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Red Oak Fund, L.P. v. Digirad Corp.

Court of Chancery of Delaware

October 23, 2013

RED OAK FUND, L.P., Plaintiff,

Submitted: August 15, 2013

Elizabeth M. McGeever, Esquire and Laina M. Herbert, Esquire of Prickett, Jones & Elliott, P.A., Wilmington, Delaware, and Daniel F. Wake, Esquire and Daniel E. Rohner, Esquire of Sander Ingebretsen & Wake, P.C., Denver, Colorado, Attorneys for Plaintiff.

John M. Seaman, Esquire and J. Peter Shindel, Jr., Esquire of Abrams & Bayliss LLP, Wilmington, Delaware, and Thomas J. Fleming, Esquire and Jennifer L. Heil, Esquire of Olshan Frome Wolosky LLP, New York, New York, Attorneys for Defendants.


NOBLE, Vice Chancellor


Before the Court is an action by Plaintiff Red Oak Fund, L.P. ("Red Oak") against Defendants Digirad Corporation ("Digirad"), Jeffrey E. Eberwein ("Eberwein"), Charles M. Gillman ("Gillman"), John M. Climaco ("Climaco"), James B. Hawkins ("Hawkins"), and John W. Sayward ("Sayward, " and, collectively, the "Defendants"). Red Oak sued the Defendants under 8 Del. C. § 225 after losing a contested election to replace Digirad's board of directors.

Red Oak asks the Court to find the contested election invalid, and therefore to order a new election to be held as soon as practicable, because of alleged breaches of fiduciary duty and other conduct by the Defendants that created an unfair proxy contest—namely, (i) touting to certain stockholders the preliminary results of the election favoring management; (ii) failing to inform Red Oak or its proxy solicitor that the preliminary proxy reports from Broadridge Financial Services, Inc. ("Broadridge") were inaccurate because they listed a proxy for Digirad's treasury stock voting for management; (iii) delaying the release of purportedly final, negative financial results from the most recent quarter until after the election; and (iv) failing to disclose that the board was considering a rights plan to protect Digirad's Net Operating Losses ("NOLs").

This post-trial memorandum opinion contains the Court's findings of fact and conclusions of law. For the reasons set forth below, Red Oak has not demonstrated that the Defendants breached any fiduciary duties or otherwise engaged in conduct that created an unfair election process. Accordingly, the Court finds the contested election valid.


Red Oak, a Delaware limited partnership based in New York City, invests in public and private companies that generally have a market capitalization less than $200 million.[1] Leading up to the proxy contest, Red Oak was Digirad's fourth-largest stockholder, owning 5.6% of its common stock.[2] David Sandberg ("Sandberg") is the managing member of Red Oak Partners, LLC, which is the general partner of Red Oak.[3]

Digirad, a Delaware corporation based in Poway, California, is a national provider of "in-office nuclear cardiology and ultrasound imaging services to physician practices and hospitals." It also operates a "nuclear camera sales and product services business."[4]

Digirad has five directors: Eberwein, who serves as chairman, as well as Gillman, Climaco, Hawkins, and Sayward (collectively, the "Board").[5] The Board was up for reelection at Digirad's 2013 annual stockholder meeting, held on May 3, 2013[6] (the "Election").[7]


At the time of the Election, Digirad's Chief Executive Officer was Todd Clyde ("Clyde"), and its Chief Financial Officer was Jeffrey Keyes ("Keyes").[8]These two executives were the most involved in the conduct at issue in this action.

After taking a 5.6% position in Digirad, Red Oak announced on February 27 that it would nominate a slate of five directors to replace the Board at the Election.[9]Digirad filed its definitive proxy statement with the Securities and Exchange Commission ("SEC") on April 4.[10] From then until the Election, both Digirad and Red Oak issued press releases and fight letters encouraging stockholders to vote for their respective nominees.[11]

A. The Alleged Material Misstatements Touting the Preliminary Election Results

The first alleged material misstatement involves information potentially shared between John Grau ("Grau"), Digirad's proxy solicitor, [12] and Tyson Bauer ("Bauer"), a sell-side stock research analyst at Kansas City Capital Associates.[13]Eberwein understood Bauer to be familiar with Digirad's stockholder base, including several of its larger stockholders.[14] On April 23, Eberwein asked Gillman to speak with Bauer and Ross Taylor ("Taylor"), a Portfolio Manager at Somerset Capital Advisors ("Somerset"), about persuading Somerset, a Digirad stockholder, to support management in the Election based on a commitment to improve Digirad's on-going stock buyback program.[15] In late March, Digirad had increased the buyback from $4 million to $12 million.[16]

Bauer testified that Gillman told him that management believed it could not lose the Election if it received the support it expected from the proxy advisor firms.[17] Soon thereafter, on April 24, Bauer asked for "indisputable proof"[18] or some other evidence supporting why Digirad was "so confident" that it was "going to win, " which was information he was ultimately seeking on behalf of Taylor.[19] Gillman apparently told Bauer that Grau would contact him. Bauer testified that, over the course of these limited conversations, Gillman did not provide him with any stockholder names, voting percentages, or other preliminary proxy tally details.[20]

In the meantime, and after presentations by Digirad[21] and Red Oak, [22] both Institutional Shareholder Services ("ISS") and Glass, Lewis & Co., L.L.C. ("Glass Lewis") recommended on April 22 that Digirad stockholders vote to reelect the Board.[23] Management soon touted this recommendation publicly, issuing a press release by the morning of April 23.[24]

