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Plaintiffs filed this lawsuit on behalf of a class of stockholders of Occam. Defendants moved for sanctions against all plaintiffs other than Derek Sheeler for trading on the basis of confidential information obtained in this litigation. With respect to Michael Steinhardt and the funds, the motion was granted. Consistent with prior rulings by this court when confronted with representative plaintiffs who have traded while serving in a fiduciary capacity, Steinhardt and the funds were dismissed from the case with prejudice, barred from receiving any recovery from the litigation, required to self-report to the SEC, directed to disclose their improper trading in any future application to serve as lead plaintiff, and ordered to disgorge profits. With respect to Herbert Chen, the motion was denied.Receive FREE Daily Opinion Summaries by Email
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
MICHAEL STEINHARDT, HERBERT CHEN,
DEREK SHEELER, STEINHARDT OVERSEAS
MANAGEMENT, L.P., and ILEX PARTNERS,
L.L.C., individually and on behalf of all others
ROBERT HOWARD-ANDERSON, STEVEN
KRAUSZ, ROBERT ABBOTT, ROBERT
BYLIN, THOMAS PARDUN, BRIAN STROM,
ALBERT MOYER, and OCCAM NETWORKS,
) C.A. No. 5878-VCL
Date Submitted: November 21, 2011
Date Decided: January 6, 2012
Robert J. Katzenstein, David A. Jenkins, Stephanie S. Habelow, SMITH,
KATZENSTEIN & JENKINS LLP, Wilmington, Delaware; Eduard Korsinsky, Michael
H. Rosner, LEVI & KORSINSKY, LLP, New York, New York; Attorneys for Plaintiffs.
Peter J. Walsh, Jr., Ryan W. Browning, POTTER ANDERSON & CORROON, LLP,
Wilmington, Delaware; Jerome F. Birn, Jr., Ignacio E. Salceda, Gregory L. Watts, Clay
Basser-Wall, WILSON SONSINI GOODRICH & ROSATI, P.C., Palo Alto, California;
Attorneys for Defendants.
LASTER, Vice Chancellor.
Plaintiffs Derek Sheeler, Herbert Chen, Michael Steinhardt, Steinhardt Overseas
Management, L.P., and Ilex Partners, L.L.C. filed this lawsuit on behalf of a class of
stockholders of Occam Networks, Inc. (“Occam” or the “Company”). The defendants
have moved for sanctions against all plaintiffs other than Sheeler for trading on the basis
of confidential information obtained in this litigation.
With respect to Steinhardt and the funds, the motion is granted. Consistent with
prior rulings by this Court when confronted with representative plaintiffs who have
traded while serving in a fiduciary capacity, Steinhardt and the funds are dismissed from
the case with prejudice, barred from receiving any recovery from the litigation, required
to self-report to the Securities and Exchange Commission, directed to disclose their
improper trading in any future application to serve as lead plaintiff, and ordered to
disgorge profits in the amount of $534,071.45. With respect to Chen, the motion is
On November 21, 2011, I held an evidentiary hearing on the sanctions motion.
Chen and Steinhardt testified live. The paper record included depositions of Steinhardt
and Chaim Rosenberg (Steinhardt‟s principal trader), two depositions of Chen, three
affidavits from Chen, documentary evidence relating to the trading allegations, and
additional deposition transcripts and documents from the injunction phase of the case.
What follows are my findings of fact for purposes of the sanctions motion.
The Relevant Parties
Before its acquisition by Calix, Inc., Occam was a publicly traded Delaware
corporation headquartered in Santa Barbara, California. Occam developed, marketed,
and supported broadband access products designed to enable telecommunications service
providers to offer advanced voice, video, and high speed broadband services over copper
and fiber optic networks.
Calix was and remains a publicly traded Delaware corporation headquartered in
Before acquiring Occam, Calix was one of Occam‟s primary
Plaintiff Steinhardt has been a professional investor for nearly forty-five years. He
reportedly has a net worth of approximately $500 million and has been described as “one
of the most successful investors in the history of Wall Street.” Aff. of Clayton BasserWall, Ex. 18 (Rediff.com, World’s 10 Greatest Investors, http://business.rediff.com/slideshow/2010/mar/05/slide-show-1-worlds-10-greatest-investors.htm (last updated Mar. 5,
2010) (last visited Jan. 4, 2012)). From 1967 until 1995, Steinhardt managed a hedge
fund. Since liquidating the fund in 1995, Steinhardt has managed his own money.
Plaintiffs Steinhardt Overseas Management, L.P., and Ilex Partners, L.L.C. (jointly, the
“Funds”) are both managed by Steinhardt.
Plaintiff Chen has been a professional investor for nearly twenty-five years. After
receiving his MBA from Wharton in 1987, Chen joined Steinhardt‟s firm as an analyst
and eventually became a partner. In 1993, Chen left Steinhardt‟s employ to trade on his
own. Around 2005, he established a fund called Lattanzio Chen Partners, L.P. with
another Steinhardt alumnus. Chen also manages his own money. Throughout his postSteinhardt career, Chen has worked out of Steinhardt‟s offices, where he receives space
free of charge. Chen‟s office is roughly twenty feet away from Steinhardt‟s.
Before the merger, Chen beneficially owned 619,946 shares of Occam,
representing 2.9% of its outstanding stock.
Chen‟s pre-merger holdings of Occam
amounted to approximately 20% to 25% of his net worth. In his deposition, Chen
characterized himself as a “champion” and “advocate” for Occam. Using pseudonyms,
he frequently posted about Occam on message boards hosted by Yahoo! and Nyquist
Forums. Chen also wrote research articles about Occam on SeekingAlpha.com under the
alias “Mr. Bert.”
