Sarnacki v. Golden, et al

Filing

OPINION issued by Sandra L. Lynch, Chief Appellate Judge; Norman H. Stahl, Appellate Judge and William J. Kayatta , Jr., Appellate Judge. [14-1414]

Case: 14-1414

Document: 00116795191

Page: 1

Date Filed: 02/04/2015

Entry ID: 5884352

United States Court of Appeals
For the First Circuit
No. 14-1414
AARON SARNACKI,
derivatively on behalf of Smith & Wesson Holding Corporation,
Plaintiff, Appellant,
v.
MICHAEL F. GOLDEN; JOHN A. KELLY; BARRY M. MONHEIT; KENNETH W.
CHANDLER; JOHN B. FURMAN; I. MARIE WADECKI; JEFFREY D. BUCHANAN;
ROBERT L. SCOTT; MITCHELL A. SALTZ; COLTON R. MELBY; ANN B.
MAKKIYA; LELAND A. NICHOLS; THOMAS L. TAYLOR; SMITH & WESSON
HOLDING CORPORATION,
Defendants, Appellees.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Michael A. Ponsor, U.S. District Judge]

Before
Lynch, Chief Judge,
Stahl and Kayatta, Circuit Judges.

Julia M. Williams, with whom Craig W. Smith, Robbins Arroyo
LLP, Terence K. Ankner, and Partridge, Ankner & Horstmann, LLP were
on brief, for appellant.
John A. Sten, with whom Jason C. Moreau, Victoria E.
Thavaseelan, and McDermott Will & Emery LLP were on brief, for
appellees.

February 4, 2015

Case: 14-1414

Document: 00116795191

Page: 2

LYNCH, Chief Judge.

Date Filed: 02/04/2015

Entry ID: 5884352

This is a shareholder derivative

suit under state law which, after investigation by a Special
Litigation Committee, the corporation rejected.

It is one of

several suits alleging that Smith & Wesson Holding Corporation
("Smith & Wesson") made misleading public statements in 2007 about
demand for its products. We previously affirmed a grant of summary
judgment for the corporation in a class action alleging that these
statements constituted violations of federal securities laws.

In

re Smith & Wesson Holding Corp. Sec. Litig., 669 F.3d 68 (1st Cir.
2012).
In this case, Aaron Sarnacki asserts Nevada state-law
claims against Smith & Wesson's officers and directors, including
breach of fiduciary duties, waste of corporate assets, and unjust
enrichment.

In reaction to earlier and parallel cases, in June

2009, Smith & Wesson's Board formed a Special Litigation Committee
(SLC) to investigate and determine the viability of any of these
claims and to make a recommendation to the Board whether to pursue
any of these claims.
claims.

The SLC recommended against filing any

On the basis of that decision, the defendants here moved

for summary dismissal under Delaware law, as adopted by Nevada.
After limited discovery, the district court granted the motion. We
affirm.

-2-

Case: 14-1414

Document: 00116795191

Page: 3

Date Filed: 02/04/2015

Entry ID: 5884352

I.
Smith & Wesson is a major gun manufacturer incorporated
in Nevada with its principal place of business in Springfield,
Massachusetts. The defendants are or were officers or directors of
Smith & Wesson, including both its CEO and former CFO. Sarnacki is
a shareholder of Smith & Wesson who is a citizen of Maine.
Sarnacki's suit alleged that, starting in the second
quarter of 2007, the defendants made or caused the company to make
a series of public statements, including press releases, touting
high sales projections due to the company's new rifle and shotgun
business.

For example, on September 6, 2007, the company issued a

press release raising sales projections for fiscal year 20081 based
on "growth in [their] core handgun business as well as [their]
newly established long gun business."2 Through September 10, 2007,
the company continued to predict strong sales growth and raised
earnings guidance in press releases, on conferences calls, and in
federal filings.
Sarnacki alleged that all this time, Smith & Wesson and
the defendants had evidence that these projections were false.
Smith

&

Wesson

had

overinvested

in

production

while

demand

1

Smith & Wesson's fiscal year begins on May 1, so FY 2008
began May 1, 2007. See In re Smith & Wesson Holding Corp. Sec.
Litig., 669 F.3d at 70 n.2.
2

The higher earnings projections were based in part on Smith
& Wesson's entrance into the market for long guns, complementing
their core business selling handguns.
-3-

Case: 14-1414

Document: 00116795191

Page: 4

Date Filed: 02/04/2015

Entry ID: 5884352

collapsed at the start of the economic downturn, leading to
excessive inventory.

