In Re Netsmart Technologies, Inc. Shareholders Litigation

OPINION

I. Introduction

This case literally involves a microcosm of a current dynamic in the mergers and acquisitions market. Netsmart Technologies, Inc. has entered into a “Merger Agreement” with two private equity firms, Insight Venture Partners (“Insight”) and Bessemer Venture Partners (“Bessemer”). If the $115 million “Insight Merger” (or “Merger”) is consummated, Netsmart’s stockholders will receive $16.50 per share and the buyers will take the micro-cap company, whose shares are currently listed on the NASDAQ, private.

Netsmart is a leading supplier of enterprise software to behavioral health and human services organizations and has a particularly strong presence among mental health and substance abuse service providers. It has been consistently profitable for several years and has effectively consolidated its niche within the healthcare information technology market. In October 2005, Netsmart completed a multi-year course of acquisitions by purchasing its largest direct competitor, CMHC Systems, Inc. (“CMHC”). After that acquisition was announced, private equity buyers made overtures to Netsmart management. These overtures were favorably received and management soon recommended, in May 2006, that the Netsmart board consider a sale to a private equity firm. Relying on the failure of sporadic, isolated contacts with strategic buyers stretched out over the course of more than a half-decade to yield interest from a strategic buyer, management, with help from its long-standing financial advisor, William Blair & Co., L.L.C., steered the board away from any active search for a strategic buyer. Instead, they encouraged the board to focus on a rapid auction process involving a discrete set of possible private equity buyers. Only after this basic strategy was already adopted was a “Special Committee” of independent directors formed in July 2006 to protect the interests of the company’s non-management stockholders. After the Committee’s formation, it continued to collaborate closely with Netsmart’s management, allowing the company’s Chief Executive Officer to participate in its meetings and retaining William Blair as its own financial advisor.

After a process during which the Special Committee and William Blair sought to stimulate interest on the paid; of seven private equity buyers, and generated competitive bids from only four, the Special Committee ultimately recommended, and the entire Netsmart board approved, the Merger Agreement with Insight. As in most private equity deals, Netsmart’s current executive team will continue to manage the company and will share in an option pool designed to encourage them to increase the value placed on the company in the Merger.

The Merger Agreement prohibits the Netsmart board from shopping the company but does permit the board to consider a superior proposal. A topping bidder would only have to suffer the consequence of paying Insight a 3% termination fee. No topping bidder has emerged to date and a stockholder vote is scheduled to be held next month, on April 5, 2007.

A group of shareholder plaintiffs now seeks a preliminary injunction against the consummation of this Merger. As a matter of substance, the plaintiffs argue that the Merger Agreement flowed from a poorly-motivated and tactically-flawed sale process during which the Netsmart board *176 made no attempt to generate interest from strategic buyers. The motive for this narrow search, the plaintiffs say, is that Nets-mart’s management only wanted to do a deal involving their continuation as corporate officers and their retention of an equity stake in the company going forward, not one in which a strategic buyer would acquire Netsmart and possibly oust the incumbent management team. The plaintiffs also insinuate that Netsmart’s Chief Executive Officer, James L. Conway, was beguiled by the riches being received by CEOs of larger companies in private equity deals and sought to emulate their success. At the end of a narrowly-channeled search, the Netsmart directors, the plaintiffs say, landed a deal that was unimpressive, ranking at the low end of William Blair’s valuation estimates.

The plaintiffs couple their substantive claims with allegations of misleading and incomplete disclosures. In particular, the plaintiffs argue that the Proxy Statement (the “Proxy”), which the defendants have distributed to shareholders in advance of their vote next month, omits important information regarding Netsmart’s prospects if it were to remain independent. In the context of a cash-out transaction, the plaintiffs argue that the stockholders are entitled to the best estimates of the company’s future stand-alone performance and that the Proxy omits them.

