deadline · 2018-06-11 · ted sarandos, greg peters, david hyman and nominal defendant netflix,...

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DEFS.’ AND NOMINAL DEF.’S MOTS. TO DISMISS

CASE NO.: 5:18-CV-02107-BLF

KEITH E. EGGLETON, State Bar No. 159842 Email: [email protected] RODNEY G. STRICKLAND, State Bar No. 161934 Email: [email protected] RYAN S. WOLF, State Bar No. 319353 Email: [email protected] WILSON SONSINI GOODRICH & ROSATI Professional Corporation 650 Page Mill Road Palo Alto, CA 94304-1050 Telephone: (650) 493-9300 Facsimile: (650) 565-5100 LORI W. WILL, Admitted Pro Hac Vice Email: [email protected] WILSON SONSINI GOODRICH & ROSATI 222 Delaware Avenue, Suite 800 Wilmington, DE 19803-5225 Attorneys for Defendants Reed Hastings, David Wells, Richard Barton, A. George (Skip) Battle, Timothy Haley, Jay Hoag, Leslie Kilgore, Ann Mather, Brad Smith, Anne Sweeney, Neil Hunt, Ted Sarandos, Greg Peters, David Hyman and Nominal Defendant Netflix, Inc.

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

CITY OF BIRMINGHAM RELIEF AND RETIREMENT SYSTEM,

Plaintiff,

v. REED HASTINGS, DAVID WELLS, RICHARD BARTON, A. GEORGE (SKIP) BATTLE, TIMOTHY HALEY, JAY HOAG, LESLIE KILGORE, ANN MATHER, BRAD SMITH, ANNE SWEENEY, NEIL HUNT, TED SARANDOS, GREG PETERS, and DAVID HYMAN,

Defendants, – and – NETFLIX INC., Nominal Defendant.

) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) )

CASE NO.: 5:18-cv-02107-BLF DERIVATIVE ACTION DEFENDANTS’ AND NOMINAL DEFENDANT’S NOTICE OF MOTIONS AND MOTIONS TO DISMISS VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT; MEMORANDUM OF POINTS AND AUTHORITIES IN SUPPORT DATE: December 13, 2018 TIME: 9:00 a.m. JUDGE: Hon. Beth Labson Freeman

Case 5:18-cv-02107-BLF Document 30 Filed 06/08/18 of 32

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DEFS.’ AND NOMINAL DEF.’S MOTS. TO DISMISS -i- CASE NO.: 5:18-CV-02107-BLF

TABLE OF CONTENTS

NOTICE OF MOTIONS AND MOTIONS .................................................................................... 1

ISSUES TO BE DECIDED ............................................................................................................. 1

MEMORANDUM OF POINTS AND AUTHORITIES ................................................................ 2

INTRODUCTION ........................................................................................................................... 2

FACTUAL BACKGROUND ......................................................................................................... 3

I. THE PARTIES ........................................................................................................ 3

II. SECTION 162(M) AND THE PERFORMANCE BONUS PLAN ........................ 4

III. PERFORMANCE BONUSES AWARDED TO OFFICER DEFENDANTS UNDER THE PLAN ............................................................................................... 6

IV. THE PROXY STATEMENTS AT ISSUE ............................................................. 7

ARGUMENT .................................................................................................................................. 8

I. THE COMPLAINT SHOULD BE DISMISSED UNDER RULE 23.1 BECAUSE PLAINTIFF FAILED TO PLEAD THAT DEMAND ON THE BOARD WOULD BE FUTILE. ............................................................................. 8

A. Plaintiff Fails to Create a Reasonable Doubt that a Majority of the Board Lacks Independence or is Interested in the Plan. ........................... 10

B. Plaintiff Fails to Create a Reasonable Doubt as to Whether a Majority of the Board Faces a Substantial Likelihood of Liability. .......... 11

1. No substantial likelihood of liability for violating federal tax law ................................................................................................. 12

2. No substantial likelihood of liability for knowing dissemination of false information to stockholders ....................... 16

3. Committee membership alone does not establish knowledge ....... 18

4. No substantial likelihood of liability for allegedly violating internal governance policies or failure to implement internal controls .......................................................................................... 19

II. THE COMPLAINT SHOULD BE DISMISSED UNDER RULE 12(B)(6) FOR FAILURE TO STATE A CLAIM ................................................................ 19

A. Plaintiff Fails to State a Claim Under Section 14(a) of the Exchange Act. ............................................................................................................ 20

1. No misstatements in the Proxies ................................................... 20

2. No injury-causing transaction ....................................................... 21

3. No culpable conduct ...................................................................... 22


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DEFS.’ AND NOMINAL DEF.’S MOTS. TO DISMISS -ii- CASE NO.: 5:18-CV-02107-BLF

B. Plaintiff Fails to State a Breach of Fiduciary Duty Claim Under Delaware Law. .......................................................................................... 22

1. No duty of loyalty claim pleaded against the Director Defendants ..................................................................................... 22

2. No gross negligence pleaded against the Officer Defendants or Mr. Wells .................................................................................. 23

C. Plaintiff Fails to State a Corporate Waste Claim under Delaware Law. ........................................................................................................... 24

CONCLUSION ............................................................................................................................. 25


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DEFS.’ AND NOMINAL DEF.’S MOTS. TO DISMISS -iii- CASE NO.: 5:18-CV-02107-BLF

TABLE OF AUTHORITIES

CASES

Abrams v. Wainscott, 2012 WL 3614638 (D. Del. Aug. 21, 2012) ........................................................................18

Aronson v. Lewis, 473 A.2d 805 (Del. 1984), ................................................................................................9, 15

Ashcroft v. Iqbal, 556 U.S. 662 (2009) .............................................................................................................20

Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) .............................................................................................................20

Braddock v. Zimmerman, 906 A.2d 776 (Del. 2006) .......................................................................................................9

Brehm v. Eisner, 746 A.2d 244 (Del. 2000) ....................................................................................9, 10, 11, 25

Brown v. Moll, 2010 WL 2898324 (N.D. Cal. July 21, 2010) ......................................................................23

Bush v. Vaco Tech. Serv., LLC, 2018 WL 2047807 (N.D. Cal. May 2, 2018) .......................................................................20

Conrad v. Blank, 940 A.2d 28 (Del. Ch. 2007) ..................................................................................................9

Desaigoudar v. Meyercord, 223 F.3d 1020 (9th Cir. 2000) ........................................................................................20, 22

Desimone v. Barrows, 924 A.2d 908 (Del. Ch. 2007) ..............................................................................................15

Dreiling v. Am. Express Co., 458 F.3d 942 (9th Cir. 2006) ..................................................................................................3

Dura Pharms., Inc. v. Broudo, 544 U.S. 336 (2005) .............................................................................................................20

Freedman v. Adams, 2012 WL 1345638 (Del. Ch. Mar. 30, 2012), aff’d, 58 A.3d 414 (Del. 2013) .......................................................................................13, 22

Freedman v. Mulva, 2014 WL 975308 (D. Del. Mar. 12, 2014) ...........................................................................15

Freedman v. Redstone, 2013 WL 3753426 (D. Del. 2013), aff’d, 753 F.3d 416 (3d Cir. 2014) .................................................................................13, 25

Guttman v. Huang, 823 A.2d 492 (Del. Ch. 2003) ..................................................................................15, 17, 23


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DEFS.’ AND NOMINAL DEF.’S MOTS. TO DISMISS -iv- CASE NO.: 5:18-CV-02107-BLF

Haber v. Bell, 465 A.2d 353 (Del. Ch. 1983) ..............................................................................................25

Horman v. Abney, 2017 WL 242571 (Del. Ch. Jan. 19, 2017) ..........................................................................19

In re 3Com Corp. S’holders Litig., 1999 WL 1009210 (Del. Ch. Oct. 25, 1999) ........................................................................24

In re Accuray, Inc. S’holder Derivative Litig., 757 F. Supp. 2d 919 (N.D. Cal. 2010) ........................................................15, 17, 19, 23, 24

In re Asyst Techs., Inc. Derivative Litig., 2008 WL 2169021 (N.D. Cal. May 23, 2008) .....................................................................22

In re Baxter Int’l, Inc. S’holders Litig., 654 A.2d 1268 (Del. Ch. 1995) ............................................................................................11

In re Caterpillar Inc. Derivative Litig., 2014 WL 2587479 (D. Del. June 10, 2014) ...................................................................16, 21

In re China Auto. Sys. Inc. Derivative Litig., 2013 WL 4672059 (Del. Ch. Aug. 30, 2013) .......................................................................18

In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106 (Del. Ch. 2009) ..................................................................................17, 19, 23

In re Dow Chem. Co. Derivative Litig., 2010 WL 66769 (Del. Ch. Jan. 11, 2010) ................................................................15, 17, 25

In re Gen. Motors Co. Derivative Litig., 2015 WL 3958724 (Del. Ch. June 26, 2015) .......................................................................12