Although aware of this, the defendants

continued to tout high projected sales, and some of the defendants
sold millions of their shares.
The

defendants

finally

corrected

their

alleged

misrepresentations. On October 29, 2007, the company reduced its
net income guidance by ten cents per diluted share, causing a 40%
drop in share price.

In that new guidance, the defendants pointed

in part to soft demand for long guns and excessive inventory.

On

December 6, 2007, the company again reduced guidance by thirteen
cents per diluted share, and on January 22, 2008, the company
withdrew their earnings guidance completely. In total, the company
lost $726 million in market capitalization.
As is often the case in these situations, a number of
securities fraud cases were brought against the company.

In

December 2007 and January 2008, three putative class actions were
filed in federal district court in Springfield against the company
and three individuals, alleging violations of federal securities
laws.

See In re Smith & Wesson Holding Corp. Sec. Litig., 604 F.

Supp.

2d

332,

334-35

(D.

Mass.

2009).

Those

actions

consolidated into one case, the "Securities Class Action."

were

Id. at

334 n.1. The district court eventually granted summary judgment to
the

defendants

on

March

25,

2011,

finding

that

there

was

insufficient evidence of scienter and that the company's statements

-4-

Case: 14-1414

Document: 00116795191

Page: 5

Date Filed: 02/04/2015

were neither false nor misleading.

Entry ID: 5884352

In re Smith & Wesson Holding

Corp. Sec. Litig., 836 F. Supp. 2d 1, 3 (D. Mass. 2011).
court affirmed.

This

In re Smith & Wesson Holding Corp. Sec. Litig.,

669 F.3d at 77.
On

February

1,

2008,

Sarnacki

filed

derivative suit in Massachusetts state court.

a

shareholder

That case was

consolidated with other similar cases and dismissed in January 2009
because the plaintiffs failed to make a proper pre-suit demand on
the Board of Directors.

See Sarnacki ex rel. Smith & Wesson

Holding Corp. v. Golden, 4 F. Supp. 3d 317, 320-21 (D. Mass. 2014)
(explaining procedural history and previous litigation).
Having received two other demand letters, Smith & Wesson
formed a Special Litigation Committee on June 22, 2009, to evaluate
the viability of claims in the demand letters.

See In re Smith &

Wesson Holding Corp. Derivative Litig., 743 F. Supp. 2d. 14, 17 (D.
Mass. 2010).

The SLC consisted of three directors: John Furman,

Robert Scott, and I. Marie Wadecki. Two of those directors, Furman
and Wadecki, were also outside directors and members of the Audit
Committee during the relevant times.

The SLC hired an independent

law firm, then known as Fierst, Pucci & Kane LLP of Northampton,
Massachusetts, and conducted the investigation at issue in this
case.
On September 4, 2009, Sarnacki sent a demand to Smith &
Wesson's

Board,

insisting

that

-5-

it

commence

an

independent

Case: 14-1414

Document: 00116795191

Page: 6

Date Filed: 02/04/2015

Entry ID: 5884352

investigation and recover damages caused by the officers' and
directors' breaches of fiduciary duties. Corporate counsel for the
Board responded to Sarnacki, notifying him of the SLC and demanding
information proving Sarnacki's ownership of shares during the
relevant

times.

The

SLC's

counsel

also

contacted

Sarnacki,

requesting similar information.
On October 28, 2010, Sarnacki filed this diversity action
in federal district court in Arizona.3

The claims arise under

Nevada state law for breach of fiduciary duty, waste of corporate
assets, unjust enrichment, and entitlement to contribution or
indemnification.
The

Sarnacki, 4 F. Supp. 3d at 321.

SLC

issued

its

report

on

December

23,

2010,

concluding that "there is insufficient evidence of any breach of
fiduciary duty by the named officers and directors" and that it is
"not . . . in the best interests of the Company" to pursue a
derivative suit. On January 13, 2011, this case was transferred to
the District of Massachusetts with the consent of both parties. On
July 1, 2011, the defendants filed a motion to dismiss, based on
the SLC's final report.