The defendant directors respond by arguing that they acted well within the bounds of the discretion afforded them by Delaware ease law to decide on the means by which to pursue the highest value for the company’s stockholders. They claim to have reasonably sifted through the available options and pursued a course that balanced the benefits of a discrete market canvass involving only a select group of private equity buyers (e.g., greater confidentiality and the ability to move quickly in a frothy market) against the risks (e.g., missing out on bids from other buyers). In order to stimulate price competition, the Special Committee encouraged submissions of interest from the solicited bidders with the promise that only bidders who made attractive bids would get to move on in the process. At each turning point during the negotiations with potential suitors, the Special Committee pursued the bidder or bidders willing to pay the highest price for the Netsmart equity. In the end, the directors argue, the board secured a deal with Insight that yielded a full $1.50 more per share than the next highest bidder was willing to pay.

Moreover, in order to facilitate an implicit, post-signing market check, the defendants say that they negotiated for relatively lax deal protections. Those measures included a break-up fee of only 3%, a “window shop” provision that allowed the board to entertain unsolicited bids by other firms, and a “fiduciary out” clause that allowed the board to ultimately recommend against pursuing the Insight Merger if a materially better offer surfaced. The directors argue that the failure of a more lucrative bid to emerge since the Merger’s announcement over three months ago confirms that they obtained the best value available. Furthermore, the directors note that, unlike certain other private equity acquisitions, the Insight Merger is not one in which the selling company’s CEO came out with a huge monetary win. Conway did all right for himself but not in any way that suggests that he received a windfall or had any particular reason to favor Insight over the other private equity bidders.

Lastly, the defendants note that most of the plaintiffs’ disclosure claims are makeweight. As to the one they concede has the most color — which goes to the question *177 of whether the Proxy discloses all the material information about management’s estimates of Netsmart’s future cash flows— the defendants claim to have gone as far as is required to disclose what reliable estimates existed.

In this opinion, I conclude that the plaintiffs have established a reasonable probability of success on two issues. First, the plaintiffs have established that the Nets-mart board likely did not have a reasonable basis for failing to undertake any exploration of interest by strategic buyers. The record, as it currently stands, manifests no reasonable, factual basis for the board’s conclusion that strategic buyers in 2006 would not have been interested in Netsmart as it existed at that time. Likewise, the board’s rote assumption (encouraged by its advisors) that an implicit, post-signing market check would stimulate a hostile bid by a strategic buyer for Nets-mart — a micro-cap company — in the same manner it has worked to attract topping bids in large-cap strategic deals appears, for reasons I detail, to have little basis in an actual consideration of the M & A market dynamics relevant to the situation Netsmart faced. Relatedly, the Proxy’s description of the board’s deliberations regarding whether to seek out strategic buyers that emerges from this record is itself flawed.

Second, the plaintiffs have also established a probability that the Proxy is materially incomplete because it fails to disclose the projections William Blair used to perform the discounted cash flow valuation supporting its fairness opinion. This omission is important because Netsmart’s stockholders are being asked to accept a one-time payment of cash and forsake any future interest in the firm. If the Merger is approved, dissenters will also face the related option of seeking appraisal. A reasonable stockholder deciding how to make these important choices would find it material to know what the best estimate was of the company’s expected future cash flows.

The plaintiffs’ merits showing, however, does not justify the entry of broad injunc-tive relief. Because there is no other higher bid pending, the entry of an injunction against the Insight Merger until the Netsmart board shops the company more fully would hazard Insight walking away or lowering its price. The modest termination fee in the Merger Agreement is not triggered simply on a naked no vote, and, in any event, has not been shown to be in any way coercive or preclusive. Thus, Netsmart’s stockholders can decide for themselves whether to accept or reject the Insight Merger, and, as to dissenters, whether to take the next step of seeking appraisal. In so deciding, however, they should have more complete and accurate information about the board’s decision to rule out exploring the market for strategic buyers and about the company’s future expected cash flows. Thus, I will enjoin the procession of the Merger vote until Netsmart discloses information on those subjects.