In re Google, Inc. S’holder Derivative Litig., 2012 WL 1611064 (N.D. Cal. May 8, 2012) .............................................................9, 12, 15

In re HP Derivative Litig., 2012 WL 4468423 (N.D. Cal. Sept. 25, 2012) .......................................................................9

In re Linear Tech. Corp. Derivative Litig., 2006 WL 3533024 (N.D. Cal. Dec. 7, 2006) .......................................................................18

In re Lear Corp. S’holder Litig., 967 A.2d 640 (Del. Ch. 2008) ..............................................................................................23

In re Maxwell Techs., Inc. Derivative Litig., 2014 WL 2212155 (S.D. Cal. May 27, 2014) ......................................................................15

In re Sagent Tech., Inc., Derivative Litig., 278 F. Supp. 2d 1079 (N.D. Cal. 2003) ...................................................................10, 12, 23

In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970 (9th Cir. 1999) ...............................................................................8, 11, 15, 17

In re Verisign, Inc. Derivative Litig., 531 F. Supp. 2d 1173 (N.D. Cal. 2007) ................................................................8, 9, 21, 22


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DEFS.’ AND NOMINAL DEF.’S MOTS. TO DISMISS -v- CASE NO.: 5:18-CV-02107-BLF

In re Walt Disney Co. Derivative Litig., 907 A.2d 693 (Del. Ch. 2005), aff’d, 906 A.2d 27 (Del. 2006) .............................................................................................24

In re Yahoo! Inc. S’holder Derivative Litig., 153 F. Supp. 3d 1107 (N.D. Cal. 2015) .................................................................................4

Ind. Elec. Workers Pension Trust Fund, IBEW v. Dunn, 2008 WL 878424 (N.D. Cal. Mar. 28, 2008), aff’d, 532 F. App’x 157 (9th Cir. 2009) ...............................................................................11

Iron Workers Local No. 25 Pension Fund v. Bogart, 2012 WL 2160436 (N.D. Cal. June 13, 2012) .....................................................................11

Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90 (1991) .................................................................................................................8

Krieger v. Atheros Commc’ns, Inc., 2012 WL 1933559 (N.D. Cal. May 29, 2012) .....................................................................22

Lewis v. Vogelstein, 699 A.2d 327 (Del. Ch. 1997) ..............................................................................................25

N.J. Bldg. Laborers Pension Fund v. Ball, 2014 WL 1018210 (D. Del. Mar. 13, 2014) .........................................................................18

N.Y. City Emps.’ Ret. Sys. v. Jobs, 593 F.3d 1018 (9th Cir. 2010) ........................................................................................20, 22

Northstar Fin. Advisors Inc. v. Schwab Invs., 779 F.3d 1036 (9th Cir. 2015) ................................................................................................3

Pogostin v. Rice, 480 A.2d 619 (Del. 1984) .....................................................................................................10

Potter v. Hughes, 546 F.3d 1051 (9th Cir. 2008) ................................................................................................8

Rales v. Blasband, 634 A.2d 927 (Del. 1993) .................................................................................................8, 10

Rosenbloom v. Pyott, 765 F.3d 1137 (9th Cir. 2014) ..........................................................................................9, 10

Seinfeld v. O’Connor, 774 F. Supp. 2d 660 (D. Del. 2011) ..................................................................13, 14, 16, 21

Shaev v. Saper, 320 F.3d 373 (3d Cir. 2003) .................................................................................................14

South v. Baker, 62 A.3d 1 (Del. Ch. 2012) ....................................................................................................18

Stone v. Ritter, 911 A.2d 362 (Del. 2006) .....................................................................................................12


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DEFS.’ AND NOMINAL DEF.’S MOTS. TO DISMISS -vi- CASE NO.: 5:18-CV-02107-BLF

Towers v. Iger, 2017 WL 6044035 (N.D. Cal. Mar. 10, 2017) ......................................................8, 9, 11, 16

Weiss v. Swanson, 948 A.2d 433 (Del. Ch. 2008) ................................................................................................8

Wilkin v. Narachi, 2018 WL 1100372 (Del. Ch. Feb. 28, 2018) ..................................................................12, 19

STATUTES

8 Del. C. § 102(b)(7) ....................................................................................................................4, 23

15 U.S.C. § 78n(a) .................................................................................................................... passim

26 U.S.C. § 162(m) (2017) ....................................................................................................... passim

RULES AND REGULATIONS

26 C.F.R. § 1.162-27 ....................................................................................................4, 5, 13, 14, 15

Fed. R. Civ. P. 12(b)(6) ............................................................................................................ passim

Fed. R. Civ. P. 23.1 .................................................................................................................. passim

Fed. R. Evid. 201(b) ...........................................................................................................................4

MISCELLANEOUS

IRS Priv. Ltr. Rul. 199950021, 1999 WL 1208442 (Dec. 17, 1999) ...............................................14


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DEFS.’ AND NOMINAL DEF.’S MOTS. TO DISMISS -1- CASE NO.: 5:18-CV-02107-BLF

NOTICE OF MOTIONS AND MOTIONS

PLEASE TAKE NOTICE that on December 13, 2018, at 9:00 a.m., before the Honorable

Beth Labson Freeman of the United States District Court for the Northern District of California,

Courtroom 3, 5th Floor, 280 South 1st Street, San Jose, California, Netflix, Inc. (“Netflix” or the

“Company”) and defendants Reed Hastings, David Wells, Richard Barton, A. George (Skip)

Battle, Timothy Haley, Jay Hoag, Leslie Kilgore, Ann Mather, Brad Smith, Anne Sweeney, Neil

Hunt, Ted Sarandos, Greg Peters, and David Hyman (the “Individual Defendants”) will and

hereby do move to dismiss the Verified Shareholder Derivative Complaint (ECF No. 25; the

“Complaint”) under Federal Rule of Civil Procedure 23.1 on the grounds that Plaintiff lacks

standing to pursue this action because it did not make a pre-filing demand on Netflix’s Board of

Directors and has not pleaded particularized facts demonstrating that such a demand would have

been futile.

PLEASE TAKE FURTHER NOTICE that at the same date, time and location referenced

above the Individual Defendants will and hereby do move to dismiss the Complaint pursuant to

Federal Rule of Civil Procedure 12(b)(6) because Plaintiff’s claims under Section 14(a) of the

Securities Exchange Act of 1934, 15 U.S.C. § 78n(a) (the “Exchange Act”), for breach of

fiduciary duty, and waste, do not state plausible claims.

These Motions are based on this Notice of Motions and Motions; the accompanying

Memorandum of Points and Authorities supporting the Motions, the Declaration of Rodney G.

Strickland and exhibits thereto; all papers filed herein; oral argument of counsel; and the record

in this action.

ISSUES TO BE DECIDED

1. Should the Complaint be dismissed because Plaintiff failed to make a pre-filing

demand on Netflix’s Board of Directors and failed to allege particularized facts demonstrating

that a demand would have been futile?

2. Should the Complaint be dismissed because Plaintiff failed to state a cause of

action against any of the Individual Defendants?


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MEMORANDUM OF POINTS AND AUTHORITIES

INTRODUCTION

In 2014, Netflix’s stockholders approved an incentive compensation plan for certain

executives. Federal tax statutes and regulations, described below, addressed the tax treatment of

such plans and provided that certain performance-based bonuses might be tax deductible. This

lawsuit, which Plaintiff purports to bring on behalf of Netflix against certain of its directors and

officers, does not challenge the validity of that compensation plan. Rather, Plaintiff alleges that

disclosures in the Company’s annual proxy statements about the potential deductibility of

performance bonuses awarded under the plan were misleading because—according to an

interpretation of tax law that Plaintiff concocted—the bonuses were not actually deductible.

The compensation plan was created so that Netflix could take advantage of available tax

deductions for bonuses paid to three of its senior officers, as permitted by the applicable tax

laws. The deductions claimed by Netflix reduced its tax burden, and therefore were beneficial to

Netflix and its stockholders. Neither the Internal Revenue Service (the “IRS”) nor any other

government entity has challenged Netflix’s tax deductions. Plaintiff’s lawsuit therefore

challenges something that benefited the Company—the opposite of the type of corporate harm

derivative lawsuits typically seek to remedy.

The Complaint should be dismissed under Rule 23.1 because Plaintiff has failed to

establish standing to pursue a derivative claim. Netflix’s current 11-member Board of Directors

(the “Board”) includes 10 outside and independent directors, two of whom are not defendants.

None of Netflix’s directors benefitted from the compensation plan. Nevertheless, Plaintiff chose

not to make a demand on the Board before filing this lawsuit. To have standing in the absence of

a demand, Plaintiff must make particularized allegations demonstrating that a majority of the

Board members—that is, at least six—could not have impartially considered a demand because

they face a substantial likelihood of liability. Plaintiff’s burden is even higher because Netflix

has an exculpatory charter provision, and so Plaintiff must show at least six directors breached

their duty of loyalty or acted in bad faith. It has not done so. Putting aside that Plaintiff’s views

on deductibility are entirely novel, the Complaint contains no particularized allegations


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suggesting that at least six directors knowingly violated the law or even had a role in the

challenged disclosures about the potential deductibility of the bonuses.

