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February 15, 2013

Facebook Derivative Claims Dismissed

By Matthew Garza, J.D.

Derivative claims brought by purchasers of shares of Facebook in its 2012 IPO were dismissed by the U.S. District Court for the Southern District of New York because the plaintiffs lacked standing, failed to make a pre-suit demand on the board, and their claims were not yet ripe (In re Facebook, Inc., IPO Securities and Derivative Litigation, February 13, 2013, Sweet, R.).

Allegations. The allegations against Facebook officers included breach of fiduciary duty, waste of corporate assets, and unjust enrichment. The plaintiffs maintained that Facebook failed to disclose that at the time of the IPO the company was experiencing a reduction in revenue growth due to an increase of users of Facebook through mobile devices rather than personal computers. They alleged that despite knowing about a reduction in advertising and declining internal revenue projections, Facebook took no action to stop its IPO from taking place. General Motors had announced on May 15, 2012 that it was pulling its advertising from Facebook because other forms of advertising were more effective, and despite this development, Facebook's final registration statement said the company had increased the IPO price range from between $28 and $35 to between $34 and $38. The court pointed out that the company had expressed caution about its revenue growth in its registration statement, saying that it believed the trend was driven by increased usage of Facebook on mobile devices, where ad revenue was lower. The action was removed on June 28, 2012 to the U.S. District Court for the Northern District of California as a covered class action under the Securities Litigation Uniform Standards Act (SLUSA). The action was then transferred to the Southern District of New York by the U.S. Judicial Panel on Multidistrict Litigation on October 4, 2012.

Forum selection clause. Facebook initially argued that the derivative claims did not belong in federal court or the California State court, but rather that the forum selection clause mandated that the Delaware Chancery Court had exclusive jurisdiction to resolve all corporate disputes. The plaintiffs responded that the forum selection clause was unenforceable because it was unilaterally adopted several days after the IPO and should apply only to shareholders who purchased stock after May 22, 2012, when trading of the stock began. The court agreed, saying that Facebook adopted changes to its certificate of incorporation to include the forum selection clause four days after the company's IPO and the plaintiffs purchased stock in the IPO on May 18, so the claims brought in this action were not subject to the clause.

Standing. Facebook secondly argued that the plaintiffs lacked standing because their claims of alleged misconduct predated their purchase of shares and because demand on Facebook's board prior to bringing the suit derivatively was not excused. The plaintiffs contended that they demonstrated contemporaneous ownership of their stock sufficiently to establish standing and that demand on Facebook's board of directors would have been futile because a majority of the board lacked independence. Here, the court wrote, the challenged disclosures were made prior to the IPO and appeared in the prospectus, which was declared effective by the SEC before the plaintiffs acquired their shares. Facebook's alleged failures included permitting completion of its IPO while allowing a misleading registration statement to be filed, knowing that a select group of potential investors were privy to proprietary information regarding the company's projected earnings. But the court found the events complained of took place before Facebook issued shares in the IPO and plaintiffs could not assert that they were shareholders at the time the disclosures were made. The plaintiff's therefore lacked standing to bring the derivative claims.

Dismissal was also required under the Federal Rules of Civil Procedure, according to the court, because the plaintiffs did not adequately plead demand futility. They failed to rebut the presumption that the majority of Facebook's board was interested and did not plead sufficient facts demonstrating the board's "conscious inaction."

Ripeness. Facebook contended that none of the plaintiff's claims were ripe because they sought only to recover damages that could result if Facebook was found liable in another proceeding. The plaintiffs countered that their claims were ripe because they alleged current injuries in the form of reputational and legal costs, and not just potential future liabilities. The court said that a showing of reputational harm must be "concrete and corroborated, not merely speculative," and the plaintiffs' claims did not meet this standard. The plaintiffs did not show that their damages were caused by actual corporate wrong which was not predicated on the resolution of other litigation, and their claims must be dismissed as not ripe.

Attorneys: Andrew J. Entwistle, Jordan Abraham Cortez, Robert N. Cappucci and Vincent Roger Cappucci (Entwistle & Cappucci, LLP) for Avatar Securities, LLC. Christopher Lovell and Victor E. Stewart (Lovell Stewart Halebian Jacobson, LLP); Douglas G. Thompson and Michael Glenn McLellan (Finkelstein Thompson, LLP); Jacob H. Zamansky (Zamansky & Associates, LLC) for Meredith Bailey, Dmitri Bougakov and Ryan Cefalu. Lorrain Chin, pro se. Darryl M. Bloodworth (Dean, Mead, Egerton, Bloodworth, Capouano & Bozarth); Margaret Osborne Padilla, Paul Lantieri , III, Stephen J Kastenberg and William A. Slaughter (Ballard Spahr, LLP) for The Nasdaq Stock Market, L.L.C. and Nasdaq OMX Group, Inc. Andrew Brian Clubok (Kirkland & Ellis, LLP); Brant Warren Bishop (Kirkland & Ellis, LLP); Andrew Ditchfield (Davis Polk & Wardwell, L.L.P.) for Marc L. Andreessen, Barclays Capital, Inc., Facebook, Inc., Goldman, Sachs & Co., J.P. Morgan Securiries, LLC, Merrill Lynch Pierce Fenner & Smith Inc., Mark Zuckerberg, Allen & Co., LLC, BMO Capital Markets Corp., Blaylock Robert Van LLC, C.L. King & Associates, Inc., Deutsche Bank Securites, Inc., E* Trade Securities, LLC, M.R. Beal & Co., Morgan Stanley & Co., LLC, Muriel Siebert & Co., Inc., Oppenheimer & Co., Inc., Piper Jaffray & Co., Wells Fargo Securities, LLC, Citigroup Global Markets, Inc. and Merrill Lynch.

Companies: Avatar Securities, LLC; Barclays Capital, Inc.; Facebook, Inc.; Goldman, Sachs & Co.; J.P. Morgan Securiries, LLC; Merrill Lynch Pierce Fenner & Smith Inc.; Allen & Co., LLC; BMO Capital Markets Corp.; Blaylock Robert Van LLC; C.L. King & Associates, Inc.; Deutsche Bank Securites, Inc.; E* Trade Securities, LLC; M.R. Beal & Co.; Morgan Stanley & Co., LLC; Muriel Siebert & Co., Inc.; Oppenheimer & Co., Inc.; Piper Jaffray & Co.; Wells Fargo Securities, LLC; Citigroup Global Markets, Inc.; Merrill Lynch

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