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Shareholder Derivative Suits—Fixing What’s Wrong with Corporate America?

By Lisa F. Geherin posted 11 days ago

  

Shareholder derivative lawsuits have long been a tool for fixing a troubled corporate culture. But now they appear to be on the rise and ripe with new theories and higher-than-ever damages claims and settlements. One need only look to the headlines to understand the magnitude of how these suits are impacting corporate America.

Boeing derivative suit. Boeing was hit with a number of shareholder derivative suits last year, most of which have now been dismissed on technicalities involving forum selection. One case recently dismissed was filed by the firm of Cohen Milstein in Illinois and alleged in part that directors and officers did not disclose the following:

  • operational and reporting failures that did not appropriately address how Boeing developed and operated the 737 MAX fleet in violation of federal and international laws
  • Boeing’s requirements under its settlement with the Federal Aviation Administration
  • Boeing’s retaliatory practices against employees who reported safety violations
  • board-approved compensation programs that incentivized the concealment of the 737 MAX fleet’s illegal design flaw

Cohen Milstein has since appealed the dismissal and filed a similar suit in the Delaware Chancery Court as an alternative route to reviving its federal derivative claims.

Large institutional shareholders also sent a clear message to the Boeing board in late April, when “[a] majority of Boeing Co. shareholders voted to separate the chief executive officer and chairman roles permanently,” reported Julie Johnsson in a recent Bloomberg Business article. In addition, Reuter’s reported that two high-profile proxy advisors recommended investors vote against key board members to show objections to the company’s handling of the 737 Max crisis, in particular against Larry Kellner, the board chairman who previously oversaw the board’s audit committee.

Wells Fargo. Shareholders were equally unhappy with the Wells Fargo board. As discussed by Kevin M. LaCroix in his D&O Diary editorial, Massive Settlement in Wells Fargo Bogus Account Scandal Derivative Suit, shareholders alleged that the bank’s board and senior executives “‘perpetuated’ a business-model based on aggressively cross-selling additional products to existing customers” and that the penalties for not making these quotas “‘effectively forced’ its employees to open over two million unauthorized accounts.” The complaint also alleged that the board “permitted these activities notwithstanding complaints to the company’s ethics line, several wrongful termination lawsuits, … whistleblower lawsuits, and a Los Angeles Times article that reported the fraudulent account creation activity.”

The settlement of the derivative lawsuit resulted in a new way of doing business at Wells Fargo. It provided for an acknowledgment by Wells Fargo that the suit was a significant factor both in the company’s adoption of several corporate governance reforms and in causing Wells Fargo to call for compensation reductions and forfeitures for certain bank executives. Finally, the cash component of the Wells Fargo settlement was one of the largest shareholder derivative settlements ever, with a monetary payment of $240 million plus another $80 million, which is the value of the government reforms and compensation reductions.

New theories for derivative suits. The #MeToo movement has resulted in an increased number of shareholder derivative suits, report Jessica Corley and Peter Starr in their article, Trends in Securities and Derivative Litigation: Record Filings and Novel Theories. Nike, Wynn Resorts, the Weinstein Company, and Lululemon Athletics are just a few of many companies in which shareholders have questioned their board’s handling of sexual harassment claims. In these cases, the theory is that the directors minimized or concealed the misconduct to protect influential executives.

Likewise, the opioid crisis is seeing its share of derivative lawsuits as well, many alleging that directors and officers pushed marketing and sales efforts despite knowing about the risks of addiction and death. Two such companies include Depomed and Endo Pharmaceuticals. And drug manufacturer McKesson recently settled its shareholder derivative suit for $175 million along with “certain corporate governance changes.”

Alternatives to shareholder suits. While shareholder derivative suits are one tool that can be used to correct corporate misconduct, much more can be done, contend Lenore Palladino and Kristina Karlsson in Towards Accountable Capitalism: Remaking Corporate Law Through Stakeholder Governance. In short, they argue that the concept of “shareholder primacy” (that the sole purpose of a corporation is to generate returns for shareholders) should be replaced by a new concept known as the “stakeholder corporate governance model.” In this model,

  1. boards of directors are accountable to all stakeholders, not just shareholders;
  2. corporate purpose statements include a requirement that corporations positively benefit society;
  3. multiple stakeholders are represented on corporate boards; and
  4. large corporations are required to charter federally, in order to enable reforms.

“Overall,” they comment, “stakeholder governance is workable, popular, and a necessary step towards rewriting the rules of the economy—one that works for the many.”

For more information on shareholder derivative suits for Michigan corporations, see Michigan Business Torts (chapter 8).

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