In Halpert, the plaintiff alleged the independent committee's investigation was inadequate because the committee failed to interview any of the 24 individual defendants named in the complaint.Summary of this case from Quantum Technology Partners II v. Altman Browning Co.
October 15, 2008.
AFTER ARGUMENT AND UPON DUE CONSIDERATION of the appeal from the United States District Court for the Southern District of New York (Baer, Jr., J.), it is hereby ORDERED, ADJUDGED, and DECREED that the judgment of the district court is AFFIRMED.
APPEARING FOR PLAINTIFF-APPELLANT: JEFFREY P. FINK (LEIGH R. LASKY, Lasky Rifkind, Ltd., New York, NY, and CAROLINE A. SCHNURER, SHANE P. SANDERS, Robbins Umeda Fink, LLP, San Diego, CA, on the brief), Robbins Umeda Fink, LLP, San Diego, CA.
APPEARING FOR DEFENDANTS-APPELLEES: STEPHANIE G. WHEELER (MICHAEL A. COOPER, JEFFREY J. CHAPMAN, CHARLESHONIG, Sullivan Cromwell LLP, New York, NY, on the brief), Sullivan Cromwell LLP, New York, NY.
PRESENT: HON. JOHN M. WALKER, JR., HON. SONIA SOTOMAYOR, HON. DEBRA A. LIVINGSTON, Circuit Judges.
Plaintiff-Appellant Halpert Enterprises, Inc. ("Halpert") appeals from a decision of the United States District Court for the Southern District of New York dismissing its shareholder derivative action on behalf of J.P. Morgan Chase Co. ("JPMorgan") against the Defendants-Appellees, twenty-four of its officers and directors, pursuant to Federal Rule of Civil Procedure 12(b)(6). On appeal, Plaintiff-Appellant challenges the District Court's holding that JPMorgan's refusal of Plaintiff-Appellant's demand that the corporation bring suit against Defendants-Appellees was not "wrongful." Specifically, Plaintiff-Appellant asserts that the board's refusal was wrongful because the investigating committee (1) failed to interview officers and directors allegedly involved with the wrongdoing and (2) was represented by the same counsel that represented defendants in prior actions relating to the same wrongdoing. We assume the parties' familiarity with the underlying facts, the procedural history, and the issues presented for review.
I. GENERAL PRINCIPLES
Federal Rule of Civil Procedure 23.1 provides that when a shareholder "bring[s] a derivative action to enforce a right that the corporation or association may properly assert but has failed to enforce," it must "state with particularity . . . any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members." Fed.R.Civ.P. 23.1. The underlying substantive requirements governing the adequacy of the plaintiff's efforts are determined by reference to state law. RCM Sec. Fund, Inc. v. Stanton, 928 F.2d 1318, 1330 (2d Cir. 1991). In this case, the parties agree that Delaware law must control because JPMorgan is incorporated in that state.