The district court denied the motion

without prejudice on March 29, 2012, and ordered limited discovery
on the adequacy of the SLC's investigation.

3

Sarnacki v. Golden,

Sarnacki insists that he filed on this date to ensure a
shareholder suit satisfied the pertinent statute of limitations,
though the SLC (allegedly unbeknownst to Sarnacki) obtained tolling
agreements.
-6-

Case: 14-1414

Document: 00116795191

Page: 7

Date Filed: 02/04/2015

Entry ID: 5884352

No. 11-cv-30009-MAP, 2012 WL 1085539, at *2 (D. Mass. Mar. 29,
2012).
After

discovery,

the

defendants

moved

for

summary

dismissal on June 28, 2013, again on the basis of the SLC's
conclusions.

Under

Delaware

law,

a

motion

to

terminate

a

derivative suit because an SLC has recommended against filing any
claims is handled by summary dismissal, a "hybrid summary judgment
motion for dismissal."
787 (Del. 1981).
12, 2014.

Zapata Corp. v. Maldonado, 430 A.2d 779,

The district court granted that motion on March

Sarnacki, 4 F. Supp. 3d at 327.

This appeal followed.

II.
The parties agree that Delaware law, by operation of
Nevada law, applies to this case.

Sarnacki, 4 F. Supp. 3d at

322;

Sarnacki, 2012 WL 1085539, at *2; see Moradi v. Adelson, No. 2:11cv-00490-MMD-RJJ, 2012 WL 3687576, at *2 n.1 (D. Nev. Aug. 27,
2012); In re Amerco Derivative Litig., 252 P.3d 681, 697 (Nev.
2011).

Under Delaware law, if the corporation moves for summary

dismissal of a shareholder suit on the basis of the SLC's judgment,
a court conducts a two-step inquiry.

First, the corporation must

prove the SLC's (1) independence, and (2) good faith and reasonable
bases for its conclusions.4

Zapata, 430 A.2d at 788-89.

4

On these

We analyze the SLC's good faith and reasonableness together,
though Delaware's courts sometimes analyze them separately.
Compare Kahn v. Kolberg Kravis Roberts & Co., 23 A.3d 831, 841-42
-7-

Case: 14-1414

Document: 00116795191

Page: 8

Date Filed: 02/04/2015

Entry ID: 5884352

questions, the burden is on the corporation to show "that there is
no genuine issue as to any material fact and that the moving party
is entitled to dismiss as a matter of law."

Id. at 788.

Second,

in the court's discretion, the court may apply "its own independent
business judgment" to "thwart instances where corporate actions
meet the criteria of step one, but the result does not appear to
satisfy its spirit."

Id. at 789.

The district court here decided

the case at the first step, and Sarnacki does not argue that it
should have conducted the step-two inquiry.
This court has never addressed the standard of review for
a summary dismissal at Zapata step one.

We now hold that the

applicable standard of review is de novo, because a summary
dismissal under Delaware law is a hybrid of a motion to dismiss and
a motion for summary judgment, both of which we review de novo.
See Booth Family Trust v. Jeffries, 640 F.3d 134, 139-41 (6th Cir.
2011). Although the standard of review is a matter of federal law,
see Booth, 640 F.3d at 140 ("[C]onsistent with the Erie doctrine,
federal law governs the standard of review of a summary judgment
motion in a diversity case."), our holding is consistent with
Delaware state law, see Kahn v. Kolberg Kravis Roberts & Co., 23
A.3d 831, 840-41 (Del. 2011) ("Zapata's first prong is subject to
a summary judgment standard, our review of which is de novo.").

(Del. 2011) (together), with Kindt v. Lund, No. Civ. A. 17751-NC,
2003 WL 21453879, at *3-4 (Del. Ch. May 30, 2003) (separately).
-8-

Case: 14-1414

Document: 00116795191

Page: 9

Date Filed: 02/04/2015

Entry ID: 5884352

Accordingly, we consider de novo whether the district
court erred in finding as a matter of law that (a) the SLC was
independent, and (b) the SLC's investigation was reasonable and
conducted in good faith.
A.

