In re Keithley Instruments, Derivative Litigation, Case No. 1:06CV2171.

599 F.Supp.2d 875

In re KEITHLEY INSTRUMENTS, INC., DERIVATIVE LITIGATION This Document Relates To: All Actions.

Case No. 1:06CV2171.

United States District Court, N.D. Ohio, Eastern Division.

March 21, 2008.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

David H. Kistenbroker, Michael J. Summerhill, Joni S. Jacobsen, Katten Muchin Rosenman, Chicago, IL, John D. Parker, Michael J. Montgomery, Baker & Hostetler, Mitchell G. Blair, Fritz E. Berckmueller, Calfee, Halter & Griswold, Cleveland, OH, for Defendants.

MEMORANDUM OPINION AND ORDER

SARA LIOI, District Judge.

This is a shareholders' derivative action. Before the Court are two motions to dismiss Plaintiffs' Second¹ Amended Consolidated Shareholder Derivative Complaint (Doc. No. 23) (the "Complaint"). On April 27, 2007, Defendants Brian Bachman, James Bartlett, Philip Estler, Allan Gaffney, James Griswold, Hermann Hamm Leon Hendrix, Jr., Mark Hoersten, Frederick Hume, Joseph Keithley, David Patricy, John Pesec, Mark Plush, Linda Rae, Ronald Rebner, N. Mohan Reddy, Gabriel Rosica, Terence Sheridan, Sherman Willows, and R. Elton White (collectively, the "Individual Defendants") filed a motion to dismiss. (Doc. No. 28.) Also on April 27, 2007, nominal defendant Keithley Instruments, Inc., ("KEI") filed its own motion to dismiss. (Doc. No. 32.)² Both the Individual Defendants and KEI seek dismissal pursuant to Federal Rules of Civil Procedure 12(b)(6) and 23.1 based on Plaintiffs' failure to make a pre-litigation demand on KEI's board of directors (the "Board") and Plaintiffs' failure to plead particularized facts showing that demand was excused as futile. Individual Defendants also seek dismissal on the grounds that Plaintiffs' substantive claims are barred by the applicable statutes of repose, are insufficient as a matter of law, and/or fail to satisfy applicable pleading standards. Plaintiffs filed separate opposition to each motion. (Doc. Nos. 36 & 38). Both the Individual Defendants and KEI filed replies. (Doc. Nos. 41 & 42.)³

I. Statement of Facts and Procedural Background

Plaintiff Michael C. Miller filed the initial complaint in this matter on August 15, 2006, in the Court of Common Pleas of Cuyahoga County, Ohio.⁴ Defendants removed the matter to this court on September 8, 2006, invoking federal question jurisdiction. (Doc. No. 1.) The Court consolidated this matter with three other actions under the caption of the instant case.⁵ (Doc. No. 33.)

This consolidated derivative action arises from allegations that directors and officers of KEI manipulated⁶ stock option grants. A brief primer on the practices encompassed by the term "manipulated," courtesy of the Delaware Court of Chancery, is instructive:

Stock options "backdating" is a practice whereby a public company issues options on a particular date while falsely recording that the options were issued on an earlier date when the company's stock was trading at a lower price. The options are purportedly issued with an exercise price equal to the market price on the date of the option grant. But, in fact, because the grant dates were falsified, the options were "in the money" when granted. The practice of "spring loading" stock options involves making market-value options grants at a time when the company possesses, but has not yet released, favorable, material non-public information that will likely increase the stock price when disclosed. Conversely, "bullet-dodging" options are granted just after the company releases negative information to the market thereby allowing the recipient the benefit of a lower exercise price that reflects the price decline caused by the negative information.

Desimone v. Barrows, 924 A.2d 908, 918 (Del.Ch.2007) (citations omitted).

The Complaint raises federal law claims under Sections 10(b), 14(a), and 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78 et seq., (the "Exchange Act"), as well as a variety of state law claims. The named Plaintiffs are, and at relevant times have been, shareholders of KEI. (Compl. ¶ 13.) KEI is an Ohio corporation engaged in the design, development, and manufacture of electronic testing and measuring equipment. (Compl. ¶ 14.) The Individual Defendants all are current or former directors and/or officers of KEI. Defendants Bachman, Bartlett, Griswold, Hendrix, Keithley, Reddy and White are current members of KEI's Board. Defendants Estler, Gaffney, Hamm, Hoersten, Hume, Keithley, Patricy, Pesec, Plush, Rae, Rebner, Rosica, Sheridan and Willows are, or were, KEI officers, each of whom is alleged to have received options to purchase KEI shares. Specific allegations regarding each of the Individual Defendants are as follows:

