Judge to WPP: Sorrell's Lawyers Can't Read, Were Asleep at the Wheel

Last Updated Sep 30, 2009 5:26 PM EDT

The ruling that dismisses WPP's stock fraud case against Spot Runner will likely infuriate CEO Martin Sorrell, as it describes a series of mistakes on the part of WPP's lawyers that led Sorrell to believe he was being defrauded when in fact he was not. By giving off-target answers to WPP's emailed questions and by seeking waivers from other investors who actually controlled WPP's investment in the company, Spot Runner seems to have done an end run around WPP. It's complicated, but it's worth understanding if you want insight into the web of sharp practices that seems to surround Spot Runner. Here's what happened, according to the ruling:

WPP invested $10 million in Spot Runner and got stock in return. The terms of the investment had two rules:

  1. Spot Runner was to alert WPP if any of the founders of the company sold their stock (an event that generally drives stock prices down).
  2. WPP was to be offered a right of first refusal if Spot Runner created any new stock (another event that tends to drive down prices).
Thus, WPP believed it was protected if the company did anything that might ruin its investment. But there was a misunderstanding regarding first rule and a loophole in the second rule -- and neither went to WPP's advantage.

In May 2007, Spot Runner began a plan to issue new stock. WPP e-mailed Peter Huie, general counsel for Spot Runner to ask:

Is there an existing investor and/or founder selling existing shares related to this offering?
Huie responded:
This offering does not involve the sale of any existing shares. It is an entirely new issuance by the Company.
At the same time, the founders of the company -- Nick Grouf and David Waxman -- were also selling their own stock. They went to two other investors, Battery Ventures and Index Ventures, who waived their right to buy the stock. Battery and Venture comprised 60 percent of all investors and triggered a loophole that allowed Spot Runner not to tell the rest of the investors -- including WPP -- that the founders' stock sale was going ahead.

WPP found out about the founders' sale later and was, predictably, furious. Its suit claimed that Spot Runner had defrauded WPP because the lawyer had specifically asked Spot Runner that month if the founders were selling shares, but Spot Runner had replied that the company was only issuing new stock. As the judge put it:

Huie's response about who was selling in "this offering" did not answer the question that Plaintiff's counsel theoretically posed, but it did not state a falsehood. Plaintiff may have misread Huie's e-mail...
WPP will appeal. It may win. The purpose of disclosure rules surrounding stock investments is to make sure that investors know exactly what is going on, not to allow elliptical answers to reasonable questions, as happened here. Appeals courts like to get to the merits of cases rather than rely on the technicalities (or at least, the good ones do).

The case underlines how careful investors and partners of Spot Runner need to be. The company has a history of controversial dealings. It lost a $2.2 million ruling which found that it had ripped off one of its own founders and refused to pay him.

There are also these underlying issues. Adweek:

In the meantime, Spot Runner will remain a black mark in WPP's portfolio. The ad group is now in the unusual position of being a shareholder in a company that's founders it has publicly accused of lying to selling over $50 million worth of stock while the company was floundering. According to WPP's suit, Spot Runner has lost more than $80 million since it was founded in 2004.
Venture Beat:
The dismissal may not save Spot Runner from turbulence: the company has gone through three rounds of layoffs lately, letting go of more than 200 employees.
Brand Republic:
According to WPP, Spot Runner has lost more than $80m since it was founded in 2004.
So, although it's amusing, it's actually a little unfair for the New York Post to accuse Sorrell of being Napoleonic (image).