Independence
The independence inquiry is highly fact specific and

centers on whether any member of the SLC, "for any substantial
reason, [is] incapable of making a decision with only the best
interests

of

the

corporation

in

mind."

In

re

Oracle

Corp.

Derivative Litig., 824 A.2d 917, 938 (Del. Ch. 2003) (citation and
quotation marks omitted).
Sarnacki's main challenge to the SLC's independence is
that two of the three SLC members, Wadecki and Furman, could not be
independent for two reasons. The first is that they are defendants
in this case.
Committee,

The second reason is that, as members of the Audit

they

reviewed

and

approved

many

of

the

allegedly

misleading statements. In particular, Sarnacki's complaint alleged
that the Audit Committtee approved financial statements, press
releases, and "financial information and earnings guidance provided
to analysts and rating agencies," though the record does not show
that they approved scripts for earnings conference calls.
There

are

no

per

se

rules

holding

that

an

SLC's

independence is destroyed by either naming a member as a defendant
or a members' past approval of a disputed statement. See Kaplan v.

-9-

Case: 14-1414

Document: 00116795191

Page: 10

Date Filed: 02/04/2015

Entry ID: 5884352

Wyatt, 499 A.2d 1184, 1189 (Del. 1985) ("Even a director's approval
of the transaction in question does not establish a lack of
independence."); Kindt v. Lund, No. Civ. A. 17751-NC, 2003 WL
21453879, at *3 (Del. Ch. May 30, 2003) ("The fact that Senator
Garn was on the board and approved the transactions does not negate
his independence.

Nor does his being named as a defendant cause

Senator Garn to lack independence." (footnotes omitted)).
the inquiry is more closely based on the facts.

Rather,

Sarnacki must

"show more" to suggest that an SLC member's "position as a member
of the Board of Directors influenced his decisions as a member of
the [SLC]."

Kaplan, 499 A.2d at 1189.

There are good reasons to reject such per se rules.
an

SLC

member's

categorically

status

subverted

as
the

a

defendant

independence

in
of

the

the

If

litigation

committee,

a

shareholder would be able to manipulate the process: he or she
would

be

able

to

name

SLC

members

as

defendants

after

the

committee's formation, thereby undercutting the legitimacy of its
conclusions. See Lewis v. Graves, 701 F.2d 245, 249 (2d Cir. 1983)
(calling, in the context of the demand requirement, such a move a
"transparent litigation tactic").

The realities of corporate

governance, in which some corporations have small boards, suggest
that an SLC will frequently include at least one director who also
approved the relevant transaction.

-10-

Cf. id. at 248 ("By virtue of

Case: 14-1414

Document: 00116795191

Page: 11

Date Filed: 02/04/2015

Entry ID: 5884352

their offices, directors ordinarily participate in the decision
making involved in such transactions.").
These realities of corporate governance play a role here.
The SLC was formed on June 22, 2009.

At that time, Smith & Wesson

had an eight-person Board including a three-person Audit Committee.
Though the three SLC members were named as alleged wrongdoers along
with the rest of the Board, neither the Securities Class Action nor
the other demand letters specified any wrongdoing by the Audit
Committee.

In creating a three-person SLC, then, the Board could

reasonably have selected members of the Audit Committee without any
attempt to undermine the SLC's independence, screening only for
expertise and ensuring that the SLC had at least two outside
directors.

It was only months after the SLC's formation that

Sarnacki sent his demand, on September 4, 2009, to the Board
specifying misconduct by the Audit Committee.

By that point, the

SLC had met, hired counsel, and begun communicating with plaintiffs
in other derivative actions. It was not unreasonable for the Board
to decline to abandon the SLC, which had already started its work,
and to reconstitute a new one.
To say there is no per se rule does not mean that there
is no cause for concern.

Those who are asked to evaluate conduct

which they have approved may have a tendency not to find fault.
But the Delaware Supreme Court has held that "a director is
independent when he is in a position to base his decision on the

-11-

Case: 14-1414

Document: 00116795191

Page: 12

Date Filed: 02/04/2015

Entry ID: 5884352

merits of the issue rather than being governed by extraneous
considerations or influences." Kaplan, 499 A.2d at 1189; see also,
e.g., Sutherland v. Sutherland, No. C.A. 2399-VCL, 2008 WL 1932374,
at *3 (Del. Ch. May 5, 2008).
actual

bias

affecting

any

Sarnacki offers no evidence of
decisionmaker

or

of

extraneous

considerations having motivated either the process or the ultimate
recommendation.

