For the second time in a week Delaware courts have explained, in the words of former Chancellor Allen, the author of the Caremark decision, why the Caremark claim is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” Citigroup, Inc. shareholders had alleged that the bank’s officers and its board failed to conduct oversight with respect to anti-money laundering violations, fraud at a subsidiary bank, foreign exchange (FX) benchmark manipulation, and unlawful credit card practices. Days before the decision in the Citigroup case, the Delaware Supreme Court had reiterated the difficulties inherent in Caremark claims by rejecting a Caremark claim brought against Duke Energy for the company’s role in an environmental catastrophe, albeit over a dissent by Chief Justice Strine (Oklahoma Firefighters Pension & Retirement System v. Corbat, December 18, 2017, Glasscock, S.).
‘Red flags’ theory insufficient. The gist of the shareholders’ Caremark theory was that Citigroup’s officers and directors ignored red flags (the complaint said the board “sat like stones growing moss”) that should have alerted them to serious misconduct on the part of the bank. Vice Chancellor Glasscock set the stage. First, for purposes of demand futility analysis, the court turned to Rales for the proposition that the directors would not be liable unless they could not exercise independent and disinterested business judgment because of the risk they may face substantial personal liability. Second, with respect to the Caremark claim, the more recent exposition of Caremark in Stone v. Ritter requires allegations that the board failed to implement a system of controls, or that the board implemented such controls and then consciously disregarded them; scienter is required to show that the directors knew they acted contrary to their fiduciary duties.
As for the AML red flags, the court concluded that demand was not excused. The shareholders pointed to numerous regulatory orders, additional warnings, and a $140 million fine as evidence that Citigroup’s directors disregarded their duties. But the court said Caremark applies where a company’s board did “nothing” and not, as in the case of Citigroup, the board took imperfect actions but nevertheless acted on the information it had. The court also suggested that the documents cited in the complaint inaccurately described the Citigroup board’s actions; on this point, the court included a footnote reference to the recent Delaware Supreme Court decision regarding Duke Energy stating how to treat a plaintiff’s alleged exaggerations (“The plaintiffs unfairly describe the overall presentation, which we are not required to accept on a motion to dismiss,” said the majority in the Duke Energy case). Moreover, the court suggested that the shareholders would have alleged a Caremark claim if Citigroup’s board had in fact “sat like stones growing moss” (the court called this the plaintiffs’ “geologic metaphor”).
Demand also was not futile regarding two significant financial hits to Citigroup. Under one theory, the shareholders alleged that Citigroup’s board failed to oversee loans made by Banamex (a subsidiary) to a borrower that perpetrated a $400 million fraud on Citigroup by securing loans from Banamex based on fraudulent accounts receivable. The court said that Caremark claims based on the failure to monitor business risks related to a third party’s actions (as opposed to those of company employees) have not been clearly recognized. The other financial hit involved Banamex being fined $2.5 million by Mexican regulators for faulty controls. The court reviewed two sets of alleged red flags and determined that neither set was related to the shareholders’ Caremark allegations.
The third set of allegations against Citigroup posit that the bank’s board was aware of issues relating to the manipulation of FX benchmarks. Citigroup was ultimately fined $2.2 billion and pleaded guilty to conspiracy to violate federal antitrust laws. But the court examined the shareholders’ red flags and found them wanting because some were not red flags, some were red flags and the bank’s board took some good faith action on them, or the red flags never reached the board. As a result, the shareholders failed to state a Caremark claim and demand was not excused.
Lastly, the shareholders’ allegations about Citigroup’s credit card practices were insufficient to excuse demand. In one set of allegations, the shareholders recited how Citigroup enticed consumers to buy add-on services for which the bank was fined $35 million by the Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency; the CFPB also ordered Citigroup to pay $700 million in restitution. But the court again found the alleged red flags wanting. One red flag involved alleged misconduct by two of Citigroup’s rivals. In another instance, Citigroup responded to warnings about control issues by requiring additional training. Yet another red flag related to Citigroup’s $1.95 million settlement with a state attorney general related to the marketing of consumer protections; the court concluded that the complaint failed to allege that at least half of the Citigroup board was aware of the settlement.
Holistic approach rebuffed. The court also took time to address two additional issues raised by the shareholders. First, the court rejected the shareholders’ request for a holistic examination of the cited red flags under Sanchez, a 2015 opinion by the Delaware Supreme Court discussing demand futility. According to the shareholders, the Citigroup defendants pursued a “divide and conquer” strategy with respect to the complaint, and they contended that the court should take a wider view of the shareholders’ red flags.
The court replied that not only was Sanchez inapt, but that it had performed the traditional Caremark analysis by asking if asserted red flags are in fact red flags and whether the company’s response to them was in bad faith. Said the court:
What emerges is a picture of directors of a very large, inorganically grown set of financial institutions, beset by control problems as it struggled to integrate. Those directors may be faulted for lack of energy, or for accepting incremental efforts of management advanced at a testudinal cadence, when decisive action was called for instead.The court explained that such facts may indicate negligence but that the shareholders hold the remedy. As a result, the court reiterated its conclusion that the facts did not show bad faith by Citigroup’s board, even if the results from the board’s actions were less than perfect. Still, the court, again citing via footnote the Duke Energy case, noted that the shareholders were right that a series of events can help in the evaluation of a board’s scienter.
Second, the court rejected the shareholders’ attempt to compare Citigroup to other companies where shareholders brought Caremark claims. In those cases, the court said the boards and managers either engaged in “extreme” behavior or had “flout[ed]” the law (e.g. Massey, Pyott (Allergan), and Westmoreland (a Seventh Circuit case involving Baxter International).
The case is No. 12151-VCG.