The Individual Defendants further contend that the Complaint should be dismissed under

Rule 12(b)(6). Plaintiff has failed to establish the elements of a Section 14(a) claim under the

Exchange Act. The Complaint also lacks a well-pleaded, non-exculpated claim for breach of the

duty of loyalty against the director defendants, and fails to allege any facts supporting a claim of

gross negligence against the officer defendants under Delaware law. Finally, Plaintiff’s

allegations quibbling with the performance bonuses come nowhere close to satisfying the high

standard for pleading a waste claim. For these reasons, the Complaint must be dismissed.

FACTUAL BACKGROUND

I. THE PARTIES Plaintiff brings this stockholder derivative action on behalf of Netflix, a Delaware

corporation with its principal executive offices in Los Gatos, California. Compl. ¶¶ 1, 16. Nine

of Netflix’s directors—Messrs. Hastings, Barton, Battle, Haley, Hoag, and Smith, and Mss.

Kilgore, Mather and Sweeney (collectively, the “Director Defendants”) are named as defendants.

Compl. ¶¶ 17, 19-26. Only one of the Director Defendants—Mr. Hastings, the Chief Executive

Officer of Netflix—is alleged not to be an outside, independent director. Compl. ¶ 17. At the

time the Complaint was filed, Netflix’s Board consisted of 11 directors—the nine Director

Defendants, plus non-defendants Rodolphe Belmer (the Chief Executive Officer of Eutelsat, one

of the world’s leading satellite operators) and Amb. Susan Rice (former Ambassador to the

United Nations and National Security Advisor to President Obama). See Decl. of Rodney G.

Strickland in Supp. of Netflix, Inc.’s and the Individual Defs.’ Mots. to Dismiss Verified

S’holder Derivative Compl. (“Strickland Decl.”) Exs. B & C.1 Plaintiff also names as defendants

1 Defendants request that the Court take judicial notice of the following documents, which

are attached to the Strickland Declaration: (A) Netflix’s Restated Certificate of Incorporation, filed with the SEC as an exhibit to Netflix’s Form 10-Q on July 17, 2015; (B) Netflix’s Form 8-K, filed with the SEC on January 24, 2018; (C) Netflix’s Form 8-K, filed with the SEC on March 28, 2018; and (D) Netflix’s Form 8-K, filed with the SEC on December 28, 2017. These documents are appropriate for judicial notice because they were publicly filed with the SEC. See Northstar Fin. Advisors Inc. v. Schwab Invs., 779 F.3d 1036, 1042-43 (9th Cir. 2015) (explaining “[i]t is appropriate to take judicial notice of this information, as it was made publicly available by [the SEC]” (citation omitted)); Dreiling v. Am. Express Co., 458 F.3d 942, 946 n.2 (9th Cir. 2006) (stating that a court “may consider documents referred to in the complaint or any matter


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five current and former non-director officers of Netflix. Compl. ¶¶ 18, 30-33. Mr. Wells is the

Company’s Chief Financial Officer. Compl. ¶ 18. The other four officers—Messrs. Hunt,

Sarandos, Peters, and Hyman (the “Officer Defendants”)—are or were covered employees whose

compensation is subject to the deductibility limits of Section 162(m)(3) of the Internal Revenue

Code. Compl. ¶¶ 30-33.

II. SECTION 162(M) AND THE PERFORMANCE BONUS PLAN According to the Complaint, this action was initiated because Netflix took a tax

deduction on performance-based bonuses awarded to the Officer Defendants, which Plaintiff

believes were not deductible under Section 162(m) of the Internal Revenue Code and the

relevant Treasury regulations. E.g., Compl. ¶ 6. Section 162(m) placed a $1 million limit on the

deductibility for income tax purposes of annual compensation paid to a “covered employee”—a

company’s CEO and its other three highest-paid officers (other than the CFO). 26 U.S.C.

§ 162(m)(1), (3); Compl. ¶ 50. Until it was amended (as explained below), Section 162(m) also

contained an exception to that limitation for qualified performance-based compensation, defined

as compensation “payable solely on account of the attainment of one or more performance

goals.” 26 U.S.C. § 162(m)(4)(C) (2017) (current version at 26 U.S.C. § 162(m)); see also 26

C.F.R. § 1.162-27(b), (e); Compl. ¶¶ 52-53.

Therefore, Section 162(m) provided a mechanism by which a company could claim a tax

deduction for bonuses awarded to senior executives. Because of the potential tax benefit, many

companies implemented Section 162(m) compensation plans. Importantly, Section 162(m)

addressed only the tax deductibility of performance-based compensation paid to covered

subject to judicial notice, such as SEC filings”). “[C]ourts routinely take judicial notice of certificates of incorporation when ruling on motions to dismiss in derivative actions.” In re Yahoo! Inc. S’holder Derivative Litig., 153 F. Supp. 3d 1107, 1117-18 (N.D. Cal. 2015).

Defendants do not seek judicial notice of the truth of all matters in these documents. Exhibit A is offered for the fact that Netflix’s Restated Certificate of Incorporation includes an exculpatory provision, which mirrors the language of Section 102(b)(7) of the Delaware General Corporation Law. Exhibits B and C are offered solely to show the composition of Netflix’s Board at the time the lawsuit was filed. Exhibit D is offered to demonstrate that bonuses are no longer being awarded under the Plan. The existence of the exculpatory charter provision, composition of Netflix’s Board, and discontinuation of the Plan are not subject to reasonable dispute and can be accurately and readily determined from sources whose accuracy cannot reasonably be questioned. See Fed. R. Evid. 201(b).


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employees—not the amount of compensation that could be awarded. Neither Section 162(m) nor

any other statute or regulation prohibited granting compensation that was not tax-deductible.

This provision of Section 162(m) on deductibility is no longer in place. Pursuant to the

Tax Cuts and Jobs Act, dated December 22, 2017 and effective January 1, 2018, the Section was

amended to expand the scope of the $1 million deduction limitation and to eliminate the

exception for performance-based compensation. 26 U.S.C. § 162(m). Because that amendment

went into effect and eliminated any tax benefit from performance-based bonuses, Netflix began

paying all cash compensation to senior executives as salary in 2018. See Strickland Decl. Ex. D.

The Treasury regulations that implemented Section 162(m)’s former exception for

performance-based compensation describe what constitutes a “performance goal” under the

statute. 26 C.F.R. § 1.162-27. Treasury Regulation Section 1.162-27(e)(2)(i) explains that a

performance goal must be established “not later than 90 days after the commencement of the

period of service to which the performance goal relates,” and “in no event will a performance

goal be considered to be preestablished if it is established after 25 percent of the period of

service . . . has elapsed.” Id. § 1.162-27(e)(2)(i). That Treasury Regulation also requires that the

“outcome” of the performance goal must be “substantially uncertain at the time the

compensation committee actually establishes the goal.” Id.; Compl. ¶ 54. The Treasury

regulations do not define the meaning of “substantially uncertain.”

On April 28, 2014, Netflix filed a definitive proxy statement (the “2014 Proxy”), seeking

stockholder approval of the Performance Bonus Plan (the “Plan”), which Plaintiff accurately

alleges was “developed to enable the Company to claim a tax deduction under Section 162(m)

for certain performance-based compensation.” Compl. ¶ 56. Before the 2014 Proxy was filed,

the Compensation Committee approved the Plan on March 26, 2014 following a review of

Section 162(m). Compl. ¶ 56 (citing minutes). In the 2014 Proxy, stockholders were informed

that, pursuant to the Plan, eligible officers might receive compensation “based upon the

Company achieving certain performance goals.” Compl. ¶ 57. The 2014 Proxy also explained

that the Plan “could permit [Netflix] to receive a full federal income tax deduction for

compensation (if any) paid under the Plan.” Id. The 2014 Proxy described the potential


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performance goals that the Compensation Committee could set in connection with the Plan,

which included revenue, among other metrics. Compl. ¶ 58. The 2014 Proxy also disclosed that

a participant’s target award would be based on achievement of “one or more performance

goal(s).” Compl. ¶ 58. On June 10, 2014, Netflix announced that stockholders approved the

adoption of the Plan, and provided a summary of the “principal features of the Plan and its

operation.” Compl. ¶ 59. Plaintiff does not challenge the 2014 Proxy or the validity of the Plan.