II. Factual Background

A. Netsmart’s Business As Of The Start Of 2006

Netsmart is the leader in the behavioral healthcare information technology market. It provides enterprise software solutions to health and human services organizations, public health agencies, mental health and substance abuse clinics, psychiatric hospitals, and managed care organizations. Since its formation in 1992, Netsmart has accumulated over 1,300 customers, including over 30 state agencies, and has become the nation’s largest supplier of automated computerized methadone dispensing systems, serving more than 400 of the 1,100 methadone clinics in the United States. *178 Over the years, Netsmart grew primarily by consolidating other firms in its niche market, and in October 2005, capped off its strategy by acquiring its largest direct competitor, CMHC. By the close of 2005, the company was riding a tide of 30 consecutive quarters of consistent profitability, and, by any metric, was doing well. 1

At the start of 2006, Netsmart was secure in its role as the largest player within its market niche. No other behavioral healthcare company possessed the financial wherewithal to acquire it. 2 Netsmart’s client base included agencies in a majority of the states; its software was dominant among the nation’s methadone clinics; and, most importantly, switching costs for those using its software were high. Likewise, the limited size of the behavioral healthcare software market also discouraged other large players from encroaching onto Netsmart’s turf.

Netsmart’s management team had been in place for some time. In particular, Netsmart had stability in the top spot, as its CEO Conway had served in that position since the 1990s. Each of the other top executives saw themselves as potential successors to Conway, who was facing some serious health issues but desired to continue, yet each continued deferred to his authority. Among these top managers were Anthony Grisanti (Chief Financial Officer), Alan Tillinghast (Chief Technology Officer and Executive Vice President for Operations), and Kevin Scalia (Execu-five Vice President for Corporate Development). Netsmart’s board of directors until December 2006 consisted of Conway, two former executives — Gerald O. Koop (former President) and John F. Phillips (former Vice President) — and four independent directors. The independent directors were Francis Calcagno (a managing director at the investment banking firm of Dominick & Dominick, L.L.C.), John S.T. Gallagher (CEO of Stony Brook University), Yacov Shamash (Vice President for Economic Development and Dean of the College of Engineering and Applied Sciences at Stony Brook University), and Joseph Sicinski (founder and chairman of the human resource firm, BDS Strategic Solutions, Inc.). 3

Although Netsmart’s directors and manager could take some pride in the operational successes the company had enjoyed, they also faced challenges presented by Netsmart’s unique position as both a relatively small firm and yet the largest company in its niche market. On December 31, 2005, Netsmart had 6,487,943 outstanding shares and its stock closed at $12.61 per share, resulting in a market value of its equity of approximately $81.8 million. 4 This micro-cap size and relatively thin float prevented many institutional investors from staking large positions in the company and dissuaded all but one research analyst from covering the company’s stock. That exception might prove the rule. 5 Additionally, from what one can *179 discern, Netsmart was negatively affected by the stratification of the American healthcare system, which appears to regard mental health and substance abuse services as tangential, rather than integral, to the core of healthcare. This caused business problems for Netsmart because the advantage the company obtained insofar as it could deliver software and related support services that met its clients’ precise needs was accompanied by a corresponding difficulty in growing substantially beyond that space or attracting the interest of larger players in the broader healthcare IT market, who served providers of, for want of a better term, physical health services (think hospitals, e.g.).

B. Netsmart’s Prior Explorations Of Strategic Combinations

The issues presented by Netsmart’s size and market were not new .ones in 2006. Although the CMHC acquisition at the end of 2005 materially enlarged the company, Netsmart’s management had pondered the prospect of outgrowing its market for some time and considered what could be done to address that concern. In order to better understand the reaction of the Netsmart directors to the private equity •attention the company received in 2006, it is therefore helpful to review the company’s previous experience in investigating strategic combinations and sales.

Over the years, one option Conway considered to address the narrowness of Netsmart’s market niche was finding a larger healthcare IT software firm to acquire Netsmart and add its software to their larger array of products and services. Conway first pursued that line of inquiry in the late 1990s. Beginning then and continuing with isolated contacts throughout the early 21st century, Conway engaged in very sporadic discussions with larger corporations that provided enterprise software solutions in the health services sector, including GE Medical Systems, Electronic Data Systems Corporation, and Perot Systems Corporation (all in the late 1990s) as well as Quality Systems, Inc. (2001), Cerner Corp. and Siemens Corp. (2003), and QuadraMed Corp. (2005). 6 According to Conway, he signaled in these discussions an interest on Netsmart’s part in a strategic alliance, a signal that given Netsmart’s tiny size relative to the companies Conway approached could only be rationally perceived as a green light for an acquisition proposal. Conway says that none of these occasional, informal discussions resulted in an expression of interest, stating that the problem was that Netsmart’s market niche was simply too small on a stand-alone basis to make Netsmart an attractive acquisition target for a larger software provider in the health services sector.

