IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
MELBOURNE MUNICIPAL )
FIREFIGHTERS’ PENSION TRUST )
FUND, derivatively on behalf of )
QUALCOMM, INCORPORATED, )
)
Plaintiff, )
)
v. )
)
PAUL E. JACOBS; STEVEN M. )
MOLLENKOPF; BARBARA T. ) C.A. No. 10872-VCMR
ALEXANDER; DONALD G. )
CRUICKSHANK; RAYMOND V. )
DITTAMORE; SUSAN HOCKFIELD; )
THOMAS W. HORTON; SHERRY )
LANSING; HARISH MANWANI; )
DUANE A. NELLES; CLARK T. )
RANDT, JR.; FRANCISCO ROS; )
JONATHAN J. RUBINSTEIN; )
GENERAL BRENT SCOWCROFT; )
MARC I. STERN; and JING WANG, )
)
Defendants, )
)
-and- )
)
QUALCOMM, INCORPORATED, )
)
Nominal Defendant. )
MEMORANDUM OPINION
Date Submitted: April 5, 2016
Date Decided: August 1, 2016
Joel Friedlander, Jeffrey Gorris, Christopher M. Foulds, and Benjamin P. Chapple,
FRIEDLANDER & GORRIS, P.A., Wilmington, Delaware; Mark Lebovitch,
David Wales, Christopher J. Orrico, and John Vielandi, BERNSTEIN LITOWITZ
BERGER & GROSSMANN LLP, New York, New York; Brett M. Middleton,
BERNSTEIN LITOWITZ BERGER & GROSSMANN LLP, San Diego,
California; Attorneys for Plaintiff Melbourne Municipal Firefighters’ Pension
Trust Fund.
Peter J. Walsh, Jr. and Andrew H. Sauder, POTTER ANDERSON & CORROON
LLP, Wilmington, Delaware; Rachel G. Skaistis, CRAVATH, SWAINE &
MOORE LLP, New York, New York; Attorneys for Defendants Paul E. Jacobs,
Steven M. Mollenkopf, Barbara T. Alexander, Donald G. Cruickshank, Raymond
V. Dittamore, Susan Hockfield, Thomas W. Horton, Sherry Lansing, Harish
Manwani, Duane A. Nelles, Clark T. Randt, Jr., Francisco Ros, Jonathan J.
Rubenstein, General Brent Scowcroft, and Marc I. Stern.
David E. Ross, ROSS ARONSTAM & MORITZ, Wilmington, Delaware; Attorney
for Nominal Defendant Qualcomm, Incorporated.
MONTGOMERY-REEVES, Vice Chancellor.
The plaintiff’s Verified Stockholder Derivative Complaint, brought on
behalf of Qualcomm, Incorporated, alleges that certain Qualcomm officers and
directors damaged the company by repeatedly allowing and causing it to violate
international antitrust laws. The crux of the plaintiff’s complaint is that
Qualcomm’s board of directors breached its duty of loyalty because it was on
notice as to corporate misconduct and consciously disregarded its duty to remedy
or prevent such misconduct—i.e., what is known colloquially as a Caremark claim.
The plaintiff did not demand that the board pursue its claims before bringing this
action. According to the plaintiff, any such demand would have been futile
because a majority of Qualcomm’s directors face a substantial likelihood of
personal liability as to the underlying claims.
The defendants responded by filing a motion to dismiss the plaintiff’s
complaint under Court of Chancery Rules 12(b)(6) and 23.1. For the reasons
stated in this Memorandum Opinion, I grant the defendants’ motion to dismiss.
1
I. BACKGROUND1
A. Parties
Plaintiff Melbourne Municipal Firefighters’ Pension Trust Fund (“Plaintiff”)
is a statutorily created Florida retirement system that provides pension benefits to
retired Melbourne municipal firefighters. Plaintiff is a stockholder of Qualcomm,
Incorporated (“Qualcomm” or the “Company”) and has been at all times relevant
for purposes of this action.
Defendants Paul E. Jacobs, Steven M. Mollenkopf, Barbara T. Alexander,
Donald G. Cruickshank, Raymond V. Dittamore, Susan Hockfield, Thomas W.
Horton, Sherry Lansing, Harish Manwani, Duane A. Nelles, Clark T. Randt, Jr.,
Francisco Ros, Jonathan J. Rubinstein, General Brent Scowcroft, and Marc I. Stern
(the “Director Defendants”) all were members of Qualcomm’s board of directors
(the “Board”) at the time Plaintiff filed its Complaint. Jacobs, Alexander,
1
The facts are drawn from the particularized allegations of the plaintiff’s Verified
Stockholder Derivative Complaint (the “Complaint”), the attachments thereto, and
the documents incorporated into the Complaint by reference. See In re Morton’s
Rest. Gp., Inc. S’holders Litig., 74 A.3d 656, 659 n.3 (Del. Ch. 2013) (“To be
incorporated by reference, the complaint must make a clear, definite and
substantial reference to the documents.” (quoting DeLuca v. AccessIT Gp., Inc.,
659 F. Supp. 2d 54, 60 (S.D.N.Y. 2010))). “When considering a motion to dismiss
under Rule 23.1, this Court affords plaintiffs all reasonable inferences that
logically flow from the particularized facts alleged in the complaint.” Postorivo v.
AG Paintball Hldgs., Inc., 2008 WL 552305, at *4 (Del. Ch. Feb. 29, 2008).
Those allegations and inferences, as well as the facts drawn from documents
attached to and incorporated by referenced into the Complaint, are assumed true
for purposes of a motion to dismiss.
2
Cruickshank, Dittamore, Horton, Lansing, Nelles, Scowcroft, and Stern all served
on the Board since before 2009.
Jacobs has served as the Chairman of the Board since 2009 and was the
Company’s CEO from 2005 to 2014. Mollenkopf has been the Company’s CEO
since 2014 and served in various other executive capacities from 2002 to 2014.
Jacobs and Mollenkopf are referred to as the “Officer Defendants”2 and, together
with the Director Defendants, “Defendants.”
Nominal Defendant Qualcomm is a San Diego-based Delaware corporation.
