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Southeastern Pennsylvania Transportation Authority v. Facebook, Inc.

Court of Chancery of Delaware

October 29, 2019

FACEBOOK, INC., a Delaware Corporation, Defendant.

          Date Submitted: July 30, 2019

          Robert J. Kriner, Jr., Esquire, Scott M. Tucker, Esquire, Tiffany J. Cramer, Esquire and Vera G. Belger, Esquire of Chimicles Schwartz Kriner & Donaldson-Smith LLP, Wilmington, Delaware, Attorneys for Plaintiffs Southeastern Pennsylvania Transportation Authority and Boston Retirement System.

          David E. Ross, Esquire and R. Garrett Rice, Esquire of Ross Aronstam & Moritz LLP, Wilmington, Delaware, Attorneys for Defendant Facebook, Inc.



         Facebook, Inc. (or the "Company") operates social media platforms used by over 2.2 billion people worldwide. Its business model contemplates that it will derive substantial revenue from selling advertisements. Given the importance of advertising revenue to its success, Facebook monitors and records advertising trends very carefully and reports that data to customers and investors. In 2016, Facebook overestimated the amount of time users spent watching video advertisements on its platforms, leading to negative media reports and lawsuits by some of its advertising customers. Almost two years later, after announcing that it expected its meteoric growth rate to decline, Facebook "suffered the biggest-ever one-day loss in market value for a U.S.-listed company."[1] As Facebook confronted these challenges, its board continued to authorize increases in executive compensation.

         Plaintiffs, Southeastern Pennsylvania Transportation Authority ("SEPTA") and Boston Retirement System ("Boston"), are Facebook stockholders. They question Facebook's executive compensation practices and have demanded to inspect Company books and records pursuant to Section 220 of the Delaware General Corporation Law ("Section 220") in aid of four stated purposes.[2]Specifically, they have advised Facebook they require inspection: (1) to determine "how to vote with respect to the 2019 Say On Pay Vote," (2) to determine "whether to pursue contact with Facebook's directors and/or minority stockholders concerning Facebook's decelerating revenue growth and executive compensation determinations," (3) to "investigate possible fiduciary wrongdoing, mismanagement or unjust enrichment by Facebook directors or officers in connection with advertising sales and compensation awards decisions" and (4) to "investigate the independence of the Board of Directors to consider and act on a stockholder demand to initiate claims for fiduciary mismanagement, wrongdoing or unjust enrichment."[3]

         In response to Plaintiffs' inspection demands, Facebook produced certain documents pursuant to a confidentiality agreement.[4] Plaintiffs asked for more; Facebook refused on grounds it had already produced enough. Plaintiffs then initiated this summary proceeding under Section 220. In its pretrial brief, Facebook stated it was resisting Plaintiffs' demands on the grounds that Plaintiffs have failed to state a proper purpose for inspection and have demanded books and records that are not necessary and essential to their stated purposes.[5]

         By stipulation of the parties, the matter was tried on a paper record.[6] After carefully reviewing the evidence and arguments of counsel, I conclude Plaintiffs have failed to demonstrate a proper purpose for inspection. The Facebook board of directors (the "Board") is exculpated from liability for breaches of the duty of care, and there is no evidence of a loyalty breach arising from Facebook's executive compensation practices. Moreover, Facebook has already produced all of the books and records that are "necessary and essential" to fulfill Plaintiffs' stated purposes. Accordingly, I decline to compel Facebook to produce the requested books and records and will enter judgment in its favor.


