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Cottrell v. Duke

United States Court of Appeals, Eighth Circuit

July 22, 2016

John Cottrell, Derivatively and on behalf of Wal-Mart Stores, Inc.; Louisiana Municipal Police Employees' Retirement System; Elizabeth Tuberville; Kathryn Johnston Lomax; William Cottrell; Andrew Richman; Larry Emory, Derivatively and on behalf of Wal-Mart Stores, Inc.; Nathan F. Austin, Plaintiffs - Appellants
v.
Michael T. Duke; Aida M. Alvarez; James W. Breyer; M. Michelle Burns; James I. Cash, Jr.; Roger C. Corbett; Douglas N. Daft; Gregory B. Penner; Steven S. Reinemund; H. Lee Scott, Jr.; Arne M. Sorenson; Jim C. Walton; S. Robson Walton; Christopher J. Williams; Linda S. Wolf; Wal-Mart Stores, Inc., Nominal Defendant; Eduardo Castro-Wright; Thomas A. Mars; Thomas D. Hyde, Defendants-Appellees Craig Herkert; Eduardo F. Solorzano Morales; Jose Luis Rodriguezmacedo Rivera; Lee Stucky, Defendant's, Roland Hernandez, Defendant-Appellee

          Submitted: April 14, 2016

         Appeal from United States District Court for the Western District of Arkansas - Texarkana.

          Before RILEY, Chief Judge, WOLLMAN and MURPHY, Circuit Judges.

          RILEY, Chief Judge.

         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[1] that the shareholders' explanation was not specific or detailed enough, and we affirm the dismissal of their complaint.

         I. BACKGROUND

         We recite the material facts taking the allegations in the shareholders' complaint as true. See, e.g., Gomes v. Am. Century Cos., 710 F.3d 811, 815 (8th Cir. 2013). In September 2005, a former Wal-Mex executive, tired of the "'pressure and stress' of participating in years of corruption" and resentful of being snubbed for a promotion, contacted the general counsel for Wal-Mart's international division and said he had information about financial "'irregularities' authorized 'by the highest levels' at Wal-Mex." Since at least 2002, he claimed, Wal-Mex had engaged in an extensive and systematic practice of bribing Mexican officials, with most of the payoffs facilitated by fixers or middlemen called "gestores." The scheme was orchestrated by top executives, including Wal-Mex's then-CEO, Eduardo Castro-Wright-a rising star who later took over Wal-Mart's U.S. division-and general counsel, José Luis Rodríguezmacedo Rivera (Rodríguezmacedo), with the goal of clearing Mexican regulatory and bureaucratic hurdles so Wal-Mex could take over market share by expanding faster than its rivals could react.[2] After hiring a Mexico City lawyer to debrief the former executive and flying south to meet face-to-face, the general counsel of the international division sent memoranda recounting his claims to Wal-Mart's senior management.

         Wal-Mart's first response was to retain an outside law firm to investigate. When the firm proposed questioning "implicated members" of Wal-Mex's board, along with anyone else who might have known about the payments, and tracing every peso Wal-Mex had paid for help getting permits over the past five years, including "any and all payments" to Mexican officials, Wal-Mart decided to have its own Corporate Investigations unit look into the allegations instead. This "Preliminary Inquiry" was expected to last about two weeks in mid-November 2005, according to a partial "Investigation and Audit Plan" attached as an exhibit to the shareholders' complaint.

         Wal-Mart's investigators quickly found evidence consistent with the executive's claims, including hundreds of recorded payments to gestores, totaling millions of dollars, plus additional millions in direct "contributions" and "donations" to Mexican authorities. Three days into the investigation, on November 14, 2005, the director of corporate investigations emailed his boss, Wal-Mart's vice president for global security, aviation, and travel, to let him know, simply, "It is not looking good." Besides the payments themselves, the investigators also turned up materials suggesting complicity at the highest levels of Wal-Mex. For example, when an internal Wal-Mex audit in 2004 warned of the increasing amounts the company was paying two gestores to make "facilitating payments" for permits to open new stores, Castro-Wright's concern was not the possibility Wal-Mex owed its rapid growth to illegal payoffs but the risk of becoming overly dependent on too few intermediaries. The solution, directed by Rodríguezmacedo, was to "diversify" the pool of gestores Wal-Mex dealt with-and to scrub references to the issue from the reports that would go to Wal-Mart management.

         The investigation ruffled feathers at Wal-Mex, and complaints made their way to the head of Wal-Mart's international division, Michael Duke. Duke, who later became Wal-Mart's president and CEO, was in Mexico on other business just as the investigators were wrapping up their review, and Duke took the opportunity to meet with and reassure Wal-Mex executives offended by the investigators' tone and questions.

         The investigators prepared a draft report, dated December 1, concluding "[t]here is reasonable suspicion to believe that Mexican and USA [sic] laws have been violated." It is unclear who saw the report. The document itself, or at least the excerpt attached to the shareholders' complaint, does not say to whom it was sent, though an introductory statement that "Wal-Mart Store's [sic] Internal Audit charter requires that the results of Internal Audit reviews be reported to management" (emphasis added) might suggest its intended recipients. The investigation and audit plan had called for "a progress report [to] be given to Bentonville"-Arkansas, Wal-Mart's headquarters-"management and the Chairman of the Audit Committee" on November 16 and for "[a]dditional progress reports [to] be given as appropriate." The shareholders allege, without additional detail, the investigators' findings and suspicions were reported to the chair of Wal-Mart's audit committee, Wal-Mart's CEO, and its general counsel and, "through these three individuals, to the entire Wal-Mart Board."

