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Shareholder Fails To Demonstrate Demand Futility Because Allegations Did Not Plead That Board Consciously Ignored Supposed Red Flags Regarding BSA/AML Controls
10/24/2016On October 18, 2016, Chancellor Andre Bouchard of the Delaware Court of Chancery dismissed a shareholder derivative action against the directors of Capital One Financial Corporation (“Capital One”), finding that plaintiff failed to plead demand futility in connection with his breach of fiduciary duty claims. Reiter v. Fairbank, C.A. No. 11693-CB, 2016 WL 6081823 (Del. Ch. Oct. 18, 2016). The Court held that the allegations—relying in large part on records obtained from Capital One under Section 220 of the Delaware General Corporation Law, which the Court found were incorporated by reference into the complaint—did not “reasonably permit . . . an inference that the defendants consciously allowed Capital One to violate the law” so as to demonstrate bad faith and excuse the demand requirement.
Beginning in 2013, Capital One became the subject of numerous regulatory investigations relating to its anti-money laundering (“AML”) compliance and Bank Secrecy Act (“BSA”) controls in connection with its check cashing business. In 2014, Capital One exited the check cashing business. In July 2015, Capital One consented to the entry of a consent order issued by the Office of the Comptroller of the Currency regarding Capital One’s BSA and AML controls.
The complaint referenced several management reports received by the directors regarding BSA/AML compliance issues. Plaintiff alleged that the reports amounted to red flags that should have caused the board to independently conduct a compliance evaluation, and that the failure to act constituted a knowing disregard for the directors’ fiduciary duties in bad faith. Therefore, according to plaintiff, the directors faced a substantial likelihood of personal liability for the underlying claims, rendering demand to pursue those claims futile.
The Court characterized the allegations as amounting to a “quintessential Caremark oversight claim,” which requires plaintiff to plead particularized facts permitting an inference that the directors acted in bad faith. See also In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996). Here, the Court found that the reports added up to “at most . . . yellow flags of caution concerning [Capital One’s] escalating AML compliance risk that was occurring in tandem with heightened regulatory scrutiny of AML compliance in the financial services industry.” Importantly, the reports did not place the board “on notice that management had refused to act or displayed an indifference to complying with the BSA/AML.” To the contrary, according to the Court, “the same reports that described the Company’s heightened compliance risk simultaneously explained to the directors in considerable detail on a regular basis the initiatives management was taking to address those problems and to ameliorate the AML compliance risk.” Thus, plaintiff failed to adequately plead demand futility.
Significantly, the Court distinguished the circumstances here from cases where particularized factual allegations demonstrated that directors were aware of continuing compliance deficiencies and management indifference or actually knowingly approved the illicit behavior. Notably, the Court’s ruling also shows that where a plaintiff relies heavily on books and records obtained from a company to support the allegations in the complaint, the Court may deem those documents incorporated by reference and draw inferences from portions not cited in the complaint that are not favorable to the plaintiff. More generally, the opinion reinforces the Delaware standard for a Caremark oversight claim, namely, that “[g]ood faith, not a good result, is what is required of the board.”
