Corporate misconduct and the perfect storm of shareholder litigation

Notre Dame Law Review

Volumn 84, Issue 1, 2008, Pages 75-130

  Erickson, Jessica ^a  

^a UNIVERSITY OF RICHMOND   (United States)

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EID: 58849148049     PISSN: 07453515     EISSN: None     Source Type: Journal    
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References (363)

1. Like Sebastian Junger, I use the term "perfect storm" in a meteorological sense, in the sense of "a storm that could not possibly have been worse." SEBASTIAN JUNGER, THE PERFECT STORM xiv (1997).
2. The use of this term is not meant to imply that corporations are blameless or that they find themselves in this predicament through mere chance. Cf. Nancy B. Rapoport, Enron, Titanic, and The Perfect Storm, in ENRON: CORPORATE FIASCOS AND THEIR IMPLICATIONS 927, 929-930 (Nancy B. Rapoport & Bala G. Dharan eds., 2004) (arguing that Enron was brought down by a "synergistic combination of human errors and hubris: a 'Titanic' miscalculation, rather than a 'perfect storm'").
3. See infra Part II.
4. I am speaking here purely about the legal means to enforce fiduciary duties. The market obviously plays a powerful role in policing corporate managers as well. See, e.g., Frank H. Easterbrook & Daniel R. Fischel, The Corporate Contract, 89 COLUM. L. REV. 1416, 1418-22 (1989).
5. In cases involving mergers or acquisitions, shareholders may also be able to enforce the fiduciary duties of corporate managers through direct suits (usually shareholder class actions) filed under state law. See, e.g., Robert B. Thompson & Randall S. Thomas, The New Look of Shareholder Litigation: AcquisitionOriented Class Actions, 57 VAND. L. REV. 133, 181 (2004) (analyzing the rise of acquisition-oriented shareholder class actions). Outside of the acquisition context and certain other narrow contexts, however, shareholders are generally limited to filing a derivative suit or a federal securities class action to enforce the legal duties of managers.
6. See, e.g., Stephen J. Choi, The Evidence on Securities Class Actions, 57 VAND. L. REV. 1465, 1468-76, 1507-22 (2004) (exploring the impact of changes in federal law on securities class actions and the possibility of exporting the securities class action model to other countries);
7. James D. Cox, The Social Meaning of Shareholder Suits, 65 BROOK. L. REV. 3, 5-19 (1999) (analyzing the deterrent and compensatory goals of derivative suits) ;
8. Reinier Kraakman et al., When Are Shareholder Suits in Shareholder Interests?, 82 GEO. L.J. 1733, 1758-61 (1994) (analyzing the conflicts of interest inherent in securities class actions);
9. Robert B. Thompson & Randall S. Thomas, The Public and Private Faces of Derivative Lawsuits, 57 VAND. L. REV. 1747, 1762 (2004) (exploring the role of derivative suits in modern corporate litigation);
10. Elliott J. Weiss &John S. Beckerman, Let the Money Do the Monitoring: How Institutional Investors Can Reduce Agency Costs in Securities Class Actions, 104 YALE L.J. 2053, 2105-09 (1995) (arguing that institutional investors should play a greater role in monitoring the settlements of securities class actions).
11. For example, when the massive fraud at Enron Corporation was revealed, the company was named in nearly one hundred securities class actions and fifty derivative suits. See Disclosure Statement for Fifth Amended Joint Plan of Affiliated Debtors Pursuant to Chapter 11 of the United States Bankruptcy Code, at app. E, In re Enron Corp., No. 01-16034 (Bankr. S.D.N.Y. Jan. 9, 2004), available at http://www.elaw4enron.com/EnronPlanframe.htm;
12. Joann S. Lublin & John R. Emshwiller, Enron Board's Actions Raise Liability Questions, WALL ST. J., Jan. 17, 2002, at Cl.
13. A few scholars have discussed briefly the relationship between various types of shareholder litigation. See, e.g., Kenneth B. Davis, Jr., The Forgotten Derivative Suit, 61 VAND. L. REV. 387, 412-15 (2008);
14. Robert B. Thompson & Hillary A. Sale, Securities Fraud as Corporate Governance: Reflections upon Federalism, 56 VAND. L. REV. 859, 887-90 (2003). No scholar, however, has ever performed an extensive analysis of this relationship.
15. See infra notes 40-42 and accompanying text
16. See infra notes 125-29 and accompanying text.
17. See, e.g., Zapata Corp. v. Maldonado, 430 A.2d 779, 784, 786 (Del. 1981) (holding that "[derivative suits enforce corporate rights" and that the law permits shareholders to sue on behalf of corporations where "it is apparent that material corporate rights would not otherwise be protected").
18. This conventional wisdom is so well accepted in the legal literature that no scholars have questioned it or even addressed it explicidy, and yet it is the common response when the topic of the relationship between securities class actions and derivative suits is raised. We can see more subde expressions of the conventional wisdom in a number of contexts. For example, courts often permit a single attorney to represent the named shareholders in both a derivative suit and a securities class action. Even though the attorney is representing the corporation in one suit and suing the corporation in the other suit, courts have held that these dual roles are permissible given that the goal of both suits is to "attack... alleged misconduct by corporate management." In re Dayco Corp. Derivative Sec. Litig., 102 F.R.D. 624, 630 (S.D. Ohio 1984);
19. see also Grace v. Rosenstock, No. CV-85-2039, 1986 WL 2709, at *3 (E.D.N.Y. Mar. 6, 1986) ("The prevailing view is that class and derivative actions represented by the same plaintiff and counsel are not inherendy precluded by conflicting party alignment."
20. (quoting HERBERT B. NEWBERG, NEWBERG ON CLASS ACTIONS §22.23 (2d ed. 1977)).
21. Courts have also permitted plaintiff shareholders to join securities claims and derivative claims in a single lawsuit. See, e.g., Keyser v. Commonwealth Nat'l Fin. Corp., 120 F.R.D. 489, 492 (M.D. Pa. 1988) (joining a securities class action and a derivative suit because both lawsuits were "equally contingent upon the proof of the same nucleus of facts"
22. (quoting In re Dayco Corp., 102 F.R.D. at 630)).
23. See, e.g., Geoffrey P. Miller, Conflicts of Interest in Class Action Litigation: An Inquiry into the Appropriate Standard, 2003 U. CHI. LEGAL F. 581, 604 ("A... zero-sum situation arises when class counsel brings both derivative and direct cases based on the same nucleus of operative fact").
24. Over 90% of securities class actions allege violations of section 10(b) of the Securities Exchange Act of 1934 (Exchange Act), 15 U.S.C. § 78j(b) (2006), which prohibits corporations or other persons from making false or misleading statements in connection with the purchase or sale of a security. See Tom Baker & Sean J. Griffith, Predicting Corporate Governance Risk: Evidence from the Directors' & Officers' Liability Insurance Market, 74 U. CHI. L. REV. 487, 498 (2007).
25. See, e.g., Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353, 365-66 (5th Cir. 2004) (holding that a corporation is directly liable for all false or misleading statements contained within "the SEC filings, reports and releases issued in its name" as long as the false or misleading statements were made with scienter);
26. In re Cylink Sec. Litig., 178 F. Supp. 2d 1077, 1088 (N.D. Cal. 2001) ("A corporate entity can be vicariously liable under section 10(b) for the fraud of its officers. So long as scienter is appropriately alleged for the officers and directors of a company, then it is appropriately alleged for the company itself." (citation omitted)).
27. See Volk v. D.A. Davidson & Co., 816 F.2d 1406, 1413 (9th Cir. 1987) (holding that the "general rule" is that shareholders in a securities class action can "recover the difference between the value of the consideration paid and the value of the securities received, plus consequential damages that can be proven with reasonable certainty to have resulted from the fraud").
28. See Van Gelder v. Taylor, 621 F. Supp. 613, 620 (N.D. 111. 1985) ("As a general rule, the plaintiff stockholder in a stockholder's derivative suit is 'at best the nominal plaintiff. '
29. The corporation is the real party in interest, regardless of the fact that the corporate management has failed to pursue the action." (citation omitted) (quoting Liddy v. Urbanek, 707 F.2d 1222, 1224 (11th Cir. 1983))).
30. See Janssen v. Best & Flanagan, 662 N.W.2d 876, 882 (Minn. 2003) ("Derivative suits allow shareholders to bring suit against wrongdoers on behalf of the corporation, and force liable parties to compensate the corporation for injuries so caused.").