         Over the next two months, the investigators urged Wal-Mart to authorize a full in-house investigation based on their preliminary findings. Instead, in February 2006, Wal-Mart's then-CEO, H. Lee Scott, transferred control over the matter from the nominally independent Corporate Investigations unit to Wal-Mex itself, under the direction of Rodríguezmacedo as general counsel. Far from undertaking the sort of in-depth, exhaustive inquiry the original investigators envisioned, Rodríguezmacedo quickly wrapped up the case, clearing himself and his Wal-Mex colleagues largely based on their denials and the absence of direct evidence-the executives never "mentioned having ordered or given bribes to government authorities." Much of his six-page report was devoted to questioning the credibility of the former executive whose allegations set the investigation in motion, suggesting the former executive had tricked Wal-Mex into paying gestores "unnecessarily, or for services never rendered" and might have pocketed some of the money for himself. Wal-Mart's director of corporate investigations, although no longer running the investigation, reviewed two drafts of the report. Even after revisions, he thought it was "truly lacking." But Wal-Mart's senior executives were satisfied and closed the inquiry.

         All was quiet for several years, until Wal-Mart learned the New York Times was conducting its own investigation into what happened at Wal-Mex in the early 2000s. Apparently the whistle-blowing former executive, dissatisfied with the company's response, had shared his story with the press as well. Facing imminent exposure, Wal-Mart resurrected its internal investigation, preemptively informed the U.S. Department of Justice and Securities Exchange Commission it was looking into possible violations of the Foreign Corrupt Practices Act, 15 U.S.C. §§ 78dd-1 to -3, and disclosed both responses in its next quarterly report. The Times article, titled "Wal-Mart Hushed Up a Vast Mexican Bribery Case, " came out on April 21, 2012. Derivative lawsuits by Wal-Mart shareholders followed within days. This case brings together eight of them.[3]

         In their consolidated complaint, the shareholder plaintiffs alleged numerous Wal-Mart directors and executives, past and present, breached their fiduciary duties to the corporation by allowing Wal-Mex's bribery, covering it up, and letting the internal investigation be watered down to nothing. They also asserted the defendants were liable to Wal-Mart for violating Sections 14(a) and 29(b) of the Securities Exchange Act, 15 U.S.C. §§ 78n(a)(1), 78cc(b), see also 17 C.F.R. § 240.14a-9(a) (implementing Section 14(a)(1)), reasoning the defendants caused Wal-Mart to issue proxy statements in connection with board elections in 2010 and 2011 that were false or misleading because they said the directors up for reelection had "integrity, " the incumbent board tried to ensure Wal-Mart followed the law, and the board and CEO followed Wal-Mart's internal ethical codes.[4] Although the causes of action arising from these alleged violations would have accrued to Wal-Mart, the shareholders did not demand that the corporation, led by its current board, pursue the claims itself. Rather, they alleged circumstances that they thought demonstrated the board could not make that decision impartially, so it was pointless to go through the motions of making demands.

         The defendants moved to dismiss on the ground that the shareholders' allegations about the futility of demanding action from the board did not satisfy the pleading requirements of Rule 23.1. See also Fed.R.Civ.P. 12(b)(6). The district court granted the motion. The shareholders appeal, invoking our appellate jurisdiction under 28 U.S.C. § 1291.

         II. DISCUSSION

         Rule 23.1(b)(3) says that shareholders seeking to enforce a corporation's rights through a derivative action must "state with particularity" "any effort" they took "to obtain the desired action from the [corporation's] directors" and "the reasons for not obtaining the action or not making the effort." On its face, that language does not make seeking action from the board a prerequisite to bringing a derivative suit, though it does "clearly contemplate[]" that such a requirement might apply. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 96 (1991). We have therefore recognized Rule 23.1 as "'a rule of pleading' that 'requires that the complaint . . . allege the facts that will enable a federal court to decide whether'" derivative plaintiffs complied with such a demand requirement imposed by another source. Gomes, 710 F.3d at 815 (quoting Halebian v. Berv, 590 F.3d 195, 211 (2d Cir. 2009), abrogated on other grounds by Espinoza ex rel. JPMorgan Chase & Co. v. Dimon, 797 F.3d 229 (2d Cir. 2015)).

         Here, the law of Delaware-where Wal-Mart is incorporated-provides the substantive demand requirement against which to test the shareholders' allegations.[5]See id. According to Delaware law, in cases like this, shareholders who did not make a demand on the board cannot bring a derivative suit unless their "particularized factual allegations . . . create a reasonable doubt that, as of the time the complaint [was] filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand."[6] Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993). One reason a board might be unable to make a disinterested decision is if a majority of the directors would face "'a substantial likelihood'" of personal liability from a lawsuit brought by the corporation. Id. at 936 (quoting Aronson, 473 A.2d at 815) ("In such circumstances, a director cannot be expected to exercise his or her independent business judgment without being influenced by the adverse personal consequences resulting from the decision.").

         Wal-Mart had fifteen directors when the shareholders filed their complaint in 2012. Two of them, Duke and Scott, allegedly dealt directly with aspects of the Wal-Mex investigation in their roles as executives, and the defendants do not argue those two were disinterested. The focus of this appeal is the seven other 2012 directors who were on the board at the time of the investigation in 2005 and 2006.[7] For those seven directors to face personal liability, the parties agree, they must have at least been aware of the claimed misconduct at Wal-Mex when they allegedly acquiesced in the hijacking of the internal investigation and the ongoing coverup and caused Wal-Mart to issue misleading proxy statements.[8]

         The upshot, then, is that the shareholders needed to plead "particularized facts"-as distinct from "conclusory allegations"-supporting "reasonable factual inferences, " see Brehm v. Eisner, 746 A.2d 244, 255 (Del. 2000), 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 ...


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