Allegations of Insider Trading Amongst Fitbit’s Board of Directors

Fitbit Inc. has found itself in the midst of a shareholder derivative suit alleging the company’s board engaged in insider trading and improper conduct surrounding the 2015 IPO, lock-up agreements, and Secondary Offering after the Court of Chancery denied Fitbit’s Motion to Dismiss earlier this month.

Fitbit launched a new technology – PurePulse in 2014 which was designed to allow Fitbit devices to record a user’s heartrate with “superior accuracy.”  The technology was publicly praised, but internally, the complaint alleges, there were serious concerns surrounding the efficacy of PurePulse.

While the public was led to believe that PurePulse was functioning at or above expectations, Fitbit management structured the company’s 2015 IPO to allow the board to sell “an unusually large percentage of the stock” at higher prices, according to a Delaware Court of Chancery opinion.  The board then voted to waive lock-up agreements that were intended to prevent the board from selling more shares for a period after the IPO.  This waiver allowed the board to offer even more shares during the Secondary Offering – amounting to some $270 million in profit.

The Fitbit board argued that the Court should dismiss the case because the investors did not make a pre-suit demand on the board nor adequately allege demand futility. The Court disagreed and found that the investors “have pled particularized facts” excusing demand under Aronson and Rales.   When the suit was first filed, Fitbit’s board had seven members. Fitbit argued that the court should consider the board as it existed when the investors filed their second amended complaint when there were nine members in determining if demand would have been futile. Under Braddock v. Zimmerman, the Court sided with the investors finding that the operative time to consider the composition of the board is when the original complaint was filed. 

The Court also refused to dismiss the complaint for failure to state a claim.  The Court initially noted that if a complaint survives a motion under Rule 23.1, “it will likely survive a motion under Rule 12(b)(6).”  The board’s additional argument here was that Plaintiffs’ claims are subject to exculpation under Section 102(b)(7) of the DGCL and the exculpation provision in Fitbit’s certificate of formation. The Court found that the exculpation provision does not extend to breaches of the duty of loyalty.  In denying the Motion to Dismiss, the Court extended the Brophy decision for trades made, not by the insider himself, but by an entity he or she controls thus implicating the duty of loyalty.  In addition, the Court found that the board’s actions surrounding the IPO, lock-up waivers, and the Secondary Offering also implicated the duty of loyalty, allowing both claims to survive. 

Read the full opinion here.

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