III. PERFORMANCE BONUSES AWARDED TO OFFICER DEFENDANTS UNDER THE PLAN

In the first quarter of 2015, the Compensation Committee acknowledged it had

determined that the Plan should be implemented so that the Company could “take advantage of

available tax deductions.” Compl. ¶ 60 (quoting minutes). Before each quarter in 2015, 2016,

and 2017, the Compensation Committee set a performance period and a goal of global streaming

revenue. Compl. ¶¶ 80, 82, 85, 87, 90, 93, 96, 98, 101, 104, 106-107. “The [Compensation

Committee] chose this goal because global streaming revenue is an important metric

demonstrating the growth of the Company.” Compl. ¶¶ 69, 75. Although the Compensation

Committee members received forward-looking projections during quarterly Board meetings

(e.g., Compl. ¶ 83), they set the global streaming revenue performance targets as “reflected in

[Netflix’s] publicly-available financial statements.” Compl. ¶¶ 69, 75 (emphasis added). Put

differently, the internal performance goals mirrored Netflix’s public guidance. At the conclusion

of each quarter, the Compensation Committee compared the Company’s actual global streaming

revenue to the performance target, and determined whether the relevant Officer Defendants were

eligible for a bonus payout under the Plan.

The Complaint demonstrates that the global streaming revenue goals increased each

quarter, such that significant growth was required for the bonuses to be awarded. The

performance target for the final quarter the Plan was in use was more than double (or increased

by over $1.4 billion) that of the first performance period in 2015. Compare Compl. ¶ 81, with id.

¶ 106. The Officer Defendants who were awarded bonuses under the Plan were Messrs.

Sarandos, Hunt, and Peters, until the third quarter of 2017 when Mr. Hyman replaced Mr. Hunt.


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Compl. ¶ 106. Netflix’s CEO, Mr. Hastings, was not awarded bonuses under the Plan. Mr.

Wells was also not awarded bonuses under the Plan because, as CFO, his compensation was not

subject to the limitations of Section 162(m) and therefore fully deductible. See supra at 4.

IV. THE PROXY STATEMENTS AT ISSUE While the performance-based bonuses were being awarded under the Plan, Netflix issued

three proxy statements before each of three annual stockholder meetings that included a

description of the bonuses, in connection with Netflix’s “say-on-pay” stockholder vote. Compl.

¶ 120. The first was issued on April 27, 2015 (the “2015 Proxy”), the second on April 27, 2016

(the “2016 Proxy”) and the third on April 24, 2017 (the “2017 Proxy” and, with the 2015 Proxy

and 2016 Proxy, the “Proxies”). Compl. ¶¶ 62, 67, 73.

The 2015 Proxy explained that the Plan had been created “[i]n order to comply with

Section 162(m),” and described that the Compensation Committee had “chos[en] to implement

the [Plan] that was approved by stockholders in 2014,” such that “certain [of the Officer

Defendants] w[ould] be eligible to receive bonuses based on targets set by the Compensation

Committee.” Compl. ¶¶ 64-65.

The 2016 Proxy and 2017 Proxy both explained that the “Plan [wa]s intended to permit

the Company to seek a full federal tax deduction for compensation paid under the Plan” and that

“bonuses earned and paid under the [Plan] [we]re intended to qualify as performance-based.”

Compl. ¶¶ 69, 71, 75, 77. The 2016 Proxy and 2017 Proxy also described the Compensation

Committee’s approval of four performance periods, each one “comprised of one of [the

Company’s] fiscal quarters,” and described its selection of global streaming revenue targets

based on Netflix’s “publicly-available financial statements.” Compl. ¶¶ 69, 75. Each quarterly

global streaming revenue performance target and each corresponding global streaming revenue

result was also disclosed. Compl. ¶¶ 70, 76.


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ARGUMENT

I. THE COMPLAINT SHOULD BE DISMISSED UNDER RULE 23.1 BECAUSE PLAINTIFF FAILED TO PLEAD THAT DEMAND ON THE BOARD WOULD BE FUTILE. Federal law determines the procedural rules that apply to stockholder derivative

complaints filed in federal court. See In re Verisign, Inc. Derivative Litig., 531 F. Supp. 2d

1173, 1188 (N.D. Cal. 2007). A stockholder seeking to pursue derivative claims on behalf of a

corporation must make a demand on the corporation’s directors to act, or must “state with

particularity” the reasons why such demand would have been futile. Fed. R. Civ. P. 23.1(b)(3);

see In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 989-90 (9th Cir. 1999). This “demand

requirement implements ‘the basic principle of corporate governance that the decisions of a

corporation—including the decision to initiate litigation—should be made by the board of

directors.’” Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 101 (1991) (citation omitted). As

the Ninth Circuit has held, “strict compliance with Rule 23.1 and the applicable substantive law

is necessary before a derivative suit can wrest control of an issue from the board of directors.”

Potter v. Hughes, 546 F.3d 1051, 1058 (9th Cir. 2008). Derivative plaintiffs must overcome the

presumption that directors fulfilled their fiduciary duties with particularized factual allegations,

meaning that the “plaintiff’s pleading burden in the demand [futility] context is more onerous

than that required to withstand a Rule 12(b)(6) motion.” Towers v. Iger, 2017 WL 6044035, at

*3 (N.D. Cal. Mar. 10, 2017) (quoting Weiss v. Swanson, 948 A.2d 433, 441 (Del. Ch. 2008)).

Because Netflix is a Delaware corporation, Delaware law supplies the substantive

standard for determining whether demand is excused. See Kamen, 500 U.S. at 108-09; Silicon

Graphics, 183 F.3d at 990. Under Delaware law, demand will be excused only if a complaint

contains “particularized factual allegations . . . creat[ing] a reasonable doubt that . . . the board of

directors could have properly exercised its independent and disinterested business judgment in

responding to a demand.” Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993). Delaware law

provides two tests for assessing demand futility—the Aronson test and the Rales test. The

Aronson test is applied if the lawsuit challenges a specific decision or transaction of the

corporation’s board, requiring the plaintiff to plead particularized facts creating a reasonable


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doubt either that (1) the directors were disinterested and independent, or (2) the challenged

transaction was the product of a valid business judgment. Aronson v. Lewis, 473 A.2d 805, 814

(Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). The

Rales test is applied if the subject of the lawsuit is not a particular business decision of the board,

or is a decision made by less than a majority of a board. See Braddock v. Zimmerman, 906 A.2d

776, 784-85 (Del. 2006).

“The Ninth Circuit has held that the difference between the Aronson and Rales tests is

blurred in cases where a derivative claim alleges wrongdoing by a majority of the board but does

not challenge a specific board decision.” Towers, 2017 WL 6044035, at *5. Here, the decision

to set performance targets and award bonuses under the Plan was an act of the Compensation

Committee (Messrs. Battle, Haley, and Hoag) who constitute just three of the 11 Board

members. See Conrad v. Blank, 940 A.2d 28, 36 (Del. Ch. 2007) (applying Rales test where

challenged option grants were authorized by compensation committee constituting less than half

of the board); see also In re HP Derivative Litig., 2012 WL 4468423, at *4 (N.D. Cal. Sept. 25,

2012) (explaining that “when the challenged act does not constitute a business decision by the

board, a court should employ the Rales test”). Nor is a “board decision” implicated by the

Proxies—there are no facts alleged regarding a majority of the Board’s involvement with the

alleged misstatements. See In re Google, Inc. S’holder Derivative Litig., 2012 WL 1611064, at

*5 (N.D. Cal. May 8, 2012) (applying Rales where directors allegedly “caused” the company to

accept and promote illegal advertisements; concluding “plaintiffs’ allegations of defendants’

‘conscious’ knowledge and inaction vis-a-vis the purportedly unlawful advertising scheme

should be analyzed under the Rales test”); see also Verisign, 531 F. Supp. 2d at 1189 (dismissing

claims; applying Rales to allegations of filing misleading proxies about option grants where

“facts as pled show[ed]” a board majority was “not involved in any decision to backdate the

option grants”). In such cases, “courts excuse demand if ‘Plaintiffs’ particularized allegations

create a reasonable doubt as to whether a majority of the board . . . faces a substantial likelihood

of personal liability.’” Towers, 2017 WL 6044035, at *5 (quoting Rosenbloom v. Pyott, 765

F.3d 1137, 1150 (9th Cir. 2014)). Because Plaintiff cannot establish that any of the directors—


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much less at least six of the 11 Board members—is not disinterested and independent or faces a

substantial likelihood of liability, demand is not excused.

A. Plaintiff Fails to Create a Reasonable Doubt that a Majority of the Board Lacks Independence or is Interested in the Plan.

To show that a director is interested, Plaintiff must plead with particularity allegations

demonstrating that “divided loyalties are present, or [that] a director either has received, or is

entitled to receive, a personal financial benefit from the challenged transaction which is not

equally shared by the stockholders.” Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984), overruled

on other grounds by Brehm, 746 A.2d at 253-54. Rather than showing that a majority of the

Board—or at least six directors—is interested, Plaintiff effectively concedes that no member of

the Board received a personal benefit from the Plan. Compl. ¶¶ 108-116. Plaintiff attempts to

single out the Compensation Committee members as lacking “the requisite level of disinterested

and independence required” to consider a demand, but focuses on their purported misconduct

(addressed below) rather than allege any personal interest in the Plan. Compl. ¶ 113. Absent

from the Complaint is an allegation that any of the Director Defendants—including the

Compensation Committee members—would have been compensated differently with or without

the Plan. Even if the Compensation Committee members’ interests were somehow separate, they

constitute just three of the 11 Board members.