“The Company designs, develops, manufactures, and markets digital
communications products and services,”3 including integrated circuits (or “chips”)
and other technologies used in telecommunications devices. “In public filings,
Qualcomm describes itself as the leader in the development and commercialization
of a digital communication technology called CDMA (Code Division Multiple
Access).”4 Its largest markets are in China, South Korea, Taiwan, and the United
2
The Complaint also names Jing Wang, a former Executive Vice President and
President of Global Business Operations for Qualcomm and the former Chairman
of Qualcomm China, as an Officer Defendant. On July 22, 2015, Plaintiff
voluntarily dismissed Wang from this action pursuant to Court of Chancery Rule
41(a)(1)(i). See Notice of Dismissal as to Defendant Jing Wang, Docket Item No.
19.
3
Compl. ¶ 12.
4
Id.
3
States. Qualcomm’s shares are listed on the NASDAQ under the symbol
“QCOM.”
B. Facts
1. Qualcomm’s market power and business practices
Qualcomm is a global force in the wireless telecommunications market.
That market utilizes industrywide standards “to ensure compatibility and
interoperability of devices manufactured by different companies.”5 Because of its
success, a number of Qualcomm’s technologies and patents have been adopted as
“essential” under the relevant industry standards. This, in turn, makes
Qualcomm’s products “integral to many aspects of wireless and mobile
communication and the associated devices.”6
As a result of its position in the wireless telecommunications market,
“Qualcomm has turned into a toll collector for almost every smartphone
manufactured.”7 Specifically, Qualcomm monetizes its technologies and patents
through two key business segments: (1) Qualcomm Technology Licensing
(“QTL”) and (2) Qualcomm CDMA Technologies (“QCT”). QTL generates the
5
Id. ¶ 58.
6
Id. ¶ 36.
7
Id. ¶ 43; see also id. ¶ 46 (“Qualcomm receives approximately 3% to 5% on every
3G/4G LTE handset sold anywhere in the world.”).
4
majority of Qualcomm’s revenue by licensing its patent portfolio to third-party
manufacturers in exchange for royalty fees. QCT, which constitutes the other
major source of Qualcomm’s revenue, designs “integrated circuit products used in
a wide variety of wireless devices.”8
Because of its market power and ownership of essential technologies and
patents, Qualcomm has acknowledged that it has an obligation to offer to license
its products on fair, reasonable, and non-discriminatory (“FRAND”) terms.9
Despite that acknowledgement, however, Qualcomm allegedly has engaged in
business practices that leverage its market power in an anticompetitive and abusive
manner. In particular, the Complaint alleges that Qualcomm has (1) charged
unreasonably high licensing fees, (2) forced licensees to pay for unwanted products
by bundling and tying patent licenses, (3) demanded licensees provide certain
royalty-free licenses in return, and (4) imposed unreasonable conditions on
licensees and chip purchasers.
2. Qualcomm pays $891 million to settle a competitor’s
antitrust claims
In 2005, Broadcom Corporation (“Broadcom”) filed a lawsuit against
Qualcomm (the “Broadcom Action”) in the United States District Court for the
8
Id. ¶ 50.
9
Id. ¶¶ 58-61.
5
District of New Jersey. Broadcom asserted antitrust claims against Qualcomm,
stating that “by its intentional deception of private standards-determining
organizations and its predatory acquisition of a potential rival, [Qualcomm] has
monopolized certain markets for cellular telephone technology and components,
primarily in violation of Sections 1 and 2 of the Sherman Act and Sections 3 and 7
of the Clayton Act.”10 Specifically, Broadcom alleged that Qualcomm falsely
induced the standards-determining organizations to adopt its technologies and
patents in the industrywide standards by falsely agreeing to license on FRAND
terms. Broadcom also accused Qualcomm of licensing its technologies and patents
on non-FRAND terms to competitors and customers who used non-Qualcomm
chips.
On August 30, 2006, the District Court dismissed the complaint for failure to
state a claim.11 On September 4, 2007, the United States Court of Appeals for the
Third Circuit reversed the District Court’s ruling in part and concluded that
Broadcom had “stated claims for monopolization and attempted monopolization
under § 2 of the Sherman Act.”12 As such, the Third Circuit remanded those
claims back to the District Court for further proceedings.
10
Broadcom Corp. v. Qualcomm Inc., 501 F.3d 297, 303 (3d Cir. 2007).
11
Id. at 305.
12
Id. at 303.
6
On April 26, 2009, Broadcom and Qualcomm settled the Broadcom Action
(the “Broadcom Settlement”). In the Settlement, Qualcomm agreed to pay
Broadcom $891 million over the next four years. According to Qualcomm’s Form
10-K filed on November 5, 2009 (the “2009 10-K”), “[t]he principal benefits to the
Company from entering into the Agreement were (i) the termination of litigation
between the parties which allows the Company to avoid future litigation expenses
and (ii) the avoidance of future customer disruption; accordingly, the predominant
component of the arrangement was the litigation settlement.”13 In addition, the
2009 10-K characterized the Broadcom Action as “without merit.”14
3. The Korea Fair Trade Commission finds Qualcomm in
violation of South Korean antitrust laws
On July 23, 2009, less than three months after the Broadcom Settlement, the
Korea Fair Trade Commission (the “KFTC”) concluded an investigation of
Qualcomm and issued a decision imposing on Qualcomm corrective orders and a
$208 million fine (the “KFTC Decision”).15 The KFTC Decision, entitled
“Qualcomm’s Abuse of Market Dominance,” found that “Qualcomm is an
unequivocally dominant firm in the Korean CDMA modem chip market with
13
Trans. Aff. of Benjamin Chapple (“Chapple Aff.”) Ex. 7 (“2009 10-K”), at F-27.
14
Id.
15
Chapple Aff. Ex. 13 (“KFTC Decision”), at 1.
7
99.4% market share.”16 Further, the KFTC Decision found that the Company
abused its dominant position by (1) licensing its technologies and patents on non-
FRAND terms to customers who used non-Qualcomm chips, (2) offering rebates to
purchasers who “[met] the great portion of their demand with Qualcomm chips,”
and (3) bundling its licenses such that licensees paid royalties for expired or invalid
patents.17 Thus, the KFTC concluded that Qualcomm, through those abusive
practices, excluded its competitors from the CDMA markets, “thereby maintaining
its market dominance.”18 And, in addition to the $208 million fine, the KFTC
Decision ordered Qualcomm to discontinue the above-described business practices.