Chen was the catalyst for Steinhardt and the Funds‟ investment in Occam. In
January 2009, the Lattanzio-Chen fund needed liquidity to meet a margin call. Chen
offered a block of Occam shares to Steinhardt at a distressed price, which Steinhardt
found attractive. As a result of the transaction and other smaller purchases, Steinhardt
came to own 2,839,983 shares of Occam, representing 13.5% of its outstanding stock. At
Chen‟s urging, Steinhardt and the Funds became representative plaintiffs in this action.
Plaintiff Sheeler beneficially owned 556,570 shares of Occam, representing 2.6%
of its outstanding stock.
Sheeler was another frequent poster about Occam on the
Nyquist Forums and Yahoo! message boards under the alias “Toad680.” Sheeler also
blogged about Occam under the alias “Derek Kent.”
Occam And Calix Announce The Merger.
On September 16, 2010, Occam and Calix announced an agreement and plan of
merger. Under the agreement, Occam would merge with a wholly owned acquisition
subsidiary of Calix, and each share of Occam common stock would be converted into the
right to receive $3.8337 in cash and 0.2925 shares of Calix common stock (the
“Merger”). On the date of announcement, the Merger consideration had an implied value
of $7.75 per Occam share.
On September 27, 2010, plaintiffs Chen, Steinhardt, and Sheeler sent a fifteenpage letter to defendant Steven Krausz, the Chairman of Occam‟s Board of Directors, in
which they detailed their objections to the Merger. In the opening two paragraphs, the
plaintiffs described themselves as “significant shareholders of the company” and noted
that “we currently own or have investment control over approximately 4 million shares,
or approximately 19% of Occam.” JX 4, Ex. 2. The plaintiffs then summarized their
Currently, despite giving consideration to the potential of the acquisition,
Occam shares closed Friday at just $7.41, representing virtually no
premium to the price range since March of this year. Further, we note that
the structure of the proposed deal significantly cashes out Occam
shareholders at a critical time, just as revenues are beginning to ramp, while
at the same time creating a potentially taxable event.
Therefore, while we appreciate the potential strategic benefits of such a
deal, we are firmly opposed to the deal as currently structured and believe it
comes nowhere close to recognizing either the intrinsic value of the
company‟s cash flows or, as in the present case, its potential strategic value
to a third party. We believe that the board of directors of Occam has acted,
once again, with reckless and wanton disregard for its shareholders, and we
hereby demand that the board move immediately to open up the sales
process by auctioning the company to the highest bidder.
Id. In the ensuing fourteen pages, the letter criticized the Occam-Calix transaction based
on industry reports, the timing of the deal, the potential impact of government stimulus,
recent trading prices, the valuation of Occam, how the sale process was conducted, and
whether it complied with Delaware law. Later that day, Chen, Steinhardt, and Sheeler
filed a Schedule 13D that included the letter as an exhibit.
The Plaintiffs File Suit.
On October 6, 2010, the plaintiffs filed this litigation. The original complaint
alleged that the Occam directors breached their fiduciary duties in approving the Merger
at an unfair price. Because Occam had not yet filed its preliminary proxy statement, the
original complaint did not assert any disclosure violations. In the first paragraph of the
original complaint, the plaintiffs stressed their combined beneficial ownership of
approximately 19% of Occam‟s outstanding common stock.
Between October 29 and November 2, 2010, Chen sold 31,000 shares of Occam
stock at an average price of $7.36 per share, less than the implied value of the Merger
consideration on the date of announcement. Chen testified credibly that he sold these
shares to generate liquidity for himself and his fund because he anticipated that once a
confidentiality order was entered, his ability to trade would be limited.
The Confidentiality Order
On November 12, 2010, I approved a Stipulation and Order Governing the
Production and Exchange of Confidential Information that the parties had negotiated (the
“Confidentiality Order”). Paragraph 8 of the Confidentiality Order provided as follows:
Confidential Discovery Material, or information derived
therefrom, shall be used solely for purposes of this Litigation
and in an appraisal proceeding that Plaintiffs in this Litigation
may file . . . . Confidential Discovery Material shall not be
used for any other purpose, including, without limitation, for
any business or commercial purpose or for any other litigation
or proceeding. Confidential Discovery Material Parties and
non-parties who receive Confidential Discovery Material
shall not purchase, sell, or otherwise trade in the securities of
any company, including but not limited to Occam and Calix,
on the basis of confidential information contained in the
Confidential Discovery Material to the extent such
information is still confidential at the time of such purchase,
sale or trade.
Confidentiality Order ¶ 8. Paragraph 8 thus contained both a general requirement that
Confidential Discovery Material “be used solely for purposes of this Litigation” (the
“Use Restriction”) and a specific restriction against purchasing, selling, or otherwise
trading “in the securities of any company, including but not limited to Occam and Calix,
on the basis of confidential information contained in the Confidential Discovery
Material” (the “Trading Restriction”).
The Plaintiffs Pursue An Expedited Injunction Application.
On November 24, 2010, the plaintiffs filed an extensively researched and highly
detailed amended complaint. The new pleading spanned 130 pages and contained 322
numbered paragraphs. It continued to challenge the fairness of the transaction and added
disclosure claims. Paragraph 1 of the amended complaint again stressed the plaintiffs‟
combined beneficial ownership of approximately 19% of Occam‟s outstanding common
stock. The plaintiffs further represented that they were “committed to prosecuting this
action” on behalf of Occam‟s public stockholders. Id. ¶¶ 309-10. Chen played a major
role in drafting the amended complaint.
On December 15, 2010, the plaintiffs moved for a preliminary injunction against
the Merger, and the parties thereafter agreed on a reasonable schedule for expedited
proceedings. The defendants started their document production on December 1, 2010,
ultimately producing over 13,000 pages.