In November 2003, Netsmart engaged William Blair as its investment banker in connection with its desire to acquire CMHC, a desire that was not satisfied until October 2005. As part of its engagement of William Blair in 2003, Netsmart entered into an arrangement whereby Blair would have the right to a fee if Netsmart were eventually sold. That fee *180 was set at 1.7% of the value of any sale of Netsmart. 7 This did not mean that William Blair was authorized to market Nets-mart as if its board had decided to sell the company; rather, it simply gave Blair a right to compensation if the board later went down that road.

From late 2003 through 2005, William Blair dropped Netsmart’s name when it made cold calls on corporations in the healthcare industry in which it specialized. As is typical of investment bankers, Blair regularly trolled for business. According to Karl A. Palasz, the Blair partner who eventually ran the sales process leading to the Insight Merger, Netsmart was among a list of companies that William Blair mentioned in cold calls, a list that largely involved companies Blair did not represent. 8 In these cold calls, Blair did not say it represented Netsmart or that it was authorized to discuss a specific transaction. 9 Rather, one senses that it was just trying to take the temperature of prospective clients and see whether there were common interests among healthcare companies with whom it had contact that could lead to a fee-paying deal. William Blair says that the hook it baited with Netsmart did not attract a hit, suggesting, like Conway, that Netsmart’s market niche did not appeal to the bigger healthcare software fish. Therefore, instead of being acquired, Netsmart made several acquisitions during the first half-decade of the new century, culminating in the purchase of CMHC.

C. Netsmart Management Decides It Wants To Ride The Private Equity Wave

The announcement of the CMHC acquisition in October 2005 caught the attention of some players in the capital-flush private equity sector. After that announcement, Vista Equity Partners (“Vista”) approached William Blair and expressed a preliminary interest in acquiring Nets-mart. 10 Upon learning of Vista’s interest, William Blair told Conway, but Conway did not immediately inform the Netsmart board of this contact, an omission he now attributes to Vista’s lack of seriousness and specificity. 11

Then, on Valentine’s Day 2006, Francisco Partners (“Francisco”), another private equity firm that, like Vista, specialized in investments in technology businesses, approached Kevin Scalia, Netsmart’s Executive Vice President, to see whether Netsmart fancied being taken in friendly conquest. 12 This initial wooing was followed by a March 24, 2006 meeting between Vista and a group of Netsmart’s key managers, including Conway. His interest piqued, Conway claims to have promptly informed the board of this expression of interest. 13

Thereafter, Conway and certain of his key advisors began chewing over options with William Blah’. Their talks soon centered on the emerging deal structure of *181 the year: a going private transaction led by a private equity buyer. Armed with active expressions of interest on that front, Conway asked Scalia to prepare a presentation for the Netsmart board outlining various strategic options available to Nets-mart — including a going private transaction.

On May 11, 2006, the Netsmart board met and Scalia presented the options he developed. Among these options were the following: (1) continuing to build as a public company; (2) finding and selling the company to a strategic buyer; or (3) taking the company private by selling to a financial buyer. 14

To help the board assess these options, Scalia outlined his estimate of Netsmart’s expected revenues and profits under its existing business plans. His “Stay the Course” projections served as a base case model illustrating his assessment of organic growth and the challenges Netsmart faced as a small public company. 15 Those challenges included the quarter-to-quarter pressures and compliance costs of public filings, the dependence on but lack of coverage by research analysts, and the necessity of acquiring new managerial talent in light of Netsmart’s increased size. 16 As a public company, Scalia implied that Nets-mart would be constrained to offer the incentives necessary to attract good candidates. 17

Scalia also presented two scenarios involving a sale. The first slide focused on the possibility of a strategic acquisition. It was brief and to the point, stating: “A strategic sale is a good alternative but we did try it once before and there was no interest so a reasonable approach would be to run a parallel track with private equity.” 18

