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In re Nine Systems Corp. Shareholders Litigation

Court of Chancery of Delaware

July 31, 2013

IN RE NINE SYSTEMS CORPORATION SHAREHOLDERS LITIGATION

Date Submitted: April 3, 2013

Anne C. Foster, Esquire, Blake Rohrbacher, Esquire, and Susan M. Hannigan, Esquire of Richards, Layton & Finger, P.A., Wilmington, Delaware; Lawrence D. Rosenberg, Esquire, Paul V. Lettow, Esquire, James M. Burnham, Esquire, Matthew F. Kuhn, Esquire, and Bryan L. Jarrett, Esquire of Jones Day, Washington, D.C.; and Robert C. Micheletto, Esquire of Jones Day, New York, New York, Attorneys for Plaintiffs.

Richard D. Heins, Esquire, Andrew D. Cordo, Esquire, Stacy L. Newman, Esquire, and Phillip R. Sumpter, Esquire of Ashby & Geddes, Wilmington, Delaware, and Richard G. Haddad, Esquire, Stanley L. Lane, Jr., Esquire, and Denaka L. Perry, Esquire of Otterbourg, Steindler, Houston & Rosen, P.C., New York, New York, Attorneys for Defendants.

MEMORANDUM OPINION

NOBLE, Vice Chancellor

Six plaintiffs (the "Kim Plaintiffs") have joined this action to challenge certain transactions (the "Transactions") preceding the acquisition of Nine Systems Corporation (the "Corporation" or "NSC") by Akamai Technologies, Inc. ("Akamai") in 2006 (the "Acquisition"). In 2008, two plaintiffs (the "Dubroff Plaintiffs") filed a putative class action challenging the Transactions (the "Class Action Complaint"). Although the Court denied class certification, it acknowledged that purported class members might be able to bring claims on an individual basis.[1] In 2010, a group of former minority shareholders in the Corporation (the "Fuchs Plaintiffs") individually brought suit (the "Fuchs Complaint"). The Court consolidated the Fuchs Plaintiffs and the Dubroff Plaintiffs' actions (the "Consolidated Action").[2] Some of their claims challenging the Transactions survived summary judgment.[3] The Kim Plaintiffs filed an initial complaint on October 22, 2012, and an amended complaint on December 17, 2012 (the "Kim Complaint, " or "Am. Compl."), raising claims similar to those brought by the Fuchs Plaintiffs.

The main difference between the Kim Complaint and the Fuchs Complaint is how the Kim Plaintiffs were situated with respect to the Corporation. There are three distinct sets of Kim Plaintiffs: (i) shareholders who owned NSC common shares from before the Transactions until the Acquisition (the "Shareholder Plaintiffs"); (ii) a shareholder who owned NSC common shares before the Transactions and was purportedly induced to sell before the Acquisition (the "Stock Sale"); and (iii) individuals who owned options to purchase NSC common stock that were extinguished by the Transactions before the Acquisition (the "Pre-2002 Options"). The Defendants have moved to dismiss the Kim Complaint.[4] The Kim Plaintiffs responded with a Motion to Strike certain elements relied upon by the Defendants in their Motion to Dismiss.[5]

I. BACKGROUND[6]

Before the Transactions, NSC's three largest shareholders—Defendants Wren Holdings, LLC ("Wren"), Javva Partners, LLC ("Javva"), and Catalyst Investors, L.P. ("Catalyst") (the "Entity Defendants")—collectively owned approximately 56% of the Corporation. The Transactions increased the Entity Defendants' ownership of NSC to approximately 90%, and decreased the Kim Plaintiffs' ownership from approximately 15% to approximately 1%.[7]

The Kim Plaintiffs, like the Fuchs Plaintiffs, complain about the dilution of their equity interest in the Corporation, especially as it occurred before the Acquisition.[8] They similarly allege claims of breach of fiduciary duty, [9] aiding and abetting, [10] and unjust enrichment[11] against the Defendants due to this dilution.[12]Earlier, on the Fuchs Complaint, the Court largely denied the Defendants' motion for summary judgment on these claims on the grounds that the Court could not decide as a matter of undisputed fact whether the Entity Defendants constituted a control group which collectively decided to carry out the Transactions.[13]