In its Form 10-K filed on November 3, 2010 (the “2010 10-K”), Qualcomm
disclosed that “[t]wo U.S. companies (Texas Instruments and Broadcom) and two
South Korean companies (Nextreaming and Thin Multimedia) filed complaints
with the KFTC” regarding the Company’s business practices,19 which ultimately
precipitated the KFTC’s investigation of Qualcomm and the KFTC Decision. As
to the KFTC Decision itself, Qualcomm stated that it did “not anticipate that the
16
Id.
17
Id. at 1-2.
18
Id. at 1.
19
Chapple Aff. Ex. 8 (“2010 10-K”), at F-26. Broadcom subsequently “withdrew its
complaint to the KFTC in May 2009,” as required by the Broadcom Settlement.
Id.
8
cease and desist remedies ordered [would] have a material effect on the results of
its operations.”20 Qualcomm also disclosed that it “believes that its practices do
not violate South Korean competition law, are grounded in sound business practice
and are consistent with its customers’ desires.”21
Although Qualcomm paid the KFTC’s $208 million fine in 2010, it
ultimately appealed the KFTC Decision to the Seoul High Court. On June 19,
2013, the Seoul High Court affirmed the KFTC Decision, and, on July 4, 2013,
Qualcomm appealed that affirmance to the Korea Supreme Court. That appeal
remains pending.
4. The Japan Fair Trade Commission finds Qualcomm in
violation of Japanese antitrust laws
On September 29, 2009, two months after the KFTC Decision and five
months after the Broadcom Settlement, the Japan Fair Trade Commission (the
“JFTC”) issued a Cease and Desist Order against Qualcomm (the “JFTC Order”).
That Order, which was issued after the JFTC performed an investigation pursuant
to Japan’s Antimonopoly Act (the “AMA”), “found [Qualcomm] to be in violation
of Article 19 of the AMA.”22 Specifically, the JFTC concluded that Qualcomm
20
Id.
21
Id.
22
Chapple Aff. Ex. 16 (“JFTC Order”), at 1.
9
had coerced Japanese manufacturers to surrender various intellectual property
rights in exchange for the right to purchase Qualcomm’s chips and license
Qualcomm’s technologies and patents.23 To remedy those abusive practices, the
JFTC ordered Qualcomm to rescind the violative provisions from the license
agreements with Japanese manufacturers and to refrain from reengaging in the
above-described conduct.
In the 2009 10-K, Qualcomm noted that the JFTC had “received unspecified
complaints alleging that the Company’s business practices are, in some way, a
violation of Japanese law” and summarized the findings and terms of the JFTC
Order.24 Qualcomm also stated that “[t]he Company disagrees with the
conclusions” in the JFTC Order and that “[t]he Company intends to invoke its right
under Japanese law to an administrative hearing before the JFTC, request that the
JFTC suspend the [Order] pending a decision following the hearing, and seek a
stay of the [Order] from the Japanese courts should the JFTC deny the Company’s
request.”25
23
Id. For example, the JFTC found that Japanese manufacturers were forced to
grant Qualcomm various royalty-free licenses and agree not to assert their
intellectual property rights against Qualcomm and its customers and licensees.
24
2009 10-K at F-26.
25
Id.
10
The JFTC granted Qualcomm’s request for an administrative hearing on the
JFTC Order, but denied Qualcomm’s request that the JFTC suspend that order
pending the outcome of the administrative hearing. Qualcomm then moved in the
Japanese courts for a stay of the JFTC Order pending the administrative hearing,
and, in February 2010, the Tokyo High Court granted that motion. The JFTC held
the first administrative hearing on February 17, 2010. The JFTC has held over
twenty additional hearings since then, and the matter remains pending.
5. China’s National Development and Reform Commission
finds Qualcomm in violation of Chinese antitrust laws
In November 2013, the National Development and Reform Commission of
the People’s Republic of China (the “NDRC”) “notified [Qualcomm] that it had
commenced an investigation of the Company relating to the Chinese Anti-
Monopoly Law” (the “AML”).26 That same month, the NDRC raided Qualcomm’s
Beijing and Shanghai offices. On February 9, 2015, the NDRC issued an
administrative penalty decision finding that Qualcomm had violated the AML (the
“NDRC Decision”). In its Decision, the NDRC concluded that Qualcomm has a
dominant position in the wireless telecommunications markets and abuses that
dominance by (1) charging licensees royalties for expired and unwanted patents,
(2) demanding that licensees provide reverse patent licenses free of charge, and (3)
26
Compl. ¶ 110.
11
forcing customers to agree to unreasonable and discriminatory conditions to
purchase Qualcomm chips.27
The NDRC also announced that it had entered into a settlement with
Qualcomm whereby Qualcomm agreed to pay an approximately $975 million
fine.28 That penalty amounted to 8% of Qualcomm’s sales in China during 2013.
In addition, the NDRC Decision required Qualcomm to cease its abusive business
practices and to license and sell its patents and technologies to Chinese companies
on FRAND terms. Qualcomm agreed not to contest the NDRC Decision or any of
its penalties and paid the $975 million fine.
C. Procedural History
Before filing its Complaint, Plaintiff sought books and records from
Qualcomm under 8 Del. C. § 220 regarding the Board’s knowledge of and reaction
to the Company’s antitrust issues (the “Section 220 Demand”). Qualcomm
satisfied that request by “produc[ing] 14,000 heavily-redacted pages of documents,
including Board and Board-committee minutes and selected presentations made to
the Board.”29
27
Chapple Aff. Ex. 1 (“NDRC Decision”), at 11-22.
28
Id. ¶ 120 (“[T]he NDRC imposed a fine on Qualcomm of 6.088 billion Chinese
Yuan Renminbi (approximately $975 million at current exchange rates) . . . .”).
29
Pl.’s Answering Br. 5.
12
On April 3, 2015, after receiving the documents Qualcomm submitted in
response to the Section 220 Demand, Plaintiff filed its Complaint. On June 12,
2015, Defendants filed a motion to dismiss the Complaint under Court of Chancery
Rules 12(b)(6) and 23.1 (the “Motion”). The parties submitted briefs supporting
and opposing the Motion, and, on April 5, 2016, I held oral argument on the
Motion. This Memorandum Opinion contains my rulings on Defendants’ Motion.