Nor does Plaintiff allege that the Director Defendants are dominated by or “beholden to”

the executives who received bonuses under the Plan such that the directors’ “discretion [has

been] sterilized.” Rales, 634 A.2d at 936; accord In re Sagent Tech., Inc., Derivative Litig., 278

F. Supp. 2d 1079, 1088 (N.D. Cal. 2003) (discussing independence standard). In addition, of the

11 Board members serving at the time the Complaint was filed, only Mr. Hastings is also an

officer—and he received no bonus under the Plan. Compl. ¶¶ 17, 19-26; see also Rosenbloom,

765 F.3d at 1148 (explaining demand “‘[f]utility is gauged by the circumstances existing at the

commencement of a derivative suit’ and concerns the board of directors ‘sitting at the time the

complaint is filed’” (citation omitted)). Accordingly, a majority of the Board is independent and


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disinterested with regard to the Plan, and would have been qualified to consider a demand, had

Plaintiff made one.

B. Plaintiff Fails to Create a Reasonable Doubt as to Whether a Majority of the Board Faces a Substantial Likelihood of Liability.

Plaintiff’s attempt to argue demand futility consists of conclusory allegations that the

Director Defendants (9 of the 11 Board members) face “a substantial likelihood of liability for

violating federal securities and tax laws,” as well as their “fiduciary duty of candor.” Compl.

¶¶ 111-112. Courts routinely find allegations that directors could be personally liable legally

insufficient to excuse demand. See Silicon Graphics, 183 F.3d at 990 (explaining that “[t]he

mere threat of personal liability . . . standing alone, is insufficient to challenge either the

independence or disinterestedness of directors” (citation omitted)); Iron Workers Local No. 25

Pension Fund v. Bogart, 2012 WL 2160436, at *3 (N.D. Cal. June 13, 2012) (accord); Ind. Elec.

Workers Pension Trust Fund, IBEW v. Dunn, 2008 WL 878424, at *6 (N.D. Cal. Mar. 28, 2008)

(“[I]t is no answer to say that demand is necessarily futile because (a) the directors would have to

sue themselves, thereby placing the conduct of litigation in hostile hands, or (b) that they

approved the underlying transaction.” (quoting Brehm, 746 A.2d at 257 n.34)), aff’d, 532 F.

App’x 157 (9th Cir. 2009). Rather, “[d]emand will be excused only if the plaintiff’s allegations

show the defendants’ actions ‘were so egregious that a substantial likelihood of director liability

exists.’” Silicon Graphics, 183 F.3d at 990 (citation omitted); In re Baxter Int’l, Inc. S’holders

Litig., 654 A.2d 1268, 1271 (Del. Ch. 1995) (stating it is “a rare case where the circumstances

are so egregious that there is a substantial likelihood of liability”).

Here, Plaintiff’s burden is even more difficult because Netflix has an exculpatory charter

provision that shields its directors from personal liability for breach of fiduciary duty, absent a

showing of intentional misconduct, self-dealing, or bad faith. See Strickland Decl. Ex. A, art.

VIII. As a result, Plaintiff “can establish the substantial likelihood of liability necessary to

excuse demand only by pleading ‘bad faith by alleging with particularity that a director

knowingly violated a fiduciary duty or failed to act in violation of a known duty to act,

demonstrating a conscious disregard for her duties.’” Towers, 2017 WL 6044035, at *5 (quoting


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In re Gen. Motors Co. Derivative Litig., 2015 WL 3958724, at *12 (Del. Ch. June 26, 2015));

Sagent, 278 F. Supp. 2d at 1095 n.9 (finding exculpatory charter provision precluded claim for

negligent breach of fiduciary duty). Plaintiff does not meet this burden, and demand is not

excused. See Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006) (explaining that actual knowledge

of unlawful conduct is required to show substantial likelihood of liability: “imposition of liability

requires a showing that the directors knew they were not discharging their fiduciary

obligations”).

1. No substantial likelihood of liability for violating federal tax law Plaintiff primarily attempts to establish demand futility by arguing that the Board faces a

substantial likelihood of liability for violating federal tax law. Compl. ¶¶ 111-115. However,

the Complaint lacks particularized allegations demonstrating that a majority of the Board, despite

having no motive to do so, breached its fiduciary duties by intentionally causing the corporation

to violate the tax laws. See Stone, 911 A.2d at 369-70 (explaining that bad faith requires a

fiduciary to have acted (1) intentionally with a purpose other than that of advancing the best

interests of the company, (2) with the intent to violate applicable positive law, or (3) with a

conscious disregard for his or her duties). Plaintiff asks the Court to infer—without making a

single particularized allegation on a director-by-director basis—that the Director Defendants

somehow knew that the bonuses were not tax deductible under Section 162(m). See Google,

2012 WL 1611064, at *7 (finding plaintiff did not demonstrate demand futility where allegations

“stated against all defendants in a collective and general fashion” without any “particularized

allegations stating which particular director or directors had knowledge of” unlawful practices).

That is not a reasonable inference to draw for several reasons.

First, Plaintiff does not demonstrate a violation of Section 162(m) or the relevant

Treasury regulations that could support a finding of substantial likelihood of liability against a

majority of the Board. This is not a case where the government has taken action to investigate or

prosecute a corporate trauma, and a stockholder derivative action is filed concerning the same

conduct. Here, there has been no enforcement action or investigation against Netflix that could

bolster Plaintiff’s conclusory allegations. See Wilkin v. Narachi, 2018 WL 1100372, at *10-11


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(Del. Ch. Feb. 28, 2018) (finding no substantial likelihood of liability for knowing violation of

positive law where plaintiff alleged board violated FDA regulations but it was “unclear . . .

exactly what law” was violated and plaintiff did not allege “with particularity any facts to

suggest that the FDA ever determined that [the company] violated anything or issued any fines

whatsoever”); see also Freedman v. Redstone, 2013 WL 3753426, at *9 (D. Del. 2013) (finding

“no clear and undisputed violation, let alone a violation that, standing alone, would create a

reasonable doubt that the [b]oard acted without knowledge or intent” in exceeding limit of a

stockholder-approved Section 162(m) plan), aff’d, 753 F.3d 416 (3d Cir. 2014).

The Complaint rests entirely on Plaintiff’s theory that if a company (allegedly) has reason

to believe it may reach a certain performance target, bonuses awarded based on the achievement

of that target are not performance-based and, thus, not deductible for purposes of Section

162(m). Cf. Freedman v. Adams, 2012 WL 1345638, *16 (Del. Ch. Mar. 30, 2012) (rejecting

plaintiff’s attempt to have a “disclosure claim . . . turn on an interpretation of tax law” where

plaintiff contended she had “concocted a superior tax strategy” to that employed by the board),

aff’d, 58 A.3d 414 (Del. 2013). However, to satisfy IRS requirements, targets need only be

“substantially uncertain.” 26 C.F.R. § 1.162-27(e)(2)(i). In Seinfeld v. O’Connor, the United

States District Court for the District of Delaware recognized that where a company “confidently

and consistently predict[s]” that it will meet its goals—even where the company has a history of

repeatedly meeting those goals—it does not follow that the company is “not substantially

uncertain” to meet those goals. 774 F. Supp. 2d 660, 672 (D. Del. 2011). Here, the Officer

Defendants would still be required to “work diligently throughout the performance period” to

accomplish the global streaming revenue targets. Id. In fact, Treasury regulations provide that

“a bonus contingent on profits is substantially uncertain even if a company has a long history of

profitability,” id. (citing 26 C.F.R. § 1.162-27(e)(2)(vii)), and that a performance goal may be

substantially uncertain where it amounts to “maintaining the status quo.” 26 C.F.R. § 1.162-

27(e)(2)(i). Thus, Netflix’s history of accurately predicting growth in quarterly global streaming

revenue—which more than doubled while the Plan was in use—does not render its performance

targets “substantially certain.”


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To the extent Plaintiff challenges the quarterly performance period set by the

Compensation Committee, Plaintiff also does not demonstrate that the Plan contravenes Treasury

regulations. Treasury Regulation Section 1.162-27(e)(2)(i) provides that a performance goal will

not be deemed “preestablished” if it is set “after 25 percent of the period of service . . . has

elapsed” (emphasis added). There is no allegation that the Compensation Committee set the goal

after 25% of the performance period had elapsed; rather, the Complaint and documents

incorporated into it show otherwise. Moreover, a private letter ruling from the IRS confirms that

the regulation cited by Plaintiff was not violated. See IRS Priv. Ltr. Rul. 199950021, 1999 WL

1208442 (Dec. 17, 1999) (“The performance period and related service period established by the

Y Compensation Committee for performance awards under the Plans may be as short as a single

calendar quarter, or the period between the IPO and the spinoff, so long as the performance goals

are established prior to or during the first 25 percent of the period of service to which the

performance goal relates.”); cf. Seinfeld, 774 F. Supp. 2d at 668 (recognizing private letter

rulings are not precedential, but may be “informative” where they “shed[ ] light on whether the

IRS would view the [Plan] to be tax deductible”). Nor is this case akin to the Third Circuit Court

of Appeals’ decision in Shaev v. Saper, where the court found that a performance bonus paid to

the company’s CEO and majority stockholder, who allegedly dominated the board, ran afoul of

Section 162(m). 320 F.3d 373, 380-81 (3d Cir. 2003). Although the nine-month performance

period was described as “too short to meet the Treasury Regulations requirements,” the court in

Shaev was concerned that the board “manipulated” an amendment of the plan to increase the

CEO’s compensation more than a million dollars beyond the maximum with just six weeks

remaining in the performance period. Id. at 380. No such particularized allegations of

intentional manipulation to benefit a controlling stockholder are present here.

