Then college sophomores Divya Narendra, Cameron Winklevoss, and Tyler Winklevoss first conceived of an idea for dating site organized as an online directory to connect students at Harvard and other universities in December 2002, and tentatively name it “Harvard Connection.” Lacking the programming expertise for this, they enlisted Sanjay Mavinkurve, then a senior, to write its code. When he left, the founders enlisted Victor Gao, then a junior. Gao left the team, and in November 2003, the founders enlisted defendant Mark Zuckerberg to complete the portion of the site devoted to student-alumni networking. The four worked over a period of three months, meeting a few times and exchanging a number of emails.

(Zuckerberg had caught the attention of Plaintiffs because in September 2003, he had created a site called “facemash,” a Harvard version of “am I hot-or-not.” It was met with intense criticism; he was accused of hacking into the university’s computer system to copy and incorporate dorm ID images, violated copyright, and personal data privacy of his fellow students, and placed on academic probation.)

The Plaintiffs told Zuckerberg what they were trying to accomplish, and Defendant agreed to finish their site. There was no formal contract, nor was pay discussed. Apparently Defendant put in about 10 hours of computer programming time. According to Defendant, the work was not clearly conveyed, and way more needed to be done than Plaintiffs thought. Defendant countered that he thought he was little more of an occasional contributor, and that he fell out of contact with Plaintiffs and barely completed any of the work Plaintiffs asked for due to his more important computer science projects. The two sides met for a planning session January 15, 2004. Meanwhile, four days prior to this, Defendant registered the domain name, thefacebook.com for himself, unbeknownst to Plaintiffs.

On February 8, 2004, Plaintiffs learned of thefacebook.com’s launch. Zuckerberg and his two roommates, Dustin Moskovitz and Chris Hughes, started that venture as an online directory for Harvard students. They designed their site in a way that it could be introduced at other schools. It had a similar look and layout to what Harvard Connection was trying for; yet at this point Harvard Connection was not ready to launch as the coding was incomplete. By June 2004, Facebook sites were available on 30 campuses and 150,000 students were registered.

Plaintiffs petitioned the university’s disciplinary board asserting that the theft of their intellectual property violated college regulations when Defendant stalled them while incorporating their ideas into his own project that became Facebook. The board ruled in Zuckerberg’s favor, as the board considered the dispute to fall outside the scope of the college’s authority.

Harvard Connection, by then re-named ConnectU, went live in May 2004, but by then it was overshadowed by Facebook.

Plaintiffs then filed suit in federal district court in Massachusetts alleging that Defendants stole the idea, their site’s source code, and business plan when he worked for them as an unpaid programmer. Further that he breached the agreement to provide source code and that his intentional delay was tortious, done simply to gain a competitive advantage. They requested that Facebook’s assets be transferred to them. Defendants countersued in federal district court in California, accusing ConnectU of unfair business practices. The California court ordered the parties into mediation.

In the Massachusetts litigation, even though discovery had not been completed, the parties agreed to suspend proceedings in anticipation of mediation. In the Term Sheet and Settlement Agreement, the parties agreed that the California federal district court shall have jurisdiction to enforce the Agreement, so litigation ended at this point.

The parties agreed to a settlement in April 2008, but right after that time, while discovery was ongoing, ConnectU reportedly found instant messages on Facebook’s computers amounting to a “smoking gun” of evidence backing its allegations, and so they tried backing out of the settlement. Facebook filed this suit seeking enforcement of the settlement.

JUDICIAL OPINION: JUDGE WARE

In the course of this series of lawsuits, the parties engaged in private mediation, culminating in a “Term Sheet and Settlement Agreement.” They agreed to resolve all of their disputes and to dismiss the pending lawsuits, and that there may be “more formal documents but these terms are binding.” After this time, they failed to reach a consensus on certain terms. In the Agreement, the parties stipulate that the federal court has jurisdiction to enforce it. Based on a belief that a court order is necessary to enforce the Settlement Agreement, Facebook filed the present motion in this Court. The question for decision is whether the Settlement Agreement contains sufficiently definite and essential terms that it may be enforced.