Scalia’s slide on the sale to a private equity buyer was more fulsome. The potential benefits of this alternative that he presented included: the ability to “operate [Netsmart’s] business on a longer term rather than a quarterly basis,” a chance to “add strength to the management team,” “add industry and technical talent to the organization” and “increase [Netsmart’s] effectiveness in product development,” an opportunity to “address the issues of data sharing and interoperability without the short term impact issues,” and the prospect of “eliminating] public company costs at the rate of $1M to $1.5M per year.” 19 Further, Scalia conveyed that this route could bear fruit, noting that “initial indications [of interest] are pretty good” and citing Vista, Francisco and two other private equity groups in support of that proposition. 20

Interestingly, another version of this same slide contained another bullet adding “Second bite at the apple” to the list of benefits in a private equity deal. 21 This reference obviously refers to the potential for management to not only profit from *182 the sale of its equity (including exercised options) in the going private transaction itself, but from future stock appreciation through options they were likely to be granted by a private equity buyer, a class of buyers that typically uses such incentives to motivate managers to increase equity value.

In summary, Scalia estimated that the company could be taken private by a private equity buyer in 2007 for a value that was attractive in a net present value comparison to the option of remaining independent. 22 To give him his due, Scalia also clearly illustrated that Netsmart had options for generating revenue and profit growth in the long-term that were also attractive. But the directional force of management’s desires was manifest. In fact, minutes from a meeting held later that day by the independent directors of Netsmart focus largely on the option of going private. 23

After the meetings on May 11, management’s focus on the going private option intensified. Over the following week, Sca-lia was working full bore with William Blair as it prepared its own assessment of these options. 24 Once that report was complete, a so-called “informal” board meeting was held on May 19. From there, things get fuzzy.

At that meeting, which was dubbed “informal” because no minutes were taken memorializing its contents, 25 William Blair reiterated many of the concerns about Netsmart’s then-existing market position previously discussed by Scalia. 26 From these premises, the William Blair slides recommended that Netsmart explore both a “going private transaction” and a “strategic sale.” 27 Along with this advice, Blair provided the board with a large volume of valuation metrics to get a sense of what value Netsmart might capture in a sale. It also provided the board with five-year projections drawn (through 2011) based on Scalia’s earlier management model containing figures through 2010. 28

Consistent with its slides indicating that Netsmart should explore a sale, William *183 Blair dumped omnibus lists of possible financial and strategic buyers on the board, which apparently consisted of all the buyers William Blair could conceive of as having an interest or involvement in healthcare. For example, William Blair included HCA Inc., a huge hospital chain that was in the midst of going private itself, as a potential strategic acquirer. The reason why a hospital chain would buy a business providing software solutions to a large variety of mental health and substance abuse providers was not explained. More logically, the presentation also included a list of strategic players involved in the business of helping healthcare providers manage information through software and related technology. 29

The most important aspect of the May 19 meeting, though, was the result of these various presentations and recommendations. The Proxy says that during this meeting an important strategic decision and a related tactical choice of similar import were both made. The strategic decision was to authorize William Blair to try to sell the company. The tactical choice was to focus on a sale to a private equity buyer and to eschew an active canvass of any strategic buyers. The Proxy describes these decisions and their rationale as follows:

On May 19, 2006, representatives of William Blair attended an informal meeting of the board of directors and made a general presentation regarding various strategic and financial alternatives for the Company.... It was concluded that William Blair should continue the exploration of a potential going-private transaction, given the Company’s size and operating characteristics, as well as the relative advantages and disadvantages of continuing to operate as a public company.... In examining the potential for a transaction with strategic acquirers, it was determined that the potential strategic acquirers in similar segments would either believe that the Company’s specific market segment was too narrow or have insufficient scale and resources to enable them to acquire a company of Net smart’s size. Furthermore, the board of directors and management considered the fact that Netsmart directly competes with these companies and ultimately made the determination that the risks involved in such an approach (including the risk of confidentiality leaks that would be detrimental to the Company in its sales efforts with customers and prospects) outweighed the benefits, especially given its previous preliminary discussions which did not result in material interest from potential strategic acquirers. 30

Frankly, there is no credible evidence in the record that buttresses this recollection of events. Due to the importance of this disclosure and its doubtful accuracy in light of the entire record, I address it in parts.

