Friday, December 04, 2015

Delaware Guidance Harpoons JPMorgan Investor’s London Whale Case

By Anne Sherry, J.D.

In its third opinion on a shareholder action against the JPMorgan board, the Second Circuit concluded that the investor failed to rebut the presumption protecting the directors’ choice not to sue over the London Whale debacle. The decision was informed by guidance from the Delaware Supreme Court reiterating the high threshold for challenging a board’s exercise of business judgment (Espinoza v. Dimon, December 3, 2015, Katzmann, R.).

Background. The shareholder sent a letter to the board demanding that it investigate aspects of the London Whale scandal. A review committee considered the demand and recommended against litigating over alleged trading losses, but it did not address the demand’s concerns about misrepresentations. On appeal after the district court dismissed the shareholder’s derivative action, the Second Circuit initially affirmed on abuse-of-discretion review. Later, on its own motion, the panel reconsidered its holding and determined that de novo review was appropriate. It certified a question to the Delaware Supreme Court for guidance on how to evaluate challenges to the scope of an investigation into one matter where the shareholder demanded an investigation into two.

State court guidance. Although the Delaware Supreme Court did not answer the certified question directly as formulated, it did provide guidance emphasizing that the appeals court’s review of a wrongful refusal suit begins from the premise that the decision to initiate a suit is within the board’s discretion as an internal corporate matter. The high court also underscored that the subject of the review is not the merits of the decision to refuse the demand, but whether the plaintiff pleaded sufficient facts suggesting that the board’s decision was unreasonable or not in good faith. Although it is conceivable that a committee could be deemed grossly negligent for carefully investigating one subject and putting the other aside, the critical question is the contextual importance of the uninvestigated issue in the overall scope of what the committee was charged with investigating.

Dismissed again. With these principles in mind, the Second Circuit concluded that the shareholder did not meet his burden to survive the defendants’ motion to dismiss. In the context of JPMorgan’s exhaustive review of the London Whale case and the fact that the misrepresentations issue was only one of the five claims raised in the demand, the board was protected by the business judgment rule. The court also noted that requiring boards to detail a response to every issue in a demand could create an incentive for plaintiffs to include a laundry list of claims. Finally, boards are entitled to, if not required to, mitigate regulatory and other legal risks in deciding how to respond to a stockholder demand. Providing additional detail in a refusal letter could expose the corporation to these risks.

The case is No. 14-1754.