Within a day, Grau and Bauer began a series of three phone conversations. Grau thought that Bauer was "somebody working with the [c]ompany who was going to assist . . . in reaching out to shareholders that may be clients of his."[25] The first call with Bauer on April 24, Grau testified, left him "very confused" because "[Bauer] wanted to know more information than [Grau] would have ever expected anyone to be interested in."[26] But Grau, believing "at the time[] that [Bauer] was an agent of Digirad's, " nonetheless shared "some back-of-the-envelope numbers on where [he] thought the vote was . . . factoring in . . . where the vote would be given the ISS recommendation."[27] Bauer's notes from the three conversations with Grau list a series of percentage breakdowns showing management first ahead 34% to 12%, then 45% to 10%, and finally management at just under 50% with 63% of shares included.[28] These percentages, Bauer testified, reflected Grau and Digirad's opinion of expected votes—particularly based on the recently announced recommendations of ISS and Glass Lewis in support of management—and not an official tally or a list of stockholders who had submitted proxies.[29]

Bauer and Grau offer competing views on the reasons why the expected vote percentages were shared. Bauer assumed that "there's no purpose for [Grau] to call [him] with those numbers" unless Grau wanted him to share them with stockholders.[30] In stark contrast, Grau testified that it was Bauer who "wanted to know" the information.[31] Consistent with his thinking that "Bauer was working for [Digirad], " Grau further testified that he did not know Bauer was having conversations with Somerset's Taylor; that he did not intend for Bauer to communicate these numbers to stockholders; and that he would not have given to Bauer the expected vote numbers had he known Bauer would share that information with stockholders.[32]

The second alleged material misstatement about the preliminary proxy tallies occurred during a conversation between Eberwein and Taylor. The testimony directly conflicts over whether Eberwein described the preliminary election results as a "landslide, " with Taylor testifying that Eberwein said it[33] and Eberwein testifying that he did not.[34] Regardless of whether Eberwein ever said "landslide, " the evidence is consistent in showing that Eberwein did not reveal to Taylor specific numbers, aside from a disputed reference to a few index funds, or the specific source of his information on preliminary voting tallies.[35]

Somerset, along with three other of Digirad's five largest stockholders (including Red Oak), voted for Red Oak's slate.[36]B. The Proxy Submitted for Digirad Treasury Stock

In early April, the competing proxy solicitors—Grau of InvestorCom, Inc. for Digirad[37] and Peter Casey ("Casey") of Alliance Advisors for Red Oak[38]— noticed an issue with how much stock was entitled to vote at the Election. Grau compared the March 12 record date list from the Depository Trust Company ("DTC") with Digirad's proxy statement, which revealed what he described as a DTC "overhang of approximately 1, 075, 000 shares."[39] An overhang meant that the DTC list of Digirad stock held in street name included more stock than the number of shares that Digirad identified in its proxy as eligible to vote. Casey also recognized the overhang and asked Grau's team whether the difference was due to Digirad's treasury stock. Grau's team confirmed on April 8 that treasury stock was the cause of the discrepancy, but, when Casey asked in a response email that same day where Digirad held its treasury stock, no one replied.[40]

Digirad held the repurchased treasury stock from its buyback program at broker Raymond James & Co. ("Raymond James"), apparently in street name. By March 12, the record date for the Election, Digirad held 1, 073, 641 shares of treasury stock with the broker.[41] Dan Warnock ("Warnock"), a member of Keyes' financial team, was the Digirad accounting manager in charge of "making sure that the financial activity through the [Raymond James treasury stock] account was appropriate." Warnock's responsibilities included receiving regular statements from Raymond James about the account.[42]

On April 9, Warnock received "an e-mail from Raymond James routed through Broadridge"[43] soliciting a proxy for the Election.[44] Under the impression that he may have personally owned Digirad stock at Raymond James, Warnock clicked an electronic link in the email, which presumably directed him to a webpage through which he then submitted a proxy in favor of management. As Keyes testified, "it wasn't apparent to [Warnock] when he pulled up the link how many shares were . . . to be voted or the fact that they might have been the company's treasury shares."[45]

By at least April 15, just under three weeks before the Election, the proxy solicitors were receiving preliminary reports from Broadridge.[46] During the Election, Broadridge's function was to be an independent third party that received proxies and shared its tabulations of these proxies in periodic reports with Digirad and Red Oak.[47] Of course, as more stockholders submitted new proxies, the preliminary Broadridge reports changed.

Broadridge provided preliminary reports about the Election to only the proxy solicitors, not Digirad's stockholders. Grau reformatted the Broadridge reports before sending them to Digirad, [48] while Casey either just forwarded[49] or similarly reformatted the reports before sharing them with Red Oak.[50] The reports from Broadridge did not name the beneficial owners who had submitted proxies; instead, they listed by street name custodian the proxies submitted for management, for Red Oak's slate, and for withhold.[51] Armed with the preliminary Broadridge reports, Grau and Casey, working independently, were generally able to figure out how Digirad's larger, institutional stockholders were voting.[52]

Digirad and Red Oak used the preliminary Broadridge reports and the stockholder information gleaned by their proxy solicitors in developing and refining their solicitation strategies.[53] Grau admitted that his strategy advice may slightly change in a particular vote if his client had a large lead in the preliminary reports, but he testified that, in general, he "would never stop soliciting proxies because it ain't over until it's over."[54] In contrast, Sandberg described Red Oak's solicitation strategy during the Election as a "fluid process" and a "cost[-]benefit" analysis that depended in large part on the preliminary results.[55] For example, Sandberg testified that it would have been a "game changer" had Red Oak known that the Broadridge reports leading up to the Election were inaccurate.[56]

After Warnock had inadvertently and unknowingly voted the treasury stock, the preliminary reports from Broadridge sent to Digirad and to Red Oak reflected that a large block at Raymond James—over one million shares, around 6% of Digirad's outstanding stock—had voted for management.[57] Reading the Broadridge reports, both Grau and Casey likely recognized that such a significant stockholder (or group of stockholders) could be ...

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