ADR, Securities Law and Facebook – I “like”

How could I not blog about the Ninth Circuit’s decision earlier this week in Facebook, Inc. v. ConnectU, Inc., No. 08-16745, 2011 U.S. App. LEXIS 7430 (9th Cir. April 11, 2011)? It involves the interaction of three of my favorite things: ADR, Securities Law and Facebook. The primary ADR issue before the Ninth Circuit was whether plaintiffs could rescind a settlement agreement based on allegedly fraudulent statements made in mediation and protected by a broad confidentiality stipulation. Chief Judge Alex Kosinski authored the opinion, which contained blistering (and unpleasantly sarcastic) attacks on the plaintiffs for, among other things, the protracted litigation that “gave bread to many lawyers.”

 

For those of you who have been living under a rock (or shun movies like The Social Network), since its inception in 2004, Facebook has been at the center of a long and drawn out legal battle against ConnectU and its twin founders Tyler and Cameron Winklevoss who maintained that Mark Zuckerberg, CEO of Facebook, stole their source code and design of the ConnectU website while classmates at Harvard University. After several years of litigation, the two sides finally reached a settlement agreement in February 2008 providing that Facebook would acquire ConnectU’s assets in exchange for 1,253,326 shares of Facebook (valued at approximately $180 million as of April 12, 2011) and $20 million in cash.

However, in March 2008, the Winklevoss twins filed another lawsuit in the federal court for the Northern District of California alleging that Facebook misled them over the true value of the stock and sought to rescind the settlement agreement. After the district court ordered the parties to mediate, the parties signed a Confidentiality Agreement stating, in relevant part, that “[n]o aspect of the mediation shall be relied upon or introduced as evidence in any arbitral, judicial, or other proceeding.” After only one day of mediation, the parties reached a global settlement that transferred ConnectU’s assets to Facebook for the above-mentioned cash and stock in the company. Additionally, the parties granted all parties “mutual releases as broad as possible.” After the parties signed the Term Sheet & Settlement Agreement, the settlement fell apart while the parties were negotiating the final form of the deal documents. In order to preserve the settlement, Facebook filed a motion in the district court to enforce the terms of the initial agreement. Over the objections of ConnectU, the district court held the agreement to be enforceable and ordered the transfer of all ConnectU shares to Facebook.

On appeal of the district court’s decision to enforce the Term Sheet & Settlement Agreement, the Winklevosses argued that the initial agreement lacked material terms and was procured by fraud in violation of the federal securities laws. In its defense, Facebook conceded that certain terms of the agreement were to be negotiated later, but that this was “typical of acquisition documents,” and that the Winklevosses could not prove fraud because the Confidentiality Agreement prohibited them from disclosing statements made during the mediation.

Since this is an ADR blog, I will spare you the details of the Ninth Circuit’s ruling with respect to securities fraud, which involved interesting questions regarding the applicability of Rule 10b-5 to settlement negotiations between sophisticated parties. (Suffice it to say that securities law gurus, including me, have been salivating over those questions). In short, the court found that, in the context of a private, securities acquisition between two sophisticated parties heavily represented by lawyers who had access to extensive discovery devices, the Winklevoss twins should have been able to figure out the company’s true valuation on their own. (It didn’t help that daddy Howard Winklevoss, a former Wharton School accounting professor and expert in valuation, participated in the mediation along with a half-dozen lawyers representing the twins.)

With respect to mediation confidentiality, Judge Kosinski wrote that, even if the court had found that the twins could use Rule 10b-5 to undo the 2008 settlement, they could not introduce evidence of any alleged fraudulent statements made during the mediation because of the Confidentiality Agreement the parties signed (but not because of mediation confidentiality stemming from Local Court Rule 6-11, as the district court had found).

Throughout the opinion, the Ninth Circuit exhibited a fair amount of contempt for the Winklevoss twins’ attempt to maneuver around their own settlement agreement after years of drawn-out litigation. Judge Kosinski’s opinion concluded with the following declaration: “At some point, litigation must come to an end. That point has now been reached.”

 

On this very point, however, Judge Kosinski may be wrong, as the media has reported this week that the twins’ lawyers intend to apply for a rehearing en banc.

Stay tuned for developments.

 

(Thanks for Chris Bloch for his substantial assistance in summarizing the Ninth Circuit’s opinion.)

2 thoughts on “ADR, Securities Law and Facebook – I “like””

  1. Looks like the twins filed their petition for rehearing en banc. I have some doubts as to whether the 9th Circuit will take the case en banc, but I am interested in seeing what happens next!

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