Business Law Chapter 40 Homework Indeed, this kind of judicial second guessing is what

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642 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW

To the extent the Court allows shareholder plaintiffs to succeed on a theory that a director is liable for a failure to

monitor business risk, the Court risks undermining the well settled policy of Delaware law by inviting Courts to perform

a hindsight evaluation of the reasonableness or prudence of directors’ business decisions. Risk has been defined as

FN58.

See

Stephen M. Bainbridge,

The Business Judgment Rule as Abstention Doctrine,

57 VAND. L.REV..

83, 114-15 (2004) (fi[T]here is a substantial risk that suing shareholders and reviewing judges will be unable

to distinguish between competent and negligent management because bad outcomes often will be regarded,

ex post, as having been foreseeable and, therefore, preventable ex ante. If liability results from bad out-

comes, without regard to the ex ante quality of the decision or the decision-making process, however, man-

FN59. Pls.’ Answering Br. at 39-40.

Plaintiffs do not contest that Citigroup had procedures and controls in place that were designed to monitor risk. Plain-

and (3) discussing with management Citigroup’s major credit, market, liquidity, and operational risk exposures and the

FN60. Compl. ¶ 185.

FN61.

Id.

¶ 187.

FN62.

Id.

¶ 189.

Plaintiffs nevertheless argue that the director defendants breached their duty of oversight either because the over-

sight mechanisms were not adequate or because the director defendants did not make a good faith effort to comply

with the established oversight procedures. To support this claim, the Complaint alleges numerous facts that plaintiffs

argue should have put the director defendants on notice of the impending problems in the subprime mortgage market

FN63. Compl. ¶ 189; Pls.’ Answering Br. at 41-45. Directors with special expertise are not held to a higher

2006);

see also

E. Norman Veasey & Christine T. Di Guglielmo,

What Happened in Delaware Corporate Law

and Governance from 1992-2004? A Retrospective on Some Key Developments,

153 U. PA. L.REV. 1399,

FN64.

Shaev,

2006 WL 391931, at *3.

FN65. That plaintiffs are unable to point to specific wrongdoing within the Company that caused Citigroup’s

FN66. Pls.’ Answering Br. at 62.

Moving from such general ipse dixit syllogisms to the more specific, plaintiffs argue that the director defendants, and

especially those nine directors who were on the board at the time, fishould have been especially sensitive to the red

FN67.

Id.

at 47.

Plaintiffs fail in their attempt to impose some sort of higher standard of liability on the director defendants that were on

Citigroup’s board at the time of its involvement with Enron. They have utterly failed to show how Citigroup’s involve-

ment with the financial scandals at Enron has any relevance to Citigroup’s investments in subprime securities. Plain-

FN68. 239 F.3d 808 (6th Cir.2001).

FN70. Pls.’ Answering Br. at 48.

FN71.

See McCall,

239 F.3d at 821.

CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 645

The Complaint and plaintiffs’ answering brief repeatedly make the conclusory allegation that the defendants have

breached their duty of oversight, but nowhere do plaintiffs adequately explain what the director defendants actually

did or failed to do that would constitute such a violation. Even while admitting that Citigroup had a risk monitoring sys-

FN72.

See Gagliardi v. TriFoods Int’l, Inc.,

683 A.2d 1049, 1051 (Del.Ch.1996) (fiThe business outcome of an

investment project that is unaffected by director self-interest or bad faith, cannot itself be an occasion for di-

rector liability.”) (footnote omitted).

This Court’s recent decision in

American International Group, Inc. Consolidated Derivative Litigation

FN73 demon-

FN73. 965 A.2d 763, 2009 WL 366613 (Del.Ch.2009).

FN74.

Id.

at 776, 2009 WL 366613 at *3.

FN76.

AIG,

965 A.2d at 797-98, 2009 WL 366613 at *22.

FN77.

Id.

at 799, 2009 WL 366613 at *23.

Contrast the

AIG

claims with the claims in this case. Here, plaintiffs argue that the Complaint supports the reasonable

conclusion that the director defendants acted in bad faith by failing to see the warning signs of a deterioration in the

subprime mortgage market and failing to cause Citigroup to change its investment policy to limit its exposure to the

FN78. If defendants had been able to predict the extent of the problems in the subprime mortgage market,

then they would not only have been able to avoid losses, but presumably would have been able to make sig-

nificant gains for Citigroup by taking positions that would have produced a return when the value of subprime

securities dropped. Compl. ¶ 78. Query: if the Court were to adopt plaintiffs’ theory of the case-that the de-

fendants are personally liable for their failure to see the problems in the subprime mortgage market and

Citigroup’s exposure to them-then could not a plaintiff succeed on a theory that a director was personally lia-

ble for failure to predict the extent of the subprime mortgage crisis and profit from it, even if the company was

not exposed to losses from the subprime mortgage market? If directors are going to be held liable for losses

for failing to accurately predict market events, then why not hold them liable for failing to profit by predicting

market events that, in hindsight, the director should have seen because of certain red (or green?) flags? If

one expects director prescience in one direction, why not the other?

