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STEIN v. BAILEY

February 4, 1982

Mary STEIN, Plaintiff,
v.
Hosea W. BAILEY, W. O. Baker, R. J. Cantwell, James E. Cunningham, Charles L. Graves, Robert K. Richie, Walter B. Shaw, George G. Zipf, McDermott Incorporated, Smith Barney, Harris Upham & Co., Incorporated, and Morgan Stanley & Co., Incorporated, Defendants



The opinion of the court was delivered by: CANNELLA

MEMORANDUM AND ORDER

Defendants' motion for summary judgment is granted. Fed.R.Civ.P. 56.

 Motion by defendant Morgan Stanley & Co., Incorporated, to dismiss for failure to state a claim upon which relief can be granted, Fed.R.Civ.P. 12(b)(6), is dismissed as moot.

 FACTS

 The facts of this case relevant to the instant motion are essentially undisputed. On July 18, 1980, this Court dismissed plaintiff's second amended complaint because (1) plaintiff had failed to state a claim for relief under the federal securities laws with respect to defendant J. Ray McDermott & Co., Incorporated's ("McDermott") *fn1" acquisition of the Babcock & Wilcox Company ("B&W"); and (2) plaintiff had not satisfied Fed.R.Civ.P. 23.1's requirement that a shareholder first make a demand upon the board of directors to enforce the corporation's rights before commencing a derivative action. Because plaintiff had also failed to demonstrate that such a demand would have been futile, the Court found that the demand requirement was not excused and granted plaintiff leave to replead after the required demand had been made. See Stein v. Aldrich, Memorandum and Order, 78 Civ. 2364 (JMC) (S.D.N.Y. July 18, 1980) ("Stein I "). *fn2"

 On August 18, 1980, plaintiff, by her attorneys, made an appropriate demand on McDermott's Board of Directors, asking that the Board sue on the claims contained in the second amended complaint. *fn3" In response, on September 25, 1980, in New Orleans, the Board established an "Independent Committee on Litigation" (the "Committee"), pursuant to the following resolution:

 
RESOLVED, That pursuant to Article II, Section 5 of the By-Laws of the Corporation, there is hereby established an Independent Committee on Litigation which shall consist of the following members of the Board: Messrs. Tweedy, Seawell and Wagner, each of whom has orally confirmed that he has not been in any way connected or involved with the matters referred to in the demand made on behalf of, and the claims made by, Mary Stein, and is not aware of any reason that might disqualify him from serving on the Committee; ... and that the Committee shall
 
1) conduct or cause to be conducted, review, analysis and investigation of the circumstances surronding (sic) all matters referred to in the letter dated August 18, 1980 from Morris J. Levy, Attorney for Mary Stein, and the demand set forth therein,
 
2) make the determination as to whether the Company should comply with such demand or any part thereof, and
 
3) undertake and supervise any action by the Corporation necessary or appropriate to implement any such determination. *fn4"

 The Committee was composed of three outside directors-John B. Tweedy, an Executive Vice President and director of Tosco Corporation; William T. Seawell, the Chairman of the Board and Chief Executive Officer of Pan American World Airways; and Russell L. Wagner, the Chairman of the Board and Chief Executive Officer of NLT Corporation-all of whom attended the September 25, 1980 Board meeting. *fn5" The three Committee members became members of McDermott's Board on March 27, 1978, June 13, 1978, and September 24, 1979, respectively. None had any prior affiliation with McDermott, and their only affiliation with McDermott has been as directors. Thus, none of the three had any involvement with McDermott during the relevant time period and none has received or is eligible to receive stock under the 1968 and 1974 executive career stock plans that are in part the subject of this litigation. *fn6" The Committee immediately conducted an organizational meeting, electing Tweedy as its chairman, and scheduled its next meeting for October 8, 1980, in New York.

 On October 1, 1980, the New York law firm of Cleary, Gottlieb, Steen & Hamilton ("Cleary, Gottlieb"), which never before had acted as counsel to McDermott or any of its Board members, was retained by Tweedy as special counsel to the Committee. Tweedy authorized Cleary, Gottlieb to (1) advise the Committee on the appropriate manner in which it should proceed; (2) conduct legal research and prepare memoranda for the Committee on the merits of the claims stated in plaintiff's demand letter; (3) assist the Committee in fact-finding, especially with respect to (i) the accuracy and completeness of the April 12, 1977, Report of the Audit Committee of McDermott (the "Audit Committee Report"), *fn7" which reported the results of the Audit Committee's investigation into certain illegal payments made by McDermott and not disclosed to the shareholders in the proxy solicitations relating to the 1968 and 1974 stock plans, (ii) the appropriateness of imposing the sanctions sought by the demand letter in addition to the sanctions already imposed by the Board following the Audit Committee Report, (iii) the consequences to McDermott of maintaining suit on the claims raised in the demand letter, and (iv) the adequacy of the Board's judgment and decisions in connection with the B&W acquisition; (4) arrange, with respect to the aforementioned fact-finding, for the Committee to interview relevant witnesses and obtain and analyze pertinent documentary evidence; and (5) prepare a report to embody the conclusions reached by the Committee.