31. See Kramer v. W. Pac. Indus., Inc., 546 A.2d 348, 351 (Del. 1988) ("In [a derivative suit] the shareholder sues on behalf of the corporation.... [A]ny damages recovered... are paid to the corporation."
32. (quoting ROBERT C. CLARK, CORPORATE LAW 639-40 (1986))).
33. See Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) ("The derivative action developed in equity to enable shareholders to sue in the corporation's name where those in control of the company refused to assert a claim belonging to it.").
34. It is true that there is often not a perfect overlap between the individual defendants in the two sets of suits. Securities class actions tend to involve claims against corporate officers, while derivative suits tend to involve claims against corporate directors. Cf. Thompson & Sale, supra note 6, at 895-96 (presenting data illustrating that corporate officers are named in securities class actions more often than corporate directors). For the corporation, however, as long as the factual allegations against the individual defendants revolve around the same core set of events, the fact that the two lawsuits do not involve the exact same group of individual defendants does little to ameliorate the company's predicament.
35. See CORNERSTONE RESEARCH, SECURITIES CLASS ACTION CASE FILINGS: 2007 MIDYEAR ASSESSMENT 13 (2007), http://securities.cornerstone. com/pdfs/2007%20MidYear%20Assessment.pdf (finding that ninety-two percent of securities class actions allege misrepresentations in financial documents).
36. See Malone v. Brincat, 722 A.2d 5, 9 (Del. 1998) ("[D]irectors who knowingly disseminate false information that results in corporate injury or damage to an individual stockholder violate their fiduciary duty, and may be held accountable in a manner appropriate to the circumstances.").
37. See, e.g., Rattner v. Bidzos, No. Civ.A. 19700, 2003 WL 22284323, at *1 (Del. Ch. Sept 30, 2003) (alleging that the individual defendants in a derivative suit "breached their fiduciary duty of care by inadequately maintaining accounting controls and utilizing improper accounting and audit practices");
38. Manzo v. Rite Aid Corp., No. Civ.A. 18451-NC, 2002 WL 31926606, at *2 (Del. Ch. Dec. 19, 2002) (relating the plaintiff's allegations that a corporation's directors and officers were liable in a derivative suit under a breach of fiduciary duty theory for allegedly false and misleading Statements "in virtually every single piece of financial information released by Rite Aid for over three years").
39. In March 2004, Stewart was convicted of conspiracy, obstruction of justice, and making false statements relating to her sale of ImClone stock. See Associated Press, Martha Stewart to Fight Civil Case, WALL ST. J., May 27-28, 2006, at B3.
40. The SEC also filed civil charges of insider trading against Stewart. See Press Release, Sec. & Exch. Comm'n, Martha Stewart and Peter Bacanovic Setde SECs Insider Trading Charges (Aug. 16, 2006), available at http://www.sec.gov/news/press/2006/2006-134.htm.
41. See Consolidated and Amended Class Action Complaint ¶ 33, Semon v. Martha Stewart Living Omnimedia, Inc., 2003 WL 22769065 (S.D.N.Y. May 23, 2003) (No. 02-CV-6273 QES)), 2002 WL 32495905 [hereinafter Securities Complaint].
42. The Consolidated and Amended Class Action Complaint is the last version of the complaint filed in the securities class action. This action consolidated seven securities class actions previously filed in the Southern District of New York. See Martha Stewart Living Omnimedia, Inc., Annual Report (Form 10-K), at 12-13 (Mar. 15, 2004).
43. See Securities Complaint, supra note 24, ¶ 33.
44. See id. ¶¶ 44-45.
45. See id. ¶¶ 49-53.
46. See id. ¶ 53.
47. See Press Release, Sec. & Exch. Comm'n, SEC Charges Martha Stewart, Broker Peter Bacanovic with Illegal Insider Trading (June 4, 2003), available at http://www.sec.gov/news/press/2003-69.htm.
48. See, e.g., Securities Complaint, supra note 24, ¶ 87 ("Martha Stewart did not receive any nonpublic information regarding ImClone prior to her sale of a small number of ImClone shares. Her transaction was entirely lawful."
49. (quoting June 7, 2002 statement by Susan Magrino, publicist for Martha Stewart Living Omnimedia, Inc.)); id. ¶ 90
50. (quoting a June 12, 2002 MSL Press release in which Stewart stated that she sold her remaining ImClone shares in December 2001 pursuant to a longstanding agreement with her broker and that she "did not have any nonpublic information regarding ImClone when [she] sold" her shares).
51. See Yahoo! Finance, Historical Prices for Martha Stewart Living Omnimedia Inc., http://finance.yahoo.com/q/hp?s=MSO&a=05&b=3&c= 2002&d=07&e=9&f=2002&g=d (last visited Nov. 11, 2008).
52. See Martha Stewart Living Omnimedia, Inc., Annual Report (Form 10-K), at 12-13 (Mar. 15, 2004) (disclosing that the company was named in seven securities class actions filed between August 6, 2002 and September 18, 2002).
53. See id. at 13 (disclosing seven shareholder derivative suits, later consolidated into four derivative suits, filed between August 15, 2002 and September 29, 2003).
54. See, e.g., Amended Complaint ¶¶ 59-65,
55. Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 833 A.2d 961 (Del Ch. 2003) (CA. No. 19844-NC), 2002 WL 32904940 [hereinafter Derivative Complaint].
56. Securities Complaint, supra note 24, ¶ 27. Compare id. (noting that at the time MSL went public the company warned that the business would be adversely affected if "Martha Stewart's public image or reputation were to be tarnished" (citing Martha Stewart living Omnimedia Inc., Amendment No. 4 to Form S-1 Registration Statement (Form S-1/A), at 14 (Oct. 18, 1999))),
57. with Derivative Complaint, supra note 34, ¶ 16 (noting that MSL warned that " 'THE LOSS OF THE SERVICES OF MARTHA STEWART... WOULD MATERIALLY ADVERSELY AFFECT OUR REVENUES'" (quoting Martha Stewart Living Omnimedia Inc., Amendment No. 4 to Form S-1 Registration Statement (Form S-1/A), at 14 (Oct. 18, 1999))).
58. See Securities Complaint, supra note 24, ¶ 53 (alleging Stewart sold remaining 3928 shares of ImClone after her broker told her that the Waksal family had sold its remaining shares);
59. Derivative Complaint, supra note 34, ¶ 30 (same).
60. See, e.g., Securities Complaint, supra note 24, ¶¶ 87, 90, 93;
61. Derivative Complaint, supra note 34, ¶¶ 33-34, 38.
62. See Securities Complaint, supra note 24, ¶ 108 (stating that MSO shares declined from $19.40 to $6.78 after government investigation of Stewart was made public);
63. Derivative Complaint, supra note 34, 1 44 (stating that MSO common stock declined sixty-six percent from the time period when public investors had no information regarding government investigation surrounding Stewart's sale of ImClone stock).
64. See Securities Complaint, supra note 24, ¶¶ 8-9;
65. Derivative Complaint, supra note 34, ¶¶ 2-3.
66. See, e.g., Dell, Inc., Current Report (Form 8-K), at 1-2 (Mar. 1, 2007) (disclosing that the company was named in four securities class actions, seven derivative suits, and four ERISA suits "all arising out of the same events and facts" related to the company's disclosures);
67. Blue Rhino Corp., Annual Report (Form 10-K), at 8 (Oct. 21, 2003) (disclosing that the company had been named in several securities class actions and derivative suits "all arising out of substantially the same alleged facts and circumstances" relating to the company's alleged failure to disclose certain facts related to various acquisitions and other transactions);
68. Taser Int'l, Inc., Quarterly Report (Form 10-Q), at 12-13 (May 10, 2007) (disclosing that the company had been named in "numerous securities class action lawsuits" related to "the safety of the Company's products and the Company's ability to meet its sales goals" and that various shareholders had subsequentiy filed "numerous shareholder derivative actions... based on similar facts and events as those alleged in the securities class action complaints");
69. Tibco Software Inc., Annual Report (Form 10-K), at 17 (Feb. 9, 2007) (announcing that the company had been named in three securities class actions and one derivative suit and that the derivative suit "was based on substantially similar facts and circumstances as the class actions").
