As highlighted in this prior post, in March 2015 a federal district court dismissed eight Wal-Mart shareholder derivative actions (consolidated into one) brought in the aftermath of the company’s FCPA scrutiny.
Last Friday in this opinion, the Eighth Circuit affirmed the dismissal.
Those who predicted that the Wal-Mart derivative actions would set a new standard for director liability were once again proven wrong (see here for the prior post).
Before turning to the opinion, if you are not familiar with derivative actions if might be useful to review this prior post which highlights the relevant procedural and pleading aspects of derivative actions.
The Eighth Circuit’s opinion began as follows.
“Owners of shares of Wal-Mart Stores, Inc. (Wal-Mart) sued directors and officers of the corporation, accusing them of breaking state and federal law by permitting and then covering up pervasive bribery committed on behalf of Wal-Mart’s Mexican subsidiary, Wal-Mart de Mexico (Wal-Mex). Because the shareholders sought to enforce rights belonging to Wal-Mart, Federal Rule of Civil Procedure 23.1 required them to explain why they did not first ask the board of directors to cause the corporation to pursue the suit itself. The shareholders claimed it would have been futile to go to the board with such a demand. We agree with the district court that the shareholders’ explanation was not specific or detailed enough, and we affirm the dismissal of their complaint.”
After reviewing the allegations in the complaints and setting forth the applicable legal framework, the court framed the issue as follows.
“The upshot, then, is that the shareholders needed to plead “particularized facts”—as distinct from “conclusory allegations”—supporting “reasonable factual inferences, that the seven continuing board members learned of the suspected bribery before word of the New York Times investigation got out and Wal-Mart began scrambling to do what it allegedly should have been doing from the beginning. The shareholders advance three accounts of how that knowledge reached the board. Reviewing their allegations de novo, we find none of the theories persuasive.”
The shareholders first theory, as stated by the court, “is that during the initial in-house investigation in late 2005, Wal-Mart’s investigators reported their preliminary findings to the then chair of the board’s audit committee, Roland Hernandez, who alerted the rest of the board.” Elsewhere, the court framed the issue as follows.
“Was the audit committee’s obligation to report to the board enough, under Delaware law, to make it reasonable to infer the board learned what Hernandez allegedly read in the in-house investigators’ draft progress report?”
The answer, in the court’s view, was no and it stated:
“Notwithstanding the shareholders’ vague references to a “plethora” of unspecified “corroborating facts,” we discern no particularized allegations supporting that conclusion other than the audit committee charter requiring “regular reports to the Board.” The shareholders’ position thus boils down to the same logic Delaware courts have consistently rejected, namely the inference that directors must have known about a problem because someone was supposed to tell them about it. In the context of a derivative suit involving a Delaware corporation, we refuse to assume so much.”
The shareholders second theory, as stated by the court, “is that other senior officers at Wal-Mart, besides Hernandez, told the board.” According to the court, this theory merited less discussion, and it stated in full:
“We do not doubt that the shareholders’ particularized allegations established a handful of officers—though not the “small army” the shareholders claim—including Duke and Scott, as well as Wal-Mart’s general counsel, received reports about the alleged bribery scheme at Wal-Mex, were involved to different degrees in making decisions about the investigation, and had duties to report wrongdoing within the corporation. Other than those reporting obligations, the shareholders did not plead any facts supporting the inference that the officers actually shared their knowledge. There are no specific allegations showing any of the identified officers met with the board, talked to board members, or otherwise made reports about Wal-Mex. This argument thus fails for the same reasons as the shareholders’ theory about Hernandez and the audit committee.”
The shareholders third theory, as stated by the court, “is that the bribery at Wal-Mex was so enormous and egregious, and the threat it posed to Wal-Mart so massive, that the board must have known about it.” The court rejected “the shareholders’ legal premise” and noted that the cases they cite “do not establish that the severity of the misconduct committed at a corporation, by itself, can be enough to infer board knowledge.”
In conclusion, the court stated:
“The specific facts alleged in the shareholders’ complaint do not give rise to a reasonable inference that Wal-Mart’s board of directors learned of the suspected bribery by Wal-Mex while the alleged bribery was being covered up and the internal investigation quashed. So the allegations do not establish “with particularity” that the threat of personal liability rendered a majority of Wal-Mart’s 2012 board incapable of fairly considering whether to pursue the corporate causes of action the shareholders seek to enforce in this case, as required by Rule 23.1 and Delaware’s heightened pleading threshold for derivative lawsuits. We therefore affirm the district court’s judgment dismissing the case.”