Moreover, the Committee did not use in-house

counsel, a disapproved practice, but chose independent counsel.
Sarnacki overstates the record when he argues there were
admissions of non-independence.

He argues that the SLC members

admitted prejudging the merits of the claims they were charged with
investigating.

But in the statements at issue, the SLC members

testified merely that they were doubtful of Sarnacki's derivative
claims

based

on

their

background

knowledge

and

the

Board's

preliminary investigations before the SLC was formed. They did not
draw any formal conclusions, and that they had some preliminary
views

is

not

surprising

and

prejudgment of the issue.

does

not

by

itself

constitute

In the case cited by Sarnacki, in

contrast to the record here, the SLC members "conducted the
investigation with the object of putting together a report that
demonstrates the suit has no merit." London v. Tyrrell, No. 3321CC, 2010 WL 877528, at *15 (Del. Ch. Mar. 11, 2010).
Sarnacki

also

argues

the

district

court

erred

by

considering each of his bias arguments separately, rather than as

-12-

Case: 14-1414

Document: 00116795191

a totality.

Page: 13

Date Filed: 02/04/2015

Entry ID: 5884352

Sarnacki complains that had the district court viewed

the structural bias, the evidence of prejudgment, and arguments on
the good faith and reasonableness prong together, it would have
seen a lack of independence by the SLC.

We do not read the

decision that way and on de novo review, considering these all
together, conclude there is no merit.
Sarnacki

finally

argues

that,

even

if

he

has

not

plausibly challenged the SLC's independence, that is not his
burden.

Rather, the defendants must prove the SLC's independence.

Sarnacki is right on the law.

See Zapata, 430 A.2d at 788.

the defendants have carried their burden.

But

Smith & Wesson's Board

appointed three experienced directors, two of whom were outside
directors on the independent Audit Committee, to the SLC.

They

were "in a position to base [their] decision on the merits of the
issue rather than being governed by extraneous considerations or
influences."

Kaplan 499 A. 2d at 1189.

And Sarnacki has offered

no plausible argument to the contrary.
We do not rely, as did the district court, on a theory
that Sarnacki "tacitly conceded the independence of the SLC by
making a demand on the board."

Sarnacki, 4 F. Supp. 3d at 325.

As

Sarnacki correctly observes, the court's analysis is incorrect.
The cases discussing this tacit concession focus on the effect of
the concession implicit in a demand on a plaintiff's later attempt
to argue that making a demand was excused.

-13-

See, e.g., Spiegel v.

Case: 14-1414

Document: 00116795191

Page: 14

Date Filed: 02/04/2015

Buntrock, 571 A.2d 767, 775-77 (Del. 1990).

Entry ID: 5884352

Delaware's cases do

not say that such a concession limits later arguments about an
SLC's independence. To the contrary, they say that a plaintiff can
make a demand and subsequently argue that the Board improperly
refused

the

independence.

demand,

including

by

challenging

the

SLC's

See, e.g., Grimes v. Donald, 673 A.2d 1207, 1219-20

(Del. 1996), overruled on other grounds by Brehm v. Eisner, 746
A.2d 244, 253 & n.13 (Del. 2000).
On the undisputed facts, the Board has met its burden as
to the independence of the SLC.
B.

Good Faith and Reasonableness
The good faith and reasonableness inquiry focuses on the

process used by the SLC, rather than the substantive outcome of the
process. See Spiegel, 571 A.2d at 778 ("The ultimate conclusion of
the [special litigation] committee . . . is not subject to judicial
review." (alterations in original)(quoting Zapata, 430 A.2d at 787)
(internal quotation marks omitted)). Courts look to indicia of the
SLC's investigatory thoroughness, such as what documents were
reviewed and which witnesses interviewed. See Sarnacki, 4 F. Supp.
3d at 325.
There is no question that the SLC relied on experienced
independent counsel, reviewed relevant discovery materials, and
released a lengthy final report, all indicia of a reasonable
process and good faith.

