14-1754
Espinoza v. Dimon
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
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August Term, 2014
(Argued: April 1, 2015 Decided: December 3, 2015)
Docket No. 14‐1754
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ERNESTO ESPINOZA, Derivatively on Behalf of JPMorgan Chase & Co.,
Plaintiff‐Appellant,
—v.—
JAMES DIMON, DOUGLAS L. BRAUNSTEIN, MICHAEL J. CAVANAGH, ELLEN V. FUTTER,
JAMES S. CROWN, DAVID M. COTE, LABAN P. JACKSON, JR., CRANDALL C. BOWLES,
JAMES A. BELL, LEE R. RAYMOND, STEPHEN B. BURKE, WILLIAM C. WELDON, INA R.
DREW, DAVID C. NOVAK,
Defendants‐Appellees,
JPMORGAN CHASE & CO.,
Nominal Defendant‐Appellee,
WILLIAM H. GRAY, III,
Defendant.
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B e f o r e: KATZMANN, Chief Judge, POOLER and CARNEY, Circuit Judges.
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Appeal from the dismissal of a derivative action seeking to compel
JPMorgan Chase & Co. to take action against the corporate officers allegedly
responsible for losses related to the “London Whale” trading incident. We sought
and received guidance from the Delaware Supreme Court on how Delaware law
treats a stockholder’s challenge to the scope of a board’s investigation of his
demand. With the benefit of that guidance, we find that the plaintiff in this case
has not met his burden to plead facts sufficient to rebut the strong presumption
that the board’s decision was a valid exercise of its business judgment.
Accordingly, we affirm the district court’s dismissal of the complaint.
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GEORGE C. AGUILAR (Jay N. Razzouk, on the brief), Robbins Arroyo
LLP, San Diego, California; Thomas G. Amon, Law Offices of
Thomas G. Amon, New York, New York, for Plaintiff‐Appellant.
RICHARD C. PEPPERMAN, II, Sullivan & Cromwell LLP, New York,
New York (Daryl A. Libow, Christopher Michael Viapiano,
Sullivan & Cromwell LLP, Washington, D.C., on the brief), for
Defendants‐Appellees James Dimon, Douglas L. Braunstein,
Michael J. Cavanagh, Ina R. Drew, and Nominal Defendant‐
Appellee JPMorgan Chase & Co.
Jonathan C. Dickey, Gibson, Dunn & Crutcher LLP, New York, New
York, for Defendants‐Appellees Ellen V. Futter, James S. Crown,
David M. Cote, Laban P. Jackson, Jr., Crandall C. Bowles,
James A. Bell, Lee R. Raymond, Stephen B. Burke, William C.
Weldon, and David C. Novak.
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KATZMANN, Chief Judge:
This is our third opinion addressing Ernesto Espinoza’s derivative suit, in
which he alleges that the board of JPMorgan Chase & Co. (“JPMorgan”)
improperly failed to investigate alleged misstatements made by JPMorgan
executives regarding the “London Whale” trading incident. Espinoza, a JPMorgan
stockholder, contends that the board wrongfully rejected his demand that
JPMorgan take action because its investigation focused only on the underlying
incident and not the executives’ subsequent statements. The United States District
Court for the Southern District of New York (Daniels, J.) dismissed Espinoza’s
complaint, finding that he had not pleaded sufficient facts to rebut the strong
presumption that the board’s decision was a valid exercise of its business
judgment.
In our first opinion, we affirmed the district court’s dismissal under an
abuse of discretion standard, at the time the traditional standard of review for
derivative actions in our circuit. See Espinoza ex rel. JPMorgan Chase & Co. v.
Dimon, 790 F.3d 125 (2d Cir.), order withdrawn (Aug. 12, 2015). We reconsidered
whether that standard of review was appropriate and determined that our review
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should instead be de novo, in line with our review of other dismissals and the
standard used in other courts, including in the First and Seventh Circuits and the
Delaware Supreme Court. See Espinoza ex rel. JPMorgan Chase & Co. v. Dimon, 797
F.3d 229, 234–36 (2d Cir. 2015).
