By Dale Campbell

The Ninth Circuit has attempted to end the disputes arising from the creation of Facebook. As dramatized in the Hollywood blockbuster, The Social Network, the Winklevoss twins and other Harvard graduates claimed that Mark Zuckerberg stole the idea for Facebook from them. The Winklevosses claimed they conceived and created the idea for a social network, then known as Harvard Connection and later as ConnectU, and hired Zuckerberg to complete the programming.

The Winklevosses claimed that Zuckerberg was involved in all aspects of the website development and business planning for Harvard Connection and acted as a member of the Harvard Connection development team. Zuckerberg was allegedly entrusted with the basic idea for the project and enterprise, including database and website design. Moreover, the Winkelvosses alleged that Zuckerberg was provided information regarding the website’s business model, functionality, concepts, and information to be collected from users. The Winklevosses alleged that Zuckerberg utilized all of this information in creating Facebook and failed to advise the Winklevosses that he had stopped working on the Harvard Connection code but, instead, was developing a competing website. The complaint alleged a variety of business torts including copyright infringement, misappropriation of trade secrets, breach of the covenant of good faith and fair dealing, breach of fiduciary duty, and interference with prospective economic advantage. 

Zuckerberg and Facebook counterclaimed, alleging that the Winklevosses had hacked into Facebook to obtain user data in an attempt to steal the users by spamming them. The litigation involved a variety of other parties, claims, and procedural issues not pertinent here. The parties were ordered to mediation to attempt to achieve a global settlement.

The parties signed a confidentiality agreement in connection with the mediation, which provided that all statements made during the mediation were privileged, non-discoverable, and inadmissible “in any arbitral, judicial, or other proceeding.” The Winklevosses were represented at the mediation by six lawyers and their father who was a business valuation expert and professor at the Wharton School of Business. After a one-day mediation, the parties signed a one-and-a-half page settlement agreement by which the Winklevosses would receive $20 million in cash and 1,250,000 shares of Facebook. At the time of the mediation, the Winklevosses believed that each share of Facebook was worth $35.90 because that is what they understood Microsoft had recently paid. The settlement agreement contained a release clause providing for “mutual releases as broad as possible,” and the Winklevosses agreed that they had no further claims against Facebook.

The settlement agreement included a clause whereby the parties agreed that additional documents would need to be prepared to finalize the transactions which had been agreed upon. Facebook prepared a stock purchase agreement, stockholders agreement, and confidential mutual release for the parties to sign. The Winklevosses refused to execute the other documents. After signing the settlement agreement, the Winklevosses were notified that Facebook had prepared an internal valuation for tax purposes that put a value of its common stock at $8.88 per share. As stated, at the mediation, the Winklevosses believed that their shares were worth $35.90 a share. Facebook filed a motion to enforce the settlement agreement and the Winklevosses moved to rescind the agreement on the basis that Facebook misled them as to the value of the stock, failed to disclose the tax valuation, and therefore allegedly violated Rule 10(b)(5) and section 29(b) of the Securities Exchange Act of 1934. The district court granted the motion to enforce the settlement agreement and the Winklevosses appealed.

The Ninth Circuit affirmed. The Court assumed, without actually ruling, that a party negotiating a settlement could possibly violate Rule 10(b)(5) by misstating or hiding information that would materially change the other side’s valuation of the settlement. If Facebook violated Rule 10(b)(5), the Winklevosses would be entitled to rescission of the settlement agreement. However, the Ninth Circuit found that the Winklevosses were sophisticated parties and were thoroughly represented by a team of extremely competent counsel and valuation experts at the mediation. Parties in an adversarial setting characteristic of litigation with adequate access to competent counsel have a high duty of inquiry and must be highly skeptical of each other’s claims and representations. However, the Ninth Circuit found that the Winklevosses could not prove their allegations because of the mediation confidentiality agreement.

The Winklevosses alleged that Facebook knew, at the time of the mediation, of the tax valuation at $8.88 a share but led the Winklevosses to believe the higher $35.90-a-share valuation paid by Microsoft. Moreover, the Winklevosses claimed that they were not told that the value paid by Microsoft was for preferred shares, while the Winklevosses were receiving only common stock. To prove their claim, however, the Winklevosses would have had to introduce evidence of what Facebook did or did not say during the mediation. The confidentiality agreement precluded them from introducing any such evidence. Without such evidence, the Winklevosses’ securities fraud claim failed.

The Winklevosses also tried to argue the release was invalid under 29(a) of the Exchange Act, which provides that any express waiver of a violation of Rule 10(b)(5) is invalid. The Ninth Circuit found that section 29(a) applies only to express waivers and, here, the Winklevosses were not precluded from proving a 10(b)(5) violation because of an express waiver but, rather, because of the confidentiality agreement which precluded them from introducing any evidence to support such a claim.

In closing, the Ninth Circuit noted that, since the litigation began, new investors valued Facebook at $50 billion, which was 3.3 times what the Winklevosses believed it was worth at the time of the mediation, a fact that made the Court question why they sought to rescind the settlement. The Court concluded, “At some point, litigation must come to an end. That point has now been reached.” Apparently, the Winklevosses do not agree and have petitioned the Supreme Court for review.