of course, is an employee of Oracle. At the same time, the defendants in the derivative action include three of Oracle's senior executive officers - Lawrence Ellison, Robert Miner, and Gary Kennedy - and three of Oracle's current directors - Ellison, Miner, and Donald Lucas. It seems indubitable, then, that the general counsel would be reluctant to recommend that the corporation take any position adverse to these men, individual defendants for whom he works on a day-to-day basis and who control his future with the corporation.
The settlement committee's reliance on the inherently biased advice of in-house counsel makes their approval of the settlement worthless for purposes of analyzing whether the settlement reasonably protects the interests of the corporation and its shareholders. As one court noted in the context of a union derivative action, "the organization is entitled to an evaluation and representation of its institutional interests by independent counsel, unencumbered by potentially conflicting obligations to any defendant officer." International Brotherhood of Teamsters v Hoffa, 242 F. Supp. 246 (D DC 1965). Here, because Oracle's special settlement committee lacked independent counsel, the derivative settlement reeks of collusion between derivative plaintiffs' counsel and the individual defendants, at the expense of the corporation. This is not to say that the terms of the proposed settlement are in fact unreasonable, but the court cannot fairly conclude otherwise based on the suspect presentations it has so far received.
The posture of this settlement stands in stark contrast to Sullivan v Hammer, P 95,415 Fed Sec L Rptr (CCH) 97,061 (Del Ch 1990), where the court approved the derivative settlement only after receiving assurances that the special committee charged wit evaluating the settlement was advised by independent counsel. See also Johnson v Hui, 811 F. Supp. 479, 487 (ND Cal 1991) (in assessing independence of special litigation committee which terminated derivative litigation, court notes that law firm representing special litigation committee had no prior contacts with corporation or the individual defendants). Unlike the special committee in Hammer, the Oracle special settlement committee acted without the benefit of disinterested legal advice on the merits of the derivative action. Oracle's decision to settle and dismiss the derivative action simply does not satisfy the independence and good faith requirements of Zapata.
For the foregoing reasons, approval of the derivative settlement is DENIED. Because the proposed class settlement is conditioned on dismissal of the derivative action, approval of the class settlement must also be DENIED.
Before examining the alternatives for resolution of the derivative suit, it should be noted, as class counsel have recently reminded the court, that the class settlement agreement permits the defendants to waive settlement of the derivative settlement as a condition to their final consent to the class settlement. Since the court is satisfied that the class settlement, with the exception of the added $ 200,000 expense provision, is reasonable, should defendants waive approval of the derivative settlement as a condition to their consent, the court is prepared to approve the class settlement agreement, minus the added expense provision, forthwith.
Whether or not the defendants choose to follow this course, the corporation must, before proceeding further with the derivative action, retain independent counsel having no prior relationship with the corporation or the individual defendants. Although some courts have gone so far as to appoint corporate counsel in derivative actions, see Rowen v Le Mars Mutual Insurance Co of Iowa, 230 N.W.2d 905 (Iowa 1975); Niedermeyer v Niedermeyer, P 94,123Fed Sec L Rep (CCH) 94,492 (D Ore 1973), it seems more appropriate here to defer to the independent directors on the selection of corporate counsel. Tydings v Berk Enterprises, 80 Md. App. 634, 565 A.2d 390 (1989); Messing v FDI, Inc, 439 F. Supp. 776, 783 (D NJ 1977). "Certainly new counsel will recognize their duty to represent solely the interests of the corporate entity. And should difficulties arise, the parties or counsel may apply to the court for additional relief." Cannon v US Acoustics Corp, 398 F. Supp. 209, 220 (ND Ill 1975).
Once the independent directors have retained independent counsel, the corporation would seem to have three options for resolution of the derivative suit: settlement, termination, or trial. While the court's role is not, of course, to advise the corporation on litigation strategy, if the investigation of independent counsel confirms derivative plaintiffs' case to be as weak as the parties have so far presented it, then termination of the derivative suit would seem the most sensible course to take. In any event, under Delaware law, a final decision on these issues depends in large part on the business judgment of the independent directors, after they have persuaded the court that they carried out a good faith investigation into the merits of the derivative action in accordance with Delaware law.
The parties shall appear for a status conference on September 10, 1993, at 2 p.m., to discuss these matters, and shall submit brief written reports not later than five days in advance of the conference.
VAUGHN R. WALKER
United States District Judge