-14-

Case: 14-1414

Document: 00116795191

Sarnacki

first

Page: 15

argues

Date Filed: 02/04/2015

that

the

SLC

Entry ID: 5884352

abdicated

its

responsibilities, placing the entire investigation in its counsel's
hands.

This is in some tension with his suggestion that the SLC

members could have been out to protect themselves.

Second, he

argues that the SLC's work was tainted, because SLC independent
counsel

collaborated

closely

with

counsel

representing

the

defendants in the Securities Class Action.
Sarnacki
statements

from

again

the

SLC

overstates
members'

the

record.

depositions

that

He
they

takes
were

generally unaware of the scope of discovery to show that they were
so uninvolved as to abdicate their roles to independent counsel.
For example, SLC counsel obtained an extensive document production
from the Securities Class Action defendants' counsel, but SLC
members could not testify as to the details of how that production
was generated or how documents from that production were selected
for their personal review.
Reliance on experienced outside counsel for the SLC is
often taken as evidence that the SLC conducted its investigation
reasonably and in good faith, not the opposite. See, e.g., Grafman
v. Century Broad. Corp., 762 F. Supp. 215, 220 (N.D. Ill. 1991).
There is no adverse inference to be drawn about the members
delegating the discovery methodology or filtering decisions to
counsel.

The SLC members did personally review the relevant

documents and make the final decisions about the contents of the

-15-

Case: 14-1414

Document: 00116795191

SLC report.5

Page: 16

Date Filed: 02/04/2015

Entry ID: 5884352

The plaintiffs cite no case for the proposition that

relying on counsel for discovery decisions, without more, is
unreasonable or a sign of bad faith.

Cf. Peller v. The Southern

Co., 707 F. Supp. 525, 529 (N.D. Ga. 1988) (explaining that while
an SLC's "reliance on counsel is an accepted practice," insulating
the investigation from scrutiny by privileging the SLC's documents
is "not good faith"); Davidowitz v. Edelman, 583 N.Y.S.2d 340, 344
(N.Y. Sup. Ct. 1992) (finding an SLC's investigation unreasonable
because

"[t]he

committee

did

not

join

in

their

counsel's

investigation or review, save in the most perfunctory manner").
The errors in those cases did not happen here.
Sarnacki

argues

that

SLC

counsel

engaged

in

"heavy

reliance" on discovery by the defendants' counsel in the federal
Securities Class Action, and this should have been a "red-flag
warning" to the SLC that they needed to supervise SLC counsel more
closely.

Since they failed to do so, the argument goes, the SLC

effectively relied on conflicted counsel.
This argument contains a fatal flaw: there is no evidence
that SLC counsel was biased or conflicted, and the SLC's choice to

5

The defendants rely heavily on the SLC's final report to
rebut Sarnacki's claims. Sarnacki rejects this by observing that
the report was authored by SLC counsel, and so cannot show that the
SLC members themselves were adequately involved in the process. We
are doubtful that the claimed inconsistencies between the final SLC
report and the SLC members' deposition testimony undermine the
report in any serious way.
Nonetheless, we do not place heavy
emphasis on that report in reaching our conclusion.
-16-

Case: 14-1414

Document: 00116795191

Page: 17

Date Filed: 02/04/2015

Entry ID: 5884352

save costs and avoid duplication in discovery by using what had
already been produced in the securities action was eminently
sensible.

Cf. Kindt, 2003 WL 21453879, at *4 (finding an SLC's

conclusion reasonably supported even as the SLC saved costs by
foregoing a formal fairness opinion of a merger).

The discovery

from the class action case was plainly relevant to the SLC's
decision.

The cases Sarnacki cites, which involved a conflict by

the SLC's own counsel, have no bearing here.

E.g., Stepak v.

