The Court of Chancery provided its latest guidance on so-called Caremark claims in a New Year’s Eve opinion issued by Vice Chancellor Glasscock in Richardson v. Clark, an action brought derivatively by a stockholder of Moneygram International, Inc. The opinion dismissing the claims, in which the Court had some fun with film titles from Tom Cruise’s career, provides an important level-setting because some have questioned whether Delaware’s courts are lowering the bar for claims alleging that a board of directors failed in its oversight duties. Richardson should provide some comfort to directors that the standards have not changed: absent particularized allegations of bad-faith action (or inaction) by a board, such claims should not survive a motion to dismiss.
MoneyGram facilitates the transfer of funds among businesses and individuals worldwide. Inherent in such a business is a risk that its platform and services will be used by criminals to aid fraud and money laundering activities. Not surprisingly, Moneygram is subject to extensive government regulation and is required to maintain rigorous internal controls and compliance systems. Noncompliance with applicable law and regulations could lead to serious consequences, including suspension or even termination of the Company’s business. Consequently, noncompliance “presents a significant risk to MoneyGram’s business model.”
Notwithstanding this substantial risk, the Company has found itself subject to several governmental actions alleging various failures in systems and controls. These actions culminated in 2012 with a deferred prosecution agreement (DPA) pursuant to which the Company agreed to (i) pay $120 million into a fund for victims of fraud enabled by the Company’s services and (ii) substantially improve the Company’s compliance systems and controls over five years. The Plaintiff alleged that, notwithstanding the DPA, complaints of fraudulent and illegal activities did not decrease and the Company was unable to meet the requirements of the DPA. The Company thereafter was compelled to pay an additional $125 million into the victims’ restitution fund and extend the DPA for an additional four years.
Plaintiff brought claims against the Company’s directors and two of its officers, alleging that these individuals had failed “to exercise oversight sufficient to comply with their fiduciary duties.” Specifically, Plaintiff claimed that the Defendants had failed the second prong articulated by the Supreme Court of Delaware in its landmark Caremark decision (discussed in prior posts): that the Defendants had in fact established compliance systems but, “having implemented such a system or controls, consciously failed to monitor or oversee operations thus disabling themselves from being informed of risks or problems requiring their attention.”
Plaintiff did not make a pre-suit demand on the Company’s board, claiming that such a demand would be futile because all of the directors were interested in the outcome of the case since they were named as defendants At the outset, the Court reiterated the familiar principle that demand would not be excused simply because the directors were defendants:
The fact that wrongdoing is alleged against the directors themselves or that directors are named defendants in an action does not by itself deprive them of independence; otherwise, compliance with Rule 23.1 in derivative pleadings would be self-proving. Instead, a plaintiff must plead facts implying a substantial likelihood of directorial liability to satisfy the rule.
Because Moneygram’s certificate of incorporation includes a Section 102(b)(7) provision that exculpates directors from liability other than for breaches of the duty of loyalty, to proceed, Plaintiff would have to plead with particularity that the Defendants had acted in bad faith which the Court equated with acting with scienter (i.e., knowingly).
The Court concluded that Plaintiff failed to meet this exacting standard. Addressing what Plaintiff had alleged were “red flags” regarding the Company’s compliance systems, the Court noted that the Company had in fact taken numerous actions to improve its anti-fraud and anti-money laundering controls, and there had been some improvement: just not enough. As the Court put it:
The DPA left it up to the company to devise methods to prevent agent fraud; on the Defendant Directors’ watch the company implemented such actions, but with insufficient speed and skill. But this allegation simply tells me the Board did a poor job applying its discretion to act; to my mind, this does not reasonably imply bad faith.
Interestingly, the Court contrasted the allegations before it in Richardson with two recent cases also involving allegations of failed oversight, Teamsters Local 443 Health Services & Insurance Plans v. Chou, and In re MetLife Inc. Derivative Litigation. In both of these cases, the plaintiffs had alleged directorial non-action in response to red flags regarding compliance deficiencies. In Chou, the Court had found the specific allegations sufficient (if proven) to lead to a substantial likelihood of director liability; in MetLife, the Court found that the allegations were insufficient. But in both of these cases, unlike in Richardson, the analysis did not turn on the sufficiency of what the boards had done, because plaintiffs alleged that no remedial actions had been taken. In Richardson, in contrast, the Plaintiff alleged that the directors took action, but that it was insufficient or ineffective. As the Court concluded:
The facts pled here suggest a failed effort, not one opposed to the interests of Moneygram or otherwise in bad faith. It is conceivable that a purported attempt at remediation could constitute bad faith; for instance, a mere sham remediation or an insincere action to fool regulators may be actionable…. If a failed directorial attempt to remediate a problem is, because of its failure, actionable, a perverse incentive will be created.
The Court’s reasoning, and differentiation between failed attempts at compliance on the one hand, and an absence or lack of effort on the other, provides important guidance to directors faced with mission-critical compliance situations. The decision also reaffirms the principle espoused in many of the long line of decisions since the original Caremark decision that a claim of bad-faith oversight failure is among the most difficult claims for a stockholder-plaintiff to advance.
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.