The opinion of the court was delivered by: KNAPP
Defendants, officers and directors of E.F. Hutton move, pursuant to Fed. R. Civ. P. Rule 23.1, to dismiss the amended consolidated derivative complaint in Strougo for failure to make a demand on the Board of Directors and to dismiss the complaint in Johnson for insufficiency of the demand. Plaintiffs argue that the demand requirement in both cases should be excused because making such a demand would have been futile. In the alternative they argue that the Johnson demand was sufficient. For the reasons that follow, the motion is granted and the complaints are dismissed without prejudice to re-pleading under specified conditions.
On May 2, 1985, in the United States District Court for the Middle District of Pennsylvania, E.F. Hutton pled guilty to all counts of an Information charging 2,000 incidents of mail and wire fraud in violation of 18 U.S.C. §§ 1341 and 1343 (1982). On the same day Hutton consented, in a parallel civil action under 18 U.S.C. § 1345 (1982), to a civil injunction barring it from engaging in the practices which had given rise to its plea of guilty. Hutton paid a $2 million fine and established a $8,750,000 fund to pay for related costs, including the $750,000 the government had spent on its investigation of Hutton, and to secure its agreement to pay restitution to any banks that had been damaged by the illegal acts.
The practice in question was Hutton's policy of excessive overdrafting from banks at which Hutton maintained accounts during the period between July 1, 1980 and February 28, 1982. In the course of the high volume of transactions made during a given day, Hutton would withdraw more money from these banks than it had on deposit, thereby gaining the interest-free use of that money.
The first of the derivative actions was filed four days after the plea of guilty had been entered. Others followed, all of which were, on September 24, 1985, transferred to this Court for pre-trial purposes by an order of the Judicial Panel on Multidistrict Litigation. On October 29, 1985 all the derivative plaintiffs except Johnson joined in the filing of an amended consolidated derivative complaint ("the consolidated complaint"), which is the object of the instant motion to dismiss for failure to make a demand. The motion to dismiss the Johnson complaint is based on the claimed insufficiency of the demand made.
The consolidated complaint asserts claims on behalf of Hutton against 34 individual defendants, 22 of whom are or were directors of Hutton. As against all defendants it alleges a cause of action under the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq. (1983), and a state law claim alleging breach of fiduciary duty; and as against the director defendants only, it alleges a further state law claim for breach of fiduciary duty .
Hutton currently has a 23 person Board of Directors, comprised of 18 inside and five outside directors. On May 28, 1986 its shareholders will have the opportunity to vote on a proposition to change the composition of the Board so that it will consist of nine directors, six of whom will be outside and three inside directors.
The consolidated complaint does not allege that any. demand to sue had been made on the board of directors, but paragraph 25 thereof alleges the following with recard to the futility of making a demand:
(a) All members of Hutton's Board of Directors knew or should have known of the existence of the overdrafting scheme due to their receipt of monthly summaries of operation which reflected profits too high to have been legitimate.
(b) Defendant directors Rae, Lynch, and "others" at E.F. Hutton had a meeting with Hutton's outside auditors, Arthur Andersen & Co. ("Andersen"). At such meeting Andersen expressed reservations about the legality of Hutton's overdrafting policies, thereby putting these directors on notice that there might be wrongdoing under foot. On two occasions Rae refused to provide a written opinion that such practices did not present any potential legal problems.
(c) All inside directors benefited from the wrongdoing in the form of large bonuses which were tied to the overall profitability of Hutton. Defendant Director Fomon has stated that he will not return any portion of the bonuses he has received.
(d) The illegal overdrafting was a policy at Hutton. Defendant directors Fomon, Latshaw, Lynch, Witt, Doree, Epstein and Rae
each received or generated ...