Under Delaware law, unless any demand would be futile, a shareholder desirous of bringing a derivative action must first "exhaust intracorporate remedies by making a demand on the directors to obtain the action desired." Kaplan v. Peat, Marwick, Mitchell Co., 540 A.2d 726, 730 (Del. 1988). A board's decision to refuse any such pre-suit demand must be analyzed under the business judgment rule. Levine v. Smith, 591 A.2d 194, 200 (Del. 1991), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). That rule establishes "a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) (citing Kaplan v. Centex Corp., 284 A.2d 119, 124 (Del.Ch. 1971); Robinson v. Pittsburgh Oil Refinery Corp., 126 A. 46 (Del.Ch. 1924)), overruled on other grounds, Brehm, 746 A.2d 244 (Del. 2000). To overcome this presumption in the context of a pre-suit demand, a plaintiff must allege facts that, if true, raise a "reasonable doubt" as to whether the board members performed their duty of due care by informing themselves of "all material information reasonably available to them." Aronson, 473 A.2d at 812; see also Spiegel v. Buntrock, 571 A.2d 767, 777 (Del. 1990) (although the business judgment rule usually requires inquiry into the independence of the board as well as its good faith and reasonableness, the plaintiff, in the context of demand refusal, has conceded the independence of the board by making a demand). But see Scattered Corp. v. Chicago Stock Exch., 701 A.2d 70, 74 (1997) ("[I]t does not necessarily follow ex post that the board in fact acted independently. . . . If there is reason to doubt that the board acted independently or with due care in responding to the demand, the stockholder may have the basis ex post to claim wrongful refusal."), overruled on other grounds, Brehm, 746 A.2d 244 (Del. 2000). The issues to be examined "are solely the good faith and reasonableness of [the board's] investigation." Spiegel, 571 A.2d at 777; see also Thorpe v. CERBCO, Inc., 611 A.2d 5, 10 (Del. Ch. 1991). The board's "`ultimate conclusion . . . is not subject to judicial review.'" Spiegel, 571 A.2d at 777 (quoting Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (Del. 1981)). The standard by which the directors' actions in conducting an investigation and seeking to inform themselves adequately are to be judged is gross negligence. Smith v. Van Gorkom, 488 A.2d 858, 873 (Del. 1985), superseded by statute on other grounds, Del. C. Ann. tit. 8, § 102(b)(7) (2008), as recognized in Emerald Partners v. Berlin, 787 A.2d 85, 90 (Del. 2001).
II. ADEQUACY OF INTERVIEW PROCEDURES
Halpert initially contends that the Audit Committee's investigation relating to its demand was unreasonable because the Committee failed to interview the twenty-four individual defendants in this action and chose instead to interview only counsel from prior regulatory investigation and litigation. We find this claim to be without merit.
An investigating board generally is under no obligation to make use of any particular investigative technique. "While a board of directors has a duty to act on an informed basis in responding to a demand such as [Halpert's], there is obviously no prescribed procedure that a board must follow." Levine, 591 A.2d at 214. More specifically, "[i]n any investigation, the choice of people to interview or documents to review is one on which reasonable minds may differ. . . . Inevitably, there will be potential witnesses, documents and other leads that the investigator will decide not to pursue." Mount Moriah Cemetery ex rel. Dun Bradstreet Corp. v. Moritz, No. 11431, 1991 WL 50149, at *4 (Del.Ch. Apr. 4, 1991). This principle is derived from the underlying norm of the business judgment rule — when making a business decision, such as whether to pursue litigation in response to a shareholder demand, a board must be free to exercise its broad discretion without excessive judicial fetters. Cf. Levine, 591 A.2d at 214 (finding that requirement to undertake particular form of investigation would constitute an "unwarranted intrusion upon the board's authority"). As such, there is no rule of general application that a board must interview every possible witness who may shed some light on the conduct forming the basis of the litigation.
Furthermore, nothing in the allegations here suggests that the Audit Committee was unreasonable in failing to interview the named defendants. Counsel for the Audit Committee "conducted a five-month investigation, interviewed 40 people, reviewed numerous documents, [and] reported to the Audit Committee three times." Halpert Enters., Inc. v. Harrison, No. 06 Civ. 2331(HB), 2007 WL 486561, at *5 (S.D.N.Y. Feb. 14, 2007). Instead of the named defendants, it chose to interview internal and external counsel from prior investigations. As the vast majority of the matters under investigation had been examined extensively in prior proceedings, much of the Committee's work had been done for it. Numerous skilled investigators already had looked into nearly all of the matters in question and exercised trained legal judgment as to the potential liability of the defendants. Because several of the prior investigations had culminated in settlement, moreover, prior thought had presumably been directed into the perceived costs and risks associated with litigation. In this situation, counsel assisting in the previous investigations, the exact class of people interviewed, likely were among the Committee's best sources of accurate information regarding the conduct at issue. Indeed, as a result of the prior investigations, a detailed and extensive record regarding the conduct at issue had already been created and was available for review by the Audit Committee. Examination of this record, in connection with the interviews of former counsel, likely was sufficient to enable the Audit Committee to inform itself of "all material information reasonably available to [it]." Aronson, 473 A.2d at 812.