ConnectU contend that Facebook’s motion should be denied because (1) the agreement is missing material terms … and (3) Facebook committed fraud in the procurement of the Agreement (valuing Facebook was difficult because it is a private company with no known business model).

THE MATERIAL TERMS

California has a strong policy in favor of enforcing settlement agreements. [Here] the Agreement clearly states the consideration for the performance required and how it must be paid. In exchange for a specified amount of cash and stock in Facebook, ConnectU founders … have no further claims against Facebook. Second, the Agreement clearly defines the structure of the transaction. Subsequent negotiations might have proposed a different structure for the transaction or other additional terms, but those proposals were, apparently, rejected. Third, the principals of each company all signed the Agreement. One ConnectU stockholder did not. A share exchange transaction only needs to be approved by majority vote. Therefore, the lack of this signature is not an impediment to enforcing the Agreement.

WHETHER THE AGREEMENT WAS PROCURED BY FRAUD?

A contract is not enforceable if it was induced by fraud. To prove fraud in the inducement of a contract, a party must establish the elements of common law fraud. ConnectU contend that they were defrauded during settlement negotiations because Facebook did not disclose a valuation of Facebook common stock that had been made by the Board of Directors. (This valuation of company stock was for $15 billion, which would have given the ConnectU founders a much larger settlement than they received, which was based on a Facebook valuation of $3.75 billion.) As the Agreement does not attribute a specific value to the Facebook shares, there is no admissible evidence of any such representation while negotiating a settlement. The Court finds ConnectU has failed to establish that Facebook made misrepresentations during negotiations. On or before June 30, 2008, the parties are directed to submit a proposed form of judgment consistent with this Order.

[The parties reached a settlement for Facebook to pay $65 million to ConnectU, most of it in Facebook stock plus $20 million in cash.]

There are three postscripts to this case:

Postscript 1: Aaron Greenspan’s HouseSYSTEM. Another aggrieved inventor. Greenspan had the original idea for this type of site and his work preceded both projects. His Web portal launched August 1, 2003, rich in features that he designed as an improvement to the official university site. It was also more useful than the printed and bound “Face Book” that every incoming freshman received (a nearly one-hundred-year old tradition). By September 2003, Greenspan referred to his invention as a “Universal Face Book,” and occasionally, as “the facebook.” He met with Zuckerberg in early January 2004, at which time Zuckerberg, Hughes, Moskovitz, and Eduardo Severin were already members of Greenspan’s HouseSYSTEM. They talked about their projects, and at one point Greenspan suggested the two integrate their systems, but in the end they decided to work on their own sites separately. Right after this meeting, on January 11, 2004, Zuckerberg registered the domain name thefacebook.com.

Postscript 2: Chang v. Winklevoss, Case No. CV 09–5397 (Superior Ct., MA, filed Dec. 21, 2009). Another aggrieved participant. Wayne Chang was well-known for his i2hub file-sharing program that relied on high-speed connections available at universities; his work caught the attention of the ConnectU founders in late 2004. At that time, Facebook had launched and ConnectU languished, but they had filed the original lawsuit. The founders approached Chang about going into business together. In Chang’s complaint, he asserts that he signed a Memorandum of Understanding (this is a statement of intent generally describing parties’ goals, not generally construed as a contract). He was given a 15 percent stake in the new venture and in return he was to provide integration of ConnectU and i2hub assets. In addition he helped build new technologies including a textbook resale site called Jungalu, and an aggregator site called Social Butterfly that pulled data from other social networking sites. He claims that the ConnectU founders abruptly severed ties in April 2005 after everything was built out, in contravention of the terms in the Memorandum, and therefore he is entitled to part of the proceeds from the multi-million-dollar ConnectU v. Facebook settlement. (See Appendix 3.)