A. Directors

Defendant Bachman has served as a director since 1996, as a member of the Board's Compensation Committee since 1997, and previously served on the Board's Audit Committee from 2000 to 2001. (Compl. ¶ 16.) Defendant Bartlett has served as a director since 1983, on the Compensation Committee from 1995 to 1997 and from 2005 to the present, and on the Audit Committee since 1998. (Compl. ¶ 17.) Defendant Griswold has served as a director since 1989, on the Compensation Committee from 1996 to 2001, and on the Audit Committee from 1995 to 2001. (Compl. ¶ 18.) Defendant Hendrix has served as a director since 1990, on the Compensation Committee since 1998, and on the Audit Committee from 1995 to 1997. (Compl. ¶ 19.) Defendant Keithley has served as the Board's Chairman since 1991. He has never served on the Compensation Committee. (Compl. ¶ 15.) Defendant Reddy has served as a director since 2001, and on the Compensation Committee from 2002 to 2004. (Compl. ¶ 20.) Defendant White has served as a director since 1994, on the Compensation Committee from 1995 to 2004, and on the Audit Committee from 1998 to 2004. (Compl. ¶ 21.) With the exception of Keithley, none of the current directors is alleged to have received any options. Defendants Bachman, Bartlett, Griswold, Hendrix, Keithley, Reddy and White are referred to collectively as the "Director Defendants." The table below illustrates the dates of board and committee service for each of the relevant directors.

-----------------------------------------------------------------------
Board Member Director Compensation Committee Audit Committee
-----------------------------------------------------------------------
Bachman        1996-present   1997-present             2000-2001
-----------------------------------------------------------------------
Bartlett       1983-present   1995-1997, 2005-present  1998-present
-----------------------------------------------------------------------
Griswold       1989-present   1996-2001                1995-2001
-----------------------------------------------------------------------
Hendrix        1990-present   1998-present             1995-1997
-----------------------------------------------------------------------
Keithley       1991-present
-----------------------------------------------------------------------
Reddy          2001-present   2002-2004
-----------------------------------------------------------------------
White          1994-present   1995-2004                1998-2004
-----------------------------------------------------------------------

B. Officers

Defendants Estler, Gaffney, Hamm, Hoersten, Hume, Keithley, Patricy, Pesec, Plush, Rae, Rebner, Rosica, Sheridan and Willows are current or former KEI officers. Each is alleged to have received manipulated options to purchase KEI shares. Of note, Defendant Keithley, KEI's President and CEO at all times relevant hereto, allegedly received at least 320,000 manipulated stock options. Keithley exercised these options, and the shares he acquired as a result were among the 3,400,000 shares he sold during the relevant time period. (Compl. ¶ 15.) These defendants are referred to collectively as the "Option Recipient Defendants."

C. The Option Grants

The allegedly manipulated stock option grants were approved pursuant to KEI's two stock option plans, the 1992 Stock Incentive Plan and the 2002 Stock Incentive Plan (the "Plans"). The Plans were approved by shareholders. (Compl. ¶ 49.) Both Plans provided that the price of any options granted was to be not less than 100% of the fair market value on the date of the grant. (Compl. ¶ 50-51.) The Plans also specifically delegated authority for their administration to the Compensation Committee. (Compl. ¶ 53.) KEI provided stock options to certain key executives on an annual basis as part of its compensation plan. In the Complaint, Plaintiffs identified eight of those annual grants (each year from 1995 to 2002) as subjects of alleged manipulation.⁷ Those eight grants encompass approximately 2.28 million shares. (Compl. ¶ 2.) According to Plaintiffs, these eight grants were made on dates on which KEI's stock was trading at or near its lowest price of the relevant fiscal quarter and/or fiscal year. (Id.) Since 1997, KEI has tracked all option grants using computer software known as "Equity Edge." (Compl. ¶ 60.)

On September 9, 1995, defendants Hamm, Hume, Keithley, Rebner and Sheridan allegedly received option grants at an exercise price⁸ of $6.84 per share. According to Plaintiffs, these grants occurred after a significant drop in the share price, and just before a sharp rebound. Plaintiffs allege that these grants initially were approved by the Compensation Committee on July 6, 1995, but were not approved by the full Board until September 9, 1995. (Compl. ¶ 62-63.)

On September 7, 1996, defendants Hamm, Hume, Keithley, Rosica and Rebner received option grants at an exercise price of $4.63 per share. Plaintiffs allege that the timing of these grants coincided with one of the lowest closing prices of KEI stock during the 1996 fiscal year. (Compl. ¶ 64.) The Compensation Committee purportedly approved the 1996 grants...