         I have drawn the facts from the parties' stipulations of fact, the joint exhibits introduced at trial and from reasonable inferences that flow from that evidence. To the extent objections have been raised with respect to proffered evidence, I have either not considered that evidence or have addressed the objection in the opinion.[7]

         A. The Parties

         Plaintiffs, SEPTA and Boston, are Facebook stockholders that have continuously owned Facebook stock since May 14, 2015 and December 31, 2013, respectively.[8] Defendant, Facebook, Inc., is a Delaware corporation with its headquarters in Menlo Park, California.[9]

         B. Facebook's Business

         Facebook operates social media platforms that connect more than 2.2 billion active users with friends and family through mobile devices, personal computers and other means of data transmission.[10] Facebook does not charge a user fee for its services but rather generates substantially all of its revenue from selling commercial advertising placements.[11] To demonstrate value to its advertising customers, Facebook has created metrics to quantify user engagement with advertisements hosted on its platforms. Advertisers rely on these metrics when determining how many advertisements to place (and pay for) with Facebook during their various business cycles.[12]

         As depicted in the chart below, between 2014 and 2018, Facebook's advertising revenue increased from $11.49 billion to $55.01 billion.[13] By 2018, advertising accounted for more than 98% of Facebook's $55.83 billion in revenue.[14]

Facebook Advertising Revenue (in millions) (and Annual Growth Rate)









$3, 317

$5, 201


$11, 795"

$14, 912


$2, 676

$3, 827

$6, 239

$9, 164

$13, 038


$2, 957

$4, 299

$6, 816




$3, 594

$5, 637


$12, 779

$16, 640


$11, 492 (65%)

$17, 079 (49%)

$26, 885 (57%)

$39, 942 (49%)

$55, 013 (38%)

         As the numbers show, while Facebook's revenue has continued to increase, the annual advertising growth rate has fluctuated and has decreased each year from 2016 to 2018.[15]

         C. Executive Compensation

         Plaintiffs seek to investigate whether the Board breached its fiduciary duties by overcompensating executives during a period when Facebook's revenue growth rate was steadily decreasing.[16] The current Board members are Mark Zuckerberg, Sheryl Sandberg, Peggy Alford, Marc Andreessen, Kenneth Chenault, Susan Desmond-Hellmann, Peter Thiel and Jeffrey Zients.[17] Two Board committees are relevant here, the Audit and Risk Oversight Committee (the "Audit Committee") and the Compensation and Corporate Governance Committee (the "C&G Committee").[18] Prior to the 2018 stockholder meeting, Susan Desmond-Hellmann, Reed Hastings and Peter Thiel were members of the C&G Committee.[19] Reed Hastings's term as a director ended in 2018-leaving only Susan Desmond-Hellmann and Peter Thiel on the C&G Committee (both of whom are independent directors).[20] Since 2012, the C&G Committee has been advised by Compensia, a leading compensation consulting firm.[21]

         The following table from Facebook's 2019 Definitive Proxy Statement reflects executive compensation from 2016 to 2018:[22]

         (Table Omitted)

         Facebook releases periodic information in SEC filings regarding the factors it considers in awarding executive compensation.[23] According to these disclosures, the C&G Committee bases its compensation determinations on business performance and seeks to motivate executives to focus on company-wide priorities, including revenue growth, by rewarding them for individual results and achievements.[24] Additionally, the C&G Committee uses comparative market data from similarly situated companies to inform compensation levels.[25]

         Stockholders are apprised of the C&G Committee's goals and processes because, in compliance with SEC guidance, Facebook conducts a non-binding Say On Pay advisory vote every three years-providing stockholders a chance to vote on proposed executive compensation.[26] Facebook's 2016 and 2019 Say On Pay proposals were approved.[27] The next Say On Pay vote is set to occur in 2022.[28]

         D. The Advertising Metric Calculation Errors

         On September 22, 2016, the Wall Street Journal published an article titled "Facebook Overestimated Key Video Metric for Two Years."[29] The article highlighted Facebook's own disclosure that the Company had artificially inflated the metric for the average time users spend watching videos.[30] Facebook responded to the article on September 23, 2016, by releasing the following statement:

[W]e found an error in the way we calculate one of the video metrics on our dashboard-average duration of video viewed. The metric should have reflected the total time spent watching a video divided by the total number of people who played the video. But it didn't-it reflected the total time spent watching a video divided by only the number of "views" of a video (that is, when the video was watched for three or more seconds). And so the miscalculation overstated this metric.[31]