Second, even if Plaintiff’s theory that the bonuses were not deductible is correct, the

Complaint does not contain even a single particularized allegation demonstrating that any of the

nine Director Defendants knew the bonuses were not deductible under federal tax law, but

decided to characterize them as performance-based anyway. There are no facts pled “detailing

the precise roles that the[ ] directors played at the company, the information that would have


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come to their attention in these roles, and any indication as to why they would have perceived the

[wrongdoing].” Google, 2012 WL 1611064, at *6 (quoting Guttman v. Huang, 823 A.2d 492,

503 (Del. Ch. 2003)); see also Silicon Graphics, 183 F.3d at 990 (citing Aronson, 473 A.2d at

814); In re Dow Chem. Co. Derivative Litig., 2010 WL 66769, at *10 (Del. Ch. Jan. 11, 2010)

(dismissing claims; finding no bad faith or knowledge where the complaint did not make

“specific factual allegations” to enable “an analysis of the state of mind of the individual

defendants” (citation omitted)). Instead, the Complaint simply argues that (1) the Board received

quarterly financial updates predicting global streaming revenue, and (2) that the Compensation

Committee set quarterly global streaming revenue performance targets under the Plan that were

similar to the Board projections. Nothing in the Complaint, or the documents referenced therein,

shows that any director at any point knew or was advised that the bonuses might not be

deductible under Section 162(m).2

Third, even if the Court infers from the Complaint that the Director Defendants were

aware of Treasury Regulation Section 1.162-27(e)(2) regarding “substantial uncertainty” of

performance targets from the allegation that the Compensation Committee “review[ed] Section

162(m),” that is not equivalent to knowingly violating the regulation. Compl. ¶ 56; see

Freedman v. Mulva, 2014 WL 975308, at *4 (D. Del. Mar. 12, 2014) (finding plaintiff failed to

allege a “knowing and intentional decision to violate the terms” of an executive compensation

plan); see also In re Maxwell Techs., Inc. Derivative Litig., 2014 WL 2212155, at *12 (S.D. Cal.

May 27, 2014) (holding demand not excused; allegations “that the director defendants reviewed

[financial] statements pursuant to their responsibilities” not sufficient to show liability given “no

specific allegations demonstrating how the directors knew that the financial statements were

incorrect”). In any event, the three-member Compensation Committee’s review of Section

162(m) cannot be imputed to the other seven Director Defendants who were not a part of that

Committee—not to mention the two new Board members who are not defendants. See Desimone

2 Nor is demand excused for Plaintiff’s waste claim. As discussed below, infra at 24-25,

boards have broad discretion in awarding executive compensation, and Plaintiff fails to plead any facts showing the bonuses—and the Director Defendants’ attempt to gain a tax deduction for the Company—were devoid of a legitimate corporate purpose. See In re Accuray, Inc. S’holder Derivative Litig., 757 F. Supp. 2d 919, 935 (N.D. Cal. 2010).


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v. Barrows, 924 A.2d 908, 943 (Del. Ch. 2007) (“Delaware law does not permit the wholesale

imputation of one director’s knowledge to every other for demand excusal purposes. Rather, a

derivative complaint must plead facts specific to each director . . . .”); see also Towers, 2017 WL

6044035, at *7. As a result, Plaintiff fails to establish that at least six of Netflix’s 11 directors

face a substantial likelihood of liability for violating federal tax laws such that demand is futile.

2. No substantial likelihood of liability for knowing dissemination of false information to stockholders

The Complaint also pleads no facts demonstrating that a majority of the Board faces a

substantial likelihood of liability for violating securities laws or its state law fiduciary duty of

disclosure. Plaintiff repeatedly makes the conclusory allegation that the Proxies were false and

misleading because they stated that the bonuses paid pursuant to the Plan were “performance-

based” under Section 162(m) while “the Individual Defendants . . . knew the Company was

substantially certain to achieve” the performance goals. E.g., Compl. ¶¶ 66, 78. However, the

Proxies at issue do not state that the Plan was guaranteed to comply with Section 162(m).

Rather, the Proxies explain that the Plan was created “[i]n order to comply with [Section]

162(m)” (Compl. ¶ 64 (quoting 2015 Proxy)), “[wa]s intended to permit the Company to seek a

full federal tax deduction for compensation paid under the Plan” (Compl. ¶¶ 69 (quoting 2016

Proxy); id. ¶ 75 (quoting 2017 Proxy)), and that the bonuses paid under the Plan “[we]re

intended to qualify as performance-based” under Section 162(m) (Compl. ¶¶ 71 (quoting 2016

Proxy); id. ¶ 77 (quoting 2017 Proxy)) (emphases added). Courts have held that similar

language of a compensation plan’s objectives is not a representation that a plan complies with

the applicable tax laws. See In re Caterpillar Inc. Derivative Litig., 2014 WL 2587479, at *14

(D. Del. June 10, 2014) (finding no demand futility where plaintiff alleged a proxy statement

represented that a plan complied with Section 162(m) when the proxy statement merely stated

awards “were intended to comply with Section 162(m), or that it was the Company’s objective

that such awards would be tax deductible, or that substantially all such compensation was

expected to be tax-deductible”); Seinfeld, 774 F. Supp. 2d at 666-67 (holding that a proxy

statement did not “say what [plaintiff] allege[d]” and did not contain false or misleading


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statements where the proxy statement explained the plan was “intended” to be deductible under

Section 162(m) but “did not represent that the [plan] was guaranteed to be tax deductible”).

The Complaint also lacks particularized allegations showing that any individual director

had knowledge that disclosures about the performance bonuses were (allegedly) false. E.g., Dow

Chem. Co., 2010 WL 66769, at *10 (explaining that determining whether directors had

knowledge of statement’s falsity or acted in bad faith “requires an analysis of the state of mind of

the individual director defendants” (citation omitted)). Even if the Complaint adequately alleged

a misstatement or omission, demand is not excused because Plaintiffs have not pled any

disclosure violations were made knowingly or in bad faith. E.g., In re Citigroup Inc. S’holder

Derivative Litig., 964 A.2d 106, 132-34 (Del. Ch. 2009) (explaining that to excuse demand on a

disclosure violation, plaintiff must show directors “deliberately misinform[ed] shareholders

about the business of the corporation” by alleging particularized facts that “the violation was

made knowingly or in bad faith” (some emphasis added) (citation omitted). As explained above,

the Complaint contains no particularized allegations showing that the Director Defendants knew

the bonuses awarded under the Plan were not tax deductible under Section 162(m). Thus, there

can be no reasonable inference drawn from the Complaint that the Director Defendants knew the

Proxies contained false or misleading statements regarding the tax deductibility of those bonuses

at the time the Proxies were filed, or that they deliberately misinformed stockholders.

The bare allegation that the Director Defendants “caused” or “ordered” the challenged

disclosures to be made is also insufficient. E.g., Compl. ¶¶ 42, 57, 62, 67, 73. Instead, Plaintiff

must allege each director’s involvement in making the challenged disclosures—which it fails to

do for any director, much less a six-member majority of the Board. See Citigroup, 964 A.2d at

133 n.88, 134 (finding allegation that directors “‘caused or allowed’ the Company to issue

certain statements” fails to show the directors prepared statements or were directly responsible

for the misstatements); Guttman, 823 A.2d at 498 (accord); see also Silicon Graphics, 183 F.3d

at 990 (holding demand not excused where there were no particularized facts alleged that board

approved fraudulent statements; a “general allegation that the Board participated” is insufficient

to allege “substantial risk of personal liability”); Accuray, 757 F. Supp. 2d at 927-28 (accord).


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Plaintiff therefore comes nowhere close to meeting its burden under Rule 23.1 with regard to the

Proxies. See N.J. Bldg. Laborers Pension Fund v. Ball, 2014 WL 1018210, at *6 (D. Del. Mar.

13, 2014) (holding disclosure claims failed to satisfy demand requirement where “[n]othing in

[the] complaint suggest[ed] that the Director Defendants were aware of the alleged

misstatements or omissions, intended to cause harm to [the company] by incurring unnecessary

tax liabilities, or acted in bad faith by not adequately informing themselves”).