70. David Priebe, Piling On: The Reemergence of the Parallel Derivative Lawsuit as the Federal Securities Class Action Window Closes, in SECURITIES LITIGATION 1999, at 333, 335 (PLI Corp. Law & Practice Course Handbook Series No. B-1136, 1999);
71. see also Peter M. Stone & Jay C. Gandhi, The "Clone" Derivative Lawsuit, ORANGE COUNTY LAWYER, July 2004, at 34 (referring to a "recent spate of 'clone' derivatives - lawsuits which merely replicate the allegations of federal securities class actions and reframe them as ordinary breach of fiduciary duty claims").
72. See Petition for Review at 9, Ellison v. Superior Court, S128367 (Cal. 2004), 2004 WL 3080563 (
73. quoting Michael A. Collora & David M. Osborne, Shareholders are Taking a Fresh Look at Derivative Suits To Pursue Investor Fraud Cases, NAT'L L.J., Feb. 15, 1999 at B8).
74. Ellison also claimed that "Silicon Valley companies, in particular, have seen a 'recent flurry of derivative suits' that 'use federal class actions as a springboard to allege fraud and insider trading'" and that "[i]t has gotten to the point that a federal securities fraud action now almost inevitably will be accompanied by a 'parallel derivative lawsuit' " Id. at 9
75. (quoting Renee Deger, State of Alert: Silicon Valley Corporate Firms On Guard As the Plaintiffs Bar Takes Securities Cases to State Court, S.F. RECORDER, Aug. 9, 2001, at 1;
76. Priebe, supra note 41, at 335).
77. LAURA E. SIMMONS & ELLEN M. RYAN, CORNERSTONE RESEARCH, SECURITIES CLASS ACTION SETTLEMENTS: 2007 REVIEW AND ANALYSIS 11, available at http://www.cornerstone.com/pdf/practice-securities/ 2007Settlements-Report.pdf.
78. Id.
79. See infra notes 96-97 and accompanying text.
80. See infra notes 122-24.
81. For a discussion of the role of federal and state law in preventing and deterring corporate misconduct, see Thompson & Thomas, supra note 4, at 1753-54.
82. See id.
83. Lawton W. Hawkins, Exchange-Enhanced Special Litigation Committees: Enforcing Fiduciary Duties Amid a Crisis of Trust, 2003 UTAH L. REV. 587, 588.
84. Surviving a motion to dismiss is a critical hurdle for plaintiffs in securities class actions, as nearly forty percent of securities class actions are dismissed at this stage. See TODD FOSTER ET AL., NERA ECON. CONSULTING, RECENT TRENDS IN SHAREHOLDER CLASS ACTION LITIGATION 4 (2007), http://nera.com/image/BRO-Recent-Trends-SEC1288-FINAL-0307.pdf.
85. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976).
86. See In re Phillips Petroleum Sec. Litig., 881 F.2d 1236, 1244 (3d Cir. 1989);
87. Van Dyke v. Coburn Enters., 873 F.2d 1094, 1100 (8th Cir. 1989);
88. McDonald v. Alan Bush Brokerage Co., 863 F.2d 809, 814 (11th Cir. 1989);
89. Hackbart v. Holmes, 675 F.2d 1114, 1117-18 (10th Cir. 1982);
90. Broad v. Rockwell Int'l Corp., 642 F.2d 929, 961-62 (5th Cir. 1981) (en banc);
91. Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1023-25 (6th Cir. 1979);
92. Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1044-45 (7th Cir. 1977).
93. See, e.g., David T. Bazelon, Clients Against Lawyers, HARPER'S MAG., Sept. 1967, at 104 ("[The business judgment rule], which began as a minor exception, is now so dominant a winning argument that the only fun left is trying to prove that [it]... does not cover absolutely all forms of corporate theft."), quoted in Lyman P.Q. Johnson, Corporate Officers and the Business Judgment Rule, 60 BUS. LAW. 439, 439 (2005).
94. In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 52 (Del. 2006)
95. (quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)).
96. 488 A.2d 858 (Del. 1985).
97. See id. at 893;
98. Christopher M. Bruner, Good Faith, State of Mind, and the Outer Boundaries of Director Liability in Corporate Law, 41 WAKE FOREST L. REV. 1131, 1141 (2006) ("The business community - and perhaps more pertinendy, their insurers - were shocked by the outcome in Van Gorkom.... Van Gorkom appeared not to have applied the BJR so much as to have eviscerated it").
99. See DEL. CODE ANN. tit. 8, § 102(b)(7) (2001);
100. see also Bernard S. Sharfman, Being Informed Does Matter: Fine Tuning Gross Negligence Twenty Plus Years After Van Gorkom, 62 Bus. LAW. 135, 136-37 (2006) (tracing the history of Delaware's exculpation statute).
101. See, e.g., MD. CODE ANN., CTS. & JUD. PROC. § 5-418 (LexisNexis 2006) (allowing corporations to exculpate their officers or directors);
102. VA. CODE ANN. § 13.1-692.1 (2006) (same).
103. See J. Robert Brown, Jr., The Irrelevance of State Corporate Law in the Governance of Public Companies, 38 U. RICH. L. REV. 317, 332 n.93 (2004) (noting that by 2003, all fifty states had statutes enabling corporations to limit or eliminate personal liability for directors).
104. Celia R. Taylor, The Inadequacy of Fiduciary Duty Doctrine: Why Corporate Managers Have Little to Fear and What Might Be Done About It, 85 OR. L. REV. 993, 1022-23 & n.131 (2006) (writing that within one year of the date that Delaware enacted its statute permitting exculpation clauses, over ninety percent of a random selection of 180 law firms had adopted such a clause);
105. see also Roberta Romano, Corporate Governance in the Aftermath of the Insurance Crisis, 39 EMORY L.J. 1155, 1160-61 & n.11 (1990) (same).
106. DEL. CODE ANN. tit. 8, § 102(b)(7).
107. See Deborah A. DeMott, Limiting Directors' Liability, 66 WASH. U. L.Q. 295, 298-310 (1988) (comparing other states' statutes with Delaware statutory scheme).
108. Davis, supra note 6, at 404 ("The exculpatory statutes and enhanced judicial deference to independent directors have combined to marginalize the derivative suit for cases not involving self-dealing or other palpable breaches of the duty of loyalty.").
109. This similarity is most pronounced in claims against large, public corporations alleging duty of care-type claims. As other scholars have noted, and as I discuss later in Part III.C, the overlap between these lawsuits is less pronounced when the derivative claims allege more classic violations of the duty of loyalty. See Davis, supra note 6, at 439-50 (discussing the fact that a substantial number of derivative suits allege that a controlling shareholder exploited control of the corporation, allegations that can be more difficult to turn into the basis of a securities class action);
110. infra notes 240-42 and accompanying text.
111. DEL. CODE ANN. tit. 8, § 102(b) (7).
112. In re Walt Disney Co. Derivative Litig., 906 A.2d 27 (Del. 2006).
113. Id. at 62-63 (emphasis added).
114. In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 289 (Del. Ch. 2003);
115. see also In re Emerging Commc'ns, Inc. S'holders Litig., No. Civ. A. 16415, 2004 WL 1305745, at *43 (Del. Ch. June 4, 2004).
116. Novak v. Kasaks, 216 F.3d 300, 308 (2d Cir. 2000) (emphasis added).
117. In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 550 (6th Cir. 1999) (emphasis added).
118. Id.
119. In re Enron Corp. Sec, Derivative & ERISA Litig., 235 F. Supp. 2d 549, 679 (S.D. Tex. 2002) (emphasis added).
120. See Greg Ip, Study Finds Wider Impact of Mortgage Losses, WALL ST. J., Mar. 1, 2008, at A2.
121. See Merrill Lynch & Co., Current Report (Form 8-K), at Ex. 99.1 (Oct. 24, 2007).
122. See Merrill Lynch & Co., Annual Report (Form 10-K), at 134 (Feb. 25, 2008).
123. Class Action Complaint for Violation of the Federal Securities Laws ¶ 47, Life Enrichment Found, v. Merrill Lynch & Co., No. 1:07-9633 (S.D.N.Y. filed Oct. 10, 2007), available at http://securities.stanford. edu/1038/MER-01/20071030-f01c-Life.pdf. Merrill Lynch's shareholders filed numerous securities class actions and derivative suits. This discussion focuses on representative complaints from one securities class action and one derivative suit.
