Delaware Court Of Chancery Dismisses Caremark And Disclosure Claims Related To Alleged Consumer Protection Law Violations For Failure To Plead Demand Futility
On March 30, 2021, Chancellor Andre G. Bouchard dismissed a derivative suit brought by a stockholder of LendingClub Corporation (the “Company”) against certain of the Company’s current and former directors and officers for failure to plead demand futility. Fisher v. Sanborn, et al., No. 2019-0631-AGB (Del. Ch. March 30, 2020). Plaintiff asserted breach of fiduciary duty claims against defendants after the Federal Trade Commission (FTC) filed a complaint against the Company for allegedly violating certain consumer protection laws by engaging in deceptive and unfair practices in connection with its lending business. Specifically, plaintiff alleged that defendants (i) breached their oversight duties by failing to monitor and oversee the Company’s compliance with consumer protection laws, and (ii) misrepresented the subject of the FTC investigation. The Court, however, found the complaint did not adequately plead that defendants failed to implement a monitoring system relevant to consumer protection law compliance or consciously disregard indications of noncompliance, as required to be alleged under Caremark. The Court also found that the complaint did not adequately plead that defendants “deliberately lied to investors.” The Court therefore held that the complaint did not demonstrate that the directors faced a substantial likelihood of liability and thus pre-suit demand on the board was not excused.
As the Court noted, to establish liability for a breach of oversight duties under In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996), a complaint must sufficiently plead that the directors “utterly failed to implement any reporting or information system or controls,” or “consciously disregard[ed]” misconduct to which they were alerted. Plaintiff argued both that the board failed to implement monitoring systems sufficient to address compliance with consumer protection laws and that the board disregarded violations of those laws.
According to the Court, however, the complaint itself evidenced that the Company had a board-level monitoring system in place. Indeed, in addition to an audit committee, the board established a separate “risk committee” to oversee risk management, which monitored consumer complaints and was routinely updated on the FTC investigation. Further, the Court rejected plaintiff’s argument that the FTC investigation and an increased volume of consumer complaints constituted unaddressed “red flags.” The Court explained that “[t]he issuance of a subpoena or the launch of a regulatory investigation does not necessarily demonstrate that a corporation’s directors knew or should have known that the corporation was violating the law.” Additionally, the complaint demonstrated that the “driving factors” behind consumer complaint trends were presented to the risk committee, along with the steps the Company had taken to address those trends, but the presentations to the committee on the consumer complaints did not indicate the Company was violating consumer protection laws.
With respect to the disclosure claims, the Court explained that a plaintiff can demonstrate a breach of fiduciary duty by showing that defendants “deliberately misinform[ed] shareholders about the business of the corporation.” Plaintiff alleged that by “lumping” its reference to the FTC investigation in public filings together with references to SEC and DOJ investigations related to the Company’s previous disclosure of material weaknesses in its internal controls, the Company created the “misimpression” that the FTC was investigating the same conduct that was the subject of the SEC and DOJ investigations. However, the Court found that those statements were not materially false or misleading because they did not identify the “subject matter” of any of the DOJ, SEC, or FTC inquiries. Moreover, according to the Court, it would have been unreasonable for an investor to conclude that the inquiries concerned the same subject matter particularly given that the Company’s public filings otherwise disclosed that the FTC enforces prohibitions against “unfair and deceptive acts or practices in or affecting commerce.” In any event, the Court concluded that the complaint failed to adequately plead scienter because it did not show that defendants “knowingly lied to investors with respect to those disclosures.”