First, entirely absent from the record is any serious “examin[ation of] the potential for a transaction with strategic acquirers.” 31 Netsmart’s board never seriously considered whether the company, as it existed in May 2006, might potentially fit under the corporate umbrella of a larger healthcare enterprise software provider. The William Blair slides are replete with examples of firms in related industries that could have been approached, and Palasz admitted that William Blair believed, going into that meeting, that a transaction stra *184 tegic buyers should at least be explored. 32 But, there is no indication that management, William Blair, or the board considered how Netsmart’s acquisition of its largest competitor, CMHC, and its concomitant attainment of dominance in its market niche might influence the ardor that any of these strategic buyers might feel. The supposed important decision— not reflected in any minutes or resolution — to forsake approaching these buyers appears to have only been justified by reference to the sporadic pitches to strategic players Conway and William Blair made over the prior decade. The relevance of these contacts will be discussed again shortly. For now, what is critical is that they do not reliably indicate that material interest from potential strategic acquirers did not exist because no contemporary search was conducted and these prior search attempts occurred when Netsmart was a very different (smaller and less consistently profitable) entity then it was in 2006.

Second, there is little, if anything, to support the assertion in the Proxy that Netsmart’s ability to sell its products would be hindered by discreet and professional overtures to select strategic players. Given Netsmart’s size, any rational customer would recognize that it and other of its competitors could be subject to aequisition. Unlike another situation with which the court is familiar, 33 the record contains no information from which one could conclude that the potential acquisition of Netsmart by a larger healthcare IT company posed any colorable threat to prospective customers of Netsmart. 34 Further, given the lack of any record of the use of confidentiality agreements during the scattershot approaches made by Conway and Blair over the years, Netsmart’s claim that overtures to much larger strategic buyers in 2006 would scare off customers creates cognitive dissonance. Those prior contacts were made when Netsmart was smaller and less secure in its market niche — that is, when it would seem to have had more to fear in terms of sales erosion from sending a signal that it was up for sale. Yet, despite those alleged contacts, Netsmart continued to make sales and gain new customers, which now face high switching costs should they consider abandoning Netsmart. 35

Put bluntly, the informal and haphazard market canvass Netsmart’s board relied on was insufficient, and it is hard to glean from the record any convincing reason why a discreet, targeted, and controlled marketing effort directed towards select strategic buyers posed a threat to Nets-mart’s ongoing operations. The Proxy implies that the absence of evidence of this *185 kind is irrelevant because there was no rational reason to believe that a search for a strategic buyer had any hope of success. But the foundation upon which that conclusion rests cannot bear that weight.

From there, the record gets even more diffuse. The defendants claim that the Proxy implicitly refers to two sets of prior contacts with strategic buyers, one set involving Conway and the other involving William Blair. These were the same contacts identified earlier, the quality and quantity of which require additional mention given the importance the defendants place upon them.

Conway’s alleged exploration of a strategic combination spans, according to him, at least the seven-year period from 1999 to 2006. During that time, he says he spoke at one time or another with “at least a half a dozen” possible strategic acquirers— nearly one each year! — about the possibility of a strategic combination. 36 Conway’s testimony about these efforts suggests they were sporadic at best, did not involve any confidentiality restrictions, and were more the product of happenstance than of a close examination of the market. 37 As important, most of them came when Nets-mart was much smaller and less established as a firm.

The William Blair contacts are even less compelling. Between 2003 and 2006, William Blair claims that it bandied Nets-mart’s name about along with the names of other companies when it made cold calls on prospective clients in the healthcare sector. 38 Again, concerns about confidentiality seem to have been non-existent. Even more important, Palasz testified that most of the companies Blair mentioned in these cold calls were not its clients and that it had no authority to tell anyone that Nets-mart was interested in a sale. 39 In fact, Palasz stated, “[T]here would be no reason for the potential acquirers to think that any of these companies would be, quote, unquote, on the block.” 40 Nor is there any indication that William Blair actually targeted its pitches to a specific set of strategic players in the healthcare IT space for whom Netsmart might be a good fit and to whom the company might make a reasoned proposal.

These erratic, unfocused, and temporally-disparate discussions by Conway and William Blair apparently constituted the information base that the board had at its disposal when it determined it was not worthwhile to seek out a strategic buyer in May 2006. Neither management nor William Blair seriously analyzed the healthcare IT universe as it existed at that time *186 or considered which companies might find Netsmart, as it existed in 2006, to be attractive. As a result, there was apparently no consideration of making careful and focused approaches to a discrete set of larger players in the healthcare IT space who might wish to round out their enterprise software offerings, a method that would balance the utility of testing the marketplace against the confidentiality and other concerns that a broader canvass might threaten.

