Ellison Settlement Questions

Lawrence J. Ellison, the CEO of Oracle Corporation, is full of surprises.  The latest one, his offer to settle a California derivative action for $122 million, is a doosey.

Last week Ellison announced that he would pay $100 million to charity and $22.5 million to the plaintiffs’ lawyers to settle a California derivative action based on claims of insider trading in January of 2001.  The settlement must be approved by the Superior Court Judge in San Mateo. 

Near the end of January in 2001, on the eve of the collapse of the high-tech stock market in March, Ellison sold a whopping 29 million shares of Oracle stock for $900 million, over 2 percent of his total Oracle holdings.  He still owns twenty four percent of the company, valued at over $13.7 billion.  He had not sold any Oracle stock for five years.  He had paid 23 cents a share and sold for $30 to 32 a share   

One month later his company announced that it might not meet the company’s forecasts of earnings for the third quarter and the stock dropped like a rock in value, bottoming at $16.88 a share.  We now know that some of the earnings decline was due to the correction of accounting improprieties.   Ellison’s $900 million sale would have garnered him around $500 million had he sold after the negative announcement, a cool $400 million cash savings.

Ellison’s remaining 24 percent lost $18.9 billion in value, however, in the high-tech share price swoon.

Plaintiffs’ lawyers sued Ellison and a colleague for insider trading in Delaware state court, Oracle is incorporated in Delaware, and in state and federal court in California, the location of Oracle’s headquarters.

The case in Delaware progressed quickly and Ellison won a summary judgment motion in the trial court in November of 2004.  Vice Chancellor Strine, in a lengthy opinion, found that no evidence that Ellison knew, at the time of the sale, that Oracle would not meet the market estimates.  Strine was resolute, calling the plaintiffs’ arguments the “ravings of conspiracy theorists.”  Last month the Delaware Supreme Court affirmed the decision.

In California, Ellison was also holding his own.  A federal district court in California dismissed the securities class action on the pleadings but the Ninth Circuit reinstated and remanded the action for trial.  The Ninth Circuit’s decision is curiously at odds with the decision in the Delaware Chancery Court, which did not refer to the accounting problems at all (except for a brief footnote implying that the plaintiffs had dropped the claims).  The Ninth Circuit held that the plaintiffs’ claim that Ellison knew of the accounting gimmickry was sufficient to justify a trial.  But the case would be tried in a district court that was obviously very skeptical about its merits.

Then came the surprise settlement.  In the pending California state court action, a derivative action, Ellison would settle the case for a staggering $122 million, one of the largest derivative action settlements of its kind.  Why?   Ellison had strong arguments that the California derivative action was decided in his favor by the Delaware decision, Oracle was a Delaware company.  The plaintiffs were suing under a California statute, creating a special derivative action, but whose law applies to define the open ended terms in the California statute (board of director "good faith" for example)?  If California law does apply is there a violation of the Commerce Clause for inconsistent results (a violation of the internal affairs doctrine)?  Is he negotiating a release of the federal action as well?  There are many, many legal questions here.

There is also the nature of the payment.  $100 million will go to charity and $22 million to lawyers, depriving the firm of the of settlement money (75 percent of which would benefit shareholders other than Ellison).  Ellison will, no doubt, claim a charitable deduction on his taxes, hoping to recoup potentially $30 million or so back from federal and state governments.

The settlement is an embarrassment for the Delaware courts.  Dismiss on summary motions an action against Ellison and he settles the same action elsewhere for $122 million – the Delaware judges have to wonder whether they were hoodwinked. 

  Strine bought the following story:  Financial advisors told Ellison he had to "diversify" by selling some stock.  He had too much of his wealth tied up in Oracle stock.  Furthermore he had a tax bill coming up on the exercise of some expiring compensatory options and would need substantial cash. Coming back from vacation he realized that he had to sell in the "window" around quarterly reports and only a few windows a year were available.  His advisors told him that the forecasts for the 3Q of 2001 were still accurate even though there could be some problems; but similar problems with earlier forecasts for past quarters had always worked out and those forecasts had been met.  He sold only 2% of his stock, even though the numbers were huge, and lost $18.7Billion on the 24% stack in Oracle that he still held.  His loss shows his belief in his company. 

   Here is an alternative plausible story, one that a $100 million settlement could support:  Ellison is smart and likes to make money.  He also knows the high-tech business better than all but a few people on the planet; indeed he is at the epicenter of the business.  He comes back from vacation and gets negative vibrations about the health of the country's high tech business (probably oral communications from trusted buddies in the business).  The written internal forecast reports hint at problems but the staff knows better than to tell the boss in writing bad news;  Ellison likes good news.  Ellison has a problem:  he is sitting on $35 billion in stock, valued at $30 that he bought, in essence, for $.25.  The securities acts limit his resales;  his resales are capped by the 33 Act that requires a full registered offering for his sales unless he can meet the limit imposed by Rule 144.  He does not have time to do the registered offering so he calls his lawyer and says sell as much as you can under Rule 144 in each of the windows that will follow.  His lawyer and broker comply with the Jan. 2001 sale, the market collapses, surprising even Ellison (his broker dumps $900 million, a pittance to Ellison but a staggering amount to mortals), and subsequent sales must wait as inside information outpaces public information for a year or two.  Ellison also knows that lawsuits are now inevitable.  He waits out the bottom, still very wealth at $13.7 billion in value in stock, but $400 million in cash better off having sold in January.  Strine, on summary judgment motions, dismisses the case based on the internal written forecasts by loyal staff.  Now Ellison, facing a real trial, throws $22 million at some very happy plaintiffs' attorneys and offers $100 m to charity (what a great guy).  He still comes out $300 ahead, more if the government gives him a tax deduction for a charitable contribution.  Is this a great country or what?