Among the many litigation threats companies face, a couple of specific kinds of cases have recently emerged: the civil action following on in the wake of an FCPA investigation or enforcement action, and the shareholder suit following after a negative “say on pay” vote. Many companies involved in an FCPA investigation or experiencing a negative say on pay vote have been hit with these kinds of suits However, as discussed below, more recently these cases appear to be failing to get past the preliminary motions stage.
FCPA Follow-On Civil Suit Dismissals
There is no private right of action under the Foreign Corrupt Practices Act. However, as I have noted previously on this blog, companies announcing an FCPA investigation or enforcement action often are hit with follow-on civil actions, in which the claimants typically allege that the company’s directors breached their fiduciary duties by failing to ensure that the company had adequate internal controls or compliance programs to have prevented the improper payments.
In at least a couple of recent instances, lawsuits involving these types of allegations have failed to get past the preliminary dismissal motions. The most example of this involved the shareholders’ derivative suit filed in the District of Massachusetts against Smith & Wesson, as nominal defendant, and members of its board of directors. The complaint followed after the indictment on FCPA allegations of the company’s former director of international sales. (The indictment was later dismissed.) The claimants essentially alleged that the company’s directors breached their duty of care by failing to have effective FCPA controls and oversight. The claimants did not make a pre-suit demand on the company’s board, alleging instead that the demand would have been futile. The defendants moved to dismiss the complaint on the grounds that the claimants had failed to establish demand futility.
In a July 25, 2012 order (here), District of Massachusetts Judge Michael A. Ponsor granted the defendants’ motion to dismiss. Judge Ponsor found two reasons for concluding that the plaintiffs had failed to establish demand futility. The first is that a previous decision in a prior, unrelated state court derivative suit (involving allegations that the company had misrepresented its financial condition), the court had concluded that demand was not excused in that prior suit because there was a disinterested and independent board majority that could have considered the pre-suit demand. Applying principles of issue preclusion, Judge Ponsor concluded that the prior court’s conclusion about the independence of the board majority was determinative of the issue in this case.
Judge Ponsor did go on to note that even if there had been no prior determination of the issue, the plaintiffs in this case had failed to present the requisite particularized allegations to establish demand futility. He noted that “nothing offered in the complaint comes close to pushing the case” over the “difficult threshold” to establish that demand would be futile, adding that “the complaint is flatly devoid of any adequate justification for failing to make the required pre-suit demand.”
The decision in the Smith & Wesson case follows shortly after a similar decision in a case in the Eastern District of Louisiana involving Tidewater, Inc. In November 2011, and in settlement of FCPA allegations involving alleged improper payments in Azerbaijan and Nigeria, the company agreed to pay the SEC $8.1 million in disgorgement and pre-judgment interesting, and also agreed to pay the U.S. Department of Justice a $7.35 million penalty as part of a Deferred Prosecution Agreement.
A Tidewater shareholder filed a shareholder derivative action against Tidewater, as nominal defendant, and against its board, alleging that the directors had breached their fiduciary duty by disregarding the payment of bribes and by failing to ensure that the company had adequate internal controls to ascertain FCPA compliance. The defendants moved to dismiss on the grounds that the plaintiff had failed to make pre-suit demand on the board and that the plaintiff had not pled sufficient facts to establish demand futility.
In a July 2, 2012 order (here), Eastern District of Louisiana Judge Jane Triche-Milazzo granted the defendants’ motion to dismiss, finding that the “even taking all of plaintiff’s allegations as truth, he has failed to plead with particularity that demand on the board would have been futile.” However, Judge Triche-Milazzo did grant the plaintiffs’ leave to file a motion to amend their complaint.
In addition to these cases involving the pre-suit demand requirements, at a recent hearing in the Delaware Chancery Court involving civil litigation arising out of the recent Wal-Mart bribery scandal, Chancellor Leo Strine chastised the prospective lead plaintiffs for rushing to file their suits without first making a books are records request as allowed under the Delaware statutes.
As discussed in Lance Duroni’s July 16, 2012 article on Law 360 (here, registration required) about the Wal-Mart hearing, the purpose of the hearing was to determine which of the competing claimants would be named as lead plaintiff in the Delaware derivative litigation seeking to hold certain Wal-Mart directors and officers liable in connection with the company’s alleged improper payments in Mexico. Chancellor Strine rejected motions from both erstwhile lead plaintiffs, stating, according to the article, that “more energy has been spent by the dueling plaintiffs on who gets to be lead plaintiff and counsel than was spent investigating and writing these complaints.” At least one other claimant had in fact made a books and records request, and Strine said he would defer choosing a lead plaintiff until the company had responded to the request and the parties had beefed up their complaints. Alison Frankel also has a July 17, 2012 article on her On the Case blog (here) discussing Chancellor Strine’s ruling in the Wal-Mart case.
If nothing else, these cases show that claimants eager to pursue shareholder derivative suits following on FCPA investigations cannot dispense with the procedural prerequisites. The requirement to conduct pre-suit due diligence and then to make the requisite pre-suit demand are substantial requirements with which a failure to comply can be prohibitive. At a minimum, the requirement for pre-suit due diligence raises the cost for prospective litigants, and the enforcement of the requirement for a pre-suit demand could represent an insurmountable barrier in many cases.