Occam‟s investment banker, Jefferies &
Company, Inc. (“Jefferies”) started its document production on December 21, eventually
producing over 3,000 additional pages.
Many of the documents were designated
“Confidential” for purposes of the Confidentiality Order. Chen reviewed much of the
On January 5 and 6, 2011, the plaintiffs deposed defendants Robert HowardAnderson and Steven Krausz. On January 7, the plaintiffs deposed Jeffrey Snyder, a
relatively junior banker on the Jefferies team whom Jefferies designated as its original
Rule 30(b)(6) representative. The deposition transcripts were designated “Confidential.”
Chen reviewed the Howard-Anderson and Krausz deposition transcripts and attended the
Steinhardt Shorts Calix.
On December 28, 2010, when the defendants‟ and Jefferies‟ document productions
were nearly complete, Steinhardt began short selling Calix common stock. His sales
continued through the closing of the Merger. In total, he sold short 589,097 shares of
Calix stock. At the Merger‟s exchange ratio of 0.2925 Calix shares per Occam share,
Steinhardt‟s short sales equated to selling 2,014,007 shares of Occam common stock.
When Steinhardt started his short selling, he beneficially owned 2,839,983 Occam shares.
After his sales, at the time the Merger closed, he effectively held 825,976 Occam shares.
Steinhardt sold Calix short as a way to exit his Occam position. By selling Calix
short, Steinhardt could both liquidate his Occam position and “tak[e] advantage of the
arbitrage spread that existed between Calix and Occam at that time.” Tr. 19. He
intended to (and later did) use the shares of Calix stock he would receive when the
Merger closed to cover his short sales, even though Steinhardt and his co-plaintiffs were
asking the Court to enjoin the closing of the Merger. Steinhardt testified that “based
upon everything that [he] knew, there was a very high probability of that merger
occurring.” Tr. 19. As described below, the universe of “everything that [Steinhardt]
knew” included detailed written and oral reports from Chen about the progress of the
Steinhardt testified that he decided to short Calix after the stock ran up.
Calix had really gone up a lot. Remember it was issued publicly for the
first time, now months ago, I think at $8, and it really had gone up a lot.
And the impression I was given from my source, Herb Chen, was that
[Calix‟s CEO] Russo was a hot shot and a little bit of wise-guy and he had
promoted the stock and got it up to whatever it was up to before all of this,
and there was a bunch of venture capital funds in it. There was a little hype
associated with it. It was up a lot.
Steinhardt Dep. 205. Steinhardt further explained his rationale as follows:
[I]f you make three times your money in a relatively short period, and much
of that money is being made in a merger that has aspects to it that are
viewed as uncomfortable and even unsavory, then the idea of sticking
around isn‟t all that attractive. Particularly if you are sticking around in a
company whose management gooses the stock from the public offering,
and gooses the stock again in anticipation of the merger, and has the
reputation of being a wise-guy. So who wants to be involved in that sort of
a management anyway, even if it does have really bullish prospects.
Particularly when the stock is up a great deal.
Id. at 219-20. Steinhardt testified that in light of the run-up, “the risk reward was no
longer so great,” and he was “happy to go home.” Id. at 206.
Steinhardt’s Receipt Of Non-Public Information About The Litigation
At the time he decided to sell, Steinhardt admittedly had been receiving regular
written and oral updates about the litigation, albeit from Chen rather than from plaintiffs‟
counsel. Steinhardt did not speak directly with plaintiffs‟ counsel until May 2011, two
days before his deposition. Instead, Chen “acted as a „conduit‟ between Mr. Steinhardt
and Plaintiffs‟ counsel” by telling Steinhardt what he learned in conversations with
plaintiffs‟ counsel and by reviewing documents and depositions. Pls.‟ Reply Br. in Supp.
of their Interim Application for Attorneys‟ Fees and Expenses at 6.
In his deposition, Steinhardt testified about the updates he received:
How frequently did you receive oral updates from Mr. Chen on the
status of this litigation?
Once every week or so.
Did Mr. Chen‟s updates with you include his description of things he
was learning about the facts of the case?
And did those oral updates include Mr. Chen‟s description of things
he was learning from his review of deposition transcripts?
I think so.
And did his oral updates with you include his description of
information he had learned from documents produced by the
defendants in this litigation?
I think so.
But Mr. Chen did provide you with summaries of what he was
Did he communicate to you that he believed he was learning more
about Occam and this merger than he would have otherwise known?
Did he in those conversations share some of that new information
Steinhardt Dep. 73-74, 99; accord Tr. 38. During the evidentiary hearing on the motion
for sanctions, Steinhardt recalled Chen describing for him some of the information
obtained through discovery. Tr. 9.
In addition, Chen provided Steinhardt with regular written updates on the case,
which Steinhardt read “thoroughly and carefully.” Steinhardt Dep. 85; see Tr. 61 (Chen
stating that he provided Steinhardt with oral updates and written memos). The updates
began before the filing of the lawsuit and continued through at least May 25, 2011, the
date of Steinhardt‟s deposition.
Disappointingly, there is no record of any written
updates to Steinhardt post-dating December 14, 2010, apparently because Steinhardt
threw them away after reading them. The plaintiffs have produced copies of ten written
updates that Chen provided to Steinhardt between September 16 and December 14, 2010,
but redacted substantial portions of those documents as privileged. Other memos were
withheld entirely as privileged.
Chen knew that Steinhardt was selling Calix short and disagreed with his decision.