Postscript 3: Ceglia v. Zuckerberg, Case No. CV-00569-RJA (Fed. Dist. Ct. W.D.N.Y., filed June 30, 2010). Paul Ceglia filed a complaint claiming that he owns a majority stake in Facebook based on a 2003 agreement he signed with Zuckerberg to perform site design and coding work. The agreement featured in Appendix 2, if true and correct, outlines a series of events that conflicts with other of Zuckerberg’s statements as to the idea and creation of the Facebook site. In any event, these claims may be time barred by New York’s six-year statute of limitations on contract claims.

CASE QUESTIONS

1.

Who do you think should be known as one who came up with the original idea for social networking? Which is more important: the idea or the execution of the idea?

2.

Given that the judge ordered a $65 million cash-stock award to the ConnectU founder, and ConnectU’s legal bill is reportedly $13 million, the ConnectU founders are in arbitration with the law firm now over the bill. Recommend an alternative verdict and award in this case.

3.

Can you identify strategies to best protect against getting beaten to market by a competitor?

(Ferrera 43-45)

Ferrera, Gerald R., Margo E. Reder, Stephen Lichtenstein, Robert Bird, Jonathan Darrow, Jeff. CyberLaw: Text and Cases. Cengage Learning, 01/2011. VitalBook file.

The citation provided is a guideline. Please check each citation for accuracy before use.

Read the case study on pp. 82-84

Shareholder Voting

Shareholders hold annual meetings at which time they vote on those matters enumerated in the corporate charter. Should they be unable to attend the meeting, they may vote their shares by proxy thus allowing another party to cast their votes. Shareholders also have the right to approve or disapprove of the following matters:

· •Changes to the articles of incorporation

· •A merger with another corporation

· •The sale of substantially all the corporation’s assets that are not in the ordinary course of business

· •The voluntary dissolution of the corporation

· •Matters in which some directors have a conflict of interest

Furthermore, shareholders may have the right to propose and vote on nonbinding recommendations about the governance and management of the corporation to the board of directors. Many shareholder recommendations currently center on CEO pay, and there are also a number relating to divestiture from conflict zones, opposing foreign government censorship, and promoting green initiatives by corporations.

Shareholder Returns

Present shareholders have what is known as a preemptive right, that is, the right to purchase newly issued shares before the general public is offered these shares. Shareholders also have the right to receive dividends approved by the board. Excess profits may be kept by corporations as retained earnings, or they may be paid out to the shareholders in the form of dividends, allocated in proportion to the shares owned.

Limitations to Shareholder Rights

Shareholders generally have no right to vote on management or operational issues that come up in the ordinary course of business. Common shareholders’ rights to company assets are inferior to creditors such as lenders, suppliers, or preferred shareholders. In the event of a liquidation, common shareholders, it should be assumed, will not receive any compensation for their investment. They can, however, assert any claims against the directors and officers by bringing a direct, indirect, or class action lawsuit against the corporation. Their rights in this respect have been severely curtailed over the years by the courts and Congress. The next case shows how courts construe shareholder rights to file a lawsuit based on allegations of fraud by officers of the corporation.

TELLABS, INC. v. MAKOR ISSUES AND RIGHTS, LTD.: 551 U.S. 308 (2007) (8-1 decision)

FACTS

Tellabs manufactures specialized equipment used in fiber optic networks. During the relevant period, Richard Notebaert was the CEO and president. Shareholders are purchasers of Tellabs stock between December 2000 and June 2001. During this period Tellabs stock fell from above $60 per share to less than $15 as sales of telecom equipment cratered. They accuse Tellabs and Notebaert, along with Michael Birck, the company’s co-founder, of misleading investors about the firm’s financial health, in four ways.

First, shareholders assert that the CEO made a statement indicating that demand for Tellabs’ flagship networking device, the TITAN5500, was continuing to grow, when in fact demand for the product was waning. Second, the CEO made a statement indicating that the TITAN6500, its next-gen networking device, was available for delivery and that demand was strong, when in fact the product was not ready for delivery and demand was weak. Third, the CEO falsely represented Tellabs’ financial results by flooding its customers with products they did not order—a practice called “channel stuffing.” Fourth, the CEO made a series of overstated revenue projections, when it was known demand was drying up for the 5500 and production of the 6500 was behind schedule.