From the record, one gleans that the board, at best, quickly determined that strategic buyers were unlikely to be interested and eschewed any real look at them. In that thinking, they appear to have been influenced by management’s and William Blair’s favorable attitudes towards the private equity option. 41 Both believed that a private equity buyer could be found and seem to have touted the prevailing trend in the M & A markets, which involved private equity players pricing strategic buyers out of deals. 42 Additionally, the board also seems to have been influenced by William Blair into perceiving that all M & A situations were the same in the sense that the signing up of a publicly-announced deal for a micro-cap company like Netsmart would generate a reliable post-signing market check in the same way that similar announcements for large-cap companies like Paramount, Warner-Lambert, MCI, and more recently, Caremark, drew other interested strategic bidders into the process. 43

In any event, given the un-minuted nature of the May 19 meeting and the lack of good recollection by the defendants involved, it is difficult to determine what exactly motivated the board’s decision, or if decision is really even the right word. What is certain is this: despite William Blair’s presentation including a litany of potential strategic buyers Netsmart might pursue, no effort was taken from that point forward to explore whether any of these buyers were interested in Netsmart. None.

*187 D. Pursuit Of A Private Equity Deal Accelerates

After the May 19 meeting, management and William Blair continued to collaborate on efforts to pursue a private equity deal. In early July, another private equity firm focused on companies in the software and healthcare markets, Thoma Cressey Equity Partners (“Cressey”), 44 approached Netsmart and expressed a preliminary interest in acquiring the company. 45 Without involvement of the board, a confidentiality agreement was inked and Cressey undertook some due diligence. 46 On July 7, Cressey made a preliminary, conditional proposal to acquire all of the company’s shares for $15 apiece. That same day, Netsmart stock closed at $12.81 per share on the NASDAQ. 47

From there, things began to move fast. On July 13, 2006, the board of directors met to consider the Cressey proposal. They decided to form a Special Committee of independent directors, with defendant Calcagno as Chairman, and defendants Gallagher, Shamash, and Sicinski as members. The Special Committee retained William Blair as its own advisor the next day.

At the same meeting, the Special Committee apparently decided on a very targeted approach to marketing the company, which involved an outreach to six private equity firms in addition to Cressey. These included Vista and Francisco, which had each already expressed an interest in a transaction with Netsmart, as well as four other firms — TA Associates, Summit Partners, Insight, and Technology Crossover Ventures — that William Blair said had each purchased healthcare software firms in the past. 48

In the foregoing discussion, I use the word “apparently” because as with the meeting of May 19, no minutes exist for these Special Committee’s deliberations that appear in the Proxy. As such, one cannot determine who was present for this meeting or what specifically was said or done. One might even reasonably speculate that no formal meeting took place as the Committee’s chairman, Calcagno, testified that there were no Special Committee meetings at which minutes were not taken. 49 In that case, Calcagno may well have signed off on the shopping list suggested by William Blair outside of the meeting room.

Ultimately, four of the seven private equity firms involved in the limited auction responded to William Blair’s initial overture in a positive way. The four were Vista, Francisco, Cressey, and Insight. After agreeing to sign confidentiality agreements in order to facilitate access to due diligence materials, each was given the opportunity to review a set of Netsmart’s records during the latter half of July and asked to provide a preliminary proposal *188 outlining the terms on which they might acquire Netsmart by August 1.

In what was to be the pattern throughout, the Netsmart side of the due diligence process was handled by company management with little involvement from the Special Committee or its advisors. This occurred despite the fact that Netsmart management was keenly interested in the future incentives that would be offered by the buyers, including what, if any, option pool would be offered to them in the resulting private company. Given its lack of participation in this process, the Special Committee had virtually no insight into how consistent management was in its body language about Netsmart’s prospects to the various private equity firms in the bidding process. But no plausible allegations of favoritism by management toward particular private equity firms among the seven have been made by the plaintiffs, and no evidence from which one can infer that Conway or other Netsmart managers had any pre-existing relationship or bias toward any of the bidders has been presented.