Chen believed that Calix would continue to move higher and argued that Steinhardt
should hold. Steinhardt testified that “if it was up to Mr. Chen I would probably still own
Calix today.” Steinhardt Dep. 199. Chen believes that he warned Steinhardt about
trading in light of his status as a representative plaintiff. Tr. 64 (“I believe I mentioned it
to him. I don‟t believe I went into his office and jumped up and down and said „You
can‟t,‟ but I believe I said, „You realize this means you shouldn‟t trade in Occam.‟”).
Steinhardt and Chen did not inform plaintiffs‟ counsel about the short sales.
Counsel only learned of the transactions after the defendants served discovery requests
directed towards the plaintiffs‟ trading.
The Injunction Decision
On January 24, 2011, I conducted a hearing in open court on the plaintiffs‟ motion
for a preliminary injunction. The hearing was broadcast by Courtroom View Network,
and Chen attended in person. At the conclusion of the hearing, I granted the plaintiffs‟
motion and enjoined the stockholder vote on the Merger pending the issuance of
supplemental disclosures and the deposition of one of the lead bankers from Jefferies.
Chen’s Sale of Occam Shares
On January 25, 2011, Chen sold an additional 2,500 shares of Occam stock. The
impetus for the trade appears to have been a margin call. Chen trades through Interactive
Brokers, a platform that liquidates stocks automatically to cover any margin deficit at the
end of the trading day.
At around 3:45 p.m. on January 25, Chen was notified that he had a margin deficit
in his account. Chen is a director of TranSwitch Corporation, by far his largest equity
position. As an insider, Chen could not freely sell TranSwitch shares. Chen feared that if
he did not sell other shares to raise cash, his broker automatically would liquidate shares
from his largest position, creating potential problems for Chen.
Chen testified that he reacted to his predicament by trying to sell shares of Cisco,
but mistakenly sold shares of Occam. Chen first offered 2,500 shares via limit order at a
price of $8.26 per share. When the limit order did not fill quickly, Chen lowered the limit
price to $8.25 per share. Chen dismisses the trade as a “fat-finger” error. Tr. 67.
As the defendants point out, the ticker symbol for Cisco (CSCO) does not closely
resemble the ticker symbol for Occam (OCNW). Moreover, on January 25, 2011, Cisco
was trading around $20.00 per share, more than twice the limit in Chen‟s order. Chen
testified that he operates his trading program by clicking his mouse on small symbols and
trading graphics on his screen, rather than by typing in letters, and he probably clicked in
the wrong spot.
He also testified that the limit price appears automatically in his
program, and he likely did not focus on price. According to Chen, he multitasks while
trading like a smart-phone-addicted teenager, including by “entering orders while talking
on the phone, or sending instant messages, or calculating margin requirements,” or
“playing speed chess.” Chen Aff. dated Sept. 23, 2011, ¶ 10; Tr. 75. For Chen, “[t]he
execution of a small 2,500 share trade (whether in Cisco or most other stocks) is a highly
routine event, one that [he] might do dozens of times a day,” and it therefore “often does
not command [his] full attention.” Chen Aff. dated Sept. 23, 2011, ¶ 10.
Sometime after the sale closed, Chen realized that he sold Occam in violation of
the Confidentiality Order. At that point, however, Chen could not unwind the sale. He
chose not to repurchase the shares, believing that trading Occam twice would be worse
than trading once. The sale of 2,500 shares represented less than one-half of one percent
of his 554,000 share position.
Chen did not inform plaintiffs‟ counsel about the transaction. As with Steinhardt‟s
short sales, counsel only learned about it when collecting information to respond to the
defendants‟ trading-related discovery requests.
Occam’s Stockholders Approve The Merger.
Occam convened and adjourned its special meeting of stockholders and made
additional disclosures in a Schedule 14A filed with the SEC on February 7, 2011. At the
reconvened special meeting on February 22, 2011, the Merger was approved by the vote
of 13,707,405 shares, representing approximately 64% of the 21,557,812 shares
outstanding and entitled to vote.
Steinhardt Tries To Fade Into The Background.
After the injunction hearing, the defendants served discovery requests seeking
information about the plaintiffs‟ trading activities. Plaintiffs‟ counsel proposed that in
lieu of responding to the discovery requests, Steinhardt would step down as a class
representative. When the defendants declined this offer, plaintiffs‟ counsel suggested
that in lieu of producing documents or responding to interrogatories, Steinhardt would sit
for a deposition. Again, the defendants declined. Through the ensuing discovery, the
defendants learned about Steinhardt‟s and Chen‟s trades.
On May 20, 2011, plaintiffs Chen and Sheeler moved for class certification and to
be certified as class representatives. Steinhardt and the Funds did not. A footnote in the
plaintiffs‟ opening brief in support of their motion for class certification explained
Steinhardt‟s decision as follows:
Named plaintiffs Michael Steinhardt, Steinhardt Overseas Management,
L.P. and Ilex Partners, L.L.C. remain fully supportive of this Action and
believe that class treatment is warranted (with Messrs. Chen and Sheeler as
the Class representatives). However, to streamline the litigation and
alleviate the burden on them created by Defendants‟ excessive discovery
demands, Mr. Steinhardt and his entities have elected to step down as
proposed class representatives.
Pls.‟ Opening Br. in Supp. of their Mot. for Class Certification 1 n.1. The brief did not
disclose or discuss Steinhardt‟s short sales.
When a stockholder of a Delaware corporation files suit as a representative
plaintiff for a class of similarly situated stockholders, the plaintiff voluntarily assumes the
role of fiduciary for the class. See Emerald P’rs v. Berlin, 564 A.2d 670, 673 (Del. Ch.
