Yes, Federal Investigations May Require Your Company to Comply With a Stockholder’s Books-and-Records Demands

Gross v. Biogen Inc., C.A. No. 2020-0096-PAF (Del. Ch. Apr. 14, 2021).

On October 11, 2016, plaintiff Melvin Gross, served the first of four books-and-records demands on defendant Biogen Inc., under DGCL Section 220. Mr. Gross was a stockholder of Biogen at the time he made the demand. The demand sought eight categories of materials in order to: (1) “investigate possible corporate wrongdoing” and mismanagement related to state and federal investigations; and (2) “determine the independence of the Board members.” Biogen rejected the October 2016 demand, contending that it did not meet Section 220’s form and manner requirements, and that Gross lacked a proper purpose to inspect Biogen’s records. Through subsequent books-and-records demands on November 4, 2016, June 21, 2018, and December 3, 2019, Gross attempted to cure the alleged deficiencies, but succeeded only in prompting Biogen to argue that certain of the records sought were neither necessary nor essential to proper purposes outlined in the demand. Biogen refused to produce any of the requested records; so in February 2020, Gross filed a petition before the Delaware Court of Chancery, seeking to compel production.

On April 14, 2021, following a half-day trial in August 2020, Vice Chancellor Paul A. Fioravanti awarded Gross the right to inspect the majority of the books and records demanded. Specifically, the vice chancellor permitted the inspection of: (1) “board-level” materials relevant to the federal investigations into Biogen’s unlawful conduct; (2) materials sufficient to demonstrate Biogen’s “policies, controls, and procedures” for ensuring compliance with relevant federal statutes and regulations, including the board committees responsible for such oversight; and (3) director questionnaires concerning independence. Relying on KT4 Partners LLC v. Palantir Technologies Inc., 203 A.3d 738 (2019), the Court of Chancery declined to permit the inspection of “electronic communications and directors’ notes” since Biogen’s board adhered to formalities and board-level materials were sufficient for the purposes described in the 220 demand.

The cautionary note here is that the vice chancellor measured not only the merits of the arguments, but the aggressiveness of Biogen’s responses. The concern that companies are being too aggressive in insulating their board decisions from shareholder scrutiny has led judges in other cases to award fees as well as production of the records.

Biogen’s Alleged Wrongdoing Prompted the Demand

On April 21, 2016, Biogen notified stockholders that it had received subpoenas from state and federal authorities, which were seeking to determine whether Biogen had participated in a kickback scheme whereby Biogen funded nonprofits and directed them to use the donated funds to help Medicare and Medicaid patients afford Biogen’s drugs. In various SEC filings, Biogen conceded that state and federal authorities were investigating its sales and promotional practices, and asserted that it was cooperating with those inquiries.

In November 2019, the U.S. Attorney’s Office for the District of Massachusetts announced a $4 million settlement with The Assistance Fund (TAF), a nonprofit that allegedly violated the False Claims Act by enabling certain pharmaceutical companies to pay kickbacks to Medicare patients who purchased the drug companies’ products (the “TAF Settlement”). According to the federal government, Biogen participated in the kickback scheme by making payments to TAF’s fund on May 24 and July 17, 2012. The TAF Settlement and related claims were covered in various media reports reviewed by Gross.

During post-trial briefing, Biogen informed the court that it had executed a settlement agreement with the Department of Justice on December 17, 2020, to resolve a qui tam action, under the False Claims Act, which asserted that Biogen’s payment of co-pays through two charitable assistance programs were kickbacks leading to the submission of false or fraudulent claims to Medicare (the “DOJ Settlement”). The DOJ Settlement required Gross to pay $22 million in exchange for releases from certain civil and administrative claims.

Investigating Biogen’s Alleged Wrongdoing Was a Proper Purpose for the 220 Demand

Biogen argued that Gross was not entitled to relief under Section 220 because, among other things, Gross: (1) lacked a proper purpose of his own; (2) failed to state a credible basis to suspect wrongdoing; and (3) did not articulate actionable claims. The vice chancellor was not swayed by Biogen’s reasoning.

Gross Had His Own Proper Purpose

Gross’s 220 demand states two purposes: (1) “to investigate ‘the possibility of breaches of fiduciary duty by Biogen’s Board related to” government investigations into kickback violations; and (2) “to investigate ‘the independence and disinterest of the Board relating to Biogen’s alleged kickback violations.”

Biogen’s first line of attack was that the purposes articulated in the 220 demand were those of Gross’s counsel; therefore, under Wilkinson v. A. Schulman, Inc., 2017 WL 5289553 (Del. Ch. Nov. 13, 2017), Gross lacked a proper purpose for inspection. In Wilkinson, the stockholder conceded that his reasons for requesting books and records under Section 220 differed substantially from those in his demand. Indeed, the stockholder was unfamiliar with the facts underlying the wrongdoing that he purportedly wanted to investigate. And, other than signing the demand and verifying the related complaint, the stockholder had no involvement in any of the efforts to secure the defendant-company’s books and records. Since counsel, not the stockholder, was the catalyst behind the demand in Wilkinson, the Court of Chancery held that the stockholder lacked a proper purpose to inspect any books and records. “Wilkinson involved extreme facts.”