D. Parties’ Contentions
The Complaint asserts four derivative counts on Qualcomm’s behalf against
Defendants. Count I is a claim for breach of fiduciary duty against the Director
Defendants. Count II is a claim for breach of fiduciary duty against the Officer
Defendants. Count III is a claim for corporate waste against all Defendants. Count
IV is a claim for unjust enrichment against all Defendants. At oral argument,
Plaintiff’s counsel agreed that it had waived the Complaint’s claims relating to
Counts III and IV.30
As to the Complaint’s remaining Counts, Plaintiff acknowledges that it “did
not make a demand on the Board to bring suit asserting [those Counts] because
pre-suit demand is excused as a matter of law.”31 According to Plaintiff, demand
upon the Board to pursue those claims would have been futile at the time it filed
30
Oral Arg. Tr. 55.
31
Compl. ¶ 180.
13
the Complaint because a majority of the Board faces a substantial likelihood of
liability for the wrongdoing alleged therein. Although Plaintiff’s Complaint
advances numerous grounds on which Defendants allegedly breached their
fiduciary duties, Plaintiff’s counsel, at oral argument, narrowed the scope of its
claims, noting that “this [action] is really about the oversight claim and the
Caremark claim related to the monopolization.”32 In other words, Plaintiff
contends that pre-suit demand on the Board was excused because Defendants face
a substantial likelihood of liability under Counts I and II for breaching their duty of
loyalty by failing to oversee the Company’s compliance with applicable antitrust
laws.
Defendants dispute that pre-suit demand on the Board would have been
futile and claim, therefore, that because Plaintiff did not make such pre-suit
demand, the Complaint should be dismissed under Rule 23.1. As to Count I,
Defendants contend that the Complaint fails to plead with particularity that a
majority of the Board faces a substantial likelihood of liability for acting in bad
faith by consciously disregarding their oversight duties. And, as to Count II,
Defendants point out that because only two of the fifteen Director Defendants on
the Board are also Officer Defendants, a majority of the Board could not possibly
32
Oral Arg. Tr. 16.
14
face a substantial likelihood of liability. Defendants also argue that Plaintiff failed
to plead facts upon which relief can be granted under Counts I and II and,
therefore, that the Complaint should be dismissed under Rule 12(b)(6).
II. ANALYSIS
A. Legal Standard for Pleading Demand Futility
A stockholder pursuing a derivative claim in this Court must satisfy the
demand requirement embodied in Court of Chancery Rule 23.1. A plaintiff
satisfies the demand requirement by either (1) making a demand on the board to
undertake a corrective action or (2) demonstrating that any such demand would
have been futile and, therefore, that the demand is excused.33 Where, as here, a
plaintiff alleges that a company suffered a corporate trauma because the board
acted in bad faith by consciously disregarding their duty to oversee the company’s
compliance with applicable laws, Delaware courts generally apply the Rales v.
Blasband34 test for to analyze demand futility.35
33
See, e.g., Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845
A.2d 1040, 1044 (Del. 2004).
34
634 A.2d 927 (Del. 1993).
35
See Wood v. Baum, 953 A.2d 136, 140 (Del. 2008) (“The [Rales] test applies
where the subject of a derivative suit is not a business decision of the Board but
rather a violation of the Board’s oversight duties.”); David B. Shaev Profit Sharing
Account v. Armstrong, 2006 WL 391931, at *4 (Del. Ch. Feb. 13, 2006) ([I]n
a Caremark claim, there is no challenged transaction to test against the business
judgment rule. Consequently, in Rales v. Blasband, the Supreme Court set out a
separate test for demand futility in this limited set of cases.” (footnote omitted)),
15
In Rales, the Delaware Supreme Court held that when a plaintiff challenges
director inaction, rather than a specific transaction, “a court must determine
whether or not the particularized factual allegations of a derivative stockholder
complaint create a reasonable doubt that, as of the time the complaint is filed, the
board of directors could have properly exercised its independent and disinterested
business judgment in responding to a demand.”36 A plaintiff may satisfy the Rales
test for demand futility by demonstrating that the complaint’s underlying claims
pose a serious threat to a majority of the board. The complained-of conduct must
“be so egregious on its face” that the board could not have exercised its business
judgment in responding to a stockholder demand to pursue those claims.37
“Demand is not excused solely because the directors would be deciding to sue
themselves,”38 and “the mere threat of personal liability . . . is insufficient to
aff’d, 911 A.2d 803 (Del. 2006); see also South v. Baker, 62 A.3d 1, 14 (Del. Ch.
2012) (applying the Rales test for demand futility to director oversight claims); In
re Goldman Sachs Gp., Inc. S’holder Litig., 2011 WL 4826104, at *7 (Del. Ch.
Oct. 12, 2011) (same); In re Dow Chem. Co. Deriv. Litig., 2010 WL 66769, at *12
(Del. Ch. Jan. 11, 2010) (same); Desimone v. Barrows, 924 A.2d 908, 927-28
(Del. Ch. 2007) (same).
36
634 A.2d at 934.
37
Aronson v. Lewis, 473 A.2d 805, 815 (Del. 1984), overruled on other grounds by
Brehm v. Eisner, 746 A.2d 244 (Del. 2000).
38
In re Citigroup Inc. S’holder Deriv. Litig., 964 A.2d 106, 121 (Del. Ch. 2009).
16
challenge either the independence or disinterestedness of directors.”39 Rather, a
majority of the board must face a “substantial likelihood” of personal liability for
demand to be excused.40 The analysis of whether a majority of the board faces a
substantial likelihood of personal liability “is conducted on a claim-by-
claim basis.”41
Finally, “[i]n evaluating whether demand is excused, the Court must accept
as true the well pleaded factual allegations in the Complaint,”42 as well as “all
reasonable inferences that logically flow from [those] facts.”43 Because Rule 23.1
requires that a derivative complaint’s allegations be pled with particularity,
however, “[v]ague or conclusory allegations do not suffice, rather the pleader must
set forth particularized factual statements that are essential to the claim.” 44
39
Aronson, 473 A.2d at 815.
40
Id.