124. Id. ¶ 9(b).
125. See Restated Certificate of Incorporation of Merrill Lynch & Co., art. XIII, § 1 (May 3, 2001), available at http://www.ml.com/ media/14259.pdf.
126. Verified Shareholder's Derivative Complaint ¶ 65, Arthur v. O'Neal, No. 1:07-9696 (S.D.N.Y. filed Nov. 1, 2007).
127. Id. ¶ 81.
128. These concerns apply even if corporations do not have an applicable exculpation clause. Absent an exculpation clause, courts review fiduciary duty claims alleging a violation of the duty of care under the business judgment rule. See Desimone v. Barrows, 924 A.2d 908, 933 (Del. Ch. 2007).
129. The Delaware Supreme Court has likened this standard to one of gross negligence. See Crescent/Mach I Partners, L.P. v. Turner, 846 A.2d 963, 985 (Del. 2000).
130. Allegations of gross negligence generally do not state a viable claim under the federal securities laws. See, e.g., DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 390 (9th Cir. 2002). However, securities plaintiffs may nonetheless be able to use information gleaned from the derivative case to help build their own cases. They will still need to prove that the officers and/or directors violated the more stringent standard applicable in their cases, but this is obviously far easier than creating a case from scratch.
131. See infra notes 139-42 and accompanying text
132. See Zapata Corp. v. Maldonado, 430 A-2d 779, 788-89 (Del. 1981).
133. No empirical evidence exists regarding the length of these committee reports, but these reports are far from short. The Delaware Chancery Court opined more than twenty years ago that "the developing rule of thumb in this jurisdiction would appear to be that a report by a Special Litigation Committee recommending dismissal of a derivative suit must be at least 150 pages in length, exclusive of appendices and attachments." Kaplan v. Wyatt, 484 A.2d 501, 510 (Del. Ch. 1984)
134. aff'd, 499 A.2d 1184 (Del. 1985).
135. Over the last twenty years, reports have only grown in length. See, e.g., In re Oracle Corp. Derivative Litig., 824 A.2d 917, 925 (Del. Ch. 2003) (noting that the committee in that case had produced a report totaling 1,110 pages, excluding exhibits and appendices).
136. See, e.g., Newby v. Enron Corp., 338 F.3d 467, 471 (5th Cir. 2003) (describing plaintiffs prior to 1995 who "would use discovery to substantiate an initially frivolous complaint");
137. Choi, supra note 4, at 1469 (describing problems with discovery in securities class actions prior to enactment of the Reform Act);
138. Cindy Krischer Goodman, Grin and Bear It? Shareholders Have Other Ideas When Stocks Sink, CHI. TRIB., Mar. 13, 2000, § 6, at 1 (noting that 1995 enactment of the Private Securities Reform Litigation Act was designed to limit discovery and accordingly reduce the number of frivolous securities class actions).
139. H.R. REP. NO. 104-369, at 37 (1995)
140. ("The House and Senate heard testimony that discovery in securities class actions often resembles a fishing expedition. As one witness noted, 'once the suit is filed, the plaintiffs law firm proceeds to search through all of the company's documents and take endless depositions for the slightest positive comment which they can claim induced the plaintiff to invest and any shred of evidence that the company knew a downturn was coming.'" (quoting testimony of Richard J. Egan, Chairman of EMC Corp.)).
141. See, e.g., In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 263 (2d Cir. 1993) (discussing the need in securities class actions to deter "the use of the litigation process as a device for extracting undeserved setdements as the price of avoiding the extensive discovery costs that frequently ensue once a complaint survives dismissal, even though no recovery would occur if the suit were litigated to completion").
142. Pub. L. No. 104-67, 109 Stat 737 (codified as amended in scattered sections of 15 U.S.C).
143. 15 U.S.C. §§ 77z-1 (b), 78u-4(b) (3) (B) (2006).
144. Id. § 78u-4(b)(2).
145. See DEBORAH A. DEMOTT, SHAREHOLDER DERIVATIVE ACTIONS § 4.15 (1994) (explaining that derivative suits are generally subject to the same discovery rules applicable to all civil actions).
146. Some corporations have been successful in obtaining a court order prohibiting derivative plaintiffs from sharing discovery with securities plaintiffs under a provision of the Reform Act that permits federal courts to stay discovery in a state derivative action if such a stay is "necessary in aid of its jurisdiction" or "to protect or [to] effectuate its judgments." See In re DPL, Inc. Sec. Litig., 247 F. Supp. 2d 946, 950 (S.D. Ohio 2003)
147. (quoting 15 U.S.C. § 78u-4(b)(3)(D));
148. see also In re Cardinal Health, Inc. Sec. Litig., 365 F. Supp. 2d 866, 871-72 (S.D. Ohio 2005) (stating that "'upon a proper showing'" a court may stay proceedings "'as necessary in aid of its jurisdiction'" or "'to protect or effectuate its judgments'"
149. (quoting 15 U.S.C. § 78u4(b)(3)(D))).
150. Some states have also adopted rules making it more difficult for shareholder plaintiffs to obtain discovery. See, e.g., Levine v. Smith, 591 A.2d 194, 208-09 (Del. 1991) (holding that a shareholder alleging that a prelitigation demand on directors has been wrongfully refused is not entitled to discovery prior to responding to a Rule 23.1 motion to dismiss). These measures, however, are not common and do not ameliorate the other problems associated with parallel lawsuits.
151. 430 F.2d 1093 (5th Cir. 1970).
152. See id. at 1103-04;
153. 5ee also Sandberg v. Va. Bankshares, Inc., 979 F.2d 332, 352 (4th Cir. 1992)
154. ("The Garner good faith exception has become accepted doctrine."), vacated, 1993 WL 524680 (4th Cir. 1993);
155. Grimes v. DSC Commc'ns Corp., 724 A.2d 561, 568 (Del. Ch. 1998) ("In determining whether a stockholder has shown sufficient 'good cause' to preclude application of the attorney-client privilege, Delaware courts follow the approach oudined in Garner").
156. See Sandberg, 979 F.2d at 353-54;
157. Ward v. Succession of Freeman, 854 F.2d 780, 786 (5th Cir. 1988);
158. Weil v. Inv./Indicators, Research & Mgmt., Inc., 647 F.2d 18, 23 (9th Cir. 1981).
159. See Rales v. Blasband, 634 A.2d 927, 933 (Del. 1993) ("Derivative suits have been used most frequently as a means of redressing harm to a corporation allegedly resulting from misconduct by its directors." (emphasis added)).
160. SIMMONS & RYAN, supra note 43, at 2;
161. see also James D. Cox & Randall S. Thomas, Does the Plaintiff Matter? An Empirical Analysis of Lead Plaintiffs in Securities Class Actions, 106 COLUM. L. REV. 1587, 1624 (2006) (finding that the median settlements in securities class actions since the 1995 passage of the Private Securities Litigation Reform Act was approximately $5.7 million).
162. See infra notes 232-35 and accompanying text.
163. Colloquy, The Role of Corporate Litigation in the Twenty-First Century, 25 DEL. J. CORP. L. 131, 151 (2000) ("[T]here's only so much blood you can get out of individual directors.").
164. A 1991 study by Roberta Romano found that only one-half of the settlements of the derivative suits examined ended with the corporation receiving a monetary payout and that the average monetary payout in these suits was approximately $6 million. See Roberta Romano, The Shareholder Suit: Litigation Without Foundation?, 7 J.L. ECON. & ORG. 55, 61 (1991).
165. As more than fifteen years have passed since Romano's study, the statistics may look very different today. Similarly, Professors Thompson and Thomas' study of all of the derivative suits filed in the Delaware Court of Chancery in 1999 and 2000 found that of the sixteen cases that ended with some
166. SIMMONS & RYAN, supra note 43, at 11 ("Derivative cases are often resolved with changes to the issuer's corporate governance practices and little or no cash payment....").
167. See Thompson & Thomas, supra note 4, at 1776-77.
168. Indeed, in situations where the corporation simultaneously settles a securities class action and derivative suit, the settlement of the derivative suit is often simply folded into the larger settlement of the securities class action with the corporation receiving little or no separate monetary benefit from settling the derivative suit. See, e.g., In re Ikon Office Solutions, Inc. Sec. Litig., 194 F.R.D. 166, 191 (E.D. Pa. 2000).
169. See Baker & Griffith, supra note 12, at 494 (explaining that public corporations have a significant need for D&O insurance as a result of shareholder litigation).
