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Steinberg v. Bearden

Court of Chancery of Delaware

May 30, 2018

CHAILE STEINBERG, Derivatively for the Benefit of and on Behalf of Nominal Defendant HORTONWORKS, INC., Plaintiff,
v.
ROBERT G. BEARDEN, PAUL CORMIER, PETER FENTON, MARTIN FINK, KEVIN KLAUSMEYER, JAY ROSSITER, MICHELANGELO VOLPI, and SCOTT J. DAVIDSON, Defendants, -and-HORTONWORKS, INC., a Delaware Corporation, Nominal Defendant.

          Date Submitted: March 27, 2018

          Seth D. Rigrodsky, Brian D. Long, Gina M. Serra, and Jeremy J. Riley of RIGRODSKY & LONG, P.A., Wilmington, Delaware; Counsel for Plaintiff.

          Elena C. Norman of YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Jordan Eth, Anna Erickson White, and Ryan Keats of Morrison & Foerster LLP, San Francisco, California; Counsel for Defendants Robert G. Bearden, Paul Cormier, Peter Fenton, Martin Fink, Kevin Klausmeyer, Jay Rossiter, Michelangelo Volpi, Scott J. Davidson, and Nominal Defendant Hortonworks, Inc.

          MEMORANDUM OPINION

          BOUCHARD, C.

          In this action, a stockholder of Hortonworks, Inc. alleges that its board of directors and two of its officers breached their fiduciary duties by making or permitting to be made several materially false and misleading statements about the Company's financial condition. Specifically, the stockholder alleges that defendants knowingly misled the market on four occasions in the latter half of 2015 by stating that Hortonworks did not need a capital infusion, when the Company allegedly was in need of cash and the board privately was considering raising additional funds in a secondary public offering.

         The complaint asserts three interrelated derivative claims, which defendants have moved to dismiss under Court of Chancery Rules 23.1 and 12(b)(6) for failure to make a pre-suit demand on the board of directors and for failure to state a claim for relief. For the reasons explained below, the motion will be granted because the complaint fails to allege particularized facts to excuse plaintiff's failure to make a demand.

         I. BACKGROUND

         The facts recited herein are taken from the Verified Shareholder Derivative Complaint filed on April 13, 2017 (the "Complaint"), [1] and documents incorporated therein, including documents produced to plaintiff in response to a request for books and records under 8 Del. C. § 220.[2] Any additional facts are either not subject to reasonable dispute or subject to judicial notice.

         A. The Parties

         Nominal defendant Hortonworks, Inc. ("Hortonworks" or the "Company") is a publicly traded corporation that "creates, distributes and supports a new class of enterprise data management software solutions built on open source technology."[3]Plaintiff Chaile Steinberg alleges she has been a Hortonworks stockholder continuously since December 2014, which covers the period relevant to this case between August 13, 2015 and January 15, 2016.

         The Complaint names eight individuals as defendants. They are all directors and/or officers of Hortonworks. Defendant Robert G. Bearden co-founded the Company, serves as its CEO, and is one of seven members who served on Hortonworks's board of directors (the "Board") during the relevant period and when this action was filed. The other six directors on the Board are defendants Paul Cormier, Peter Fenton, Martin Fink, Kevin Klausmeyer, Jay Rossiter, and Michelangelo Volpi (the "Director Defendants"). Klausmeyer, Fenton, and Volpi served on the Board's Audit Committee during the relevant period. The eighth named defendant is Scott J. Davidson, Hortonworks's CFO.

         B. Alleged False and Misleading Statement #1

         On August 13, 2015, Hortonworks filed its Form 10-Q for the period ended June 30, 2015 (the "Second Quarter 10-Q").[4] Addressing the Company's future liquidity expectations, the Second Quarter 10-Q stated: "We believe that our existing cash and cash equivalents balance, together with cash generated from sales of our support subscriptions and professional services to customers, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months."[5] Steinberg contends that this statement "was materially false and misleading because it omitted the fact that the Board approved" a secondary public offering "on August 20, 2015, exactly one week later, and was undoubtedly considering it at the time of the statement."[6]

         Bearden and Davidson, as the Company's CEO and CFO, each signed a certification for the Second Quarter 10-Q pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 ("SOX"). In their SOX certifications, Bearden and Davidson each attested, among other things, that they had reviewed the Second Quarter 10-Q and that it "does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report."[7]

         C. The Board Considers a Secondary Public Offering

         On August 20, 2015, the Board held a regularly-scheduled meeting during which Davidson reviewed "the Company's recent financial results and key metrics."[8] During this review, Davidson made a presentation concerning a potential $130 million secondary public offering, with 95% of the shares to be offered by Hortonworks.[9] Davidson's presentation listed four reasons to complete the offering at that time:

• Competitive dynamics (get ahead of potential IPOs from Cloudera and MapR)
• Increase liquidity and float as larger investors want more of both
• Alleviate investor concerns of our need to have more cash on the balance sheet
• CFO rulebook # 1: "always take the $ when you don't need it[10]

         At its August 20 meeting, the Board unanimously adopted resolutions authorizing the Company to continue undertaking preparations for a secondary public offering. The Board also appointed a pricing committee, consisting of defendants Bearden, Fenton, and Klausmeyer, to negotiate with underwriters.[11]Despite these preparations, Hortonworks did not pursue further a secondary public offering at the time.

