The opinion of the court was delivered by: Laura Taylor Swain, United States District Judge
This Document Relates To: All Actions
Louisiana Municipal Police Employees Retirement System ("Plaintiff" or "Louisiana Municipal") is the lead plaintiff in these consolidated derivative actions brought on behalf of nominal defendant American International Group, Inc. ("AIG" or the "Company"), a Delaware corporation, against individual current and former AIG directors and officers (collectively, "Defendants") and, nominally, AIG, for breaches of fiduciary duty, waste of corporate assets, unjust enrichment, and contribution. Plaintiff also asserts claims for violations of the Securities Exchange Act of 1934 ("Exchange Act") Section 20(a), 15 U.S.C. § 78t-1 ("Section 20(a)"), Exchange Act Section 10(b), 15 U.S.C. § 78j(b) ("Section 10(b)"), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 ("Rule 10b-5 "). The Court has jurisdiction of this action pursuant to 28 U.S.C. §§ 1331, 1332 and 1367.
Plaintiff is, and has been throughout the Relevant Period (February 8, 2006, through the present), an owner and holder of AIG common stock. Plaintiff's claims are predicated upon, among other things, the AIG officers and directors' alleged: failure to properly oversee the Company's credit default swap contracts, which were largely based on subprime mortage-backed collateralized debt obligations; and material misstatements and omissions regarding AIG's financial health and risk management. Plaintiff also asserts claims based on the AIG Board of Directors' decision to increase AIG's dividend payment and authorize and execute a common stock repurchase plan shortly before the Company faced a liquidity crisis, and its approval of certain compensation arrangements with three senior executives and certain personnel in AIG's Financial Products division. AIG moves to dismiss Plaintiff's amended consolidated complaint (the "Complaint" or "ACC") pursuant to Federal Rule of Civil Procedure 23.1, on the grounds that Plaintiff did not make a demand on the Company's Board of Directors (the "Board") prior to bringing this derivative action and failed to plead with particularity why such a demand would have been futile.*fn1 The Court has considered carefully all of the parties' submissions, including multiple notices of supplemental authority. For the following reasons, the Complaint is dismissed in its entirety for failure to fulfill the requirements of Federal Rule of Civil Procedure 23.1.
The following facts are taken from the Complaint, the documents incorporated by reference therein, and public filings of which the Court may take judicial notice,*fn2 unless otherwise noted. AIG was founded by Cornelius Vander Starr in 1919. Under the leadership of Starr and his successor, Maurice Greenberg, it grew to employ more than 97,000 people, underwrite more than $41 billion of insurance premiums annually, and serve more than 65 million customers worldwide. The Company touted itself as a world leader in general insurance, life insurance and retirement services, financial services, and asset management. At the end of its 2006 fiscal year it reported nearly a trillion dollars of assets on its balance sheet and enjoyed a market capitalization of over $180 billion. Fewer than two years later, in September 2008, the Company faced a liquidity crisis (the "September 2008 Liquidity Crisis") that required an unprecedented bailout by the United States Government (the magnitude of which ultimately reached $173 billion) (the "September 2008 Government Bailout") in order to stave off bankruptcy. (ACC ¶ 12.) Plaintiff's 210-page pleading alleges, in copious detail, the facts that caused an erstwhile component of the prestigious Dow Jones Industrial Average to become dependent on taxpayer assistance for its survival. As familiarity with the ACC and the motion papers is assumed, the Court will only provide a basic summary of the core allegations below.
AIGFP and the Company's Credit Default Swap Portfolio
In 1987, former AIG Chief Executive Officer Maurice Greenberg created AIG Financial Products ("AIGFP") in order to take advantage of the company's cash reserves, credit rating, and knowledge of the insurance industry by entering into derivative transactions. AIGFP became a wholly-owned subsidiary of the company in 1993. (ACC ¶ 124.) Defendant Cassano was the President of AIGFP throughout the Relevant Period.