The first public glimmer that business was not healthy came in March 2001 when Tellabs reduced sales projections. In the next months it issued more cautious statements, and suddenly the company substantially lowered revenue projections. Shareholders filed a class action lawsuit alleging that defendants engaged in securities fraud; also that Notebaert as CEO was a “controlling person” as defined by the securities laws (one who possess actual control and supervisory responsibility and participates in the fraud with knowledge the securities laws were being violated) and therefore derivatively liable for the company’s fraudulent acts. Tellabs successfully moved to dismiss the complaint on grounds that the Shareholders failed to plead their case with sufficient particularity as required by the Private Securities Litigation Reform Act (PSLRA). The Shareholders amended their complaint with more specific allegations but again the trial court dismissed the claims. The Court of Appeals for the Seventh Circuit reversed, concluding that Shareholders met the standard for pleading.

JUDICIAL OPINION

Justice Ginsburg: We granted certiorari to resolve the disagreement among the Circuits on whether, and to what extent, a court must consider competing inferences in determining whether a securities fraud complaint gives rise to a “strong inference” of scienter [knowledge of wrongdoing].

Under SEC Rule 10b-5 which implements Section 10(b) of the Securities Exchange Act of 1934 it is unlawful:

· (a)To employ any device, scheme, or artifice to defraud,

· (b)To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statement made … not misleading, or

· (c)To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection wit the purchase or sale of any security.

Section 10(b) … affords a right of action to purchases or sellers of securities injured by its violation.

In an ordinary civil action, the Federal Rules of Civil Procedure require only “a short and plain statement of the claim showing that the pleader is entitled to relief.” Congress enacted the PSLRA in part to curb perceived abuses of the section 10(b) private right of action, and changed many procedural rules aimed to decrease individual suits and increase the likelihood that if there was litigation, institutional investors would likely serve as the lead plaintiffs. Congress also limited damages and attorneys’ fees, provided a safe-harbor for forward-looking statements, and sanctions for frivolous litigation, and a stay on discovery until after any hearings on a motion to dismiss. Under the PSLRAs heightened pleading instructions, any private securities complaint alleging defendants made false and misleading statements must:

(1) specify each statement alleged to have been misleading and the reason why the statement is misleading; and

(2) state with particularity facts giving rise to a strong inference that defendants acted with the required state of mind.

The “strong inference” standard unequivocally raised the bar for pleading scienter. But Congress did not throw much light on what facts suffice to create a strong inference. With no clear guide from Congress other than its intention to strengthen existing pleading requirements, Courts of Appeals have diverged. Our task is to prescribe a workable construction of the “strong inference” standard … geared to the PSLRA’s twin goals: to curb frivolous, lawyer-driven litigation, while preserving investors’ ability to recover on meritorious claims. In determining whether the pleaded facts give rise to a strong inference of scienter, the court must take into account plausible opposing inferences. The strength of an inference cannot be decided in a vacuum. The inquiry is inherently comparative: How likely is it that one conclusion, as compared to others, follows from the underlying facts? A court must consider plausible, nonculpable explanations for the defendant’s conduct, as well as inferences favoring the plaintiff. The inference … need not be irrefutable, i.e., of the “smoking gun” genre, or even the “most plausible of competing inferences.” A complaint will survive, we hold, only if a reasonable person would deem the inference of scienter cogent, and at least as compelling as any opposing inference of nonfraudulent intent. Plaintiffs must plead facts rendering an inference of scienter at least as likely as any plausible opposing inference. The judgment of the Court of Appeals is vacated, and the case is remanded. IT IS SO ORDERED.

[Postscript: On remand, the Seventh Circuit denied Tellabs’ motion to dismiss, ruling that it was “exceedingly unlikely” that the material misrepresentations allegedly made by the corporate defendant were “the result of merely careless mistakes at the management level based on false information” provided by nonofficer employees. It reasoned that defendants failed to assert a “plausible story” to indicate that Tellabs’ officers who were “authorizing or making public statements” did not know the statements were false. 513 F.3d 702 (7th Cir. 2008).