 Between September 25 and October 8, each Committee member reviewed the Audit Committee Report, minutes of meetings of the Audit Committee and the McDermott Board relating to that report, plaintiff's demand letter, the second amended complaint, the motion papers relating to defendants' motions to dismiss the second amended complaint, and the Court's decision in Stein I. The Committee met on October 8, with special counsel present, and interviewed Bartlett H. McGuire, a member of the law firm of Davis Polk & Wardwell, which served as special counsel to the Audit Committee, and John A. Morgan, the chairman of the Audit Committee.

 McGuire described in detail the methods, scope and substance of the Audit Committee's investigation, which was begun in August 1976. Approximately two months earlier, McDermott had disclosed in its Annual Report that its management had participated in making certain "questionable payments" in its domestic and foreign operations. Soon thereafter, the full Board ratified the Audit Committee's decision to investigate, and on April 12, 1977, the Audit Committee issued its final report. The Audit Committee retained Arthur Young & Company to act as special auditors and to make an independent search of McDermott's financial records. More than one hundred interviews were conducted throughout the world, and Arthur Young and McDermott employees expended approximately 80,000 man-hours assisting in the investigation. The Audit Committee Report describes the extent of the questionable payments and identifies several then present or former directors and executives who participated therein, including four defendants in the instant action, Bailey, Cunningham, Graves and Richie.

 Also at the October 8 meeting, Morgan, the Audit Committee chairman, discussed and explained the various recommendations and sanctions suggested by the Audit Committee in its report. The Audit Committee's recommendations included: (1) restructuring the Board so that it would have a majority of nonmanagement directors; (2) reorganizing the company's internal audit staff; (3) creating an in-house legal staff; (4) replacing the company's outside accountant with a major international accounting firm; and (5) restating the company's policy on improper payments. The Audit Committee also recommended that the Board sanction the four executives most directly involved, Bailey, Cunningham, Graves and Richie, by reducing their compensation in the fiscal year ending March 31, 1977, in an aggregate amount of approximately $ 300,000. All the above recommendations were adopted by the full Board. The Audit Committee considered and rejected other sanctions, including rescinding the stock awards made under the Company's stock plans.

 In addition, at the October 8, 1980 meeting, special counsel advised the Committee that it should assess both the legal and business ramifications of taking the steps requested in plaintiff's demand letter. Following that, each Committee member described his own relationship with McDermott and affirmed that he had not been involved in any of the occurrences to which the demand letter alluded. The Committee members then expressed tentative views that the claims relating to the stock plans should not be pursued. Finally, the Committee requested Cleary, Gottlieb to prepare and distribute a legal assessment of plaintiff's claims by October 15, and scheduled the next meeting for November 3, 1980, in New York.

 A preliminary draft of Cleary, Gottlieb's memorandum, limited to an analysis of the stock plan claims, was distributed to the Committee members on October 15, and a final draft was made available at the November 3 meeting. *fn8" At that meeting, the Committee discussed the preliminary draft with special counsel, focusing on whether the admitted failure to disclose the questionable payments in the 1968 and 1974 proxy solicitations was material, an essential element of plaintiff's securities law claims. Special counsel had discovered the existence of several lawsuits containing nearly identical claims, each of which had been dismissed for lack of materiality. In addition, special counsel pointed out that in August 1980 McDermott's shareholders had approved a new executive compensation plan, including stock awards, with full knowledge of both the earlier illegal payments and the fact that several executives who participated in the illegal payments, and who were defendants in the then-pending instant suit, would be eligible for stock awards under the new plan. Special counsel, therefore, offered its opinion that the stock plan claims would fail for lack of materiality.

 In the preliminary draft, special counsel also opined that even if the stock plan claims could be proven, a court would not order the remedy plaintiff demanded-namely, cancellation and surrender of all stock issued under the 1968 and 1974 plans-because although approximately 110 executives received stock under the plans, only six were involved in the illegal payments. Thus, to penalize all 110 would, in counsel's opinion, be inequitable and in contravention of the relevant statute. *fn9"

 In addition, at the November 3 meeting, Edwin B. Mishkin, on behalf of Cleary, Gottlieb, explained the legal standards that would govern the B&W acquisition claim. Mishkin noted that this Court had already ruled that the acquisition claim did not state a claim for relief under the federal securities laws, as framed in the second amended complaint. He also advised the Committee that if this claim were viewed instead as a claim for breach of the duty of care imposed by state law, the directors would likely be found not liable because their decisions would be found to have been reached in the good faith exercise of their reasonable business judgment. *fn10"

 During the November 3 meeting, the Committee interviewed John A. Lynott, a director and officer of McDermott, who was its Treasurer at the time of the B&W acquisition, by telephone, concerning the circumstances of the acquisition and subsequent merger. The Committee focused its questions on the purposes of the merger, the role of the Board and other participants in the tender offer decision-making, other courses of ...


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