         Facebook notified advertising agencies that it "likely overestimated average time spent watching videos by between 60% and 80%."[32] While admitting some metrics were incorrect, Facebook indicated the error did not affect billing and was addressed and corrected immediately.[33] This, however, was not Facebook's only metric calculation error. Between September 2016 and November 2017, Facebook disclosed twelve measurement errors that skewed the data Facebook provided to advertisers.[34] Generally, the errors had the effect of inflating Facebook's apparent advertising reach.[35]

         On February 10, 2017, Facebook responded to its advertisers' concerns by arranging an audit by the Media Rating Counsel to verify the accuracy of the information it provides to advertisers.[36] Facebook also announced a comprehensive plan to "provide transparency, choice and accountability" to advertising customers.[37]Additionally, Facebook engaged PricewaterhouseCoopers and Deloitte to review the Company's advertising metrics systems.[38] The reports from these firms were promptly presented to the Audit Committee.[39]

         Some Facebook advertisers reacted to the metric error issues by either cutting spending on Facebook advertising or filing lawsuits.[40] For instance, on December 23, 2016, a class action suit on behalf of former Facebook advertisers was filed in the United States District Court for the Northern District of California.[41]And, on July 10, 2018, a class of former customers filed an action in Arkansas state court for improper charges generated by fake clicks in violation of Facebook's terms of service.[42] The Wall Street Journal reported advertisers such as Subway and "[o]ne global beverage company" were planning to cut their advertising spending with Facebook "because of concerns about whether [their] ads are being viewed sufficiently."[43] The article also reported Proctor and Gamble "cut more than $200 million in digital ad spending in 2017, including 20% to 50% cuts at 'several big digital players.'"[44] Despite these cuts, Facebook's advertising revenue continued to grow at rates of 49% and 38%, respectively, for fiscal years 2017 and 2018.[45]

         E. The Revenue Growth Rate Decline

         During an investor call on July 25, 2018, Facebook's CFO, David Wehner, announced that "total revenue growth rate decelerated approximately 7 percentage points in Q2 compared to Q1."[46] He predicted "total revenue growth rates will continue to decelerate in the second half of 2018, and we expect our revenue growth rates to decline by high single digit percentages from prior quarters sequentially in both Q3 and Q4."[47] Wehner listed several factors contributing to the deceleration, including Facebook's plans to grow certain experiences with lower monetization levels and to provide its users with more choices regarding data privacy.[48]For context, while Facebook's growth rate decreased by 7%, its revenue increased by more than $3.9 billion, its advertising revenue grew by 42% and its net income increased more than 31%.[49]

         The 2018 growth rate deceleration was not a complete surprise. Facebook disclosed in a 2012 SEC filing that "revenue growth will inevitably slow as [Facebook] achieve[s] higher market penetrations rates."[50] Facebook continued to make this disclosure in subsequent SEC filings.[51] Nevertheless, one day after Wehner's investor call, Facebook "suffered the biggest-ever one day loss in market value for a U.S.-listed company."[52] Its stock price dropped 19%, erasing approximately $119.1 billion in market value.[53]

         F. Plaintiffs' Books and Records Demands

         On August 2 and August 10, 2018, respectively, SEPTA and Boston sent their demands seeking to inspect Facebook's books and records under Section 220 of the DGCL (the "Demands").[54] As required by statute, [55] both SEPTA and Boston's demands stated purposes for inspection, which were substantively identical.[56] The Demands claimed the advertising metric errors resulted in class action lawsuits and caused advertisers to reduce spending on Facebook advertisements.[57] Against this backdrop, the Demands stated a purpose to investigate the amount of executive compensation paid "in the period of distorted ad sales and related revenue, "[58] and conveyed the stockholders' doubt that "the C&G Committee or the Board or any other committee ha[d] considered the data errors . . . in connection with the executive compensation determinations."[59]

         On August 31, 2018, Facebook refused Plaintiffs' demands because they failed to state a proper purpose and because the categories for inspection were overbroad.[60] The parties met and conferred and Facebook thereafter agreed to produce "board level material[s] (i.e., minutes and presentations) [] relevant to 'measurement errors relating to data provided to Facebook advertisers.'"[61]Facebook's production revealed that the Audit Committee had discussed advertising metric errors and had taken measures, including seeking accreditations from the Media Rating Council and engaging Ernst & Young, Deloitte and PricewaterhouseCoopers, to investigate and address the issue.[62]