Plaintiffs’ Disclosure Allegations

[31] Plaintiffs argue that demand is excused as futile because the director defendants face a substantial likelihood of

personal liability for violating their duty of disclosure and would therefore be unable to exercise independent and disin-

FN79. Plaintiffs argue that the disclosure claims relate to actions taken by the board and are therefore subject

to the

Aronson

standard. Plaintiffs request, however, that the Court review demand futility under the substan-

tial likelihood of liability standard and present their demand futility arguments under that standard.

FN80. Compl. ¶ 172.

FN81.

Id.

at ¶ 70.

FN82.

Id.

at ¶¶ 163–65.

[32][33] fi[E]ven in the absence of a request for shareholder action, shareholders are entitled to honest communication

CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 647

FN83.

In re infoUSA, Inc. S’holders Litig.,

953 A.2d 963, 990 (Del.Ch.2007).

FN84.

Malone v. Brincat,

722 A.2d 5, 14 (Del.1998) (emphasis added);

see infoUSA,

953 A.2d at 990 (finding

FN85.

O’Reilly v. Transworld Healthcare, Inc.,

745 A.2d 902, 915 (Del.Ch. Aug. 20, 1999).

FN86. 8

Del. C.

§ 141(e) (fiA member of the board of directors, or a member of any committee designated by

the board of directors, shall, in the performance of such member’s duties, be fully protected in relying in good

faith upon the records of the corporation and upon such information, opinions, reports or statements present-

ed to the corporation by any of the corporation’s officers or employees, or committees of the board of direc-

FN87.

See Pfeffer v. Redstone,

965 A.2d 676, 687 2009 WL 188887, at *6 (Del. 2009) (fiAlthough there is ‘no

reason to depart from the general pleading rules when alleging duty of disclosure violations,’ ‘it is inherent in

disclosure cases that the misstated or omitted facts be identified and that the pleading not be merely conclu-

sory.’ ”) (quoting

Loudon v. Archer-Daniels-Midland Co.,

700 A.2d 135, 140 (Del.1997)).

FN88. Compl. ¶¶ 160-73. To be fair, plaintiffs point to some specific statements in the Complaint. For exam-

ple, paragraph 82 of the Complaint alleges that the director defendants ficaused or allowed” Citigroup to issue

a press release that highlighted, among other things, fipositive trends from Citigroup’s strategic actions.” Par-

agraphs 88 and 99 of the Complaint allege that the director defendants ficaused” Citigroup to issue press re-

FN89. Compl. ¶ 172.

FN90.

Id.

at ¶ 161.

[34] In other words, the disclosure allegations in the complaint do not meet the stringent standard of factual particu-

larity required under Rule 23.1. They fail to allege with particularity which disclosures were misleading, when the

FN91. The closest plaintiffs come to alleging a specific disclosure violation are the allegations that the Com-

pany failed to disclosure the existence of the liquidity puts until November 2007 and failed to disclose that the

Company may have to take certain assets held by SIVs back onto its balance sheet. Compl. ¶¶ 70, 165-69.

Even these claims, however, are vague and relatively light on the details of what the Company was required

FN92.

See Wood,

953 A.2d at 142 (fiThe Board’s execution of [the company’s] financial reports, without more,

is insufficient to create an inference that the directors had actual or constructive notice of any illegality.”).

Third, and perhaps most importantly, the Complaint does not sufficiently allege that the director defendants had

knowledge that any disclosures or omissions were false or misleading or that the director defendants acted in bad

faith in not adequately informing themselves. FN93 Plaintiffs have not alleged particular facts showing that the director

FN93.

See Pfeffer,

965 A.2d 676, at 687, 2009 WL 188887, at *6 (fiWhen pleading a breach of fiduciary duty

based on the … Directors’ knowledge, [the plaintiff] must, at a minimum, offer ‘well-pleaded facts from which it

FN94. Compl. ¶ 191.

FN95.

See AIG,

965 A.2d at 763, 2009 WL 366613 at *21 (fiAlthough these allegations are varied and far

reaching, … these allegations are supported by the pled facts. For starters, the Complaint is not laden with

such accusations against the D & O Defendants as a group; these group accusations are used sparingly.”).

Although the members of the ARM Committee were charged with reviewing and ensuring the accuracy of Citigroup’s

financial statements under the ARM Committee charter, director liability is not measured by the aspirational standard

established by the internal documents detailing a company’s oversight system. Under our law, to establish liability for

misstatements when the board is not seeking shareholder action, shareholder plaintiffs must show that the misstate-

ment was made knowingly or in bad faith. Additionally, even board members who are experts are fully protected un-

der § 141(e) in relying in good faith on the opinions and statements of the corporation’s officers and employees who

were responsible for preparing the company’s financial statements. Plaintiffs’ allegations that the members of the

ARM Committee were financial experts and were aware of the fired flags” alleged in the Complaint do not support a

reasonable inference that the director defendants’ reliance on the officers and experts who prepared the financial

statements was not in good faith.

