Shearman & Sterling LLP | Securities Litigation Blog | Eighth Circuit Dismisses Derivative Action For Failure To Adequately Allege Futility Of Making Pre-Suit Demand To Board Of Directors<br >  
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  • Eighth Circuit Dismisses Derivative Action For Failure To Adequately Allege Futility Of Making Pre-Suit Demand To Board Of Directors
     

    08/01/2016
    On July 22, 2016, the Court of Appeals for the Eighth Circuit dismissed a shareholder derivative action alleging that directors and executives at Wal-Mart Stores, Inc. (“Wal-Mart”) permitted and then covered up pervasive bribery at its Mexican subsidiary, Wal-Mart de Mexico (“Wal-Mex”).  Cottrell v. Duke, No. 15-1869 (8th Cir. July 22, 2016).  Plaintiffs were seeking to enforce rights belonging to Wal-Mart, but alleged that they were not required to demand that Wal-Mart itself pursue the claims, because the current board of directors was not impartial, meaning that such a demand would have been futile.  Applying Delaware law (the state of Wal-Mart’s incorporation), the Court found plaintiffs’ allegations insufficient to excuse demand as futile, and upheld the dismissal of the action.

    Rule 23.1(b)(3) requires shareholders seeking to enforce a corporation’s rights through a derivative action to “state with particularity” any efforts they made to have the corporation’s directors pursue the action and “the reasons for not obtaining the action or not making the effort.”  The Court explained that Rule 23.1 is a “rule of pleading” that requires derivative plaintiffs to allege facts to enable a court to decide whether the plaintiffs complied with a demand requirement imposed by another source.  In this case, that source was Delaware law, as the state of Wal-Mart’s incorporation.  The Court further explained that, under Delaware law, a derivative plaintiff is excused from making a pre-suit demand upon the corporation’s board of directors only if the complaint’s particularized allegations create a “reasonable doubt” that, at the time the complaint was filed, the directors “could have properly exercised independent and disinterested business judgment.”

    Plaintiffs contended that a majority of the board was not disinterested because the members themselves faced personal liability in connection with the matter and because they allegedly knew about the bribery but failed to act.  The Court rejected as “conclusory” plaintiffs’ three theories for inferring that the board of directors knew about the alleged bribery at Wal-Mex but failed to act.  Two theories involved plaintiffs’ argument that the Board knew about the alleged bribery because individuals with a duty to report to the Board knew about it.  More specifically, plaintiffs alleged (a) that Wal-Mart’s internal investigators reported findings suggestive of wrongdoing to the then chair of the Board’s audit committee (though the complaint contained no particularized facts confirming this), who had an obligation to report those findings, and (b) that certain Wal-Mart officers had duties to report the results of the investigation to the board of directors.  The Court, however, rejected both theories on the basis that Delaware courts had “consistently rejected . . . the inference that directors must have known about a problem because someone was supposed to tell them about it.”  (Slip Op. at 17.)  In other words, it was not enough for plaintiffs to allege merely that individuals with knowledge of the investigation’s findings had a duty or were otherwise obligated to report those findings to the Board.  What was required, but was lacking from plaintiffs’ complaint, were particularized factual allegations supporting an inference that someone did in fact report the results of the investigation to the Board.  

    In their third theory, plaintiffs argued that the underlying misconduct was so widespread that the Board must have known about it.  The Court held that while the “magnitude and duration may be probative of whether the Board knew or should have known about a violation of the law . . . these factors will rarely suffice in their own right to satisfy Rule 23.1’s requirement.”  (Slip Op. at 18-19).  Moreover, the Court rejected plaintiffs’ argument that their three theories “buttress[ed] each other” and thus together satisfied Rule 23.1.  The Court held that, where the complaint “lack[ed] particularized allegations about the same key point . . . viewing the complaint as a whole cannot fill in the missing pieces.”  (Slip Op. at 20).
    CATEGORY: Derivative Claims

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