1989); Youngman v. Tahmoush, 457 A.2d 376, 379 (Del. Ch. 1983). As a fiduciary, the
representative plaintiff “owes to those whose cause he advocates a duty of the finest
loyalty.” Barbieri v. Swing-N-Slide Corp., 1996 WL 255907, at *5 (Del. Ch. May 7,
1996) (internal quotation marks omitted).
This Court has addressed trading by representative plaintiffs in a series of rulings.1
As the Court has explained, trading by plaintiff-fiduciaries on the basis of information
obtained through discovery undermines the integrity of the representative litigation
process.2 Consequently, it is unacceptable for a plaintiff-fiduciary to trade on the basis of
non-public information obtained through litigation.3 Depending on the facts of the case,
See In re Netezza Corp. S’holder Litig., Consol. C.A. No. 5858-VCS (Del. Ch.
Apr. 6, 2011) (TRANSCRIPT) (“Netezza Ruling”); Berger v. Icahn Enters. L.P., C.A.
No. 3522-VCS (Del. Ch. Oct. 23, 2009) (TRANSCRIPT) (“Berger Ruling”); Sample v.
Morgan, C.A. No. 1214-VCS (Del. Ch. Aug. 5, 2008) (TRANSCRIPT) (“Sample
Ruling”); Benton v. Guitar Ctr., Inc., C.A. No. 3075-VCS (Del. Ch. Sept. 7, 2007)
(TRANSCRIPT) (“Benton Ruling”); In re Netsmart Techs., Inc. S’holders Litig., Consol.
C.A. No. 2563-VCS (Del. Ch. May 1, 2007) (TRANSCRIPT) (“Netsmart Ruling II”); In
re Netsmart Techs., Inc. S’holders Litig., Consol. C.A. No. 2563-VCS (Del. Ch. April 11,
2007) (TRANSCRIPT) (“Netsmart Ruling I”).
See Benton Ruling at 77 (“Once you get access to information only for litigation
purposes, it‟s particularly kind of unsightly to trade below a deal and then try to prevent
other people from trading on the deal because people get access.”); Netezza Ruling at 1516 (“Once really counsel start getting into it and discussing things, like even whether
you‟re going to expedite a case, you know, even before confidential discovery shifts
hands, counsel for the client often knows things that members of the investing public
don‟t -- and members of this court don‟t. And I care about the representative litigation
process. No one wants to shut it down.”); see also Berger Ruling at 63 (“[W]e‟re in a
court where we believe that representative litigation is important and has value. The
more you believe that, the more important it is that it proceed with integrity.”); Netsmart
Ruling I at 8 (“I believe that the representative litigation process has value. But it only
has value when it has integrity. And when its integrity is undermined, you can have -you can give arguments to people to take down the whole system.”).
See Berger Ruling at 55-56 (“I think it‟s far simpler than that, which is you kind
of come in to litigation with what you have; and then if you want to sign up for
confidential information, you‟re going to deal with limitations on your ability to buy and
sell.”); Netsmart Ruling I at 12-14 (“[P]eople don‟t get to be plaintiffs to go ferret around
for nonpublic information and then make their own trading decisions and leave
everybody else with the costs.”); Benton Ruling at 77 (“You own what you own coming
in.”); Sample Ruling at 4 (“I do think there‟s a larger lesson that‟s arisen in not just this
the Court has exercised its remedial discretion by (i) dismissing the plaintiff from the
case with prejudice, (ii) barring the plaintiff from participating in any recovery from the
litigation, (iii) requiring self-reporting of the trading activity to the SEC, (iv) ordering the
party to disclose its improper trading in any future application to serve as lead plaintiff,
and (v) requiring disgorgement of trading profits.
In the Netsmart litigation, a sophisticated hedge fund serving as one of the
representative plaintiffs sold stock during the pendency of the litigation. At the time, the
plaintiff had received advice from counsel on the likely outcome of the litigation, and
counsel‟s views were informed by the discovery taken in the case. The confidentiality
order only contained a use restriction, not an additional trading restriction. The hedge
fund consulted with class counsel, who advised that the trade was permissible. Rather
than profiting, the hedge fund lost money on the trade. The Court nevertheless imposed
sanctions, explaining that because class representatives “act as fiduciaries on behalf of
others,” they cannot come to the Court “as a free agent able to get nonpublic information
and make [their] own trading decisions. [They] lose that freedom when . . . [they] sue.”
Netsmart Ruling I at 14.
The Court emphasized that trading based on non-public
information obtained through litigation “is just not done,” “is just not acceptable,” and “is
not stuff you mess around with.” Id. at 13. The Court dismissed the plaintiff from the
case but out of several recent cases . . . in terms of not trading in securities during the
pendency of a representative action . . . .”); Netezza Ruling at 15 (“When you file a suit
and you‟re purporting to represent a class, absolutely there has to be an understanding
that you are not free to buy and sell securities in the same way that you were
before . . . .”).
case with prejudice and required the plaintiff to report the sales to the relevant
enforcement unit at the SEC. In re Netsmart Techs., Inc. S’holders Litig., Consol. C.A.
No. 2563-VCS (Del. Ch. July 16, 2007) (ORDER).
Likewise, in Berger, a representative plaintiff bought shares during the pendency
of the lawsuit and while in possession of non-public confidential information, including
class counsel‟s views based on discovery and knowledge of an early settlement proposal
from the defendants that class counsel declined.
The Court made clear that a
representative plaintiff cannot “get access to litigation information that other people don‟t
have and then [trade] at the expense of people in the class whose interest he represents . .
. .” Berger Ruling at 59. Rather, “you kind of come in to litigation with that you have;
and then if you want to sign up for confidential information, you‟re going to deal with
limitations on your ability to buy and sell.” Id. at 55-56.