Halpert relies on Hasan v. CleveTrust Realty Investors, 729 F.2d 372 (6th Cir. 1984), but in that case the court indicated that the omitted interviews actually might have provided evidence that was both otherwise unavailable and necessary to evaluate the finding in the committee's report that the plaintiff's allegations were unfounded. Id. at 379. In this case, by contrast, there is little to suggest that interviewing the defendants would have uncovered any new, material facts that could have altered the Audit Committee's recommendation. Halpert fails to allege, for example, why the information provided by attorneys who had worked extensively on prior investigations and litigation was insufficient to give the board a sense of what had happened at JPMorgan in connection with the alleged wrongdoing or why interviews of the named defendants would provide any unique information.
This is not to say that interviews with the named defendants necessarily would have uncovered no new material information. Rather, we merely find that Halpert has not met the heavy burden imposed upon it. Under the circumstances of this case, the District Court did not abuse its discretion in concluding that Halpert's allegations with regard to the Audit Committee's investigatory measures did not raise a reasonable doubt as to whether the board satisfied its duty of due care by availing itself of all reasonably available material information.
III. INDEPENDENCE OF COUNSEL
Halpert's only other claim on appeal is that the Audit Committee's investigation was unreasonable because its counsel in the investigation, Sullivan Cromwell LLP ("SC"), also represents the named defendants in the current action, as well as a prior derivative action based upon substantially similar allegations. We find this contention to be equally lacking in merit.
As a threshold matter, Halpert failed to raise this claim in the District Court proceedings below. It made no mention of any such allegation in either its amended complaint or its memorandum of law opposing the motion to dismiss. At oral argument before the District Court, it made an oblique reference to SC's representation of "the entire group of defendants from the beginning of litigation," but did not assert a claim of wrongful refusal of demand based upon such representation. (Hearing Transcript, Jan. 19, 2007 ("Tr."), at 11.) The question, therefore, was raised for the first time before this Court. We decline to consider this claim, which is raised for the first time on appeal, because there is no indication that hearing it is "necessary to avoid a manifest injustice or [that it] presents a question of law and there is no need for additional fact-finding." Sniado v. Bank Austria AG, 378 F.3d 210, 213 (2d Cir. 2004).
Furthermore, given Halpert's failure to mention this argument in either its complaint or its memorandum, raising any such claim even explicitly at oral argument would have been to no avail. See In re Monster Worldwide, Inc. Sec. Litig., 251 F.R.D. 132, 137 (S.D.N.Y. 2008) ("[T]his argument was raised for the first time at oral argument and so was waived in terms of this motion."); accord Design Strategy, Inc. v. Davis, 469 F.3d 284, 300 (2d Cir. 2006).
The record here is devoid of allegations raising a reasonable doubt as to whether the board satisfied its duty of due care as a result of the Audit Committee's representation by SC. Although SC's dual representation of the named defendants and the Audit Committee could, in theory, have given rise to a conflict of interest sufficient to render the board's refusal of Halpert's demand wrongful, see, e.g., Stepak v. Addison, 20 F.3d 398, 407 (11th Cir. 1994), the amended complaint provides no detail relating to any such representation. The exact nature of SC's representation of the "entire group of defendants from the beginning of litigation" is not clear. (Tr. at 11) No specific facts implicating the concerns discussed in Stepak are alleged. Because this issue was not raised before the District Court, the record is simply incomplete. As a result, we cannot exercise our discretion to consider Halpert's claim for the first time in this proceeding. Sniado, 378 F.3d at 213.
Furthermore, SC's representation of the named defendants appears to have been confined to litigation concerning the futility of Halpert's making a demand of the board. The record contains no allegations that SC had any lingering allegiance to the named defendants regarding those matters, was reluctant to advance arguments disadvantageous to the named defendants, or was impeded by the ethical rules relating to confidentiality. Under these circumstances, there is no basis on which to conclude that a refusal to consider a claim that Halpert raises for the first time before this Court works a "manifest injustice." Sniado, 378 F.3d at 213.
For the foregoing reasons, the judgment of the district court is AFFIRMED.