         D. Alleged False and Misleading Statement #2

         On November 4, 2015, Hortonworks held an earnings call after releasing its third quarter financial results that day.[12] The following exchange occurred during the call:

Q: I think you gave the headcount number at about 800. Obviously, it's good growth year-over-year. I know there was some acquisition in there. But when you think about just sort of feeding the beast of sales and marketing here, because you do keep acquiring more new customers but also the deal sizes to existing customers are getting bigger, I mean how should we think about how you are ramping that sales force? And then also kind of relative to some of those partnerships in the channel, et cetera that you also have?
BEARDEN: Yes. So it is about actually overall enabling the model. There will be always organic adding of direct field reps, in addition to that though we are very focused on the ecosystem and creating [pull ph] markets with our partners. And we are actually seeing that part of our business begin to gain real traction and seeing actual pull through revenue, that's meaningful, come through. And that gives us leverage of course. The other thing that we are able to do now is also get incremental leverage from our existing sales organization with the new product that we just obviously outlined on this call and which is the Hortonworks DataFlow platform. And so now we can as a multi product company get more leverage per rep with incremental product. And so we are going to see the benefit of that going forward as well.[13]

         Steinberg asserts that Bearden's statement on this call "was false and misleading because he 'knew the Company needed more cash than it was generating going forward, hence the resolution approving the secondary offering, and that the additional sources of revenue [he] cited . . . would be insufficient to meet the Company's needs.'"[14]

         E. Alleged False and Misleading Statement #3

         On November 12, 2015, Hortonworks filed its Form 10-Q for the period ended September 30, 2015 (the "Third Quarter 10-Q") in which it included the same statement about the Company's future liquidity expectations as it did in the Second Quarter 10-Q, i.e., "We believe that our existing cash and cash equivalents balance, together with cash generated from sales of our support subscriptions and professional services to customers, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months."[15] Bearden and Davidson signed SOX certifications for the Third Quarter 10-Q, as they did for the Second Quarter 10-Q.[16] The Audit Committee "reviewed and discussed with Management the Third Quarter 2015 financial statements and Form 10-Q" and resolved that "the Company shall include the Company's Third Quarter 2015 financial statements in the Company's Quarterly Report on Form 10-Q to be submitted to and filed with the SEC."[17]

         Steinberg contends that the statement (quoted above) about the Company's future liquidity expectations "was materially false and misleading in that it omitted the fact the Board approved the [secondary public offering] on August 20, 2015 because the Company needed more cash."[18]

         F. Alleged False and Misleading Statement #4

         On December 1, 2015, Bearden and Brian Marshall, Hortonworks's Vice President of Corporate Development, attended the Credit Suisse Technology, Media, and Telecom Conference.[19] During the Company's session, questions were asked about Hortonworks's cash position:

Q: You said the B word so I'm going to ask a question, burn. So cash burn because obviously I've been getting that question, you know, last night, this morning. You know, when you guys look at your sort of cash position, and you're obviously in this point of your lifecycle where you're growing fast, you're hiring people, big market opportunity you just talked about, and then big market opportunity hitting inflection point. You know, how do you sort of balance the need to invest, but also looking at your burn and at the, you know just the cash on the balance sheet? So kind of a question for both of you, like how do you think about that because-yeah, I'll just leave it there.
BEARDEN: Well, we have a model that today shows us getting the cash (inaudible) profitability in early 2017. Even with the two acquisitions that we've done, we're very comfortable with that model. In fact we're showing improved performance against that, that Brian [Marshall] just pointed out in Q3, quarter-over-quarter. And with that we have roughly $116 million in cash. It gives us a fully funded model to that point of profitability when you do, you know, when you extrapolate your model, we're somewhere under $50 million in cash. We're comfortable operating on that.
Q: That was my next question.
BEARDEN: Yeah. We're comfortable operating on that. At some point we may choose to take an opportunistic view downstream into the markets, but we'll do that on an opportunistic basis when the time is right.
Q: Got it. Okay, so, because that's the question, like I've given you this example before, you know plane taking off the aircraft carrier, you don't mind getting close to the water, just don't crash into it, you know. So there's enough air, so to speak, between you and the water you feel comfortable with? Okay.
BEARDEN: Very much so. And we see the market continuing to expand, and you know we're very comfortable with our positioning and where we are from an execution against our model.[20]

         Steinberg contends that "[d]efendant Bearden's statements at the Credit Suisse Conference that the Company was comfortable operating on its cash model, even if its cash balance dipped below $50 million, and that it 'may choose' to look for . . . additional cash in the markets were false and misleading because, unknown to investors, the Board had already approved the secondary public offering and Bearden knew the Company needed additional cash."[21]

         G. Hortonworks Launches a Secondary Public Offering

         On January 13, 2016, the Board unanimously adopted resolutions authorizing the Company to prepare for a new secondary public offering and appointed a pricing committee consisting of Bearden, Fenton, and Volpi.[22] This pricing committee was different from the one that previously had been appointed on August 20, 2015, which consisted of Bearden, Fenton, and Klausmeyer.