In 1998, AIGFP began engaging in a particular type of derivative transaction known as a credit default swap ("CDS"), in which it insured its counterparty against the credit risk of an underlying reference obligation, typically a fixed-income security. AIGFP received fees and regular premium payments in exchange for its commitment to compensate the counterparty in the event the reference obligation defaulted or experienced any other defined credit event. (ACC ¶¶ 127, 133.) In 2005, AIGFP entered into a much larger volume of CDS contracts than it had in previous years and, in the bulk of those CDS contracts, the Company assumed the credit risk of a collateralized debt obligation ("CDO"). These CDOs were collateralized by portfolios of miscellaneous financial assets, most commonly residential mortgage-backed securities. AIG's dramatic expansion into the CDS market in 2005 thus had the effect of greatly increasing the Company's exposure to the residential mortgage market, particularly the subprime mortgage market. (ACC ¶¶ 127-38.) By early 2006, AIG's exposure to subprime CDOs had grown to $89 billion. (ACC ¶ 141.) This activity appeared profitable: AIGFP contributed 17.5% of the Company's overall operating income in 2005. (ACC ¶ 142.)
The CDS portfolio put the Company at risk in three ways. Most obviously, AIG would have to make large payments in the event that a significant proportion of the underlying reference securities defaulted. Additionally, if the market value of the reference securities declined -- due, for example, to a market perception that the mortgage-backed securities within the CDOs were increasingly likely to fall short of providing the expected cash flows because of increasing defaults on the underlying mortgages -- AIG would be forced to post collateral to its counterparties to provide security that it could make good in the event of a default. Morever, in such a scenario AIG would be required to mark-to-market the declining value of the CDS assets on its financial statements. Such marking to market would cause it to recognize a loss on paper even before it experienced an actual economic loss. (ACC ¶¶ 143-47.)
The CDS Risks Prompt the September 2008 Liquidity Crisis
As AIG underwrote an ever larger volume of unhedged credit default swaps on CDOs (often writing multiple swaps on the same CDO), its leveraged exposure to the credit market and, particularly, the subprime mortgage market, soared. (ACC ¶¶ 143-47.) That market, as has been extensively documented elsewhere, imploded: by late fall 2007, banks, brokerages, and lenders had announced almost $50 billion in losses related to the writedown of subprime mortgage-related products. (ACC ¶ 178.) On February 11, 2008, the Company issued a Form 8-K that disclosed that the losses in its CDS portfolio exceeded by $4 billion the losses it had announced previously. (ACC ¶ 216.) On February 28, 2008, the Company issued its Form 10-K for fiscal year 2007, which revealed that AIG's CDS portfolio had declined by $6 billion more than the amount disclosed in the February 11 8-K. (ACC ¶ 222.) Additional losses announced at the end of the first quarter of 2008 "brought the Company's CDS portfolio to a cumulative $20.6 billion loss between October 2007 and May 2008." (ACC ¶ 225.) These losses continued through the second quarter of 2008, causing the Company's September 2008 Liquidity Crisis, in which a government bailout was necessary to save the Company from bankruptcy. (ACC ¶ 229.)
Unwinding of the CDS Portfolio
AIGFP had stopped writing new credit default swaps on mortgage-backed CDOs by the end of 2005. (ACC ¶ 403.) However, it did not take any measures to significantly reduce the exposure it had accumulated, which had reached a notional value of $2.7 trillion, until after the September 2008 Liquidity Crisis, which was itself largely the product of the CDS portfolio. (ACC ¶ 278.) In January 2009, aided by the funds received in the government bailout, AIG began to unwind its CDS portfolio, and in doing so it often paid a full 100 cents on the dollar to its counterparties. (ACC ¶ 279.) Plaintiff alleges that the Defendants responsible for this process wasted corporate assets because they "took no steps to . . . assure that [the Company] received the best settlement terms from its counterparties." (ACC ¶ 279.) Plaintiff further alleges that Directors Liddy and Johnson have ties to CDS counterparty Goldman Sachs that call into question whether they acted solely out of concern for AIG's best interests in settling those CDS contracts. Plaintiff similarly alleges that Director Offit's ties to Wachovia call into question his actions with respect to the settlement of CDS contracts with that entity. (ACC ¶ 280.)