The Court dismissed the
representative plaintiff who purchased stock from the action with prejudice and precluded
him from receiving any recovery from the litigation for shares purchased after the
confidentiality order was entered. See Berger v. Icahn Enters. L.P., C.A. No. 3522-VCS
(Del. Ch. Nov. 16, 2009) (ORDER); see also Benton Ruling at 77 (noting in denying
application for preliminary injunction that “it‟s important that plaintiffs representing
classes b[e] very careful about their trading when they have access to confidential
information. . . . It‟s not good policy. You own what you own coming in.”).
The Court has reiterated its concerns about trading in other contexts. In Sample,
after learning that the representative plaintiff sold shares of company‟s stock after filing
its lawsuit and while in possession of non-public information regarding a settlement
reached by his counsel, the Court declined to approve the settlement unless the
representative plaintiff self-reported to the SEC and disclosed his trading in the notice of
settlement. See Sample v. Morgan, C.A. No. 1214-VCS, at 8 (Del. Ch. May 14, 2008)
(TRANSCRIPT). The Court suggested that the plaintiff relinquish to the defendant
company the 1,000 shares that he purchased while in possession of non-public
information. Id.; see Sample v. Morgan, C.A. No. 1214-VCS (Del. Ch. Aug. 5, 2008)
(ORDER). In Netezza, after plaintiffs‟ counsel disclosed during the settlement approval
hearing that the plaintiffs may have sold their shares after the parties reached settlement,
the Court agreed to approve the settlement only if the plaintiffs submitted affidavits
detailing any trading during the pendency of the lawsuit and explaining the reasons for
each transaction. Netezza Ruling at 14; see In re Netezza Corp. S’holder Litig., Consol.
C.A. No. 5858-VCS (Del. Ch. Apr. 13, 2011) (ORDER).
Steinhardt decided to sell Calix common stock short after receiving detailed
information from Chen about the ongoing litigation, both in the form of written memos
and oral reports. Chen was deeply involved in the case, reviewed Confidential Discovery
Material, worked closely with counsel, and received reports on depositions or attended
them himself. Information gleaned from Confidential Discovery Material and counsel‟s
litigation assessments permeated Chen‟s views and informed his communications with
Steinhardt. In his interrogatory responses, Steinhardt admitted that his trading decisions
were “influenced by Mr. Chen.” Basser-Wall Aff., Ex. 8 at 8.
As this Court‟s prior rulings demonstrate, the fact that a representative plaintiff
does not directly have access to confidential information produced in discovery is not the
determinative issue. The core problem is simple: When a representative plaintiff and its
counsel wield the clout of a class action, gain access to expedited discovery, and pursue a
preliminary injunction against a market-moving transaction, the representative plaintiff
and its counsel almost invariably acquire non-public information about the transaction
that ordinary investors do not have. The plaintiff‟s lawyer is duty-bound to discuss with
her clients important developments and major decisions in the litigation, including
whether and on what terms to settle. Counsel‟s advice necessarily will be influenced by
her review of the discovery record and other non-public information, including
communications with defense counsel and the content of any settlement offers. Indeed,
the most value-relevant information may not be any specific document or information
obtained in discovery, but rather counsel‟s overall sense of how well discovery has gone,
whether there is a genuine chance for an injunction, and whether the claims are likely to
lead to a favorable litigation outcome or settlement.
This case illustrates the problem. Steinhardt sold Calix short with the benefit of
knowledge received from Chen, whose insights in turn were based on discussions with
counsel and the discovery record. “[E]verything that [Steinhardt] knew”—including
knowledge about the litigation—led Steinhardt to conclude that the Merger would be
consummated with no change in price. The reverse example occurred in Sample, when
the plaintiff learned that his counsel had secured a settlement that would generate
additional cash for the class. Sample v. Morgan, C.A. No. 1214-VCS, at 5-6 (Del. Ch.
May 14, 2008) (TRANSCRIPT). The plaintiff then bought shares at a price below what
the settlement would justify. See id. at 10. In both situations, a plaintiff who stepped
forward as a fiduciary for the other stockholders used non-public information for personal
advantage in securities transactions with members of the class that the plaintiff proposed
Conduct of this nature undermines the integrity of the representative
litigation process and is inconsistent with the behavior expected of a self-designated
Steinhardt personally made the decision to sell Calix short. Steinhardt did not
make any effort to establish an internal ethical wall or otherwise segregate litigation
responsibility from trading responsibility. To suppose that Steinhardt could mentally
segregate the knowledge he received from Chen and exclude it from his trading decisions
would require “an epistemological leap of heroic proportions.”
In re Pennzoil Co.
S’holders Litig., 1997 WL 770663, at *3 (Del. Ch. Oct. 27, 1997) (rejecting assertion that
“„litigation consultants‟ would be able to „segregate mentally‟ confidential financial
information when they switch[ed] into their role as „financial consultants‟”); see Berger
Ruling at 39 (dismissing as “nonsense” the plaintiff‟s contention “that what he does as a
trader and what he does as a plaintiff are separate”).
By trading after receiving
information from Chen that was derived from Confidential Discovery Material,
Steinhardt and the Funds breached their fiduciary obligations as representative plaintiffs
and violated both the Use Restriction and the Trading Restriction.
The attempt by Steinhardt and the Funds to step down as proposed class
representatives does not moot their past violations. Regardless of whether they continue
acting as representative plaintiffs, Steinhardt and the Funds breached their fiduciary
duties while serving as self-appointed class representatives.
The breach of duty is
complete and cannot be undone. So is the violation of the Confidentiality Order.
Consistent with prior rulings, as a remedy for their improper trading, Steinhardt
and the Funds are (i) dismissed from the case with prejudice and barred from receiving
any recovery from the litigation, (ii) required to self-report to the SEC, (iii) directed to
disclose their improper trading in any future application to serve as lead plaintiff, and (iv)
ordered to disgorge their trading profits.