Accordingly, we then reviewed Espinoza’s complaint de novo. We
determined that Espinoza’s appeal presented a question that was unclear under
Delaware law, i.e., how to evaluate a stockholder’s challenge to the scope of a
board’s investigation, separate from the procedures it followed in reaching that
decision. Rather than attempt to fill any potential gap in Delaware law ourselves,
we certified the following question of law to the Delaware Supreme Court:
If a shareholder demands that a board of directors investigate both
an underlying wrongdoing and subsequent misstatements by
corporate officers about that wrongdoing, what factors should a
court consider in deciding whether the board acted in a grossly
negligent fashion by focusing its investigation solely on the
underlying wrongdoing?
Id. at 240. The Delaware Supreme Court granted our request for certification, and
provided helpful guidance in its answer. See Espinoza ex rel. JPMorgan Chase & Co.
v. Dimon, __ A.3d __, 2015 WL 5439176 (Del. Sept. 15, 2015) (hereinafter,
“Delaware Response”).
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With the benefit of that guidance, which we are bound to follow, we now
find that the plaintiff in this case has not met his burden to rebut the business
judgment presumption. Accordingly, we affirm the district court’s dismissal of
Espinoza’s complaint.
Because our previous opinion extensively discussed the background of this
case, we do not repeat that history here. Instead, we focus on the legal analysis
underlying our conclusion that Espinoza’s complaint should be dismissed.
DISCUSSION
A. Delaware’s Response to our Certified Question
“We receive the response to our certification ‘bearing in mind that the
highest court of a state has the final word on the meaning of state law.’” Engel v.
CBS, Inc., 182 F.3d 124, 125 (2d Cir. 1999) (quoting Cty. of Westchester v. Comm’r of
Transp., 9 F.3d 242, 245 (2d Cir. 1993)). The adequacy of a complaint alleging
wrongful refusal of a stockholder demand is determined under the law of the
state of incorporation, here, Delaware. See RCM Sec. Fund, Inc. v. Stanton, 928 F.2d
1318, 1326 (2d Cir. 1991).
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As we noted in our previous opinion certifying a question to the Delaware
Supreme Court, and as the Delaware Supreme Court emphasized in its response,
our review of a wrongful refusal suit starts from the premise that the decision to
initiate a lawsuit is an internal corporate matter within the board’s discretion.
Any plaintiff attempting to bring a derivative suit therefore bears the “difficult”
burden to plead facts sufficient to rebut the strong presumption that the board’s
decision not to take action was a valid exercise of its business judgment. Delaware
Response at *2. As the Delaware Supreme Court discussed in Aronson v. Lewis:
The business judgment rule is an acknowledgment of the managerial
prerogatives of Delaware directors under [Del. Code Ann. tit. 8, §]
141(a). It is a presumption that in making a business decision the
directors of a corporation acted on an informed basis, in good faith
and in the honest belief that the action taken was in the best interests
of the company. Absent an abuse of discretion, that judgment will be
respected by the courts. The burden is on the party challenging the
decision to establish facts rebutting the presumption.
473 A.2d 805, 812 (Del. 1984) (citations omitted), overruled on other grounds by
Brehm v. Eisner, 746 A.2d 244, 253 (Del. 2000).
The Delaware Supreme Court’s response to our certified question also
underscores that the subject of our review is not the merits of JPMorgan’s decision
to refuse Espinoza’s demand; rather, we consider only whether the plaintiff has
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pleaded sufficient facts to suggest that the board’s decision was unreasonable or
not made in good faith, in the context of all of the factors that the board had to
consider. See Delaware Response at *2 (“Delaware law on the relevant topic is
settled, and requires that the decision of an independent committee to refuse a
demand should only be set aside if particularized facts are pled supporting an
inference that the committee, despite being comprised solely of independent
directors, breached its duty of loyalty, or breached its duty of care, in the sense of
having committed gross negligence.”); id. at *2 n.10 (“[T]o survive a motion to
dismiss, the plaintiff stockholder asserting wrongful refusal of a demand must
allege with particularity in the complaint facts that give rise to a reasonable doubt
as to the good faith or reasonableness of that investigation.’” (quoting Wolfe &
Pittenger, Corporate and Commercial Practice in the Del. Court of Chancery
§ 9.02[b][3], at 9–108 (Matthew Bender & Co. 2013)). This approach is consistent
with the view of Delaware courts that judges are ill‐suited to second‐guess board
decisions. See In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 124 (Del.