Plaintiff argues that numerous "red flags" that arose during the Relevant Period provided the Board with constructive knowledge that its CDS activity was increasingly placing AIG in peril. Plaintiff also argues that these "red flags" provided the Board with constructive knowledge that the inadequacy of the Company's risk management and accounting systems (particularly with respect to its CDS portfolio) was perilous as well. The "red flags" of greatest significance, according to Plaintiff, were: (i) warnings from AIG's primary federal regulator, the Office of Thrift Supervision ("OTS"), including a warning to the Board in March 2006 about the Company's risk management and financial reporting generally and a March 2008 Supervisory Letter critiquing the Company's risk management with respect to its CDS activities specifically (ACC ¶¶ 148-51); (ii) warnings from the Company's external auditor, PricewaterhouseCoopers ("PWC"), including warnings made to former CEO Sullivan in November 2007 and multiple warnings to the Audit Committee in December 2007, January 2008, and February 2008, concerning "material weaknesses . . . related to risk management" and the inadequacy of AIGFP's valuation process (ACC ¶¶ 187-90); (iii) the October 1, 2007, resignation of Joseph St. Denis, Vice President of Accounting Policy, due in part to his frustration that Cassano had been excluding him from the valuation process for the CDS portfolio (ACC ¶¶ 161-72); (iv) the deterioration of the subprime mortgage market throughout 2007 and the losses announced by numerous financial firms related to that market deterioration (ACC ¶¶ 178-83); (v) collateral calls made by CDS contract counterparties in August and October 2007 (ACC ¶¶ 173-77); and (vi) the Company's recent history (under previous management) of accounting malfeasance, which occurred from 2000-2005 and required restatements of financial results as late as 2007 (ACC ¶¶ 122-24).
The Company's Dividend Increase and Share Repurchases
In May 2008, after the occurrence of many of the events described in the preceding paragraph, AIG announced that it would increase its dividend by 10% over the prior year, which "would cost AIG at least an additional $200 million per year in addition to the estimated $2 billion the dividend already cost the Company." (ACC ¶ 230.) Plaintiff alleges that "the dividend declaration was directly tied to the desire to compensate certain Officer Defendants," insofar as those Defendants had outstanding claims of entitlement to certain Company stock on which the dividend would be paid. (ACC ¶¶ 230-32.) Plaintiff alleges that increasing the dividend constituted corporate waste in light of the allegedly predictable September 2008 Liquidity Crisis.
Plaintiff similarly alleges that the Company's share repurchase program constituted corporate waste. The Board authorized a share repurchase program in the first quarter of 2007*fn3 and the Company repurchased approximately $7 billion worth of its own stock from March 2007 through April 2008, at an average price of $61 per share. (ACC ¶ 249.) Shortly thereafter, the Company raised capital to fortify its balance sheet by selling shares of its common stock at an average price of $38 per share. (ACC ¶ 249.) In short, AIG bought its own shares high and sold them low. Plaintiff alleges that these unfavorable transactions were not the product of poor business judgment but, rather, the product of actionable willful misconduct.
AIG's Compensation of Senior Executives and AIGFP Personnel
Plaintiff asserts claims premised upon four compensation-related Board decisions:
(i) approval of a March 31, 2008, separation agreement with defendant Cassano that classified his departure as "without cause," allowed him to retain his rights under the AIG Financial Products Corp. 2007 Special Incentive Plan, and provided him with a severance package that allegedly totaled $43 million, all despite the fact that Cassano's AIGFP business was chiefly responsible for the September 2008 Liquidity Crisis (ACC ¶¶ 290-93); (ii) a June 2008 determination that defendant Sullivan, upon his departure as CEO, was entitled to between $33 and $47 million in various forms of compensation, despite the fact that shortly before he announced his departure the Securities and Exchange Commission and the Department of Justice had announced that they were commencing investigations into potential wrongdoing at the Company (ACC ¶¶ 294-95); (iii) the June 2008 approval of a compensation package for defendant Willumstad, upon his selection as CEO following Sullivan's resignation, that included $24.5 million in AIG stock; and (iv) approval of the retention agreements that were signed with approximately 130 AIGFP personnel in March 2008 and pursuant to which payments were made in December 2008 and December 2009 despite the ruinous performance of AIGFP. (ACC ¶¶ 287-89, 301-05.)