On the eve of receiving expressions of interest, July 31, the Special Committee met in its first minuted meeting. At that session, which was attended by CEO Conway and Netsmart’s general counsel, the Special Committee retained Patterson Belknap Webb & Tyler as its legal counsel. 50 The same day as it was retained, Patterson Belknap provided a review for the Special Committee of its legal obligations. 51

E. The Preliminary Bids Come In And The Board Confirms Its Prior Decision Not To Seek A Strategic Buyer

On August 3, the Special Committee met to consider the preliminary bids its limited action had generated. Each of the preliminary bids contemplated, as one would expect from private equity buyers, a continuing role for existing management after the sale and the provision of equity incentives to them. Cressey declined to update its prior $15 per share expression of interest. The other expressions of interest were: Insight (at $15.40-$15.60 per share); Francisco ($15.75 to $16.75 per share); and Vista (at $17.00 per share). 52

The Special Committee, with involvement by Conway, again rejected any broader market canvass. Instead, it decided to offer the two bidders who made the most attractive offers the opportunity to conduct additional due diligence in contemplation of making final bids on August 28. In coming to the conclusion not to try to approach a broader range of bidders, the Special Committee relied in important part on the intuition that, so long as the Merger Agreement contained a fiduciary out and did not contain preclusive deal protections, other strategic or financial buyers with an interest would seize on the public announcement of a Merger Agreement as an invitation to make a topping bid. 53

*189 In August, Vista and Francisco conducted due diligence, without involvement by the Special Committee, and also had talks with Conway about incentives for management. When bids came in on August 28, Francisco’s expression of interest had been reduced to $15 per share. Vista, meanwhile, submitted a bid of $16.75 per share. Insight, which had not been invited to the second round, continued to poke around the process, seeking to engage Conway’s interest but being rebuffed.

On August 29, the Special Committee met. It received updated valuation figures from William Blair to use as a basis for assessing the bids and, more generally, the merits of pursuing a sale. The Special Committee discussed the relative advisability of Netsmart remaining independent as opposed to engaging in a going private transaction. Among the issues considered were Netsmart’s current market valuation, serious health issues facing Conway and the succession issues that posed, and the company’s need to raise large amounts of capital if it were to continue on its own. At the end of the discussion, the Special Committee asked Conway to leave and held an executive session during which it concluded that a transaction in the range proposed by Vista would be attractive and resolved to authorize William Blair to negotiate with Vista. The terms the Special Committee authorized Blair to seek included a purchase price of $17 per share (a quarter more than Vista’s current bid), a 15-day exclusivity period (instead of the 25-day period Vista requested), and a break-up fee of no more than 3% in the final Merger Agreement.

Although Vista did not raise its price, an exclusivity agreement was struck allowing Vista an additional two weeks of due diligence. Again, Netsmart management, without the Special Committee’s involvement, administered this process. At the end of Vista’s review, disappointment resulted. Vista told Palasz of William Blair that it was no longer interested in making an offer at the $16.75 per share level and would only proceed at a level “materially south” of that number. 54 Palasz probed what that meant and came away with the reasonable impression it meant a bid of around $15 per share. 55

William Blair and the Special Committee were not well pleased with Vista. They viewed them as having sported with the process. William Blair gave Vista the news that its reduced level of interest was not attractive. This put the onus on Vista to get its bid back up if it wished to stay in the game. Vista never did so and disappears from our story. A similar tack had been taken with Cressey earlier.

The peskiness of Insight, however, left the Special Committee with another option. On September 20, Insight had again approached Conway to inquire about the process and signaled an interest in making a bid higher than its prior $15.60 overture. Conway directed Insight to the Special Committee’s advisor, William Blair. After Vista dropped its bid, William Blair followed up with Insight and determined it was serious. On September 27, the Special Committee met with its advisors as well as Conway. The Special Committee decided to give Insight, the highest bidder at that time, a chance to conduct due diligence in a tight timeframe.

*190 On October 4, that due diligence was completed and Insight made a written expression of interest at $16.40 a share. By that date, Netsmart’s management was completing the retention of counsel for themselves, to negotiate the conditions on which they might be retained by a private equity buyer. The Special Committee had left that separa