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Martha Stewart and a group of current and former Martha Stewart LivingOmnimedia directors have thwarted a derivative suit filed in the Courtof Chancery. Dismissing the suit in its entirety, Chancellor William B. Chandler IIIrejected plaintiff Monica A. Beam’s assertion that MSLO’s directorsshould have monitored Stewart’s personal, financial and legal affairs toprevent harm to the company. In his 49-page opinion in Beam v. Stewart, Chandler also determined thatdismissal of plaintiff’s breach of fiduciary duty claim against Stewartwas warranted by Beam’s failure to make a demand upon MSLO’s board ofdirectors or to adequately plead demand futility. In that claim, Beamhad alleged that Stewart breached her fiduciary duties to the companyand its shareholders by selling ImClone Systems stock shortly before aDecember 2001 Food and Drug Administration announcement caused the stockto nose-dive, and by making certain public statements about the stocksale. Chandler also ruled that Beam failed to state claims upon which reliefcould be granted when she argued that Stewart and a former directorusurped a corporate opportunity by selling close to 5 million shares ofMSLO in early 2002, and that the corporation’s directors should haveaddressed the alleged impropriety of split-dollar insurance policypremiums the company paid on Stewart’s behalf. THE PARTIES MSLO is a Delaware corporation that operates in the publishing,television, merchandising and Internet industries, according to theopinion. MSLO markets products that bear the “Martha Stewart” brandname. Stewart, a former stockbroker, became a household name by providingadvice on cooking, decorating and entertaining. In 1999, she took herlifestyle empire public with the launch of MSLO. Stewart served as chairwoman and chief executive officer of the companyuntil June, when she was indicted on federal charges stemming from hersale of ImClone stock. Currently, she serves as a director and chiefcreative officer of MSLO. According to Chandler’s opinion, Stewart owns or beneficially holds 100percent of the corporation’s B shares in conjunction with enough Ashares that she controls more than 94 percent of the shareholder vote.Chandler noted that the market for MSLO’s products “is uniquely tied tothe personal image and reputation of its founder.” In fact, MSLO’s firstpublic offering prospectus said that impairment of Stewart’s services tothe company, including the tarnishing of her public reputation, wouldharm the business, the opinion said. Defendant Sharon L. Patrick, is the president, CEO and a director ofMSLO. According to the opinion, she is also a longtime friend ofStewart. Defendants Arthur C. Martinez, Darla D. Moore and Jeffrey W. Ubben arealso MSLO directors. Ubben is chairman of the board, and Martinez islead director. Defendants Naomi O. Seligman and L. John Doerr are former directors. THE IMCLONE TRANSACTIONS According to the opinion, Stewart’s alleged misadventures with ImClonearose in part from a personal friendship with Samuel D. Waksal, who is aformer ImClone CEO. In December 2001, the speculative value of ImClone stock was tied towhether the FDA would approve its application to market a cancertreatment drug, the opinion states. On Dec. 26, 2001, Waksal receivedinformation that the FDA would reject the application, Chandler said.The following day, Waksal tried to sell his own shares and tipped hisfather and daughter to do the same, the opinion said. Stewart also soldher shares on Dec. 27, and, after the close of trading on Dec. 28,ImClone publicly announced the rejection of its application to marketthe drug. On Dec. 29, 2001, ImClone’s closing price was approximately 20 percentlower than it had been on Dec. 27. By the summer of 2002, Stewart’s ImClone trading had attracted theattention of the media and federal prosecutors, the opinion said.”Stewart’s publicized attempts to quell any suspicion were ineffectiveat best because they were undermined by additional information as itcame to light and by other parties’ accounts of the events,” Chandlerwrote. “After barely two months of such adverse publicity, [MSLO's] stock pricehad declined by slightly more than 65 percent. In August 2002 …[MSLO's] chief financial officer cited uncertainty stemming from theinvestigation of Stewart in response to questions about earnings prospects in the future,” Chandler said. BREACH OF THE DUTY TO MONITOR CLAIM Count II of the complaint alleged that MSLO’s directors breached theirfiduciary duties by failing to ensure that Stewart would not conduct heraffairs in a manner that would injure the company. The duty to monitor, which stems from the core fiduciary duties of careand loyalty, has generally been litigated in a corporate liabilitycontext where directors have been accused of negligence in monitoring acompany’s activities, Chandler said. The claim that MSLO’s board shouldhave monitored Stewart’s personal affairs is a novel one, the opinionsaid. “That the company is closely identified with Stewart is conceded,”Chandler wrote, “but it does not necessarily follow that the board isrequired to monitor, much less control, the way Stewart handles herpersonal financial and legal affairs.” Concluding that it would be unreasonable to impose such a duty on theboard, the court dismissed Count II pursuant to Court of Chancery Rule12(b)(6). BREACH OF FIDUCIARY DUTY CLAIM Count I of the complaint alleged that Stewart breached her