170. See Matthew Brodsky, The Soft Side of Executive Scandals: D&O Coverage Seems More Important These Days, and Luckily, It's Cheap, RISK & INS., Apr. 1, 2006, at 10, 10.
171. A 1991 study revealed that D&O insurance pays only fifty to eighty percent of the settlement monies in securities class actions. See Janet Cooper Alexander, Do the Merits Matter? A Study of Settlements in Securities Class Actions, 43 STAN. L. REV. 497, 550 (1991).
172. See TOWERS PERRIN, DIRECTORS AND OFFICERS LIABILITY: 2007 SURVEY OF INSURANCE PURCHASING AND CLAIM TRENDS 14 (2008).
173. Not surprisingly, the largest companies report the largest policy limits. Companies with over $10 billion in assets report average policy limits of approximately $146 million. See id.
174. See supra note 97 and accompanying text
175. See Tom Baker & Sean J. Griffith, The Missing Monitor in Corporate Governance: The Directors' & Officers'Liability Insurer, 95 GEO. L.J. 1795, 1815 (2007).
176. See, e.g., Baker & Griffith, supra note 12, at 488 n.3 ("There may be a recent trend in the U.S. toward increasing (but still small) numbers of settlements above the D&O policy limits.") ;
177. see also Press Release, CryoLife, Inc., CryoLife Announces Agreements in Principle to Setde Shareholder Class Action and Shareholder Derivative Action Lawsuits (July 28, 2005), available at http://phx.corporate-ir.net/phoenix.zhtml?c=80253&p=irol-newsArticle&ID= 736340&highlight= (announcing that the company had agreed to settle a securities class action for $23.25 million, approximately $11.5 million of which would be paid from insurance proceeds);
178. Press Release, DHB Indus., Inc., DHB Industry Enters into Memorandum of Understanding to Setde Class Action and Derivative Lawsuits (July 13, 2006), available at http://phx.corpo-rate-ir.net/phoenix.zhtml?c=75442&p= irol-newsArticle&ID=1074443&highlight= (announcing that the company had agreed to settle a securities class action and derivative suit for $34.9 million in cash, of which $12.9 million would be paid by the company's D&O carrier).
179. As Professors Baker and Griffith have noted in a forthcoming article, when boards learn that the entire settlement in a securities class action will be funded by insurance, "[t]he next question is 'What time is lunch?'" Tom Baker & Sean J. Griffitii, How the Merits Matter: D&O Insurance and Securities Settlements, 157 U. PA. L. REV. (forthcoming 2008) (manuscript at 38-39), available at http://ssrn.com/abstract=110 1068.
180. This example is obviously oversimplified. The corporation will only be content to allow the derivative suit to move forward if the corporation is also compensated for all of the costs related to the increased settlement in the securities class action, including legal fees, lost time of executives, additional negative publicity, and future increases in its insurance premiums.
181. See, e.g., Abbey v. Computer & Commc'ns Tech. Corp., 457 A.2d 368, 375 (Del. Ch. 2003) (holding that a derivative suit should only be stayed for a "reasonable time" to permit an SLC to complete its investigation).
182. The corporation can try to predict its exposure, of course, based on the drop in the company's stock price during the relevant time period and other factors, but its predictions will likely be far from perfect, especially prior to discovery.
183. See Lisa L. Casey, Reforming Securities Class Action from the Bench: Judging Fiduciaries and Fiduciary Judging, 2003 BYU L. REV. 1239, n.91 ("[M]ost negotiated resolutions of securities class actions follow a similar pattern. The settling defendants, while denying all wrongdoing, agree to pay to the class some amount of money and/or securities, often funded with the proceeds of directors' and officers' liability insurance, into a fund from which class members may make claims and class counsel will receive compensation and reimbursement of costs.").
184. See James D. Cox, Heroes in the Law: Alford v. Shaw, 66 N.C L. REV. 565, 570 (1988) ("The central problem with derivative suit litigation is the weak incentives of each of the suit's participants to serve the corporation's interests.").
185. See, e.g., Breault v. Folino, No. SACV010826GLTANX, 2002 WL 31974381, at *1 (C.D. Cal. Mar. 15, 2002);
186. Goodwin v. Castleton, 144 P.2d 725, 732 (Wash. 1944).
187. See FED. R. CIV. P. 23.1 (requiring only that the derivative plaintiff allege that he or she "was a shareholder or member at the time of the transaction complained of").
188. See Lewis v. Curtis, 671 F.2d 779, 788 (3d Cir. 1982) (holding that the fact that the shareholder plaintiff owned only 100 out of 8 million outstanding shares was "irrelevant");
189. Ohio-Sealy Mattress Mfg. Co. v. Kaplan, 90 F.R.D. 21, 25 (N.D. 111. 1980) (holding that plaintiffs adequately represented the corporation even though they together owned only 0.7% of the corporation's outstanding shares).
190. See Kenneth B. Davis, Jr., Structural Bias, Special Litigation Committees, and the Vagaries of Director Independence, 90 IOWA L. REV. 1305, 1355-56 (2005) ("While often appearing as lead plaintiffs in securities class actions, [institutional investors] have rarely done so in derivative suits.").
191. In response to this point, one might ask why shareholders bother to serve as derivative plaintiffs when the financial rewards are so minimal. There is no empirical research on this question, but anecdotal evidence suggests that many derivative plaintiffs lend their name to the suit because they are angry that alleged corporate misconduct caused them financial harm and want to punish the wrongdoer. See, e.g., David A. Skeel.Jr., Shamingin Corporate Law, 149 U. PA. L. REV. 1811, 1823-26 (2001).
192. Alternatively, plaintiffs may view themselves as "corporate gadflies" who view their stock ownership as a means of enforcing corporate norms in society generally. Charles M. Yablon, Overcompensating: The Corporate Lawyer and Executive Pay, 92 COLUM. L. REV. 1867, 1906
193. (reviewing GRAEF CRYSTAL, IN SEARCH OF EXCESS (1991)).
194. In such instances, the derivative plaintiff's interests are not aligned with the corporation's interests because the plaintiff is more interested in deterring corporate misconduct generally than in ensuring that the corporation is compensated for its own managers' alleged misdeeds. See, e.g.,John C. Coffee.Jr., Rescuing the Private Attorney General: Why the Model of the Lawyer as Bounty Hunter Is Not Working, 42 MD. L. REV. 215, 218 (1983) (noting the "conventional theory" that the "role of private litigation is not simply to secure compensation for victims, but is at least equally to generate deterrence").
195. Joy v. North, 692 F.2d 880, 887 (2d Cir. 1982).
196. See 4 ALBA CONTE & HERBERT B. NEWBERG, NEWBERG ON CLASS ACTIONS § 14.6 (4th ed. 2002) (stating that the usual attorneys' fee award is twenty to thirty-three percent of a common fund).
197. See Franklin A. Gevurtz, Who Represents the Corporation? In Search of a Better Method for Determining the Corporate Interest in Derivative Suits, 46 U. PITT. L. REV. 265, 290-91 (1985) (explaining the calculus for plaintiffs' attorneys).
198. Cf. William B. Rubenstein, On What a "Private Attorney General" Is - And Why It Matters, 57 VAND. L. REV. 2129, 2131 (2004) ("[T]here are so many players [in litigation] who mix public and private functions in so many different ways... [that] '[a]nyone... can call himself a "private attorney general."'"
199. (quoting Jeremy A. Rabkin, The Secret Life of the Private Attorney General, 61 LAW & CONTEMP. PROBS. 179, 194 (1998))).
200. See, e.g., John C Coffee, Jr. & Donald E. Schwartz, The Survival of the Derivative Suit: An Evaluation and a Proposal for Legislative Reform, 81 COLUM. L. REV. 261, 307-08 (1981) ("The differences between deterrent and compensatory rationales come into clearest focus when one poses the hardest practical questions about derivative litigation: Should a court dismiss an otherwise meritorious derivative action if it appears that costs of litigation will exceed the likely recovery?");
201. Cox, supra note 4, at 13 ("[T] he public role of shareholder suits is muted, and indeed obfuscated, both by the characterization of their mission as the compensation of those harmed by the defendant's misconduct and by the nurturing of settlements through the courts' extraordinary deference to the bargain struck by the suit's attorneys. In the end, shareholder suits have but a private existence so that in the public's eye they are just another commercial dispute.");
202. Thompson & Thomas, supra note 4, at 1774 ("There are two main benefits that result from derivative suits: (1) the deterrence of corporate wrongdoing provided by their very existence, and (2) the possibility that the suits yield a positive net recovery for shareholders.").