3. Committee membership alone does not establish knowledge In lieu of particularized facts showing that any of the Director Defendants acted in bad

faith, Plaintiff cites to Messrs. Battle, Haley and Hoag’s membership on the Compensation

Committee as evidence of having “caused Netflix to misrepresent the[ ] bonuses as ‘performance

based’ under Section 162(m).” Compl. ¶ 113. If that allegation was sufficient to excuse demand

for the Compensation Committee members, it would implicate just three out of 11 Board

members, leaving eight other directors who could consider a demand. But it is not sufficient.

The fact that the Compensation Committee was charged with setting performance goals

and awarding bonuses under the Plan does not create a substantial likelihood of liability for those

directors “without supporting allegations of particularized facts showing bad faith.” In re China

Auto. Sys. Inc. Derivative Litig., 2013 WL 4672059, at *8 (Del. Ch. Aug. 30, 2013) (finding that

conclusory allegations based on committee membership “d[id] not give rise to a substantial

threat of personal liability”); see South v. Baker, 62 A.3d 1, 17 (Del. Ch. 2012) (“[T]hat the

underlying cause of a corporate trauma falls within the delegated authority of a board committee

does not support an inference that the directors on that committee knew of and consciously

disregarded the problem for purposes of Rule 23.1.”). Once again, there are no facts alleged

from which one can reasonably infer that the individual Compensation Committee members

knew the bonuses were not tax deductible (as Plaintiff alone alleges) such that they acted in bad

faith by awarding them. See Abrams v. Wainscott, 2012 WL 3614638, at *3 (D. Del. Aug. 21,

2012) (rejecting argument that compensation committee members faced a substantial likelihood

of liability for allegedly misleading disclosures that compensation was deductible under Section

162(m) because no facts pled that violation was knowing and intentional); In re Linear Tech.


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Corp. Derivative Litig., 2006 WL 3533024, at *2-3 (N.D. Cal. Dec. 7, 2006) (holding demand

not excused on allegations of backdating, and rejecting argument that compensation committee

members “face a substantial likelihood of liability for their having approved the stock options” in

the absence of particularized facts about each individual director’s role and knowledge).

4. No substantial likelihood of liability for allegedly violating internal governance policies or failure to implement internal controls

Finally, Plaintiff’s conclusory allegation that the Director Defendants somehow violated

“the Company’s own internal governance controls” by seeking a tax deduction does not excuse

demand under Rule 23.1. Delaware law provides that allegations of violations of a company’s

internal Code of Ethics or other internal governance policy do not expose directors to a

substantial likelihood of personal liability. See Accuray, 757 F. Supp. 2d at 929 (“[I]t is

important to note that ‘liability is not measured by the aspirational standards established by . . .

internal documents . . . .’” (quoting Citigroup, 964 A.2d at 135)); see also Wilkin, 2018 WL

1100372, at *10-11 (stating that “failure to follow best practices does not create a substantial

likelihood of liability” and does not suffice to establish a breach of fiduciary duty). Plaintiff’s

acknowledgement that Netflix has internal governance policies in place also belies Plaintiff’s

conclusory allegation that the “Director Defendants face a substantial likelihood of liability to

Netflix for failing to correct and/or implement the necessary internal controls.” Compl. ¶ 9; see,

e.g., Horman v. Abney, 2017 WL 242571, at *8 (Del. Ch. Jan. 19, 2017).

* * *

Thus, Plaintiff fails to plead sufficient facts that at least six of the 11 Board members—

ten of whom are independent, eight of whom were not on the Compensation Committee that

awarded the performance bonuses, and two of whom are not defendants—could not impartially

consider a demand. The Complaint should therefore be dismissed pursuant to Rule 23.1.

II. THE COMPLAINT SHOULD BE DISMISSED UNDER RULE 12(B)(6) FOR FAILURE TO STATE A CLAIM

Even if demand was excused, the Individual Defendants contend that the Complaint

should be dismissed for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6).


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To state a claim, a complaint “must contain sufficient factual matter, accepted as true, to ‘state a

claim to relief that is plausible on its face.’” Bush v. Vaco Tech. Serv., LLC, 2018 WL 2047807,

at *4 (N.D. Cal. May 2, 2018) (quoting Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)). “Where a

complaint pleads facts . . . ‘merely consistent with’ a defendant’s liability, it ‘stops short of the

line between possibility and plausibility,’” Ashcroft, 556 U.S. at 678 (quoting Bell Atl. Corp. v.

Twombly, 550 U.S. 544, 557 (2007)), and dismissal is appropriate.

Each of Plaintiff’s claims fail. First, Plaintiff’s Section 14(a) claim fails to sufficiently

allege any misstatement, injury, causation, or negligence. Second, Plaintiff has failed to allege

facts to support its breach of fiduciary duty claim against the Individual Defendants. Third,

Plaintiff makes no allegations that satisfy the high standard for a waste claim.

A. Plaintiff Fails to State a Claim Under Section 14(a) of the Exchange Act. To state a claim under Section 14(a), a plaintiff must establish that “(1) a proxy statement

contained a material misrepresentation or omission which (2) caused . . . injury and (3) that the

proxy solicitation itself, rather than the particular defect in the solicitation materials, was an

essential link in the accomplishment of the transaction.” N.Y. City Emps.’ Ret. Sys. v. Jobs, 593

F.3d 1018, 1022 (9th Cir. 2010), overruled in part on other grounds by Lacey v. Maricopa Cnty.,

693 F.3d 896, 925 (9th Cir. 2012); see also Desaigoudar v. Meyercord, 223 F.3d 1020, 1022 (9th

Cir. 2000) (stating a plaintiff must also “demonstrate that the misstatement or omission was

made with the requisite level of culpability”). The Complaint must set forth a causal connection

between the material misrepresentation and an economic loss. See generally Dura Pharms., Inc.

v. Broudo, 544 U.S. 336, 347 (2005) (“[A]llowing a plaintiff to forgo giving any indication of

the economic loss and proximate cause that the plaintiff has in mind would bring about the harm

of the very sort the statutes seek to avoid.”). Plaintiff’s Section 14(a) claim fails because it does

not allege a misrepresentation or omission resulting from negligent conduct that caused an injury

to Netflix.

1. No misstatements in the Proxies Plaintiff alleges that the Director Defendants and Mr. Wells made material misstatements

in the Proxies regarding the tax deductibility under Section 162(m) of bonuses awarded to the


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Officer Defendants under the Plan. Compl. ¶¶ 62-78. This allegation rests on Plaintiff’s own

interpretation of Section 162(m) that bonuses awarded based on a performance goal a company

allegedly had reason to believe it could attain are not deductible. If Plaintiff’s interpretation is

wrong, the bonuses paid under the Plan are deductible under Section 162(m) and Netflix made

no misstatement regarding their deductibility in the Proxies. As discussed above, the plain

language of the relevant Treasury regulations shows that is incorrect—compensation can qualify

as performance-based where the company believes the goal is within reach. See supra at 13.

Even if there was validity to Plaintiff’s reading of Section 162(m) and the relevant

Treasury regulations, none of the challenged disclosures is false—Netflix never represented that

the bonuses paid under the Plan were guaranteed to be deductible. The allegedly misleading

disclosures are: (1) that the Plan was created “[i]n order to comply with 162(m)” and that the

Officer Defendants “may receive compensation” under the Plan (Compl. ¶¶ 64-65 (quoting 2015

Proxy)); and (2) that the “Plan [wa]s intended to permit the Company to seek a full federal tax

deduction for compensation paid under the Plan” and that the Company’s global streaming

revenue as “reflected in [its] publicly-available financial statements” was the goal selected for

bonuses which were “intended to qualify as performance-based.” Compl. ¶¶ 69-70 (quoting

2016 Proxy); id. ¶¶ 75-77 (quoting 2017 Proxy) (emphases added). Plaintiff therefore cannot

identify a misstatement—the Proxies do not “assert that the [Plan] w[ould] be tax-deductible,

only that it [wa]s intended to be deductible under IRC § 162(m).” Seinfeld, 774 F. Supp. 2d at

668 (dismissing Section 14(a) claim regarding deductibility of performance-based bonuses); see

also Caterpillar, 2014 WL 2587479, at *14 (finding no demand futility where plaintiff alleged a

proxy statement represented that the plan complied with Section 162(m) when it merely stated

the company’s intention that awards would be deductible); supra at 16.

2. No injury-causing transaction “Damages are recoverable under [Section] 14(a) ‘only when the votes for a specific

corporate transaction requiring shareholder authorization . . . are obtained by a false proxy

statement, and that transaction was the direct cause of pecuniary injury for which recovery is

sought.’” Verisign, 531 F. Supp. 2d at 1213 (citation omitted). That is, for the alleged


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misstatements in the Proxies to form the basis for a Section 14(a) violation, the Complaint must

“connect any proxy misstatements or omissions with an actual economic harm.” Krieger v.