A. The Shareholder Plaintiffs

Plaintiffs Rick Murphy, Thomas Murphy, Rounsevelle W. Schaum ("Schaum"), and Newport Capital Partners, Inc. ("Newport") were either founders of, or original investors in, the Corporation, a privately-held company incorporated in Delaware in 1999.[14] Rick Murphy was the Chairman of the Board and Chief Executive Officer of the Corporation at the time. He acquired NSC common shares in 1999 and 2000 and held them until the Acquisition.[15] Thomas Murphy, the father of Rick Murphy, was the first investor in the Corporation. He acquired NSC common shares in 1999 and 2000, and held a portion of them until the Acquisition.[16] Schaum was a founding director of the Corporation, and its then-Chief Financial Officer.[17] Schaum, or Newport (of which Schaum is the sole shareholder), [18] obtained NSC common shares in 1999-2000 and held them until the Acquisition.[19] Rick Murphy, Thomas Murphy, Schaum, and Newport collectively owned common shares representing about 15% of the Corporation's equity before the Transactions.[20]

B. The Stock Sale

Thomas Murphy acquired 45, 000 NSC common shares in 1999 and 2000, and sold 44, 000 shares back to NSC for $1 per share on June 6, 2006, before the Acquisition.[21] Thomas Murphy claims that he decided to sell shares at that price based on conversations with Snyder, Dwyer, and then-CFO John Walpuck on May 30, 2006.[22] During these conversations, Thomas Murphy specifically asked Snyder and Dwyer for an update on the Corporation's activities and business prospects.[23] In their responses, Snyder and Dwyer did not mention that NSC was at the time in discussions with third parties, including Akamai, about a potential merger.[24] Snyder and Dwyer had participated in these discussions, and knew the terms of potential deals.[25] They suggested to Thomas Murphy the $1 per share purchase price and assured him it was fair under the circumstances, and he relied on their representations.[26]

According to the Kim Plaintiffs, NSC had begun discussions regarding a potential sale, acquisition, or combination with parties including Akamai months before the Stock Sale.[27] In connection with these negotiations, the Corporation suggested to Akamai a purchase price of $200 million, or approximately $15 per share of NSC common stock. Thomas Murphy alleges that had he known about the talks involving the sale of NSC at the time of the Stock Sale, he would not have resold his NSC common shares and would have received approximately $13 per share from the Acquisition six months later.[28]

C. The Pre-2002 Options

Peter Mountanos ("Mountanos") joined the Corporation as Vice President during its first months in business and then became its Chief Technology Officer.[29]Mountanos claims that he was issued options to purchase 140, 000 shares of NSC common stock in 2000, amounting to approximately 3% of the Corporation's total equity.[30] Mountanos was married to Jenny Kim ("Kim") during most of the period that he worked for the Corporation. After they divorced, Kim acquired a portion of Mountanos's options.[31]

In 2002, as part of the Transactions, the Defendants cancelled the Pre-2002 Options.[32] A shareholder list from before the Transactions, dated March 28, 2001, lists Mountanos as owner, [33] but the capitalization table from immediately after the Transactions does not.[34] Mountanos and Kim claim that the Pre-2002 Options were cancelled by the Defendants to ensure that options could be issued to Snyder in 2002 and that there would be sufficient issuable common stock remaining to carry out the Transactions.[35]

Beginning in mid-2002, and over the course of the next several years, Mountanos and Kim requested information about the Pre-2002 Options, including: capitalization tables, stock option agreements, and other option-related documents. The Defendants did not provide them with this information.[36] On or about January 4, 2005, Mountanos called Snyder to inquire about the Pre-2002 Options.[37]Part of the conversation involved Mountanos' stating to Snyder that "[t]here was no notification made to me as an employee of changes to my option status or numbers nor did I sign any type of release with respect to those previous grants."[38]Snyder told Mountanos that the Pre-2002 Options were not properly authorized by the Board and that Dwyer and the Board had reached this conclusion.[39]According to the Kim Plaintiffs, but for the Defendants' misrepresentations and active concealment, Mountanos and Kim would have sought to exercise the Pre-2002 Options and would have discovered (and thus been able to challenge) their cancellation.[40] By cancelling the Pre-2002 Options in 2002 and ...


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