Cases

In re DRS Technologies, Inc. Derivative Litigation

Nickell v. Shanahan et al., Case No. 4:07-cv-01406-SNL (United States District Court for the Eastern District of Missouri)

This is a shareholder derivative action and was filed on August 7, 2007. Click here to view the current complaint. The case was filed on behalf of DRS Technologies, Inc. and against its board of directors and four individuals who were executive officers and directors of Engineered Support Systems, Inc. (″ESSI″), a company which DRS Technologies, Inc. acquired in January 2006. Both the United States Attorney and the Securities and Exchange Commission (″SEC″) have filed criminal and/or civil cases against Defendants Shanahan, Shanahan Jr., Gerhardt and Landmann (the former officers and directors of ESSI) pertaining to the wrongdoing that such defendants engaged in while executive officers and directors of ESSI. Such defendants routinely backdated stock options at ESSI for over seven years (from 1997 through at least 2003) and also filed false financial statements with the SEC.

This is an extremely high-profile case in the stock option backdating scandal, which has attracted national headlines. Though many corporations have been investigated, the criminal indictments of Shanahan, Shanahan Jr., and Gerhardt represent some of the first indictments by the United States Attorney′s Office in the stock option backdating cases. Gregory Reyes and Stephanie Jensen, the former CEO and V.P. of Human Resources, respectively, of Brocade Communications Systems, Inc., were among the first corporate executives to be indicted. On August 7, 2007, a jury in San Francisco convicted Mr. Reyes of all ten counts charged. Judge Breyer subsequently denied Mr. Reyes′ request for a new trial. See United States of America v. Reyes, 2007 U.S. Dist. LEXIS 66074 (N.D. Cal. Aug. 29, 2007). Ms. Jensen was subsequently convicted by a separate jury in a Verdict dated December 5, 2007. Johnson Bottini LLP is Lead Counsel in this case and is Co-Lead Counsel in the Brocade case.

The backdating of stock options by corporate executives involves a practice whereby corporate executives or directors such as defendants Shanahan, Shanahan Jr., Gerhardt and Landmann issue stock options at strike prices which are less than the fair market value of the underlying stock on the grant date. This violates the express terms of the shareholder-approved stock option plans, which preclude the officers and directors from setting the strike price of the options below the fair market value of the underlying stock on the grant date. The officers and directors additionally lied to the shareholders in SEC filings by falsely claiming that the stock options they issued complied with the stock option plans, and that the company was not required to recognize any charge against earnings which would be required if options were granted with strike prices less than fair market value.

In a recent decision addressing stock option backdating in the context of a shareholder derivative lawsuit, the Delaware Chancery Court explained that backdating clearly violates numerous fiduciary duties owed by officers and directors to a corporation and its shareholders. The court also explained that the failure of a board of directors to pursue remedies against the faithless fiduciaries who abused their positions of power demonstrates demand futility and thus that a shareholder derivative lawsuit must be allowed to proceed: ″Coming as this complaint does in the middle of a national scandal involving backdated options, there never was any doubt that various theories exist on which to recover from the corporation′s officers and directors where evidence of improperly dated options exists. Nonetheless, after finding substantial evidence that options were, in fact, mispriced, the company and the audit committee ended their ‹review‹ without explanation and apparently without seeking redress of any kind. In these circumstances, it would be odd if Delaware law required a stockholder to make demand on the board of directors before suing on those very same theories of recovery.″ See Conrad v. Black, 2007 Del. Ch. LEXIS 130, at *21-22 (C.A. No. 2611, Sept. 7, 2007).

Here, nominal defendant DRS Technologies, Inc. and its current board of directors have taken no action whatsoever to pursue redress against the Shanahans, Gerhardt, or Landmann, despite the fact that such defendants have either been criminally indicted or pled guilty to civil charges brought by the SEC. Plaintiff in the case, represented by Johnson Bottini LLP, seeks to recover money from the defendants for their illegal options backdating activity.

1 After the close of the prosecution′s case-in-chief, Judge Breyer denied Mr. Reyes′ motion for an acquittal under FRCP 29. See United States of America v. Reyes, 2007 U.S. Dist. LEXIS 60003 (N.D. Cal. August 7, 2007).

2 If options were issued with strike prices less than fair market value, Generally Accepted Accounting Principles (″GAAP″) required ESSI, at all times relevant to Plaintiff′s Complaint, to take a charge against earnings for compensation expenses, measured by the difference between the backdated strike price and the fair market value of ESSI′s stock on the grant date. See Accounting Principles Board Opinion No. 25, ‹Accounting for Stock Issued to Employees,‹ and Financial Accounting Standards Board Principle No. 123. ESSI and Shanahan, Shanahan Jr., Gerhardt and Landmann did not want to disclose the backdating and cause ESSI to recognize the accounting charge because to do so would have reduced ESSI′s reported earnings and thus would have caused the company to be less profitable than its competitors, reducing its stock price. In addition, since the individual defendants had no authority or discretion to grant options with strike prices less than the fair market value of ESSI stock on the grant date, disclosing the ″backdating″ would have exposed the wrongdoing of the defendants.