Addison, 20 F.3d 398, 406-08 (11th Cir. 1994).6
Having dealt with Sarnacki's second argument, we point
out that the differences between Sarnacki's claims and those of the
class action did not render use of that discovery unreasonable or
in bad faith.
Sarnacki next places heavy emphasis on the SLC's reliance
on two experts who were also used by the defendants in the

6

Sarnacki also emphasizes that the SLC members, in their
depositions, could not recall basic information about their task.
For example, Sarnacki emphasizes that the SLC members did not
remember the contents of Sarnacki's demand letter. Their lack of
memory, he argues, supports the view that the SLC members were so
uninvolved in the investigation that they abdicated their
responsibilities.
This argument is unsupported by the record. See Sarnacki, 4
F. Supp. 3d at 326. While the SLC members failed to recall answers
to many questions asked, substantial time passed between their
depositions in this case (in March and April 2013) and the SLC's
final report (in December 2010). Some details unknown to the SLC
members pertained to the discovery process, which the SLC delegated
to counsel. Finally, as Sarnacki explains in other parts of his
brief, the SLC members' answers of "Not that I recall" often meant
"No we did not," rather than "I do not remember."
-17-

Case: 14-1414

Document: 00116795191

Securities Class Action.

Page: 18

Date Filed: 02/04/2015

Entry ID: 5884352

The SLC retained Dr. Craig Moore, an

economic expert, to analyze financial data.

The SLC also retained

the DiNatale Detective Agency to investigate allegations made by
unnamed former employees.

As to Dr. Moore, the defendants note

that the SLC was aware of his potential conflict, reviewed the
deposition transcript from the class action in which Dr. Moore was
cross-examined,

and

reviewed

deposition

plaintiffs' experts from the class action.

transcripts

of

the

The SLC was perfectly

capable of evaluating the soundness of Dr. Moore's opinion in light
of his potential conflict.
As to DiNatale, the defendants argue that the agency only
provided "written reports of factual interviews," to which Sarnacki
replies that those reports were not passed along to the SLC
members.

If the DiNatale agency did not produce any information

actually used in the SLC's decision, it could not have caused the
SLC members to act in bad faith or unreasonably.

The SLC's use of

the defendants' experts is not always a best practice, but these
facts

do

not

raise

a

plausible

inference

of

bad

faith

or

unreasonableness under these circumstances.
Sarnacki's

last

challenge

is

that

the

SLC's

almost

exclusive7 reliance on the Securities Class Action materials was

7

The SLC's reliance on the Securities Class Action discovery
was not entirely exclusive. Near the end of the investigation, SLC
counsel interviewed seven defendants in the derivative actions
unnamed in the Securities Class Action. One SLC member described
them as a matter of "wrapping up," but the same member testified
-18-

Case: 14-1414

Document: 00116795191

necessarily incomplete.

Page: 19

Date Filed: 02/04/2015

Entry ID: 5884352

His complaint focuses on forward-looking

statements dismissed from the Securities Class Action and names
eleven individual defendants unnamed in the class action.

These

distinctions, he argues, show that relevant information was omitted
from the discovery the SLC used.
Insofar as the overlap in materials was extensive, it is
also not indicative of any unreasonableness.

Sarnacki does not

identify a "fact or line of investigation that Defendants missed."
Sarnacki, 4 F. Supp. 3d at 327.
Action

did

not

include

Though

discovery

about

the Securities Class
any

forward-looking

statements, it did include statements of present or historical
fact.

In re Smith & Wesson Holding Corp. Sec. Litig., 669 F.3d at

72. The discovery for these claims is significantly similar.
forward-looking

statements

at

issue

here

are

alleged

to

The
be

materially misleading because they projected growth based on high
future demand, while the statements of historical fact at issue in
the class action were alleged to be materially misleading because
they claimed strong existing demand -- both allegedly in conflict
with contemporary internal corporate data. See id. at 74-77.

The

basic narrative in the two cases is the same: Smith & Wesson and

that the class discovery had shown "nothing . . . to warrant
further going down further paths," especially in light of the
difficulty of proving fraud arising from forward-looking
statements.
Nonetheless, other than the SLC final report, the
record contains no evidence that the SLC members themselves read
transcripts or summaries of the interviews.
-19-

Case: 14-1414

Document: 00116795191

Page: 20

Date Filed: 02/04/2015

Entry ID: 5884352

its management inflated expectations about their sales of guns in
2007 and early 2008 based on assertions about high demand that were
false.
The distinctions Sarnacki emphasizes are ones without a
difference -- or at least, a difference that was not cured by the
SLC's additional interviews.