C. Demand Futility Allegations Regarding Plaintiffs’ Waste Claims

Count III of the Complaint alleges that certain of the defendants are liable for waste for (1) approving the Letter

Agreement dated November 4, 2007 between Citigroup and defendant Prince; (2) allowing the Company to purchase

over $2.7 billion in subprime loans from Accredited Home Lenders at one of its fifire sales” in March 2007 and from

Ameriquest Home Mortgage in September 2007; (3) approving the buyback of over $645 million worth of the Compa-

ny’s shares at artificially inflated prices pursuant to a repurchase program in early 2007; and (4) allowing the Compa-

ny to invest in SIVs that were unable to pay off maturing debt.FN96

2006) (fiTo excuse demand on the grounds of waste, the complaint must allege particularized facts sufficient

to create a reasonable doubt that the

board authorized action on the corporation’s behalf

on terms that no

person of ordinary, sound business judgment could conclude represents a fair exchange.”) (emphasis added).

Second, and in the alternative, the director defendants do not face a substantial likelihood of personal liabil-

ity for these claims because the Complaint is devoid of any allegation that would lead to the conclusion that

FN97.

Aronson,

473 A.2d at 814.

[35][36] Delaware law provides stringent requirements for a plaintiff to state a claim for corporate waste, and to ex-

FN98.

Brehm,

746 A.2d at 263 (quoting

In re The Walt Disney Co. Derivative Litig.,

731 A.2d 342, 362

(Del.Ch.1998));

see Highland,

2006 WL 741939, at *7.

FN99.

White v. Panic,

783 A.2d 543, 554 n. 36 (Del.2001).

Approval of the Stock Repurchase Program

[37] Plaintiffs’ claim for waste for the board’s approval of the stock repurchase program falls far short of satisfying the

standard for demand futility. Plaintiffs allege that fiin spite of its prior buybacks below $50 per share and in spite of the

FN101.

Id.

Specifically, plaintiffs argue the following:

As set forth in the Complaint, the Director Defendants recklessly failed to consider and account for the subprime

FN102.

Id.

(citation omitted).

To say the least, this argument demonstrates that the Complaint utterly fails to state a claim for waste for the board’s

approval of the stock repurchase. Plaintiffs seem to completely ignore the standard governing corporate waste under

Delaware law-a standard that requires that plaintiffs plead facts overcoming the presumption of good faith by showing

FN103.

Brehm,

746 A.2d at 263 (quoting

Disney,

731 A.2d at 362).

Approval of the Letter Agreement

[38] Plaintiffs allege that the board’s approval of the November 4, 2007 letter agreement constituted corporate waste.

FN104.

Aronson,

473 A.2d at 814.

[39][40][41] The directors of a Delaware corporation have the authority and broad discretion to make executive com-

FN106.

Id.

at 262 n. 56 (citing

Saxe v. Brady,

184 A.2d 602, 610 (Del.Ch.1962));

see Grimes v. Donald,

673

A.2d 1207, 1215 (Del.1996).

According to plaintiffs’ allegations, the November 4, 2007 letter agreement provides that Prince will receive $68 million

upon his departure from Citigroup, including bonus, salary, and accumulated stockholdings.FN107 Additionally, the let-

and (2) the real value, if any, of the various promises given by Prince. Without more information and taking, as I am

required, plaintiffs’ well pleaded allegations as true, there is a reasonable doubt as to whether the letter agreement

FN107. Compl. ¶ 122; Pls.’ Answering Br. at 57–58.

FN108. Compl. ¶ 124.

FN109. The Court takes judicial notice of the letter agreement, a publicly available document that was integral

to plaintiffs’ waste claim and incorporated into the Complaint.

See Vanderbilt Income & Growth Assocs.,

L.L.C. v. Arvida/JMB Managers, Inc.,

691 A.2d 609, 613 (Del.1996).

FN110.

See Malpiede v. Townson,

780 A.2d 1075, 1082-83 (Del.2001).

FN111.

Id.

The standard for pleading demand futility under Rule 23.1 is more stringent than the standard under Rule 12(b)(6),

FN112.

McPadden v. Sidhu,

C.A. No. 3310-CC, 2008 WL 4017052, at *7 (Del.Ch. Aug. 29, 2008).

FN113. I am also not convinced that defendants would be exculpated under Citigroup’s certificate for commit-

ting waste.

See In re Walt Disney Co. Derivative Litig.,

907 A.2d 693, 749 (Del.Ch.2005) (fiThe Delaware Su-

preme Court has implicitly held that committing waste is an act of bad faith.”) (citing

White v. Panic,

783 A.2d

CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 653

543, 553-55 (Del.2001)).

1. The motion to dismiss or stay in favor of the New York Action is denied;

2. Counts I, II, and IV of the Consolidated Second Amended Derivative Complaint are hereby dismissed pursuant to

Court of Chancery Rule 23.1; and

3. Defendants’ motion to dismiss is denied as to the claim in Count III of the Complaint for waste for the board’s ap-