Atheros Commc’ns, Inc., 2012 WL 1933559, at *7 (N.D. Cal. May 29, 2012) (citing Jobs, 593

F.3d at 1023). However, Plaintiff fails to demonstrate how the alleged misstatements in the

Proxies about the tax deductibility of bonuses caused Netflix to suffer an injury—monetary or

otherwise. See In re Asyst Techs., Inc. Derivative Litig., 2008 WL 2169021, at *8 (N.D. Cal.

May 23, 2008) (stating that a derivative Section 14(a) claim requires pleading of facts “that a

defendant made a material misstatement in a proxy statement which caused the Company injury”

and that the proxy solicitation was the “transactional cause of harm of which plaintiff

complains”). Even if Plaintiff was correct that the bonuses were improperly deducted under

Section 162(m), the Complaint does not allege that Netflix was harmed—nor could it. The

Director Defendants were permitted to grant compensation that is not tax-deductible and “there

is no general fiduciary duty to minimize taxes.” Freedman, 2012 WL 1345638, at *12

(dismissing disclosure claims; explaining “deference to directors’ business judgment is

particularly broad in matters of executive compensation” (citation omitted)).

3. No culpable conduct Finally, the Complaint lacks allegations giving rise to a strong inference that any Director

Defendant or Mr. Wells acted with negligence—“[t]he required state of mind for a § 14(a)

claim.” Verisign, 531 F. Supp. 2d at 1213; see Asyst, 2008 WL 2169021, at *8. A Section 14(a)

plaintiff “must demonstrate that the misstatement” was “made with the requisite level of

culpability.” Desaigoudar, 223 F.3d at 1022. Plaintiff’s failure to “plead the required state of

mind with particularity as to each defendant” requires dismissal of its Section 14(a) claim.

Verisign, 531 F. Supp. 2d at 1206-07 (dismissing Section 14(a) claim where plaintiffs pleaded no

“particularized facts giving rise to a strong inference that [each] defendant acted with the

required state of mind” (citation omitted)).

B. Plaintiff Fails to State a Breach of Fiduciary Duty Claim Under Delaware Law.

1. No duty of loyalty claim pleaded against the Director Defendants The exculpatory provision in Netflix’s certificate of incorporation bars Plaintiff from


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pursuing any claims against the Director Defendants for non-intentional breaches of fiduciary

duty, pursuant to Section 102(b)(7) of the Delaware General Corporation Law. See Strickland

Decl. Ex. A, art. VIII. “[T]o the extent that the complaint alleges any negligent breach of

fiduciary duty, such a claim is precluded by the exculpatory clause”; allegations that the Director

Defendants engaged in intentional misconduct or bad faith are therefore required. Sagent, 278 F.

Supp. 2d at 1095 n.9; see also Brown v. Moll, 2010 WL 2898324, at *5 (N.D. Cal. July 21, 2010)

(finding no well-pleaded allegations sufficient to defeat protection under exculpatory provision);

Citigroup, 964 A.2d at 125 (stating that Section 102(b)(7) “place[s] an extremely high burden on

a plaintiff to state a claim for personal director liability”). As shown above, there is not a single

fact alleged that any of the Director Defendants knew that the bonuses awarded pursuant to the

Plan were not deductible under Section 162(m) but nonetheless intentionally issued misleading

disclosures about those bonuses. See supra at 16-18. Plaintiff therefore has failed to plausibly

plead that the alleged disclosure violations were “made with knowledge of alleged inaccuracies

or in bad faith,” as Plaintiff was required to do to plead a non-exculpated breach of fiduciary

duty claim. Accuray, 757 F. Supp. 2d at 934 (dismissing breach of fiduciary duty claim where

plaintiff failed to allege disclosures made with knowledge of falsity or in bad faith).

2. No gross negligence pleaded against the Officer Defendants or Mr. Wells

Regarding the Officer Defendants and Mr. Wells, the Complaint makes no allegations

whatsoever that could support a breach of fiduciary duty claim against them. To state a claim,

Plaintiff must plead gross negligence, which “requires the articulation of facts [of] a wide

disparity between the process . . . used . . . and that which would have been rational.” Guttman,

823 A.2d at 507 n.39. This is a “stringent” standard “not readily satisfied,” Accuray, 757 F.

Supp. 2d at 934, and “imports the concept of recklessness,” In re Lear Corp. S’holder Litig., 967

A.2d 640, 652 & n.45 (Del. Ch. 2008). Plaintiffs do not meet this “stringent” standard.

The only allegation regarding Messrs. Hunt, Sarandos, Peters, and Hyman is that they

received bonuses under the Plan from the Compensation Committee. Compl. ¶¶ 7, 30-32. This

allegation does not plausibly suggest that the Officer Defendants acted with reckless indifference


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to Netflix’s stockholders or acted “without the bounds of reason.” Accuray, 757 F. Supp. 2d at

934 (quoting In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 750 (Del. Ch. 2005), aff’d,

906 A.2d 27 (Del. 2006)) (dismissing claims against officers where gross negligence not pled).

It is unclear why Messrs. Hunt, Sarandos, Peters and Hyman are named as defendants in the first

place, as Plaintiff does not seek any relief from them. See Compl. at 32-33.

As to Mr. Wells, the Company’s Chief Financial Officer, Plaintiff makes a bare

allegation that Mr. Wells “knew, or should have known, that the Company’s public statements

concerning its executive compensation concealed the fact that the Company’s performance-based

bonus plan did not comply with Section 162(m),” and that Mr. Wells “caused Netflix to

disseminate false and misleading Proxy Statements.” Compl. ¶ 18. The Complaint does not

suggest why Mr. Wells would have been motivated to “conceal” information from stockholders,

how he “knew” that the bonuses were not deductible, or what involvement he had in awarding

the bonuses or preparing the challenged disclosures in the Proxies that would suggest deliberate

or reckless conduct. See Accuray, 757 F. Supp. 2d at 934-35 (dismissing breach of fiduciary

duty claim against CEO and CFO where plaintiffs did not allege they “deliberately disregarded

or were recklessly indifferent”). Plaintiffs therefore also do not state a breach of fiduciary duty

claim against Mr. Wells.

C. Plaintiff Fails to State a Corporate Waste Claim under Delaware Law. Finally, Plaintiff’s waste claim is without merit. Under Delaware law, [t]he standard for

a waste claim is high and the test is ‘extreme [and] very rarely satisfied by a shareholder

plaintiff.’” In re 3Com Corp. S’holders Litig., 1999 WL 1009210, at *4 (Del. Ch. Oct. 25, 1999)

(citation omitted). Plaintiff claims that the Director Defendants and Mr. Wells “caused Netflix to

waste valuable corporate assets” by awarding bonuses to the Officer Defendants based on

“achievement of performance goals that were substantially certain to be reached, disqualifying

them as ‘performance-based’ bonuses under Section 162(m).” Compl. ¶ 129. But the Complaint

contains no allegations indicating that the Director Defendants’ awarding of bonuses under the

Plan, with the goal of achieving a tax deduction for the Company, was irrational, or “an

exchange of corporate assets for consideration so disproportionally small as to lie beyond the


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range at which any reasonable person might be willing to trade.” Lewis v. Vogelstein, 699 A.2d

327, 336 (Del. Ch. 1997). Nor does Plaintiff make any allegations against Mr. Wells that would

suggest his involvement in the award of bonuses under the Plan.

Plaintiff also appears, at times, to quibble with the size of the performance bonuses that

were awarded or the form of that compensation. See Compl. ¶ 40 (discussing payment of “more

than $27 million in unnecessary cash payments”); id. ¶ 127 (stating Director Defendants “pa[id]

excessive fees to certain executive officers”). To the extent that Plaintiff is arguing the size of

the bonuses constitutes waste, Delaware law provides that directors’ determination of how to

compensate employees “is protected by the presumption of the business judgment rule in the

absence of a showing that the business judgment rule does not apply because of a disabling

factor.” Haber v. Bell, 465 A.2d 353, 359 (Del. Ch. 1983); see also Freedman, 753 F.3d at 428

(declining to second-guess compensation committee’s exercise of business judgment in awarding

compensation because “a board’s decision on executive compensation is entitled to great

deference” and “the size and structure of executive compensation are inherently matters of

judgment” (quoting Brehm, 746 A.2d at 263)). Plaintiff does not allege that any of the bonuses

paid under the Plan was awarded made in bad faith, as is required. See Dow Chem. Co., 2010

WL 66769, at *6 (rejecting allegation that board caused excessive and wasteful compensation to

be made where there were “no particularized allegations in the complaint”).

CONCLUSION

The Individual Defendants and Netflix respectfully submit that the Complaint should be

dismissed pursuant to Rule 23.1, and the Individual Defendants respectfully submit that the

Complaint should also be dismissed pursuant to Rule 12(b)(6).

Dated: June 8, 2018 WILSON SONSINI GOODRICH & ROSATI Professional Corporation By: s/ Keith E. Eggleton

Keith E. Eggleton Attorneys for Defendants and Nominal Defendant


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deadline · 2018-06-11 · ted sarandos, greg peters, david hyman and nominal defendant netflix,...

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