         On January 19, 2019, Facebook advised Plaintiffs its production was complete and reported that it had "searched for potentially responsive minutes and materials originating from the full Board or any Committee thereof, and ha[d] produced all responsive documents generated from those searches."[63] Facebook confirmed there were no discussions of the advertising metric issues by the C&G Committee.[64]When discussions between the parties broke down, Plaintiffs commenced this action because they were dissatisfied that Facebook's production did not contain broader "documents relating to the directors' compensation determinations and decisions."[65]

         By the time of trial, two categories of documents requested in the Demands remained in dispute:

1.[C&G Committee] minutes and materials concerning growth or decline in Facebook advertisers or advertising-based revenue in connection with compensation determinations for any executive or director (which category includes any such minutes or materials concerning any (i) communication involving an NEO [(named executive officer)] concerning any change in revenue growth, and (ii) communications with advertisers concerning return on advertising investment); and
2. Director independence questionnaires.[66]

         With respect to Board materials, Plaintiffs clarified at trial that they are seeking to inspect only Board-level meeting materials from 2016 to present concerning the extent to which the Board (or its committees) considered advertising revenue growth deceleration in its executive compensation decisions.[67]

         II. ANALYSIS

         A stockholder's right to inspect the books and records of companies in which they are invested is broad but not unlimited.[68] When seeking to inspect books and records-"other than [the corporation's] stock ledger or list of stockholders"[69]-a stockholder bears the burden of proving by a preponderance of the evidence that: "(1) such stockholder is a stockholder; (2) such stockholder has complied with [Section 220] respecting the form and manner of making demand for inspection of such documents; and (3) the inspection such stockholder seeks is for a proper purpose."[70]

         A. The Proper Purpose Requirement

         A proper purpose is a purpose "reasonably related to [a stockholder's] interest as a stockholder."[71] Plaintiffs' stated purposes for inspection are:

(1) to aid [Plaintiffs] in determining how to vote with respect to the 2019 Say On Pay Vote, the election of Directors and other matters to be considered at the 2019 Annual Meeting of Shareholders;
(2) to aid [Plaintiffs] in determining whether to pursue contact with Facebook's directors and/or minority stockholders concerning Facebook's decelerating revenue growth and executive compensation determinations, and the performance of Facebook officers, directors and advisors;
(3) to investigate possible fiduciary wrongdoing, mismanagement or unjust enrichment by Facebook directors or officers in connection with advertising sales and compensation awards decisions for Facebook's NEOs, and disclosures regarding Facebook's executive compensation process and determinations to stockholders; [and]
(4) to investigate the independence and ability of the Board of Directors to consider and act on a stockholder demand to initiate claims for fiduciary mismanagement, wrongdoing or unjust enrichment.[72]

         When a stockholder seeks to inspect certain documents in furtherance of a particular purpose, the stockholder "must prove by a preponderance of the evidence that [his] primary purpose as to each category of the demand is proper."[73] As noted, the two categories of documents subject to dispute at trial were (1) C&G Committee materials regarding advertising revenue in connection with executive compensation determinations and (2) director independence questionnaires.[74] Plaintiffs clarified that "[e]ach of the four stated purposes relate[] to the Facebook board's consideration of Facebook's acknowledged internal advertising measurement problems and the trajectory of advertising revenue growth in the executive compensation process."[75]

         Based on Plaintiffs' arguments in their briefs and at trial, it is clear the third purpose (i.e., investigating wrongdoing related to executive compensation) is Plaintiffs' primary purpose.[76] I begin the analysis there.