Ch. 2009) (observing that Delaware’s focus on the “decision‐making process
rather than on a substantive evaluation of the merits of the decision . . . follows
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from the inadequacy of the Court, due in part to a concept known as hindsight
bias, to properly evaluate whether corporate decision‐makers made a ‘right’ or
‘wrong’ decision”) (footnote omitted).
Accordingly, to meet his burden at the motion to dismiss stage, a plaintiff
alleging wrongful refusal of a demand must plead facts supporting a plausible
inference that the board’s decision not to take action was a result of gross
negligence, defined under Delaware law as “conduct that constitutes reckless
indifference or actions that are without the bounds of reason.” McPadden v. Sidhu,
964 A.2d 1262, 1274 (Del. Ch. 2008). As this Court has noted, “few, if any,
plaintiffs surmount this obstacle.” RCM Sec. Fund, Inc., 928 F.2d at 1328.
B. Delaware’s Approach Applied to this Case
With these principles of Delaware law in mind, we find that Espinoza has
not met his burden to survive the defendants’ motion to dismiss. JPMorgan’s
investigation into the entire London Whale incident was exhaustive. The board
created a Review Committee composed of three outside board members, who
retained independent counsel and an expert advisor to assist in the investigation.
The Review Committee also oversaw a management Task Force, also assisted by
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separate independent counsel. Their efforts resulted in the publication of two
extensive written reports, a 129‐page report prepared by the Task Force and a
shorter report compiled by the Review Committee, and led to many of the
changes demanded by Espinoza, including clawbacks, reductions in
compensation, and reformed internal guidelines and controls. This case is
therefore distinguishable from those in which a board, faced with similar
demands, conducted only a half‐hearted investigation, peremptorily stopped the
investigation, or did nothing with the results. See, e.g., Rich ex rel. Fuqi Int’l, Inc. v.
Yu Kwai Chong, 66 A.3d 963, 973, 979 (Del. Ch. 2013) (denying the defendants’
motion to dismiss where the special committee investigating the plaintiff’s
demand held no meetings, released no reports, and eventually was left with no
members); Thorpe v. CERBCO, Inc., 611 A.2d 5, 8–11 (Del. Ch. 1991) (denying the
defendants’ motion to dismiss where the members of the special litigation
committee resigned after producing a report, the corporation never showed the
contents of the report to stockholders, and the directors never formally responded
to the plaintiff’s demand letter).
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Moreover, under Delaware law, the board was not required to send
Espinoza a detailed letter explaining its refusal with a point‐by‐point response to
each of the five claims he raised in his demand letter. See, e.g., Baron v. Siff, No.
15152, 1997 WL 666973, at *3 (Del. Ch. Oct. 17, 1997) (“The refusal letter’s failure
to state that the Board held a meeting and failure to contain a point‐by‐point
response to all allegations in the demand letter does not stand for the proposition
that the Board did not consider the demand before refusing it. . . . The Board’s
detailed responses to several of plaintiff’s allegations reveal its familiarity with
the issues plaintiff raised.”). The minimal requirements for boards contemplating
stockholder demands are consistent with “a central tenet of Delaware corporate
law, that there is ‘no single blueprint a board must follow to fulfill its duties,’
including with respect to stockholder demands.” Ironworkers Dist. Council of
Philadelphia & Vicinity Ret. & Pension Plan v. Andreotti, No. 9714‐VCG, 2015 WL
2270673, at *26 n.254 (Del. Ch. May 8, 2015) (quoting Barkan v. Amsted Indus., Inc.,
567 A.2d 1279, 1286 (Del. 1989)). For example, in Levine v. Smith, 591 A.2d 194, 214
(Del. 1991), overruled on other grounds by Brehm, 746 A.2d 244 at 253, the Court of
Chancery found that the “only reasonable inference to be drawn” from the
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board’s five‐line reply letter advising the stockholder that it had “review[ed] . . .
the matters” set forth in the stockholder’s demand letter was that the board “did
act in an informed manner in addressing Levine’s demand.” In this case, by
describing the nature of its investigation and the remedial steps taken as a result,
JPMorgan’s four‐page refusal letter thus far exceeded the minimum required.