Sarnacki has not identified any key

factual predicates which might be discoverable but did not fall
within the class action discovery.
At bottom, there is inadequate evidence to permit a
reasonable

finder

of

fact

to

conclude

that

SLC

counsel

was

conflicted, that the SLC members read too few discovery materials,
or that the SLC's involvement was merely perfunctory.

On the

undisputed facts, the SLC's investigation was reasonable and in
good faith.
C.

Scope of Discovery Allowed to Sarnacki
Sarnacki concludes by arguing that, at minimum, the

district

court

should

have

granted

broader

discovery.

In

particular, Sarnacki wants access to the communications among the
SLC, their counsel, the defendants, and the defendants' counsel.
Sarnacki also asks for the minutes of the SLC meetings and the
retention agreements between the SLC and its advisors.

Since the

SLC did not police these relationships, Sarnacki argues, he is
entitled to evidence allowing him to probe them for bias.

-20-

Case: 14-1414

Document: 00116795191

Page: 21

Date Filed: 02/04/2015

To succeed, Sarnacki must overcome two hurdles.

Entry ID: 5884352

First,

we review the district court's decisions about the scope of
discovery for abuse of discretion, reversing only "upon a clear
showing [that] . . . the lower court's discovery order was plainly
wrong and resulted in substantial prejudice to the aggrieved
party."

United States ex rel. Duxbury v. Ortho Biotech Prods.,

L.P., 719 F.3d 31, 37 (1st Cir. 2013) (alterations in original)
(citations and internal quotation marks omitted).

Second, Zapata

itself contemplates only "[l]imited discovery . . . to facilitate"
the inquiry.

430 A.2d at 788.

This discovery is "intended more as

an aid to the Court than it is as a preparation tool for the
parties," and "is not afforded to the plaintiff as a matter of
right but only to such extent as the Court deems necessary."
Kaplan v. Wyatt, 484 A.2d 501, 510 (Del. Ch. 1984), aff'd 499 A.2d
1184 (Del. 1985).
Sarnacki cites a series of cases in which courts have
granted discovery of the type of documents he seeks.

E.g., Zitin

v. Turley, No. Civ. 89-2061-PHX-CAM, 1991 WL 283814, at *2-4 (D.
Ariz. June 20, 1991) (granting discovery of communications between
an SLC and its counsel).

Only one case suggests that plaintiffs

should receive that discovery as a matter of course. Grimes v. DSC
Commc'ns Corp., 724 A.2d 561, 567 (Del. Ch. 1998).

But even that

case does not suggest that, in the highly fact-intensive context of
a Zapata inquiry, a more limited discovery scope is an abuse of

-21-

Case: 14-1414

Document: 00116795191

Page: 22

Date Filed: 02/04/2015

Entry ID: 5884352

discretion.
In this case, the defendants provided the final SLC
report, all documents relied on by the SLC to produce that report,
Board minutes regarding the formation and appointment of the SLC,
and the SLC members for deposition.
321.

Sarnacki, 4 F. Supp. 3d at

Sarnacki did not file under Fed. R. Civ. P. 56(d) alleging

that it could not present facts in response to the motion for
summary dismissal essential to its opposition.

See Jones v.

Secord, 684 F.3d 1, 6 (1st Cir. 2012) (describing Rule 56(d) as a
"safety net for parties that need more time to gather facts
essential to resist a motion for summary judgment").

Considering

the specific discovery requests in Sarnacki's motions to compel
further discovery, the district court decided that they were
"overbroad, extending well beyond the intent of the court in
permitting

limited

discovery"

and

that

the

"substantial

disclosures" already provided were "sufficient to permit [Sarnacki]
to build an adequate record."
serious

challenge

to

the

Sarnacki has also failed to mount a
independence,

good

faith,

and

reasonableness of the SLC inquiry. The district court decided that
the discovery was adequate to aid its review, and that decision was
not an abuse of the court's discretion.

-22-

Case: 14-1414

Document: 00116795191

Page: 23

Date Filed: 02/04/2015

Entry ID: 5884352

III.
After a careful review of the record, we find that
Smith & Wesson satisfied the Zapata steps.
district court is affirmed.
So ordered.

-23-

The judgment of the