First, Steinhardt and the Funds are dismissed from the case with prejudice and
barred from participating in any recovery from the litigation. By deciding to sell Calix
short, Steinhardt sought to exit his Occam position and accept the benefits of the thenpending Merger. By doing so, he abandoned the class, acquiesced in the Merger, and
waived his claims. See Bershad v. Curtiss-Wright Corp., 535 A.2d 840, 842 (Del. 1987).
Second, Steinhardt and the Funds shall self-report to the Director of the Division
of Enforcement of the SEC. See Netsmart Ruling II at 34-35. Copies of the self-report
shall be filed with the Court and served on all counsel of record. The SEC will then be
able to determine whether any further remedial action is warranted.
Third, Steinhardt and the Funds will disclose their improper trading in any future
application to serve as lead plaintiff and shall provide the judge with a copy of this
decision. See also Beck v. Atl. Coast PLC, 868 A.2d 840, 857 (Del. Ch. 2005) (requiring
in addition to sanctioning counsel that “in the future, any application by Scott or Roth, or
by any lawyer at the firm of Lukins & Annis, for admission pro hac vice shall be
accompanied by a copy of this decision”). With the benefit of this information, the judge
in the future case will be able to determine whether to allow Steinhardt or the Funds to
serve in a representative capacity.
Fourth, Steinhardt and the Funds shall disgorge their gains from trading in breach
of their duties and in violation of this Court‟s Order. See Kahn v. Kohlberg Kravis
Roberts & Co., 23 A.3d 831, 837-38 (Del. 2011) (recognizing disgorgement remedy for
improper trading by a fiduciary independent of harm to beneficiary).
It is an act of disloyalty for a fiduciary to profit personally from the use of
information secured in a confidential relationship, even if such profit or
advantage is not gained at the expense of the fiduciary. The result is
nonetheless one of unjust enrichment which will not be countenanced by a
Court of Equity.
Oberly v. Kirby, 592 A.2d 445, 463 (Del. 1991); accord Thorpe v. CERBCO, Inc., 676
A.2d 436, 445 (Del. 1996); In re Tri-Star Pictures, Inc., Litig., 634 A.2d 319, 334 (Del.
To avoid imposing a disproportionate sanction, the disgorgement remedy must be
tailored to the wrongful conduct. In theory, Steinhardt and the Funds could be forced to
disgorge all profits generated from the 2,014,007 shares of Occam that they effectively
sold by shorting 589,097 shares of Calix. When all of these trades were made, Steinhardt
and the Funds were serving as self-appointed fiduciaries, operating within the strictures
of Confidentiality Order, and receiving information from Chen.
The disgorgement remedy, however, should not encompass profits unrelated to
any advantage that Steinhardt and the Funds gained by serving as representative
plaintiffs. Steinhardt and the Funds originally acquired nearly all of their Occam shares
in January 2009 by purchasing them from Chen at a distressed price. Much of their
eventual profits came from the opportunistic purchase and had no connection to the
litigation. It would be overly punitive to require Steinhardt and the Funds to disgorge
their entire gain as measured by the difference between their original basis and their
effective sale price.
It likewise seems overly punitive to require Steinhardt and the Funds to disgorge
profits on shares sold after the injunction hearing. The hearing was open to the public
and broadcast by Courtroom View Network. At the conclusion of the hearing, I granted
the plaintiffs‟ motion and enjoined the Merger pending the issuance of supplemental
disclosures and a deposition of one of the lead bankers from Jefferies. That ruling
eliminated Steinhardt‟s ability to benefit from Chen‟s insights about the litigation and the
potential for an injunction. The ruling also eliminated the last major impediment to
closing by limiting the pre-closing remedy to the issuance of supplemental disclosures. It
would have been reasonably clear to anyone buying or selling Occam or Calix shares that
the Merger was highly likely to close once the supplemental disclosures went out.
During the limited post-injunction window when he shorted the bulk of the Calix shares,
Steinhardt did not have a meaningful advantage from serving as a fiduciary for the class,
and he therefore will not be required to disgorge profits from Calix shares sold after the
By serving as representative plaintiffs, Steinhardt and the Funds gained access to
real-time insights informed by Confidential Discovery Material and counsel‟s litigation
assessments. Based in part on this information, Steinhardt and the Funds decided to
abandon their challenge to the Merger and exit their Occam position in a manner
designed to capture the arbitrage spread between Occam and Calix. The disgorgement
remedy should target that slice of profits.
Steinhardt and the Funds generated total proceeds of $1,886,751.98 from short
selling 112,014 shares of Calix stock before the injunction hearing:
Having decided not to use Steinhardt and the Funds‟ historical basis in their Occam
shares, I need implied purchases against which to measure profits.
To model the
arbitrage spread, the implied purchases should be of Occam shares rather than Calix. At
the Merger exchange ratio of 0.2925 Calix shares for each Occam share, the 112,014
Calix shares equate to 382,954 Occam shares.
This figure temporarily ignores the
additional Merger consideration of $3.8337 per Occam share in cash.
Ordinarily, a trader capturing a merger arbitrage spread would trade in both the
acquirer‟s and target‟s shares (or related options) simultaneously. Steinhardt and the
Funds, however, already owned their Occam shares. To focus on the merger arbitrage
opportunity while excluding gains from the distressed-sale purchase, I deem Steinhardt
and the Funds to have bought the 382,954 Occam shares in equal increments across the
trading days running from October 6, when Steinhardt and the Funds filed the current
action and assumed their fiduciary mantle, through November 11, the day before the
Confidentiality Order went into effect and imposed the Use and Trading Restrictions. By
spreading the deemed purchases equally over this period, I avoid giving disproportionate
emphasis to the price on any particular date.