The parties agree that the Board's composition on the date the ACC was filed is the relevant consideration for the purposes of the motion to dismiss the Complaint for failure to make a demand. (See Def.'s Reply, 3.) As of June 3, 2009, the date that the ACC was filed, nine individuals, all named as defendants in this action, served on the Board: Edmund S.W. Tse ("Tse"), Edward M. Liddy ("Liddy"), Martin S. Feldstein ("Feldstein"), George L. Miles ("Miles"), Morris W. Offit ("Offit"), James F. Orr III ("Orr"), Stephen F. Bollenbach ("Bollenbach"), Suzanne Nora Johnson ("Johnson"), and Dennis M. Dammerman ("Dammerman") (collectively, the "June 2009 Directors").*fn4 (ACC ¶¶ 55-73.) Liddy joined the Company as Chief Executive Officer and Chairman of the Board on September 15, 2008. (Id. at ¶ 58.) The Company's June 5, 2009, proxy statement discloses that he received only one dollar as his annual salary during the relevant period and that he did not receive any year-end variable performance-based pay (i.e., a bonus), stock option grants, or long-term performance cash awards. (Allerhand Decl., Ex. 23.) Tse was employed as AIG's Senior Vice Chairman - Life Insurance during the relevant period and his daughter was employed by AIG during the relevant period as well. (ACC ¶¶ 57, 450.) The other seven June 2009 Directors were non-executive "outside directors."
At all relevant times, Offit served on the Board's Audit Committee and Finance Committee (ACC ¶¶ 442, 443), Miles served on the Audit Committee (ACC ¶ 442), Feldstein served on the Finance Committee (ACC ¶ 443), and Orr served on the Compensation and Management Resources Committee (ACC ¶ 446). Bollenbach joined the Board on January 16, 2008, and served on the Audit Committee from that date; he also joined the Finance Committee on June 15, 2008, and the Compensation and Management Resources Committee on November 12, 2008. (ACC ¶ 71). Johnson joined the Board on July 16, 2008, and joined the Finance Committee and the Compensation and Management Resources Committee on January 14, 2009. (ACC ¶ 72.)*fn5 Dammerman joined the Board on November 12, 2008 (ACC ¶ 73), and Plaintiff has conceded in its submissions that there is no reason to doubt either his disinterestedness or his independence with respect to any of the claims asserted in this action. Most importantly for the analysis that follows, neither Orr nor Tse served on either the Audit Committee or the Finance Committees; Liddy and Dammerman joined the Board after the September 2008 Liquidity Crisis (and thus after nearly all of the alleged wrongdoing had occurred); and Johnson joined the Board shortly before the September 2008 Liquidity Crisis but did not join the Finance Committee until January 2009.
Plaintiff alleges that it would have been futile to make a demand on the Board that it bring the claims asserted in this action because, among other things: wrongdoers dominated and controlled the Board on the date the ACC was filed (ACC ¶ 464); the acts complained of are violations of the Board members' fiduciary duties and were illegal and improper (and therefore incapable of ratification) (ACC ¶ 468); the Company's directors' and officers' liability insurance policies for the relevant period have an "insured v. insured" exclusion that would expose these individuals to personal liability (ACC ¶¶ 467, 471); and the directors are disinclined to sue themselves and their fellow directors and top-ranking Company officials, with whom they have unspecified personal and professional relationships. (ACC ¶ 470.) Plaintiff also alleges that, as members of the various committees, the June 2009 Directors breached important specific duties, including duties outlined in the relevant committee charters, and therefore face a substantial likelihood of liability for their actions and omissions. (ACC ¶¶ 442-46.)
