Stanley Lerner, Derivatively on Behalf of Nominal, Defendant CITIGROUP INC., Plaintiff,
Charles O. Prince, III et al, Defendants, and CITIGROUP INC., Nominal Defendant.
For Plaintiff Stanley Lerner: Greenfield & Goodman, LLC (Richard D. Greenfield, Esq.) Cuneo Gilbert & LaDuca, LLP
For Defendants: Cravath, Swaine & Moore LLP (Richard W. Clary, Esq.) Paul, Weiss, Rifkind, Wharton (Jane O'Brien, Esq.) Wachtell, Lipton, (Bradley R. Wilson, Esq.)
Bernard J. Fried, J.
Motion Sequence Numbers 002, 003, and 004 are consolidated for disposition and are disposed of in accordance with the following decision and order.
Defendants, the current and former outside directors of Citigroup, the current and former inside directors, officers and employees of Citigroup, and the nominal defendant Citigroup, move to dismiss the plaintiff's amended complaint, pursuant to CPLR 3211 (a) (1), (3), and (7), based on documentary evidence, lack of standing, and for failure to state a claim.
This is a derivative action, commenced by shareholders of Citigroup Inc. (Citigroup) in the wake of the collateralized debt obligation (CDO) and subprime mortgage-related asset debacle which unfolded in late 2007, and which resulted in a Citigroup estimated $8-$11 billion write-down on its subprime-related assets for the fourth quarter of 2007. On December 7, 2007, plaintiff made a formal demand to Citigroup's Board of Directors (the Board) asking that the Board sue certain current and former directors, officers, and employees for alleged breaches of fiduciary duty related to Citigroup's sub-prime-related exposures. The Board formed a demand committee of one Citigroup outside director to investigate plaintiff's allegations, which committee hired counsel and conducted a two-and one-half-year investigation. The Board ultimately refused plaintiff's demand to sue. Plaintiff now seeks to pursue many of the same claims raised in his demand in his complaint. Defendants move to dismiss, asserting that in this "demand refused" case, the claims must be dismissed because plaintiff fails to plead facts to create a reasonable doubt as to the good faith or reasonableness of the Board's investigation of the demand. Defendants also assert that plaintiff's allegations that certain directors wasted corporate assets in engaging in the investigation of the demand to sue must be dismissed for failure to make a pre-suit demand, or to plead facts establishing futility of such a demand. Plaintiff opposes, urging that he has pled with particularity that his demand was wrongfully refused by the Board, which delegated the matter to a sham committee with an overburdened and unqualified single member, and to a conflicted team of lawyers, and that this was all a pretext for delay and part of a scheme to deflect and defend any shareholder claims. As to the claim that the investigation itself was a waste of corporate assets, plaintiff asserts that his initial demand, as well as a subsequent letter he sent to the Demand Committee, were sufficient to cover this claim, or that such demand would have been futile.
Plaintiff is the owner and holder of common stock in Citigroup (Amended Complaint, ¶ 11). Citigroup is a publicly traded financial services institution that provides, through its subsidiaries and divisions, commercial and investment banking and brokerage services (id., ¶ 12). From 2004 through 2007, Citigroup aggressively expanded into the CDO market, which obligations are repackaged pools of lower rated securities that are created by acquiring asset-backed securities, including residential mortgage-backed securities, and then selling rights to the cash flows from the securities in classes, or tranches, with different levels of risk and return (id., ¶¶ 36-37, 44-49). Citigroup's mortgage issuing subsidiaries expanded into the subprime and Alt-A mortgage market in the fall of 2005 through the summer of 2007 (id., ¶ 56). In late 2007, as a result of severe dislocations in the CDO market and in the credit markets generally, and the sudden decline in the value of mortgage-backed securities (id., ¶¶ 63, 65, 67), Citigroup reported multi-billion dollar write-downs on its losses related to its subprime-secured assets (id., ¶¶ 69, 71-72). During the fourth quarter of 2007, several officers, managers, and investment bankers were fired or resigned (id., ¶ 70). From the fourth quarter of 2007 through the first quarter of 2009, Citigroup reported losses in excess of $25 billion, and asset write-downs (or the equivalent) well in excess of $65 billion (id., ¶ 78). The vast majority of these write-downs stemmed from holdings in mortgage-related securities, particularly in super-senior tranches of CDOs (id.).