As the price for each deemed purchase, I use the market low on that day.
“Delaware law dictates that the scope of recovery for a breach of the duty of loyalty is
not to be determined narrowly.” Thorpe, 676 A.2d at 445. As recently re-affirmed by the
Delaware Supreme Court, Delaware‟s disgorgement remedy rests upon “a wise public
policy that, for the purpose of removing all temptation, extinguishes all possibility of
profit flowing from a breach of the confidence imposed by the fiduciary relation.” Kahn,
23 A.3d at 840 (quoting Guth v. Loft, Inc., 5 A.2d 503, 510 (Del. 1939)). Although it
would be improbable (bordering on impossible) for even a legendary trader like
Steinhardt to maximize his potential profit by buying at precisely the market low each
day, the faithless fiduciary must shoulder the burden of uncertainty, not his innocent
Cf. Duncan v. Theratx, Inc., 775 A.2d 1019, 1023-24 (Del. 2000)
(measuring damages where a party wrongfully deprived another of the ability to sell
shares by subtracting the average price during a reasonable period after reinstatement of
the ability to sell from the highest intermediate value during a reasonable period after the
ability to sell was suspended); Paradee v. Paradee, 2010 WL 3959604, at *13 (Del. Ch.
Oct. 5, 2010) (“Where a party has wrongfully deprived another of the ability to sell
shares, damages are measured using the highest intermediate value of the shares less the
value at the time of judgment.”).
This approach results in the following deemed purchases:
The final step is to deal with the cash portion of the Merger consideration. When
Steinhardt covered his short positions with Calix shares received in the Merger, he got to
keep the portion of the Merger consideration paid in cash. Put differently, after the
Merger announcement, Occam‟s trading price reflected the expectation that each Occam
share would be converted into the right to receive both 0.2925 shares of Calix stock and
$3.8337 in cash. To force disgorgement of the share-related spread on an apples-to26
apples basis, the cash consideration of $1,468,130.75 tied to 382,954 Occam shares must
be backed out. This can be accomplished either by adding the cash consideration to the
Calix sale proceeds or subtracting the cash consideration from the deemed purchase
price. Following the latter course and deducting $1,468,130.75 from $2,820,811.28
results in an implied basis of $1,352,680.53 for the right to the equity portion of the
Merger consideration represented by the Occam shares, which was the underlying
property right in Steinhardt‟s arbitrage play.
Deducting the implied basis from the actual sales proceeds generates a
disgorgement amount of $534,071.45. If the same methodology were used for all of the
sales of Calix stock, including those post-dating the injunction hearing, the total
disgorgement amount would be $3,477,534.97. Steinhardt and the Funds will disgorge
$534,071.45 as a sanction for their improper trades.
Chen‟s trades were materially different from Steinhardt‟s. Chen‟s sales of 31,000
shares of Occam stock between October 29 and November 2, 2010 were not improper.
Chen convinced me that he sold shares to generate liquidity before his ability to trade
became limited. The defendants had not yet produced any non-public information, and
the Confidentiality Order had not yet been entered. Chen therefore did not possess any
non-public information that would have given rise to a conflict with the class he had
volunteered to represent, and the Use Restriction and Trading Restriction were not yet
in place. Chen‟s sales of a small fraction of his Occam holdings do not undercut his
litigation position or suggest fiduciary misconduct.
Chen‟s sale of 2,500 shares on January 25, 2010 also was not improper. Despite
the defendants‟ vigorous attacks on Chen‟s credibility, I am convinced that the sale was
an unintentional “fat-finger” error.
Because of the small size of the trade and its
inadvertence, it would be inequitable to sanction Chen. In addition, the January 25 trade
came on the heels of preliminary injunction hearing on January 24, which eliminated the
principal benefit Chen obtained from accessing Confidential Discovery Information.
I am more troubled by Chen‟s decision to continue providing Steinhardt with
written and oral updates on the litigation despite knowing that Steinhardt was shorting
Calix in violation of the Use and Trading Restrictions. Although I have concerns about
Chen‟s role in Steinhardt‟s short-selling, Chen testified credibly during the evidentiary
hearing that he advised Steinhardt not to trade. Steinhardt, however, did what he wanted
to do. Tr. 76 (“Michael does what he wants to do.”). Moreover, the relationship between
the two men was such that Chen could not realistically do more. As Chen explained,
“[y]ou have to remember that he is the legendary hedge fund investor and, you know,
when there is yelling, it usually goes from his direction to my direction, not the other way
. . . .” Tr. 77.
Chen has amassed extensive knowledge about Occam and the Merger. He has
proven himself to be a highly motivated and effective representative plaintiff.
sanction Chen and remove him from the litigation would inflict significant harm on the
Chen committed an error of judgment by continuing to communicate with
Steinhardt, but I have addressed the harm caused by that error by imposing a remedy on
Steinhardt, the primary wrongdoer. Chen‟s involvement does not warrant an additional
sanction that would serve primarily to penalize the class.
For the foregoing reasons, the motion for sanctions is granted as to Steinhardt and
the Funds but denied as to Chen. I encourage the parties to double-check my math and
confer regarding how the funds should be handled. If administratively feasible, the funds
could be distributed to the class now. Alternatively, the funds could be held in escrow
pending the outcome of this proceeding and allocated as part of any future remedy.
Because former holders of Occam shares owned less than 20% of Calix‟s shares
immediately after closing, I am not inclined to award the disgorged funds to Calix as a
proxy for the class; however, there may be other possibilities. After conferring, the
parties shall submit an implementing order.