         On January 15, 2016, Hortonworks filed a Form S-3 and issued a press release announcing that it would be conducting a secondary public offering.[23] The Form S3 stated "[t]he principal purposes of this offering are to raise additional capital to increase our financial flexibility. We intend to use the net proceeds that we receive from this offering for working capital or other general corporate purposes, including funding our growth strategies discussed in this prospectus."[24]

         On January 19, 2016, the first trading day after the announcement of the secondary public offering, the Company's stock closed down 37 percent, falling from $16.57 per share to $10.44 per share.[25] The next day, on January 20, the Board convened a special meeting to review the "market reaction to the Company's filing of a Registration Statement on Form S-3 on January 15, 2016."[26] During the meeting, the Board:

discussed possible timelines for completing an equity offering in a registered transaction and alternative methods for the Company to raise additional financing, including possible timelines and terms for doing so. Alternatives discussed included, but were not limited to, the follow-on equity offering (as planned or adjusted), private investments, and debt financing options. The Board agreed to continue discussions regarding the various financing options and to discuss such alternatives with the Company's advisors.[27]

         On January 25, 2016, the Board appointed a Special Committee "to explore one or more potential financing transactions."[28] The Special Committee held a series of meetings to address the benefits and risks of the various options, consulted with advisors, and ultimately resolved on January 26, 2016 to raise up to $100 million through the secondary public offering announced on January 15.[29] On February 1, 2016, the pricing committee approved the sale of shares in the offering at a price of $9.50 per share.[30]

         H. The Securities Class Action

         On February 29, 2016, a federal securities class action was filed in the Northern District of California, captioned Monachelli v. Hortonworks, Inc. et al., Case No. 3:16-cv-980-SI (N.D. Cal.). The First Consolidated Amended Complaint in Monachelli asserted securities fraud claims against Hortonworks, Bearden, and Davidson.[31] The six non-management directors on the Board were not named as defendants.

         The First Consolidated Amended Complaint alleged that between August 5, 2015 and January 15, 2016, Hortonworks, Bearden, and Davidson "provided a steady stream of false and misleading statements as to the strength of Hortonworks' cash holdings, its revenues and cash being derived from sales to customers, and its ability to meet capital needs from these sources of cash."[32] Plaintiffs in Monachelli did not plead, and the court did not consider, the Board's August 20, 2015 approval of a secondary public offering as indicative of the purported falsity of the statements in question.[33]

         On December 5, 2016, the district court granted defendants' motion to dismiss but with leave to amend.[34] The court found that allegations about "the Company's state of rapid growth and increased expenses . . . do not adequately establish that any of the statements made by defendants during the Class Period were false."[35]Plaintiffs in the Monachelli action later agreed to settle the case on behalf of the class for $1.1 million.[36] The court approved the settlement on October 10, 2017.[37]

         II. PROCEDURAL HISTORY

         On April 13, 2017, Steinberg filed the Complaint, asserting three claims derivatively on behalf of Hortonworks. Count I asserts that defendants breached their fiduciary duties "by making, allowing, or failing to correct the materially false and misleading misrepresentations and omissions alleged herein."[38] Count II "seeks relief from defendants on the theory of contribution and indemnity to the extent that the Company is liable for allegations that the Individual Defendants violated their fiduciary duties in connection with false statements about the Company's cash requirements, including but not limited to the liability agreed upon in the settlement of the Monachelli Action."[39] Count III is a claim for unjust enrichment that seeks restitution from defendants and "an order from this Court disgorging all profits, including any performance-based compensation, obtained by the Defendants due to their wrongful conduct and breach of their fiduciary duties."[40]

         On July 3, 2017, defendants moved to dismiss this action under Court of Chancery Rules 23.1 and 12(b)(6) for failure to make a pre-suit demand on the Board and for failure to state a claim upon which relief may be granted.[41] The court heard argument on the motion on March 27, 2018.

         III. ANALYSIS

         I first consider defendants' motion to dismiss under Rule 23.1 for failure to make a demand on the Board. For the reasons explained below, I find that demand is not excused and thus defendants' motion to dismiss must be granted. Based on this conclusion, it is not necessary to address defendants' motion to dismiss under Rule 12(b)(6) for failure to state a claim.

          A.Legal Standard Governing ...


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