203. Coffee, supra note 120, at 218 ("The conventional theory of the private attorney general stresses that the role of private litigation is not simply to secure compensation for victims, but is at least equally to generate deterrence, principally by multiplying the total resources committed to the detection and prosecution of the prohibited behavior.").
204. See id.
205. See Colloquy, supra note 99, at 155 (stating that Delaware corporate law can only develop through litigation);
206. Davis, supra note 6, at 435 (discussing "the production of precedent" as another "public good that sometimes is cited on behalf of derivative litigation").
207. I am distinguishing here general deterrence, or deterrence in society generally, from specific deterrence, or deterrence directed at the plaintiff corporation. See Hawkins, supra note 49, at 593-95. The desire for general deterrence comes within the scope of the public model, while the desire for specific deterrence would come within the private model.
208. See, e.g., Coffee & Schwartz, supra note 125, at 302 (noting that the public model "has never been the dominant rationale" for derivative suits, and "indeed some decisions appear frankly skeptical of it").
209. These rules have been met with much scholarly resistance, which courts and legislators have traditionally ignored. See, e.g., Cox, supra note 4, at 8 ("[1]n the corporate setting, shareholder suits are consistently dismissed when they fail to serve a compensatory end, even though the goal of deterrence would be advanced by the suit's successful prosecution. Simply stated, compensation is the prevailing objective of shareholder suits and deterrence, its valuable byproduct").
210. See FED. R. CIV. P. 23.1 (a) ;
211. DEL. CODE ANN. tit. 8, § 327 (2001 );
212. see also Strategic Asset Mgmt v. Nicholson, No. 20360-NC, 2004 Del. Ch. LEXIS 178, at *4 (Del. Ch. Nov. 30, 2004) ("The 'continuous ownership' requirement is a fundamental and ongoing burden that a plaintiff in a Delaware derivative action must satisfy.").
213. See 1 R. FRANKLIN BALOTTI & JESSE A. FINKELSTEIN, DELAWARE LAW OF CORPORATIONS AND BUSINESS ORGANIZATIONS § 13.11, at 13-33 (3d ed. 1997 & Supp. 2008).
214. The American Law Institute has proposed that states relax the contemporaneous ownership rule to allow directors of coiporations to file derivative suits, but the motivation for the proposal appears to be to to increase the number of plaintiffs likely to act in the corporation's interest, not to change the purpose of these suits. See 2 AM. LAW INST., PRINCIPLES OF CORPORATE GOVERNANCE § 7.02(c) & cmts. (1994).
215. See Lawrence A. Larose, Suing in the Right of the Corporation: A Commentary and Proposal for Legislative Reform, 19 U. MICH. J.L. REFORM 499, 514 (1986) (arguing that allowing a wider range of plaintiffs would allow more effective sanctions against corporate wrongdoers).
216. This requirement stems from a series of New York state cases, particularly in the antitrust context. The defendants in these cases argued that the cases should be dismissed because the derivative plaintiffs failed to allege that the plaintiff corporations suffered a net loss as a result of the defendants' conduct. The defendants suggested that the derivative plaintiffs had failed to include such allegations because the defendants' conduct had actually benefited the plaintiff corporations. See, e.g., Borden v. Cohen, 231 N.Y.S.2d 902, 903 (N.Y. Sup. Ct 1962);
217. Spinella v. Heights Ice Corp., 62 N.Y.S.2d 263, 263 (N.Y. Sup. Ct. 1946);
218. Diamond v. Davis, 31 N.Y.S.2d 582 (N.Y. Sup. Ct 1941). The courts held that the derivative plaintiffs' allegations were insufficient because there is no "actionable claim unless the acts otherwise worked harm to the corporation."
219. Borden, 231 N.Y.S.2d at 903;
220. see also Spinella, 62 N.Y.S.2d at 263 (holding that the derivative complaint was "insufficient in law" because there was no demonstration of damage to the corporation);
221. Diamond, 31 N.Y.S. 2d at 584 (dismissing the suit because, inter alia, the acts complained of were "not such that the injury to the corporation would ordinarily be inferred" from them).
222. See Cox, supra note 4, at 8-9 ("[Directors who knowingly violate the law are not without a defense. Absent proof that the corporation suffered a net loss through their illegal act, the suit must be dismissed. Therefore, if the plaintiff fails to establish that the harm suffered by the corporation as a consequence of the misconduct exceeded the benefits it received by their misconduct, the defendant escapes any sanction by a derivative suit").
223. See, e.g., SIMMONS & RYAN, supra note 43, at 11-13 (finding that securities class actions with high estimated damages are more likely to be accompanied by derivative suits or SEC enforcement actions than securities class actions with lower estimated damages);
224. James D. Cox & Randall S. Thomas, SEC Enforcement Heuristics: An Empirical Inquiry, 53 DUKE L.J. 737, 763-77 (2003).
225. See Zapata Corp. v. Maldonado, 430 A.2d 779, 785 (Del. 1981).
226. See id. at 788;
227. see also Daniel S. Kleinberger, Direct Versus Derivative and the Law of Unlimited Liability Companies, 58 BAYLOR L. REV. 63, 81-86 (2006) (detailing SLC procedures).
228. See Zapata Corp., 430 A.2d at 788.
229. See id. ("The basis of the [plaintiff corporation's] motion is the best interests of the corporation, as determined by the committee.").
230. See Cohen v. Beneficial Indus. Loan Corp., 337 U.S. 541, 550 (1949) (holding that states have "plenary power" over derivative suits). This section discusses the relevant standards for so-called demand excused cases, or cases where the court has determined that the shareholder was not required to make a demand on the corporation prior to filing suit. I focus on this standard because it is my experience that shareholders rarely make a demand and therefore the more deferential standard applicable in cases where shareholders do make a demand rarely comes into play. Instead, at least in my own experience, shareholders almost always allege that demand is futile, knowing that their suit will be dismissed if they are wrong, but that they will get the benefit of the Zapata standard if they can persuade the court on this crucial point.
231. See, e.g., CONN. GEN. STAT. § 33-724(a) (2005 & Supp. 2008) ("A derivative proceeding shall be dismissed by the court on motion by the corporation if [the SLC] has determined in good faith, after conducting a reasonable inquiry upon which its conclusions are based, that the maintenance of the derivative proceeding is not in the best interests of the corporation.");
232. ASS. ANN. LAWS eh. 156D, § 7.44 (LexisNexis 2005) ("A derivative proceeding commenced after rejection of a demand shall be dismissed by the court on motion by the corporation if the court finds that either: (1) [the SLC] has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation; or (2) shareholders specified in subsection (b) (3) have determined that the maintenance of the derivative proceeding is not in die best interests of the corporation.").
233. 430 A.2d 779 (Del. 1981).
234. See id. at 788-89.
235. Id. at 789.
236. Id. (emphasis added);
237. see also Biondi v. Scrushy, 820 A.2d 1148, 1164 n.40 (Del. Ch. 2003) (holding that the second step of Zapata is intended "to provide a safeguard against the danger that the difficult-to-detect influence of fellow-feeling among directors (i.e., so-called 'structural bias') does not cause cessation of meritorious litigation valuable to the company),"
238. aff'd sub nom. In re HealthSouth Corp. S'holders Litig., No. 19896, 2004 WL 835879 (Del. Apr. 14, 2004).
239. Zapata Corp., 430 A.2d at 789.
240. See, e.g., Abbey v. Computer & Commc'ns Tech. Corp., 457 A.2d 368, 369 (Del. Ch. 2003).
241. It is common for courts to stay derivative suits during an SLC investigation. Such a stay, however, ends when the SLC issues its recommendation, which is often long before the end of a related securities class action. See, e.g., id. at 375 (holding that a derivative suit should only be stayed for a "reasonable time" to permit an SLC to complete its investigation).
242. In re Tyco Int'l, Ltd. Multidistrict Litig., No. 02-1335-B, 2003 WL 23830479 (D.N.H. Jan. 29, 2003).
243. See Andrew Ross Sorkin, Tyco's Ex-Chief Going to Court in 'Greed Case, 'N.Y. TIMES, Sept 29, 2003, at Al. Tyco's CEO L. Dennis Kozlowski was later sentenced to 8 1/3 to 25 years in prison for his role in the scandal.