Defendants move to dismiss the Complaint pursuant to Rule 23.1 of the Federal Rules of Civil Procedure based on Plaintiff's failure to make a pre-suit demand on the Board. Plaintiff argues that its pleading is sufficient to demonstrate that the demand requirement is excused and to satisfy the pleading standards with respect to its substantive claims.
Rule 23.1 and Demand Futility
"It is a long held principle of corporate law that directors manage the business of the corporation." Kernaghan v. Franklin, No. 06 Civ. 1533, 2008 WL 4450268, at *3 (S.D.N.Y. Sept. 29, 2008) (citing Aronson v. Lewis, 473 A.2d 805, 811 (Del.1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000)). "By its very nature the derivative action impinges on the managerial freedom of directors." Aronson, 473 A.2d at 811. Thus, under Federal Rule of Civil Procedure 23.1, a plaintiff bringing a shareholders' derivative suit must state with particularity that the plaintiff has made a demand on the board of directors to take the requested action or the reasons for not making the demand. Fed. R. Civ. P. 23.1(b); accord Del. Ch. Ct. R. 23.1.*fn6 "Rule 23.1 is not satisfied by conclusory statements or mere notice pleading." Brehm v. Eisner, 746 A.2d 244, 254 (Del. 2000). "Because Rule 23.1 requires that plaintiffs make particularized allegations, it imposes a pleading standard higher than the normal standard applicable to the analysis of a pleading challenged under Rule 12(b)(6)." Kernaghan, 2008 WL 4450268, at *3. Plaintiff asserts that it is excused from making a demand under Rule 23.1 because its pleading adequately alleges that to do so would have been futile.
There are two tests for determining demand futility under Delaware law. The two-pronged Aronson test applies where a plaintiff is challenging "conscious" board conduct. Aronson, 473 A.2d at 813. Such conscious conduct includes a conscious decision to refrain from acting. Id. at 813. Under Aronson, "plaintiffs seeking to establish demand futility must plead particularized facts that create a reasonable doubt that 1) the directors are disinterested and independent, or that 2) the challenged transaction was a valid exercise of business judgment." In re Morgan Stanley Derivative Litig., 542 F. Supp. 2d 317, 321-22 (S.D.N.Y. 2008) (internal quotation marks and citations omitted). "The prongs of the Aronson test are in the disjunctive; therefore, if plaintiff creates a reasonable doubt as to either prong of the test, demand is excused." Kahn v. Portnoy, No. 3515, 2008 WL 5197164, at *9 (Del. Ch. Dec. 11, 2008). "[F]utility is gauged by the circumstances existing at the commencement of a derivative suit," Aronson, 473 A.2d at 810, and such reasonable doubt "must be raised as to a majority of the board of directors sitting at the time the complaint is filed," In re Morgan Stanley, 542 F. Supp. 2d at 322. The existence of reasonable doubt "must be decided by the trial court on a case-by-case basis" and not by any "rote and inelastic" criteria. Grobow v. Perot, 539 A.2d 180, 186 (Del. 1988), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000).
The single-part Rales test applies "[w]here there is no conscious decision by directors to act or refrain from acting" and the Aronson test is thus inapplicable. Rales v. Blasband, 634 A.2d 927, 933 (Del.1993). As the Rales court noted, "[t]he absence of board action . . . makes it impossible to perform the essential inquiry contemplated by Aronson -- whether the directors have acted in conformity with the business judgment rule in approving the challenged transaction." Id. at 933. Accordingly, the Rales test focuses solely on the first part of the Aronson test: whether the plaintiff has alleged particularized facts creating a reasonable doubt that a majority of directors are disinterested and independent. Id. at 933-34. However, considerations of the business judgment rule inform the Rales analysis as well. Plaintiffs frequently argue that there is reason to doubt that a majority of directors are disinterested because the complaint alleges director conduct "so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability therefore exists." In ...