Amongst the issues discussed in a Delaware Chancery Court opinion in a case captioned In re Plug Power Inc. Stockholder Derivative Litigation, was whether SEC comment letters formed a basis for a Caremark Claim.
The Company received five comment letters from the SEC between mid-2018 and early 2021. The letters were dated September 5, 2018, April 24, 2019, June 20, 2019, December 16, 2020, and February 10, 2021. The Company responded to the letters on September 19, 2018, May 8, 2019, July 5, 2019, and January 14, 2021.12 The allegations reflect that the Audit Committee discussed SEC letters during that period, although there was scant mention of those letters in the minutes.
The comment letters inquired into the following, among other things:
- Discussing revenue and gross profit on a gross basis excluding the effects of the provision for the fair value of warrants issued as sales incentives;
- Presenting non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP;
- Presenting revenue by line item and in total, excluding the provision for the fair value of warrants issued as sales incentives;
- Presenting non-GAAP measures with greater prominence than the directly comparable GAAP measure, or failing to discuss the comparable GAAP measure at all;
- Describing adjusted EBITDA as purely a liquidity metric, not a performance measure;
- Excluding cash flow effects associated with changes in working capital from the adjusted EBITDA measure, which was inconsistent with presenting it as a liquidity measure and potentially misleading investors; and
- Lease accounting and accounting for lease financing implicating Plug Power’s application and presentation of Topic 842, including “right of use” accounting issues.
Caremark claims can be brought in one of two ways if a plaintiff alleges particularized facts that establish:
- the directors utterly failed to implement any reporting or information system or controls (an information systems claim), or
- having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention (a red flag claim).
To support their information systems claim the Plaintiffs argued:
- SEC comment letters generally present a distinct risk that requires its own monitoring system beyond the ambit of the Audit Committee; and
- The Audit Committee discussions were not sufficiently robust.
The Court noted that Delaware law does not dictate what structure a reporting system must take. Rather, under Delaware law, “how directors choose to craft a monitoring system in the context of their company and industry is a discretionary matter.” That is, the law requires courts to exercise good faith oversight, “not to employ a system to the plaintiffs’ liking.”
Turning toward the allegation that the Audit Committee discussions were not sufficiently robust, the Court noted the “absence of regular board-level discussions on the relevant topic” “alone is not enough for the [c]ourt to conclude a board of directors acted in bad faith.” Plaintiffs’ disagreement with the adequacy of the Audit Committee’s or Board’s consideration of the SEC comment letters did not mean that the Board failed to make a good-faith effort to establish a system.
As to the Plaintiff’s red flag allegations, the Court doubted receipt of an SEC comment letter alone was a red flag. Even if the comment letters constituted a red flag, it was not reasonable to conclude based on the facts alleged that the Board ignored them in bad faith. Plug Power’s system in place worked to some degree—Plug Power responded promptly to each of them and the Audit Committee received reports about them.
Finally, the Court noted the Plaintiff’s had not specifically plead any corporate trauma resulting from the comment letters. Even assuming for purpose of the analysis that Plaintiffs adequately pled a corporate trauma, they have not proffered any theory that connects the dots between the Board’s alleged conduct and that harm.
Accordingly, the Court dismissed the Caremark claim pursuant to Rule 12(b)(6).