244. See Andrew Ross Sorkin, Ex-Tyco Officers Get 8 to 25 Years, N.Y. TIMES, Sept. 20, 2005, at A1.
245. See Consolidated Securities Class Action Complaint - 243,
246. In re Tyco Int'l, Ltd. Multidistrict Litig., No. 02-1335-B, 2008 WL 489257 (D.N.H. Feb. 20, 2008), 2004 WL 3770745.
247. See Tyco Int'l, Ltd., Annual Report (Form 10-K), at 22-30 (Dec. 11, 2006).
248. In re Tyco, 2003 WL 23830479, at *3.
249. See id.
250. See id. at *4.
251. See id. at *3.
252. Id.
253. Id.
254. Id. at *4;
255. see also In re FirstEnergy S'holder Derivative Litig., 219 F.R.D. 584, 587 (N.D. Ohio 2004) (holding that the court was "utterly unconvinced that it should enter a protective order [in a derivative suit] based on [the] speculative harm" that the plaintiff in a parallel securities action could use information it obtained against the corporation in that action).
256. Tyco eventually setded the consolidated securities class action for $2.975 billion, one of the largest settlements in history in a securities class action. See Press Release, Tyco Int'l, Ltd., Tyco Enters into Agreement to Resolve Legacy Securities Class Action Litigation (May 15, 2007), available at http://investors.tyco.com/phoe-nix.zhtml?c=112348&p= irolnewsArticle&ID=1000469&highlight=.
257. No. SACV010826GLTANX, 2002 WL 31974381 (C.D. Cal. Mar. 15, 2002).
258. See id. at *1.
259. See id.
260. See id.
261. Id.
262. See id. at *2.
263. See id.
264. See id.;
265. see also In re E.F. Hutton Banking Practices Litig., 634 F. Supp. 265, 270 (S.D.N.Y. 1986) (stating that "a disinterested board" faced with parallel derivative suits and securities class actions "might well... conclude it to be unwise to subject [the corporation] to further litigation [in the derivative suit] clearly calculated to undercut [the individual defendants'] veracity and general effectiveness as witnesses");
266. Brudno v. Wise, No. Civ. A. 19953, 2003 WL 1874750, at *1 (Del. Ch. Apr. 1, 2003) (staying a derivative suit that was in reality a placeholder indemnity action "for any injury suffered by [the corporation] as a result of the Federal Securities Action").
267. See 15 U.S.C. § 78u(3)(A) (2006).
268. 28 U.S.C. § 2462 (2006).
269. See, e.g., SEC v. Rind, 991 F.2d 1486, 1492 (9th Cir. 1993);
270. SEC v. Williams, 884 F. Supp. 28, 30-31 (D. Mass. 1995).
271. See, e.g., Kahn v. Seaboard Corp., 625 A.2d 269, 270-71 (Del. Ch. 1993) (noting that the statute of limitations in derivative actions is three years unless a continuing wrong extends the applicable limitations period).
272. 692 F.2d 880 (2d Cir. 1982).
273. See id. at 884.
274. See id. The SLC also recommended that the company attempt to settle the claims against other defendants.
275. Id.
276. See id.
277. See id. at 892.
278. See id.
279. Id.
280. Id.
281. Id.
282. Id.
283. Id.
284. See supra note 138 and accompanying text.
285. See, e.g., In re Par Pharm., Inc. Derivative Litig., 750 F. Supp. 641, 647 (S.D.N.Y. 1990) (holding expressly that an SLC cannot consider the impact of a derivative suit on other pending litigation because "[t]he issue... is whether [the derivative] claims are viable in this derivative action not whether they conflict with the position taken in another litigation").
286. 132 F.R.D. 455 (E.D. Mich. 1990).
287. See id. at 458.
288. See id. at 478-79.
289. Id. at 478.
290. See id. at 486.
291. See id.
292. Id.
293. Id.
294. Id.
295. For example, in Weiland v. Illinois Power Co., No. 89-1088, 1990 WL 267364 (C.D. Ill. Sept 17, 1990), a corporation moved to dismiss a derivative suit on the basis of an SLC report The plaintiff argued that the SLC could not have been independent or acted in good faith because the SLC would have exposed the corporation to liability in an investigation by the Illinois Commerce Commission if it had recommended going forward with the derivative suit
296. Id. at *10. Applying Zapata, the court rejected this argument. The court stated that "the future impact a derivative action will have on a corporation is a relevant consideration in addition to the consideration of the likelihood of the success of the claims."
297. Id. at *15.
298. See Davis, supra note 119, at 1326 ("From the outset, the SLC conducts its process with the awareness that its recommendation, if favorable to the director-defendants, will almost certainly be challenged and scrutinized.").
299. See supra notes 18-19 and accompanying text.
300. Kaplan v. Peat, Marwick, Mitchell & Co., 529 A.2d 254, 259 (Del. Ch. 1987) (stating that it is a "basic principle of corporate governance that decisions on behalf of a corporation (including a decision whether to commence litigation) are normally made by the corporation's board of directors"),
301. off d in part, rev'd in part by 540 A.2d 726 (Del. 1988).
302. See Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) ("The machinery of corporate democracy and the derivative suit are potent tools to redress the conduct of a torpid or unfaithful management. The derivative action developed in equity to enable shareholders to sue in the corporation's name where those in control of the company refused to assert a claim belonging to it").
303. See, e.g., Davis, supra note 6, at 434 (asking whether the shareholders of the corporation named in a derivative suit should be asked to subsidize society's deterrent efforts).
304. This step would apply in jurisdictions that follow the Delaware Supreme Court's decision in Zapata Corp. v. Maldonado, 430 A.2d 779, 788-89 (Del. 1981).
305. See supra notes 147-48 and accompanying text (discussing Zapata's "second step").
306. This calculation should include the corporation's desire for specific deterrence, or deterrence of the plaintiff corporation's own officers and directors. Corporations that take a hard stand against wrongdoing by their executives are less likely to be victims of similar wrongdoing in the future. Corporations that have had to pay significant damages as a result of their executives' conduct may want to take such a hard stand to avoid a repeat of such situations in the future.
307. SIMMONS & RYAN, supra note 43, at 12.
308. As just one example, a Westlaw search reveals that the decision has been cited over fifteen hundred times over the last seventeen years.
309. See supra notes 145-48 and accompanying text.
310. See Zapata Corp., 430 A.2d at 788-89.
311. Id. at 789. At least one judge has been skeptical of this standard, stating that the second step of Zapata requires him to determine in his "oxymoronic judicial 'business judgment,' [whether the suit] is in the best interests of the [corporation]."
312. In re Oracle Corp. Derivative Litig., 824 A.2d 917, 928 (Del. Ch. 2003);
313. see also Jonathan R. Macey & Geoffrey P. Miller, The Plaintiffs' Attorney's Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U. CHI. L. REV. 1, 39 (1991) ("[T]he idea that a trial court can exercise 'business judgment' is anomalous. Trial judges are not businesspeople; they do not possess the practical experience and exposure to the special needs of the corporation that characterizes the business judgment of corporate managers.").
314. Zapata Corp., 430 A.2d at 789.
315. I am not the first commentator to find fault with this step of the Zapata test. See James D. Cox, Searching for the Corporation's Voice in Derivative Suit Litigation: A Critique ofZapata and the ALI Project, 1982 DUKE L.J. 959, 988-89 ("Although the court in Zapata apparently approved [of courts taking into account the public interest in deciding whether to dismiss a derivative suit, this position] conflicts with accepted views of the purpose of derivative suits and would pose insurmountable problems." (footnote omitted)).
316. See, e.g., 2 AM. LAW INST., PRINCIPLES OF CORPORATE GOVERNANCE § 7.10 cmt d (1994) ("Commentators have emphasized that a consistent pattern has surrounded the use of the special litigation committee: once such a committee is formed to review the merits of the litigation, the outcome of the process is generally a foregone conclusion - namely, dismissal of the action is recommended against all defendants.").
317. Zapata Corp., 430 A.2d at 787.
318. See supra notes 171-74 and accompanying text.
319. In jurisdictions with less extensive judicial review of SLC recommendations, an SLC may be entitled to greater deference in deciding between a stay and outright dismissal. See, e.g., VA. CODE ANN. § 13.1-672.4 (2006) (requiring a court to dismiss a derivative proceeding if an SLC, after a good faith review and evaluation, has determined that a derivative proceeding is not in the best interests of the corporation).