According to the vice chancellor, such circumstances did not exist in Gross. In response to Biogen’s efforts to paint Gross’s efforts under Section 220 action as lawyer-driven, the Court of Chancery noted that a stockholder is expected to rely on his attorney given the complexity of Section 220 and the fact that the provision expressly permits an attorney to make a demand on his stockholder-client’s behalf. And, unlike Wilkinson, where the stockholder was unaware of the facts relevant to the unlawful conduct he purportedly wanted to probe, Gross’s demand was motivated by allegations he read in a news article and encouraged by Biogen’s own disclosures in public filings and settlements with government authorities. Given that, the court found that the 220 demand stated Gross’s own proper purpose — not that of counsel.

The 220 Demand Stated a Credible Basis to Suspect Wrongdoing

The vice chancellor also dismissed Biogen’s contention that Gross lacked a credible basis to investigate mismanagement and wrongdoing.

The credible-basis standard is the lowest possible burden of proof. It is a threshold that can be met by demonstrating, “through documents, logic, testimony or otherwise, that there are legitimate issues of wrongdoing” or that “wrongdoing is merely possible.” Ongoing or concluded investigations or lawsuits typically are sufficient “evidentiary basis to suspect wrongdoing or mismanagement warranting further investigation.” In this case, the Court of Chancery held that the demand stated a credible basis of wrongdoing since Biogen’s alleged misconduct was the subject of various state and federal investigations, related subpoenas, and two settlements.

Nevertheless, Biogen argued that the demand lacked a credible basis because Gross did not demonstrate that Biogen’s directors or officers were complicit. But such a showing is unnecessary to support a credible basis where, as in Gross, the plaintiff has not limited his purpose to pursuing a derivative claim. In any event, Gross’s demand and 220 petition did “demonstrate a credible basis to infer possible mismanagement at the level of the board or senior officers.” Among other things, Biogen’s board established and oversaw a compliance committee that existed to prevent the very conduct at issue in the state and federal investigations, the TAF settlement, the DOJ settlement, and Gross’s 220 demand. Additionally, Biogen’s vice president was alleged to have actively participated in the challenged scheme, which would demonstrate knowledge at a management level.

Gross Did Not Need to Assert Actionable Claims in the 220 Demand

Biogen further argued that Gross’s 220 demand should be denied because it did not demonstrate an ability to bring a lawsuit based on the wrongdoing Gross sought to investigate. The court swiftly rejected that argument, pointing out that the Delaware Supreme Court has held “that a stockholder who demonstrates a credible basis from which the court can infer wrongdoing or mismanagement” need not “demonstrate that the wrongdoing or mismanagement [was] actionable.” While there are two exceptions to that rule — the stockholder’s only proper purpose was to pursue litigation or a purely procedural obstacle — those exceptions rarely occur, and neither existed in Gross.

Books and Records Requested Must be Necessary and Essential for the Proper Purpose

The scope of a demand under Section 220 typically is limited to formal board-level documents essential to the proper purpose articulated in the demand. A stockholder is entitled to informal materials, such as text messages, emails, and notes, only where such materials are necessary and essential because the board conducted corporate business informally, rendering formal board materials insufficient to investigate wrongdoing. In Gross, plaintiff did not present any evidence that informal board materials were necessary or that the documents presented to the board were insufficient. Therefore, the Court of Chancery declined to compel Biogen to produce notes taken by board members, emails or text messages. But the vice chancellor ordered Biogen to produce board-level documents and materials:

• Relating to the state and federal investigations in to the kickback scheme;
• Concerning corporate policies or procedures implicated in the investigations;
• Sufficient to demonstrate Biogen’s policies, controls and procedures for ensuring compliance with the Anti-Kickback Statute and the lawful contribution of grants to nonprofit organizations;
• Evidencing the board committee and/or subcommittee responsible for monitoring the state and federal investigations; and
• Consisting of director questionnaires regarding director independence.

Key Takeaways

Seemingly unprompted, the vice chancellor admonished Biogen’s repeated and complete denials of Gross’s 220 demand because they reflected a “recent trend” towards “overly aggressive” responses. In a couple of other recent cases, a corporation’s recalcitrance has caused the Court of Chancery to order the company to pay legal fees and expenses related to the stockholders’ 220 demand. Thus, companies responding to a 220 demand must be strategic and reasonable, perhaps even restrained, in their response. If the scope of the demand is the only true controversy, corporations should refrain from pursuing weak arguments about other aspects of the demand.

Another lesson from the Gross decision is that while the credible-basis standard has a low threshold, company counsel should pay attention to whether the stockholder’s only stated purpose is to pursue derivative or other litigation; because in such instances, the stockholder must demonstrate that the claims he seeks to bring are actionable and a stockholder’s failure to do so can be fatal to the 220 demand.