41
Teamsters Union 25 Health Servs. & Ins. Plan v. Baiera, 119 A.3d 44, 58 n.71
(Del. Ch. 2015) (quoting Cambridge Ret. Sys. v. Bosnjak, 2014 WL 2930869, at
*4 (Del. Ch. June 26, 2014)).
42
Citigroup, 964 A.2d at 120.
43
Postorivo, 2008 WL 553205, at *4.
44
Id. (citing Brehm, 746 A.2d at 254).
17
B. Demand Was Not Excused as to Count I Under Rule 23.1
In Count I of the Complaint, Plaintiff seeks money damages against the
Director Defendants for breaching their fiduciary duties. Plaintiff avers that
demand would have been futile as to Count I because a majority of the Board faces
a substantial likelihood of liability for acting in bad faith by consciously
disregarding their duty to oversee the Company’s compliance with applicable laws.
This is a quintessential Caremark claim.
1. Legal standard for a Caremark claim
“A breach of fiduciary duty claim that seeks to hold directors accountable
for the consequences of a corporate trauma is known colloquially as
a Caremark claim, in a tip of the judicial hat to Chancellor Allen’s landmark
decision [In re Caremark International Inc. Derivative Litigation].”45 “In a typical
Caremark case, plaintiffs argue that the defendants are liable for damages that arise
from a failure to properly monitor or oversee employee misconduct or violations of
law.”46 “The claim is that the directors allowed a situation to develop and continue
which exposed the corporation to enormous legal liability and that in so doing they
45
La. Mun. Police Empls.’ Ret. Sys. v. Pyott, 46 A.3d 313, 340 (Del. Ch. 2012)
(citing In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996)),
rev’d on other grounds, 74 A.3d 612 (Del. 2013).
46
Citigroup, 964 A.2d at 123.
18
violated a duty to be active monitors of corporate performance.” 47 A Caremark
claim “is possibly the most difficult theory in corporation law upon which a
plaintiff might hope to win a judgment,” and bad faith on the part of the
corporation’s directors “is a necessary condition to liability.”48
In Stone v. Ritter, the Delaware Supreme Court restated the bases on which
directors may be found liable for a breach of their fiduciary duties under
Caremark:
We hold that Caremark articulates the necessary
conditions predicate for director oversight liability: (a)
the directors utterly failed to implement any reporting or
information system or controls; or (b) having
implemented such a system or controls, consciously
failed to monitor or oversee its operations thus disabling
themselves from being informed of risks or problems
requiring their attention. In either case, imposition of
liability requires a showing that the directors knew that
they were not discharging their fiduciary obligations.
Where directors fail to act in the face of a known duty to
act, thereby demonstrating a conscious disregard for their
responsibilities, they breach their duty of loyalty by
failing to discharge that fiduciary obligation in good
faith.49
47
Caremark, 698 at 967.
48
Id. at 967, 971.
49
Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006) (footnotes omitted) (citing In re
Walt Disney Co. Deriv. Litig., 906 A.2d 27, 67 (Del. 2006); Guttman v. Huang,
823 A.2d 492, 506 (Del. 2003)).
19
In this case, Plaintiff’s claim is based on the second of Stone’s two articulations of
a Caremark claim.
Under this formulation of Caremark, a plaintiff may state a valid oversight
claim by pleading (1) that the directors knew or should have known that the
corporation was violating the law, (2) that the directors acted in bad faith by failing
to prevent or remedy those violations, and (3) that such failure resulted in damage
to the corporation.50 In practice, plaintiffs often attempt to satisfy the elements of a
Caremark claim by pleading that the board had knowledge of certain “red flags”
indicating corporate misconduct and acted in bad faith by consciously disregarding
its duty to address that misconduct.51 “A claim that an audit committee or board
had notice of serious misconduct and simply failed to investigate, for example,
50
See Caremark, 698 A.2d at 971 (“[P]laintiffs would have to show either (1) that
the directors knew or (2) should have known that violations of law were occurring
and, in either event, (3) that the directors took no steps in a good faith effort to
prevent or remedy that situation, and (4) that such failure proximately resulted in
the losses complained of.”).
51
See, e.g., South, 62 A.3d at 15 (“A plaintiff . . . can plead that the board
consciously failed to act after learning about evidence of illegality—the proverbial
‘red flag.’”); Armstrong, 2006 WL 391931, at *5 (“[A] Caremark plaintiff can
plead that ‘the directors were conscious of the fact that they were not doing their
jobs,’ and that they ignored ‘red flags’ indicating misconduct in defiance of their
duties.” (quoting Guttman, 823 A.2d at 506-07)), aff’d, 911 A.2d 802 (Del. 2006);
see also In re Chemed Corp., S’holder Deriv. Litig., 2015 WL 9460118, at *22 (D.
Del. Dec. 23, 2015) (Mag.’s Report & Recommendation) (distinguishing between
actual board knowledge of corporate misconduct and actual board knowledge of
“red flags that should have put [the board] on notice about that same
misconduct”), adopted by KBC Asset Mgmt. NV v. McNamara, 2016 WL 2758256
(D. Del. May 12, 2016) (ORDER).
20
would survive a motion to dismiss, even if the committee or board was well
constituted and was otherwise functioning.”52 The subsequent complained-of
“corporate trauma,” however, must be sufficiently similar to the misconduct
implied by the “red flags” such that the board’s bad faith, “conscious inaction”53
proximately caused that trauma.54
2. The Complaint pleads insufficient facts to infer that a
majority of the Board faced a substantial likelihood of
liability under Count I
Plaintiff’s Caremark claim, as pled in the Complaint and as refined in its
brief and at oral argument, is that the Broadcom Settlement, the KFTC Decision,
and the JFTC Order constituted red flags of Qualcomm’s misconduct.55 According
to Plaintiff, a majority of the Board was aware of those alleged red flags because
52
Armstrong, 2006 WL 391931, at *5.
53
South, 62 A.3d at 15.
54
See id. at 17 (“Although the complaint asserts that the directors knew of and
ignored the 2011 safety incidents, the complaint nowhere alleges anything that the
directors were told about the incidents, what the Board’s response was, or even
that the incidents were connected in any way.” (emphasis added)); Dow Chem.,
2010 WL 66769, at *13 (finding “similar [mis]conduct by different members of
management, in a different country, in an unrelated transaction” to be “simply too
attenuated to support a Caremark claim”); Citigroup, 964 A.2d at 129 (noting that
alleged red flags must put directors “on a heightened alert” to the problems that
subsequently cause damage to the corporation).