320. See supra notes 85-90 and accompanying text.
321. See supra notes 92-96 and accompanying text
322. The Annotated Model Act statutory comparison provides, "[A]ll 52 jurisdictions provide for committees to be appointed by the board of directors. The District of Columbia and South Dakota statutes only refer specifically to an executive committee. The other jurisdictions follow the Model Act in expressly allowing for the creation of other committees." 2 MODEL BUS. CORP. ACT ANN. §8:25, at 8-146 (Supp. 2002).
323. Cf. Coffee & Schwartz, supra note 125, at 324 (arguing that SLCs should be required to "advance a substantial business judgment independent of the merits of the litigation" to justify dismissal of a derivative suits because "courts and not litigants should decide the merits of the litigation").
324. In re Oracle Corp. Derivative Litig., 824 A.2d 917, 938 (Del. Ch. 2003)
325. (quoting Aronson v. Lewis, 473 A.2d 805, 816 (Del. 1984));
326. see also Strougo v. Padegs, 27 F. Supp. 2d 442, 449-50 (S.D.N.Y. 1998) (refusing to accept plaintiffs argument that an SLC member was not independent because, inter alia, he allegedly considered the interests of the public at large, in addition to the corporation's interests, in deciding whether to recommend that a derivative suit be allowed to proceed).
327. See, e.g., supra notes 96-113 and accompanying text (discussing the inability of derivative actions to recoup the losses from security actions).
328. See, e.g., Seth W. Ashby, Strengthening the Public Company Board of Directors: Limited Shareholder Access to the Corporate Ballot vs. Required Majority Board Independence, 2005 U. ILL. L. REV. 521, 540-45;
329. William B. Chandler III & Leo E. Strine, Jr., The New Federalism of the American Corporate Governance System: Preliminary Reflections of Two Residents of One Small State, 152 U. PA. L. REV. 953, 967 (2003) (explaining the increased push for director independence in the wake of Enron);
330. Charles M. Elson & Christopher J. Gyves, The Enron Failure and Corporate Governance Reform, 38 WAKE FOREST L. REV. 855, 856 (2003);
331. Jeffrey N. Gordon, What Enron Means for the Management and Control of the Modern Business Corporation: Some Initial Reflections, 69 U. CHI. L. REV. 1233, 1241 (2002).
332. See, e.g., AM. LAW INST., supra note 213, § 7.10 cmt d ("Commentators have emphasized that a consistent pattern has surrounded the use of the special litigation committee: once such a committee is formed to review the merits of the litigation, the outcome of the process is generally a foregone conclusion-namely, dismissal of the action is recommended against all defendants.").
333. In re Consumers Power Co. Derivative Litig., 132 F.R.D. 455, 487-88 (E.D. Mich. 1990).
334. Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 731 (Del. 1988).
335. I note here again, however, that an SLC (or a reviewing court) may determine that staying a parallel derivative suit is a more appropriate prophylactic than dismissing the case entirely.
336. This apt analogy was developed by Professor John Coffee. See Coffee, supra note 120, at 228 (describing litigation as often "resembling the Oklahoma land rush, in which the filing of the public agency's action serves as the starting gun for a race between private attorneys, all seeking to claim the prize of lucrative class action settlements, which public law enforcement has gratuitously presented them").
337. Interestingly enough, for all of the scholarly focus on shareholder litigation, no one really argues that derivative suits are an effective weapon in the fight against corporate misconduct. See, e.g., AM. LAW INST., supra note 213, at 5 (stating that the ALI "recognizes that the derivative action is neither the initial nor the primary protection for shareholders against managerial misconduct").
338. See Coffee & Schwartz, supra note 125, at 307-08 (stating that under the private model of derivative suits, courts will be "placed in the morally compromising position of having... to acknowledge that, despite the best efforts of the state, crime did indeed pay").
339. Robert Thompson and Hillary Sale reviewed all of the complaints in securities fraud class action suits filed in 1999 in the Courts of Appeals for the Second, Third, and Ninth Circuits. See Thompson & Sale, supra note 6, at 895. They found that all the complaints named the corporation as a defendant.
340. Id. In only four of the eighty-six complaints, however, was the corporation the only defendant.
341. Id. The remaining eighty-two complaints named individual defendants as well.
342. See id.
343. Press Release, Sec. & Exch. Comm'n, Statement of the Securities and Exchange Commission Concerning Financial Penalties (Jan. 4, 2006), available at http://www.sec.gov/news/press/2006-4.htm.
344. See, e.g., 17 C.F.R. § 229.510 (2008) (stating that, in the SECs view, corporate promises to indemnify officers and directors for violations of the Securities Act of 1933 are "against public policy" and "therefore unenforceable").
345. As Professors Coffee and Schwartz have noted, "[T] he key question must be whether derivative litigation is likely substantially to further and enforce the policies of [federal law] in a manner superior to other means of enforcement." Coffee & Schwartz, supra note 125, at 298. Given the well-known weaknesses of the derivative suit, there is no reason to believe that the derivative suit will provide greater deterrence than these other suits.
346. See, e.g., Davis, supra note 6, at 428 ("[I]n circumstances where securities class actions had also been filed... it is questionable what [derivative suits] add by way of either compensation or deterrence.").
347. See M.P. Narayanan et al., The Economic Impact of Backdating of Executive Stock Options, 105 MICH. L. REV. 1597, 1601-02 (2007) ("[N]either backdating nor forwarddating by itself is illegal, as long as it is duly authorized by the board, fully disclosed, and reported in keeping with tax rules.").
348. See Frank Ahrens, Scandal Grows Over Backdating of Options, WASH. POST, Oct. 12, 2006, at D01.
349. See id.
350. The D&O Diary, http://www.dandodiary.com/ (July 20, 2006) (post entitled "Counting the Options Backdatings Lawsuits"), http://www.dandodiary.com/2006/07/aiticles/options-backdating/ counting-the-options-backdating-lawsuits.
351. For a detailed examination of the different types of derivative suits, including certain types of suits diat shareholders cannot easily morph into securities class actions, see Davis, supra note 6, at 414-49.
352. Professors Thompson and Thomas's study of all of the derivative suits filed in the Delaware Court of Chancery in 1999 and 2000 found that shareholders alleged self-dealing by corporate managers in eighty-four percent of the suits involving privately held corporations and forty-nine percent of the suits involving public corporations. See Thompson & Thomas, supra note 4, at 1766, 1772.
353. See, e.g., Davis v. Anten, No. B118437, 2006 WL 848282 (Cal. Ct. App. Apr. 3, 2006) (ruling on a derivative suit filed against former officer alleging that he had embezzled funds from the corporation).
354. Professors Thompson and Thomas's study also showed that of the twenty-five derivative suits filed against private companies in the Delaware Court of Chancery in 1999 and 2000, only a single company was named in more than one suit See Thompson & Thomas, supra note 4, at 1765. They note, "By contrast, in derivative and class actions against public companies, the same transaction generated up to forty-one separate suits."
355. Id. They conclude that: [Derivative] suits retain an important role in policing management in closely held corporations. Unlike public corporations, there is neither an established market for a private company's stock nor similar constraints on manager's misuse of the centralized power that is given to directors under Section 141 of the Delaware Code and Section 8.01 of the Model Business Corporation Act. Derivative suits can play an important role for protecting minority shareholder rights in the private company setting.
356. Id. at 1760. As Dean Davis points out, however, shareholders may be able to file other types of suits in this context including petitions for dissolution and direct suits for minority oppression.
357. See Davis, supra note 6, at 423-27.
358. See Choi, supra note 4, at 1466, 1499-502 ("For smaller firms, private class action litigation is exceedingly rare.").
359. See, e.g., Thompson & Thomas, supra note 4, at 1760 (arguing that although "the academy has virtually ignored derivative suits against private companies,... in many states, such suits retain an important role in policing management" in these companies).
360. Cox, supra note 4, at 5-9 (arguing, inter alia, that "the message of the individual derivative suit or securities class action is affected by the company it keeps with other shareholder suits").
361. See id. at 14-15.
362. See id. at 8;
363. see also Hawkins, supra note 49, at 602 (noting that "no shame is attached to being the victim of an unfair proceeding").