fiduciaryduties to MSLO and its shareholders by selling her shares of ImClone inDecember 2001 and by making public statements regarding the sale. Defendants asserted that plaintiff’s breach of fiduciary duty claimagainst Stewart should be dismissed under Court of Chancery Rule 23.1because plaintiff failed to make a demand on the board or demonstratewhy demand on the board would have been futile. Under the rule,plaintiff was required to state with particularity her efforts toconvince the board to take action on her concerns, or to show why doingso would have proved fruitless. The opinion states that Beam said demand would have been futile becauseMSLO’s directors were incapable of acting independently anddisinterestedly on the insider-trading accusations. However, Chandlersaid he could not infer as much from the complaint. “Plaintiff offers various theories to suggest reasons that the outsidedirectors might be inappropriately swayed by Stewart’s wishes orinterests,” Chandler wrote, “but fails to plead sufficient facts thatcould permit the court reasonably to infer that one or more of thetheories could be accurate. Evidence to support or refute any of thetheories might have been uncovered by an examination of the corporatebooks and records, to which the plaintiff would have been entitled forthis purpose.” Chandler expressed frustration with litigants who “notwithstandingrepeated suggestions, encouragement and downright admonitions over theyears by both this court and the Delaware Supreme Court … continue tobring derivative complaints pleading demand futility on the basis ofprecious little investigation beyond perusal of the morning newspapers.”In a page-long footnote, the opinion lists and discusses numerous casesin which the two courts have urged counsel to conduct diligentinvestigations. Failure to investigate whether a majority of directors could fairlyevaluate demand wastes the resources of the court and the litigants,Chandler admonished. Additionally, not discovering and pleading facts that support reasonabledoubt ties the hands of the court and prevents it from protecting theinterests of shareholders where a board is unable or unwilling to do so,the opinion said. “The assertion of plaintiff’s counsel at oral argument that this casewas filed before such investigation became a standard practice appearsunfortunately to be correct but, nonetheless, does nothing to ease themind of the court on this point,” Chandler wrote. “Although I hope thatadequate pre-suit investigation does become the norm, the fact that ahalf-dozen of the opinions just cited were issued in the last sevenmonths would seem to indicate that it has not yet become a matter ofcourse.” Chandler said that because Beam did not establish in the pleadingsreasonable doubt regarding the disinterest or independence the outsidedirectors — those other than Stewart or Patrick — dismissal of Count Iwas warranted. Chandler did not consider the demand issue with respect to the remainderof the complaint’s counts because they were dismissed on other grounds. DISMISSAL OF THE REMAINING CLAIMS In Count II, Beam contended Stewart and Doerr usurped a corporateopportunity by selling large blocks of MSLO stock to “ValueAct.” According to the opinion, the amended complaint used ValueAct as adesignation for a combination of four interrelated business entities.Chandler determined that the alleged opportunity — the sale of theshares to ValueAct — was not within MSLO’s line of business, was nottied to the nature of MSLO’s business and did not place either defendantin a position inimical to their duties to MSLO. Accordingly, hedismissed Count II. Finally, the court held that the plaintiff did not state a claim uponwhich relief could be granted when she asserted in Count III that thedirectors should have addressed the split-dollar insurance premiums paidon Stewart’s behalf. According to the U.S. Treasury Department, split-dollar arrangementswere often provided as executive compensation. But due to Septemberchanges to the tax consequences of such policies, companies can nolonger use split-dollar life insurance arrangements to provide tax-freepayment to executives, the department said in a news release. MSLO’s board properly disclosed Stewart’s split-dollar policy in anApril 2002 proxy statement, the court’s opinion states. Further,Chandler said, the company’s lawyers and accountants were at the time ofsuit examining the ramifications of continuing the insurance. “Plaintiff does not allege that the premiums paid by [MSLO] wereunlawful,” Chandler wrote, “[or] that MSO failed to disclose theexistence of the policy, or that the board failed to take action oncethe governing law changed.” Accordingly, the chancellor said, theplaintiff’s claim failed under Chancery Court Rule 12(b)(6). The plaintiff has appealed the case to the Delaware Supreme Court. Andre Bouchard of Bouchard Margules & Friedlander in Wilmington servedas local counsel for Stewart. A. Gilchrist Sparks III and S. Mark Hurdof Morris Nichols Arsht & Tunnell in Wilmington were local counsel forPatrick, Martinez, Seligman, Moore and Ubben. Sparks and Hurd alsorepresented MSLO as nominal defendant. Gregory Varallo, Lisa Schmidt,Kelly Green and Richard Rollo of Richards Layton & Finger in Wilmingtonwere local counsel for Doerr. Pamela Tikellis, Robert Kriner Jr. and Brian Long of Chimicles &Tikellis in Wilmington served as local counsel for Beam.

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