In the wake of these events, and pursuant to Business Corporation Law § 626 (c), by letter dated December 7, 2007, plaintiff made his demand (Demand) on the Board (id., ¶ 150; Exhibit A to Amended Complaint). The Demand alleged breaches of fiduciary duty and mismanagement relating to Citigroup's sub-prime assets and related structured finance and credit business (Exhibit A to Amended Complaint). It alleged a wasteful $30 billion spending spree over the previous two years, a systemic failure of risk management at the senior management and Board levels which caused Citigroup to suffer billions of dollars in damages and "untold billions going forward" (id. at 2). It pointed to, among other things, Citigroup's contingent liabilities and off-balance sheet transactions, its losses from trading in CDOs, its management's manipulations of reported earnings, assets, and net worth, and the write-downs that were likely to be reported in the fourth quarter (id. at 2-3). Based on this alleged misconduct, plaintiff demanded that Citigroup bring suit against each present and former member of the Board serving since the release of Citigroup's 2005 financial results, senior officers who allegedly participated, and aided and abetted, in such mismanagement, and Citigroup's outside auditor KPMG, LLP and firms that provided appraisals for the real estate-related transactions (id. at 3). Plaintiff demanded that Citigroup seek to recover the damages suffered as a result of the mismanagement, and require the allegedly responsible individuals to account to and repay it amounts by which they were unjustly enriched at Citigroup's expense (id. at 3-4).
Plaintiff alleges that upon receipt of his Demand, Citigroup's in-house counsel conspired with counsel for the Board, and a group of lawyers for Citigroup's present and former Board members, to determine a strategy to best protect the defendants named in this action and all members of the Board from liability (Amended Complaint, ¶ 155).
By letter dated January 4, 2008, counsel to Citigroup's Board informed plaintiff's counsel that the Board would consider the Demand at the Board's January 14, 2008 meeting, and asked whether there was any additional information plaintiff wanted to convey to the Board (id., ¶ 156). Plaintiff's counsel then requested that he be given the opportunity to appear before the Board at a meeting (id., ¶ 157). By letter dated January 11, 2008, the Board's counsel affirmed that the Board would consider the Demand at the January 14 meeting, and informed plaintiff's counsel that it would contact him if it wanted to hear from him in person, and asked if there was any additional written material plaintiff would like the Board to consider (id., ¶ 158). By letter dated January 17, 2008, counsel to the Board indicated that the Board had reviewed the Demand and subsequent correspondence by plaintiff's counsel at the January 14 meeting, and would continue to consider the matters raised in its January 31, 2008 meeting (id., ¶ 159).
By letter dated March 4, 2008, the Board's counsel advised plaintiff's counsel that, at its February 28, 2008 meeting, the Board had formed a Demand Committee to investigate, review, and analyze the allegations in the Demand, and had appointed Franklin A. Thomas as the sole member to the Demand Committee (id., ¶ 166). The Demand Committee then retained Potter Anderson & Corroon, LLP (Potter Anderson) as its independent Delaware counsel to assist in the investigation and evaluation of the Demand (id., ¶¶ 160, 164). By letter dated May 14, 2008, Potter Anderson informed plaintiff's counsel of their retention, and offered to meet with plaintiff and his counsel in person (id., ¶ 167). Plaintiff asserts that he never received any substantive communication from Potter Anderson, and that by the end of 2008, it had admitted that it had not consulted with an accounting or auditing expert regarding the Demand (id.).
In April 2009, defendant Thomas was replaced by defendant Michael O'Neill on the Demand Committee after Thomas retired from the Board (id., ¶ 168).
On July 15, 2009, plaintiff commenced this shareholder derivative action in which he claimed that his Demand had been constructively and wrongfully refused by the Board. Shortly thereafter, Potter Anderson offered to meet in person with plaintiff, his counsel, and O'Neill, which meeting occurred on September 16, 2009 (id., ¶¶ 174-175).
On May 27, 2010, the Demand Committee met with the Board and provided it with its description of the committee's process, findings, observations, and recommendations (see Exhibit 1 to Affirmation of Christopher B. Harwood in Support, dated October 1, 2010, at 7). It determined that, based on its investigation, Citigroup was unlikely to prevail if it pursued the claims in the Demand, that the litigation was not in the best interests of Citigroup or its ...