55
Oral Arg. Tr. 29-32.
21
they were disclosed in various SEC filings that a majority of the Board signed.56
Plaintiff alleges that the Board’s conscious disregard for its duty to remedy and
prevent that misconduct is evidenced by the absence of any indication that the
Board took steps “to address the continuing and repeated violations of fair
competition laws in these foreign markets.”57 And, Plaintiff contends that the
Board’s bad faith, conscious inaction resulted in the NDRC Decision, which
included the NDRC’s $975 million fine.58
I conclude that the Complaint does not plead sufficient facts from which I
may reasonably infer that a majority of the Board faced a substantial likelihood of
liability under Count I. Specifically, Plaintiff has not pled adequately that the
Board’s response to the three alleged red flags constituted bad faith. I agree with
Defendants, therefore, that Plaintiff has not demonstrated that demand would have
been futile as to Count I. Because the Complaint does not plead facts from which I
may reasonably infer that the Board acted in bad faith, Plaintiff’s Caremark claim
necessarily fails, and I need not consider (1) whether the Broadcom Settlement, the
KFTC Decision, and the JFTC Order actually constituted red flags or (2) whether
the Board’s response to those alleged red flags proximately caused the damage that
56
Pl.’s Answering Br. 39.
57
Compl. ¶ 72.
58
Oral Arg. Tr. 32.
22
Qualcomm suffered from the NDRC Decision. For purposes of evaluating whether
the Board acted in bad faith by consciously disregarding its duties, however, I
assume that the Broadcom Settlement, the KFTC Decision, and the JFTC Order
actually constituted red flags.
a. Legal standard for bad faith
In order to plead successfully that the Board’s inaction amounted to bad
faith, Plaintiff must plead particularized facts from which it is reasonably inferable
that the Board consciously disregarded its duties by “intentionally fail[ing] to act in
the face of a known duty to act.”59 “‘Conscious disregard’ involves an ‘intentional
dereliction of duty’ which is ‘more culpable than simple inattention or failure to be
informed of all facts material to the decision.’”60 Such inaction “is fully consistent
with . . . the lack of good faith conduct that the Caremark court held was a
‘necessary condition’ for director oversight liability, i.e., ‘a sustained or systematic
failure of the board to exercise oversight.’”61 Simply alleging that a board
59
Disney, 906 A.2d at 67.
60
Goldman Sachs, 2011 WL 4826104, at *13 (quoting Disney, 906 A.2d at 66).
61
Stone, 911 A.2d at 369.
23
incorrectly exercised its business judgment and made a “wrong” decision in
response to red flags, however, is insufficient to plead bad faith.62
In addition, “[u]nder Delaware law, a fiduciary may not choose to manage
an entity in an illegal fashion, even if the fiduciary believes that the illegal activity
will result in profits for the entity.”63 “Delaware law does not charter law
breakers,” and “a fiduciary of a Delaware corporation cannot be loyal to a
Delaware corporation by knowingly causing it to seek profit by violating the
law.”64 A board also is not insulated from Caremark liability merely because it
“think[s] it knew better than those charged with enforcing the law, and in fact,
often argued with the law itself.”65
62
See Citigroup, 964 A.2d at 131 (“Instead of alleging facts that could demonstrate
bad faith on the part of the directors, by presenting the Court with the so called
‘red flags,’ plaintiffs are inviting the Court to engage in the exact kind of judicial
second guessing that is proscribed by the business judgment rule. In any business
decision that turns out poorly there will likely be signs that one could point to and
argue are evidence that the decision was wrong. Indeed, it is tempting in a case
with such staggering losses for one to think that they could have made the ‘right’
decision if they had been in the directors’ position. This temptation, however, is
one of the reasons for the presumption against an objective review of business
decisions by judges, a presumption that is no less applicable when the losses to the
Company are large.”).
63
Metro Commc’n Corp. BVI v. Advanced Mobilecom Techs. Inc., 854 A.2d 121,
131 (Del. Ch. 2004).
64
In re Massey Energy Co., 2011 WL 2176479, at *20 (Del. Ch. May 31, 2011).
65
Id.
24
b. The Board did not consciously disregard the red flags
and, therefore, did not act in bad faith
The Complaint cites to a number of items that Plaintiff received in its
Section 220 Demand as alleged evidence of the Board’s bad faith inaction in the
face of the three red flags that indicated continuing violations of antitrust law by
Qualcomm’s QTL and QCT business segments.66 Plaintiff points out that “[t]he
Board was well aware of Qualcomm’s monopolistic conduct from multiple
sources,” including, for example, “[a] Board package dated February 1, 2012 . . . in
preparation for the directors’ March 5, 2012 meeting,” which stated that it was the
Company’s intention in China to “[c]ontinue to monitor and attempt to influence
direction of SAC/CNIS regulations, indigenous innovation policies and regulation
of license fees under guise of anti-monopoly law” to protect its business model and
preserve its intellectual property.67 Plaintiff also highlights “a Board package
dated June 17, 2013 . . . in preparation for the directors’ July 15, 2013 meeting,”
which stated that “some companies in China have started to use their Anti-
Monopoly Law (AML) against foreign companies as a competitive tool and as a
way of reducing their cost.”68 Further, Plaintiff notes that the Board’s Audit
66
Compl. ¶¶ 63-72.
67
Id. ¶¶ 63, 66.
68
Id. ¶ 67.
25
Committee materials “for each year between 2010 and 2014” included draft 10-Ks
with “a description of the pending investigations and regulatory actions”69 and that
“the 10-Ks for each year between 2009 and 2014 have a description of the pending
investigations and regulatory actions, and each was signed by each board member,
who constitute a majority of the Director Defendants.”70 Plaintiff then alleges
broadly that in response to the Section 220 Demand, Defendants failed to produce
“any evidence of any efforts or actions the Board undertook to address the
continuing and repeated violations of fair competition laws in these foreign
markets.”71 From this, Plaintiff concludes that “[t]he only reasonable inference is
that the Board consciously declined to act in the face of a known duty to do so.”72
Plaintiff relies most heavily, however, on a June 28, 2010 Board package
prepared in anticipation of the Board’s July 30, 2010 meeting. That package—
which is addressed to Alexander, Cruickshank, Dittamore, Horton, Jacobs,
Lansing, Nelles, Scowcroft, Stern, Mollenkopf, and Wang—contains a strategic
plan review (the “July 30, 2010 Plan”).73 Slide fifty-one of that Plan includes a
69
Id. ¶ 70.