As the Delaware Supreme Court observed in its response, “No doubt it is
conceivable that an investigative committee that was charged with investigating
two materially important and materially distinct subjects could be deemed
grossly negligent if it did an indisputably careful job investigating one, and did
no job at all of investigating the other,” but the critical question is the “contextual
importance of that [allegedly uninvestigated] issue in the overall scope of what
the committee was charged with investigating.” Delaware Response at *2. In other
words, whether JPMorgan’s board discharged its duty to investigate Espinoza’s
demand depends on whether the “supposedly distinct category [he] allege[s]
went uninvestigated . . . was . . . distinct from the category that was indisputably
investigated, and whether it was material, when viewed in the overall context of
the debacle.” Id. at *3.
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Reviewing the record in light of the Delaware Supreme Court’s response,
we note that investigating the allegedly “materially false/misleading statements
and omissions” made by JPMorgan executives was just one of five claims raised
in Espinoza’s demand letter, and bringing legal action against the alleged
wrongdoers was but one of the many remedies that Espinoza demanded. J.A. 69–
70. It is also clear from the Task Force report, cited in JPMorgan’s response to
Espinoza, that the board was well aware of the executives’ statements referenced
in Espinoza’s letter, see J.A. 340–41, and that the board investigated the extent of
the executives’ knowledge at the time the statements were made as part of its
overall inquiry, see J.A. 334; 339; 361. After conducting “[a]n evaluation of the
claims against potential defendants and the likelihood of a recovery of damages,”
the board determined that “litigation would not be in the best interests of”
JPMorgan. J.A. 85. JPMorgan’s response, together with the Task Force report, thus
directly contradicts Espinoza’s contention that the board was recklessly
indifferent to the claims he raised or unreasonable in refusing his demand.
Accordingly, we find that Espinoza has not met his burden to rebut the strong
presumption of the business judgment rule, as defined by Delaware law.
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In addition to recognizing that Delaware law rejects judicial second‐
guessing when a board has made a decision on a matter of internal corporate
affairs, we also note two practical considerations. First, as we observed in our
previous opinion, to require boards to detail a response to every issue raised in a
demand letter could risk incentivizing plaintiffs to include a laundry list of
potential claims, each of which boards would have to respond to, no matter how
meritless. See Espinoza, 797 F.3d at 240; cf. Levine, 591 A.2d at 214 (“While a board
of directors has a duty to act on an informed basis in responding to a demand . . . ,
there is obviously no prescribed procedure that a board must follow.”).
Second, providing additional detail in a refusal letter could expose the
corporation to regulatory or other legal risks, and the board is entitled to—and
typically, required to—mitigate that risk in deciding how to respond to a
stockholder’s demand. Indeed, the board cited the risk of adverse legal action
against JPMorgan as one of its reasons not to pursue litigation. See J.A. 85 (listing
“[t]he effect of litigation brought by the Company on the Company’s position in
third‐party litigation, regulatory investigations, and potential enforcement
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proceedings” as a factor in deciding “that litigation would not be in the best
interests” of JPMorgan). As the Court of Chancery has observed:
A board may in good faith refuse a shareholder demand to begin
litigation even if there is substantial basis to conclude that the lawsuit
would eventually be successful on the merits. It is within the bounds
of business judgment to conclude that a lawsuit, even if legitimate,
would be excessively costly to the corporation or harm its long‐term
strategic interests.
In re infoUSA, Inc. S’holders Litig., 953 A.2d 963, 986 (Del. Ch. 2007).
For the foregoing reasons, we conclude that Espinoza has not sufficiently
rebutted the presumption that JPMorgan’s board acted in good faith in
responding to his demand letter, and we accordingly AFFIRM the district court’s
dismissal of his complaint.
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