         B. Plaintiffs Failed to Prove a Credible Basis that Mismanagement or Wrongdoing May Have Occurred

         Delaware law recognizes "a stockholder's desire to investigate wrongdoing or mismanagement" is a proper purpose.[77] "Such investigations are proper, because where the allegations of mismanagement prove meritorious, investigation furthers the interest of all stockholders and should increase stockholder return."[78] When stockholders seek documents to investigate wrongdoing, they must prove "some credible basis from which the court can infer that waste or mismanagement may have occurred."[79] A plaintiff meets that standard by introducing "some evidence of possible mismanagement as would warrant further investigation of the matter."[80]"[M]ere curiosity or a desire for a fishing expedition will not suffice."[81] The credible basis standard is "the lowest possible burden of proof" in Delaware law, but it is still a burden Plaintiffs must carry.[82] To meet their burden, Plaintiffs were obliged to make "a credible showing, through documents, logic, testimony or otherwise, that there are legitimate issues of wrongdoing."[83]

         As the Court determines whether Plaintiffs have proven their stated purpose to investigate corporate wrongdoing, the Court must account for Facebook's charter provision that limits director liability "to the fullest extent permitted by law."[84] Because Facebook's charter incorporates Section 102(b)(7) of the DGCL, [85]a purpose aimed at investigating and exposing breaches of the Board's duty of care will not support a demand for inspection.[86] In other words, Plaintiffs' purpose to investigate corporate wrongdoing is only proper to the extent it implicates the Board's duty of loyalty.[87]

         The duty of loyalty requires corporate fiduciaries to act in good faith for the benefit of the corporation.[88] To prove a breach of the duty of loyalty, a plaintiff must establish that the fiduciary either consciously disregarded his duties to stockholders or acted in his own interest to the detriment of stockholders.[89] This standard regulates conduct that is "qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence)."[90]

          To be sure, Plaintiffs are "not required to prove by a preponderance of the evidence that waste and [mis]management are actually occurring."[91] But they are obliged to present some evidence that there are legitimate issues of actionable wrongdoing.[92] This is a tall order given that the focus must be on the duty of loyalty. In this regard, Plaintiffs do not argue the C&G Committee members were conflicted or otherwise not acting independently. Thus, in the absence of a conflict of interest, Plaintiffs must fall back to argue that the "action complained of is otherwise inexplicable, so that bad faith-a motive other than the interest of the Company- must be at work."[93]

         Plaintiffs attempted to carry their burden to prove a credible basis to investigate Board-level bad faith by arguing "there is a credible basis to infer that the compensation determinations have not duly considered the known internal problems and ramifications to a huge and vital part of the business."[94] Plaintiffs essentially argue the Board's decision to "overcompensate" executives, notwithstanding the advertising metric issues and declining revenue growth, can only be explained by bad faith.[95]

         Plaintiffs' bad faith theory fails for three separate reasons. First, Plaintiffs failed to present any credible evidence that Facebook overcompensated its executives. Second, Plaintiffs presented no credible evidence to support an inference that Facebook's stock drop was related to the advertising metric errors that were discovered and reported two years earlier. Lastly, even if there was some evidence that the metric errors and the stock drop were correlated, there is still no credible evidence that the Board's compensation decisions were motivated by bad faith.

         1. No Credible Basis to Infer Overcompensation

         The trial record is devoid of any credible evidence from which the Court could undertake any meaningful analysis of the propriety, or not, of Facebook's executive compensation levels. For example, there is no evidence from which to infer that any individual's salary is inconsistent with Facebook's stated goals of incentivizing revenue growth.[96] Absent some evidentiary basis upon which to question how much Facebook executives are paid, the Court cannot and will not second-guess the C&G Committee's determination of how to best incentivize the Company's officers to generate more revenue.[97]

         2. No Correlation Between Metric Errors and Stock Price Drop

         As for the correlation evidence, Plaintiffs ask the Court to draw an inference that the stock drop resulted from the metric errors because a September 22, 2016, Wall Street Journal article indicated that some advertisers decreased their advertising spend after the errors were disclosed.[98] The metric errors were discovered and publicly addressed by Facebook in September of 2016.[99] Thereafter, Facebook made no mention of the metric errors in its seven subsequent earnings calls.[100] Indeed, it was not until after Facebook announced a declining revenue growth rate (attributed to factors other than the advertising metric errors) during an investor call ...

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