70
Id. ¶ 71.
71
Id. ¶ 72.
72
Id.
73
Chapple Aff. Ex. 14, at Melbourne0003999.
26
“Strategic Imperative,” stating that “[w]e continue to see aggressive efforts
worldwide to increase regulation of IP or create new rules / laws that devalue IP”
and highlighting “[r]ecent activity in Europe, China, India, Japan, Korea and
U.S.”74 That slide also indicates that the Board expected to continue to face
regulatory complaints and investigations” in the future.75 Given its timing—ten
months after the JFTC Order—it is reasonable to infer that the Plan was
referencing the three alleged red flags.
Slide fifty-one of the July 30, 2010 Plan also includes an “Action Plan” in
response to the Strategic Imperative. The Board’s Action Plan includes the
following items: “Proactively Lobby Government Agencies/Officials,” “Academic
Advocacy Program to foster creation and publication of favorable papers on key
issues,” “Speak / Present at key conferences on competition, standards and IPR
around the world,” “Creation / participation in coalitions of like-minded
companies,” and “Improve Image / Brand Awareness.”76 In other words, the
Board’s July 30, 2010 Plan to respond to the three red flags was based largely on
public relations and lobbying rather than substantive change to their QTL and QCT
business segments to avoid potential future antitrust violations. That response
74
Id.
75
Id.
76
Id.
27
appears to have been based on the Board’s views that Qualcomm’s business
practices were not, in fact, violative of any country’s antitrust laws and that the
legal actions it faced were the result of political and competitive opposition, as
opposed to an indication of actual illegal conduct.
The Board’s attitude as reflected in the July 30, 2010 Plan also is consistent
with the Board’s disclosed views on the three red flags in its public SEC filings. In
its 2009 10-K, the Board characterized the Broadcom Action as “without merit.”77
The Board also, in that same 10-K, stated that “[t]he Company disagrees with the
conclusions” in the JFTC Order.78 In its 2010 10-K, the Board stated that it
“believes that its practices do not violate South Korean competition law, are
grounded in sound business practice and are consistent with its customers’
desires.”79 And, the Board promptly appealed both the JFTC Order and the KFTC
Decision.
Plaintiffs contend that this situation resembles the bad faith inaction that the
Court found sufficient to plead a Caremark claim in In re Massey Energy Co.80
77
2009 10-K at F-27
78
Id. at F-26.
79
2010 10-K at F-26.
80
2011 WL 2176479. Although Defendants point out that Massey found that the
plaintiffs had pled a Caremark claim for purposes of Rule 12(b)(6) rather than
Rule 23.1, I note that the Court acknowledged that “the plaintiffs have likely pled
28
The Massey decision involved “a coal mining corporation . . . [c]onvinced that it
knew better than the public authorities charged with enforcing laws designed to
make mining a safer and cleaner business.”81 The company’s CEO in Massey
“believ[ed] he knew better about how to run mines safely than the” government
agency charged with regulating mine safety and “publicly stated that the idea that
governmental safety regulators knew more about mine safety than he did was
silly.”82 The Massey plaintiffs pled “that the independent directors of the Massey
Board did not make a good faith effort to ensure that Massey complied with its
legal obligations” and that the board failed to “respond to numerous red and yellow
flags by aggressively correcting the management culture at Massey that allegedly
put profits ahead of safety.”83 Then-Vice Chancellor Strine held as follows:
To be plain, when a company already has been proven to
have engaged in illegal conduct, it is a high risk strategy
for it to embrace the idea that its regulators are
wrongheaded and to view itself as simply a victim of a
governmental conspiracy. . . . As a kid, most of us are
taught that it is not a good excuse to argue with the rules.
Telling your parents that all the kids are getting caught
shoplifting, cheating, or imbibing illegal substances is
[a Caremark claim] that would survive a motion to dismiss, even under the
heightened pleading standard applicable under Rule 23.1.” Id. at *21.
81
Id. at *1.
82
Id. at *19.
83
Id.
29
not, fortunately, a good excuse. For fiduciaries of
Delaware corporations, there is no room to flout the law
governing the corporation’s affairs. If the fiduciaries of a
Delaware corporation do not like the applicable law, they
can lobby to get it changed. But until it is changed, they
must act in good faith to ensure that the corporation tries
to comply with its legal duties.84
The Court, therefore, agreed with the plaintiffs that it was reasonable to infer that
the Board had consciously disregarded its duties in bad faith.
Similarly, Plaintiff notes that in Louisiana Municipal Police Employees’
Retirement System v. Pyott,85 the plaintiff brought a Caremark claim against
Allergan, Inc.’s board for failing to prevent the company’s continuing violations of
the U.S. ban on off-label drug marketing. As the Court noted, “[b]ecause a
physician legally can prescribe a product for off-label use, a manufacturer legally
can sell a product notwithstanding its potential off-label use. It is illegal, however,
for a manufacturer to market a drug for off-label use.”86 The company’s general
counsel advised the board that the company likely had engaged in such illegal
conduct.87 The plaintiffs in Pyott claimed that, despite the general counsel’s
warning, “the Board discussed and approved a series of annual strategic plans that
84
Id. at *21 (footnotes omitted).
85
46 A.3d 313.
86
Id. at 317-18.
87
Id. at 320.
30
contemplated expanding Botox sales dramatically within geographic areas that
encompassed the United States” and that those “plans contemplated new markets
for Botox that involved applications that were off-label uses in the United
States.”88 Vice Chancellor Laster held as follows:
It is not unreasonable to infer that the Board and CEO
saw the distinction between off-label selling and off-label
marketing as a source of legal risk to be managed, rather
than a boundary to be avoided. Based on this premise,
the CEO and his management team devised, and the
Board approved, a business plan that relied on off-label-
use-promoting activities, confident that the risk of
regulatory detection was low, that most regulatory
problems could be solved, and that dealing with
regulatory risk was a cost of doing business. As profits
increased and the regulatory risk seemed well managed,
the extent of off-label use-promoting activities grew. The
appearance of formal compliance cloaked the reality of
non-compliance, and directors who understood the
difference between legal off-label sales and illegal off-
label marketing continued to approve and oversee
business plans that depended on illegal activity. 89
As a result, the Court concluded that the plaintiffs’ Caremark claim should survive
the defendants’ motion to dismiss under Rule 23.1.