These procedural requirements are of course not new. If however prospective litigants recognize that they are not going to be able to bypass these requirements, at least some prospective litigants may be deterred from filing their suits. If that were to happen, there might be fewer of these FCPA enforcement follow-on civil suits filed I n the first place.
Say on Pay Suits Fare Poorly
During 2011, the first year in which companies held advisory shareholder votes on executive compensation as required by the Dodd-Frank Act, many of the companies experiencing negative shareholder votes subsequently were hit with shareholder suits, often filed in reliance of the negative “say on pay” vote (as I discussed in posts at the time, here and here).
Early on, these cases looked like they may have legs, particularly after a judge in the Southern District of Ohio denied the motion to dismiss in the shareholder suit filed against Cincinnati Bell and certain of its directors and officers after the company experienced a negative say on pay vote. As discussed here, Southern District of Ohio Judge Timothy Black held in a September 2011 opinion that, where plaintiffs alleged that the company’s directors breached their fiduciary duty when they approved an executive pay package after a negative say on pay vote, “the plaintiff’s allegations create a reasonable doubt that the challenged transaction is the result of valid business judgment, and accordingly, the directors possess a disqualifying interest sufficient to render pre-suit demand futile and hence unnecessary.”
However, as discussed in a July 10, 2012 memo from the Vinson & Elkins law firm entitled “Say-on-Pay Lawsuits Losing Steam” (here), many courts considering these same issues after the Cincinnati Bell decision have reached a contrary conclusion, and have rejected the argument that a negative say on pay vote rebuts the business judgment rule or constitutes a disqualifying interest. The subsequent cases “indicate that Cincinnati Bell’s approach is quickly falling in to disfavor,” noting that “courts have repeatedly disavowed this approach.”
The article notes that these more recent decisions do not necessarily mean that “companies will cease to be sued for negative say-on-pay results.” However, the decisions “do suggest that derivative suits in the wake of an adverse say-on-pay vote may soon be less common than before.”
Both of these types of lawsuits – the follow-on FCPA-related civil action and the shareholder suit following a negative say-on-pay vote – seemed to attract a great deal of interest from certain parts of the plaintiffs’ bar. However, recent dismissal motion outcomes in these cases are beginning to suggest that these cases are not faring all that well in the courts. Even if these recent dismissal motion rulings do not discourage the filing of these cases altogether, it may deter some suits from being filed. In many instances these kinds of suits may not represent the opportunity that plaintiffs’ lawyers may have thought earlier on.
To be sure, many of the say-on-pay lawsuits may not have been about money. In some instances, the lawsuits may simply represent one more way that activist shareholders are trying to pressure corporate boards about executive compensation issues. To the extent that the lawsuits are simply one more tactical approach in a larger strategic battle about executive compensation, the adverse dismissal motion rulings may represent less of a deterrent.
Community Banks and D&O Insurance: If you have not yet seen it, you may want to take a look at the June 2012 paper that Advisen has posted on its website entitled “Community Bank Lending: Practices and Failures, and the Role of Directors and Officers (D&O) Insurance” (here). The paper provides an interesting top level overview of the risks and exposures facing community banks and their directors and officers – particularly the former directors and officers of failed banks. A more current update of the statistical information in the paper can be found in my recent post on FDIC failed bank lawsuits here.
This is Going to Really Bug You: In his article “The Mosquito Solution” in the July 16, 2012 issue of The New Yorker (here), Michael Spector writes, with respect to mosquitos, that “there has never been a more effective killing machine” adding that “researchers estimate that mosquitos have been responsible for half of the deaths in human history.”
Malaria accounts for much of the mortality, but mosquitos “also transmit scores of other potentially fatal infections, including yellow fever, dengue fever, chikungunya, lymphatic filariasis, Rift Valley fever, West Nile fever and several types of encephalitis.” Mosquitos “pose a greater risk to a larger number of people than ever before.”
Spector’s article describes an experimental approach to try to combat mosquitos, by releasing genetically altered male mosquitos into the wild. The modified males mate but their progeny are genetically programed to die quickly after hatching. This approach has shown early promise by reducing the mosquito populations in controlled release areas. However, the proposal to release genetically altered bugs into the wild has proved to be controversial, as described in the article.
This is an interesting and important article.
Three Thoughts About the London Olympics:
1. Her Royal Majesty Queen Elizabeth II as a Bond girl. Sheer brilliance. The rest of the opening ceremony looked a lot like chaos dressed up in period costumes.
2. After waiting four years to see Olympic sports competition, and after an entire day of Olympic competition in which numerous medals were awarded, we turn on our TV in prime time, and what does NBC choose to show us? A preliminary round of Beach Volleyball. And Ryan Seacrest. Oh. My. God.
3. Ryan Lochte wins Olympic gold in the 400 meter individual medley. Switch to a commercial break with three ads featuring Ryan Lochte. And to think that Jim Thorpe once had to forfeit his Olympic medals for violating the principles of amateurism because he had played semi-pro baseball to earn a living.