Plaintiff posits that the Board’s response to the alleged red flags in this case
constitutes bad faith under Massey and Pyott because it is reasonable to infer that
the Board was on notice as to Qualcomm’s misconduct and consciously
88
Id. at 352.
89
Id. at 355-56 (footnotes omitted) (citing Massey, 2011 WL 2176479, at *19).
31
disregarded its duty to remedy or prevent that misconduct. Plaintiff contends that
the Board’s “consciousness” is demonstrated by the fact that in the July 30, 2010
Plan it explicitly considered the past and potential future regulatory actions. The
Board’s “inaction” allegedly is demonstrated by the fact that it failed to alter its
business practices to avoid further antitrust violations. According to Plaintiff,
therefore, just as the defendants in Massey were not insulated from liability simply
because they disagreed with the regulator’s interpretation and application of the
relevant law, the Director Defendants here are not insulated simply because they
believed they were unfairly being targeted by regulators and competitors. Instead,
the alleged red flags put the Board on notice as to misconduct at Qualcomm,
triggering the Board’s obligation to take actions in good faith to avoid further
misconduct.
Both Massey and Pyott, however, are distinguishable from this case. The
red flags alleged in Massey were far more egregious and indisputable than those
alleged here. Notably, in Massey, the company “pled guilty to criminal charges
including one felony count for willful violation of mandatory safety standards
resulting in death, eight counts for willful violation of mandatory safety standards,
and one count for making a false statement, and agreed to pay a $4.5 million
32
fine.”90 Further, the company’s attitude regarding coal mining safety indicated not
simply that it disagreed with the regulator’s interpretation of applicable safety
laws, but “that the company’s management knew better than the law about what
was necessary to run safe mines.”91 Although the Board at all times has
maintained that its business practices do not violate applicable antitrust laws,
Plaintiff fails to allege that the Board ever expressed disagreement with the
underlying laws themselves.
In addition, the plaintiffs’ Caremark claim in Pyott alleged that Allergan’s
board caused the company to adopt a business plan that included illegal conduct.
The Court concluded that “a reasonable inference can be drawn from the
particularized allegations of the Complaint and the documents it incorporates by
reference that the Board knowingly approved and subsequently oversaw a business
plan that required illegal off-label marketing and support initiatives for Botox.”92
Thus, contrary to the formulation of Caremark in this case and in Massey,93 the
board’s alleged bad faith in Pyott was not based on its conscious disregard for its
duty to prevent the company from engaging in illegal conduct. Instead, it was
90
2011 WL 2176479, at *6.
91
Id. at *19.
92
Pyott, 46 A.3d at 356.
93
See supra text accompanying note 32.
33
based on the board’s alleged decision to cause the company to engage in illegal
conduct. Even if Plaintiff alleged a Pyott-style Caremark claim, the Complaint
does not include any particularized allegations indicating that the Board knowingly
caused Qualcomm to adopt any monopolistic practices.
In this case, even if the alleged red flags actually constituted evidence of
misconduct at Qualcomm, it is unreasonable to infer that the Board consciously
disregarded its fiduciary duties in response to those red flags. The Complaint
concedes that the Board continuously monitored each of the three alleged red flags
as well as the NDRC Decision. The Complaint also acknowledges that the Board
consistently expressed—both verbally and through its actions—its view that its
business practices were not violative of international antitrust laws and elected to
address the relevant legal actions by focusing on educating industry participants
and government officials as to why its practices were legal and by pursuing
appeals. As such, Plaintiff’s argument is not that the Board completely failed to
act in response to those red flags, but instead that the Board’s response was
insufficient. Red flags that rise to the severity of those in Massey may implicate an
immediate duty to alter a company’s culture and business practices. This case,
however, is not one in which the company pled guilty to criminal charges—as in
Massey—or was advised by its general counsel that its business plan included
potentially illegal conduct—as in Pyott. On the contrary, the Complaint indicates
34
that the Board, at all times, was under the impression that its conduct did not
violate applicable antitrust laws. Plaintiff, therefore, fails to allege that the Board
acted in bad faith where it concluded that Qualcomm’s business practices were
legal, appealed the regulatory findings and penalties, and publicly proclaimed the
Company’s innocence.
Because the Complaint fails to plead particularized facts from which it is
reasonable to infer that the Board faces a substantial likelihood of liability as to
Count I, demand was not excused as to Count I under the Rales test for demand
futility. As such, that Count is dismissed under Rule 23.1.
C. Demand Was Not Excused as to Count II Under Rule 23.1
Plaintiff’s legal theory in Count II is the same as in Count I.94 The Rales test
for demand futility, therefore, applies to Count II as well.95 At oral argument,
Plaintiff’s counsel indicated that despite the dearth of claims as to the Officer
Defendants in its answering brief, Plaintiff did not intend to waive Count II.96 It is
unclear, however, how a majority of the Board could face a substantial likelihood
of liability as to Count II when only two of the fifteen members of the Board—
94
See Oral Arg. Tr. 16, 55 (“I think this is really about the oversight claim and the
Caremark claim related to the monopolization. . . . Count II is a breach of
fiduciary duty against officers qua officers . . . .”).
95
See supra note 35 and accompanying text.
96
Oral Arg. Tr. 55.
35
Jacobs and Mollenkopf—are included as Officer Defendants. Assuming Plaintiff
seeks to avoid dismissal of Count II under an alternative theory of demand futility,
Plaintiff has not articulated that theory in either its brief or at oral argument. Thus,
Plaintiff has failed to plead that demand would have been futile as to Count II of
the Complaint, and that Count also is dismissed under Rule 23.1.97
III. CONCLUSION
For the foregoing reasons, Defendants’ Motion is granted.
IT IS SO ORDERED.
97
See Emerald P’rs v. Berlin, 726 A.2d 1215, 1224 (Del. 1999) (“Issues not briefed
are deemed waived.”).
36