City of Cambridge Retirement v. Ersek ( 2019 )

FILED
United States Court of Appeals
PUBLISH Tenth Circuit
UNITED STATES COURT OF APPEALS April 16, 2019
Elisabeth A. Shumaker
FOR THE TENTH CIRCUIT Clerk of Court
_________________________________
CITY OF CAMBRIDGE RETIREMENT
SYSTEM; MARTA/ATU LOCAL 732
EMPLOYEES RETIREMENT PLAN,
derivatively on behalf of the Western
Union company,
Plaintiffs - Appellants,
and
STANLEY LIEBLEIN,
Plaintiff,
v. No. 17-1381
HIKMET ERSEK; JACK M.
GREENBERG; DINYAR S. DEVITRE;
RICHARD A. GOODMAN; BETSY D.
HOLDEN; LINDA FAYNE LEVINSON;
ROBERTO G. MENDOZA; SOLOMON
D. TRUJILLO; FRANCES M. FRAGOS
TOWNSEND; THE WESTERN UNION
COMPANY, a Delaware corporation,
nominal defendant,
Defendants - Appellees.
_________________________________
Appeal from the United States District Court
for the District of Colorado
(D.C. No. 1:14-CV-00144-MSK-KLM)
_________________________________
Jeroen Van Kwawegen of Bernstein Litowitz Berger & Grossmann LLP, New York, New
York (David J. MacIsaac of Bernstein Litowitz Berger & Grossmann LLP, New York,
New York; Jeffrey A. Berens of Berens Law LLC, Denver, Colorado; and Michael I.
Fistel, Jr. of Johnson Fistel LLP, Marietta, Georgia, with him on the briefs), for Plaintiffs-
Appellants.
David F. Graham of Sidley Austin LLP, Chicago, Illinois (Hille R. Sheppard of Sidley
Austin LLP, Chicago, Illinois; and Holly Stein Sollod and Christina Gomez of Holland &
Hart LLP, Denver, Colorado, with him on the brief) for Defendants-Appellees.
_________________________________
Before MATHESON, PHILLIPS, and McHUGH, Circuit Judges.
_________________________________
PHILLIPS, Circuit Judge.
_________________________________
In this shareholder-derivative action, Shareholders of The Western Union
Company aver that several of Western Union’s Officers and Directors breached their
fiduciary duties to the company by willfully failing to implement and maintain an
effective anti-money-laundering-compliance program (AML-compliance program),
despite knowing of systemic deficiencies in the company’s AML compliance. The
Shareholders didn’t make a pre-suit demand on Western Union’s Board of Directors
to pursue this litigation, and the district court found no evidence that such demand
would have been futile. The district court thus dismissed the case, reasoning that the
Shareholders’ obligation to make a pre-suit demand on the Board was not excused.
Exercising jurisdiction under 28 U.S.C. § 1291, we affirm.
BACKGROUND
Western Union is a public Delaware corporation that facilitates electronic
money transfers through a sprawling international network of about 550,000
“agents”—individuals and entities that serve as storefronts where customers can send
2
or receive funds—located in over 200 countries and territories. Appellants’ App. vol.
4 at 854–55, ¶ 14. Western Union’s primary business flows through Western Union
Financial Services, Inc. (WUFSI), a wholly-owned subsidiary which facilitates
consumer-to-consumer money transfers. Western Union also offers business-to-
business and business-to-consumer transfers through another wholly-owned
subsidiary, Western Union Business Solutions.
Given its vulnerability to criminal exploitation, the money-transmittal industry
is heavily regulated. Under the Bank Secrecy Act of 1970 (BSA), 31 U.S.C. §§ 5311–
5332, financial institutions—including “money services businesses” like Western
Union1—must implement and maintain effective AML-compliance programs. See id.§ 5318(h)(1). At a minimum, these programs must provide for internal controls to
guard against money laundering, for monitoring and independent compliance testing,
and for personnel training. See 31 U.S.C. § 5318(h); 31 C.F.R. § 1022.210. A money-
services business with foreign agents must also adopt risk-based approaches to cross-
border transactions to help “guard against the flow of illicit funds.” 69 F.R. 74439,
74440 (Dec. 14, 2004). Finally, financial institutions must maintain records and file
reports on transmittals that exceed certain amounts or are “relevant to a possible
violation of law or regulation.” 31 U.S.C. § 5318(g)(1). “Structuring” or breaking
transactions into smaller denominations to avoid the BSA’s recordkeeping and
reporting requirements is a crime. Id. § 5324.
1
A “money services business” qualifies as a “financial institution” under the
BSA. See 31 C.F.R. §§ 1010.100(t) & 1010(ff).
3
Regulators have long monitored Western Union’s compliance with these
requirements. Between 2002 and 2006, when Western Union became a public
company, WUFSI entered into four settlement agreements concerning alleged AML
violations with federal regulators and state authorities in Arizona, California, and
New York. Without admitting liability, WUFSI promised to remedy deficiencies in
its recordkeeping, reporting, and monitoring practices. Yet WUFSI struggled to
achieve these objectives, and in 2008, it reached a second settlement with Arizona
regarding alleged recordkeeping violations. A third settlement with Arizona followed
in 2010: the Southwest Border Agreement (SBA).
The SBA centered on violations that occurred between 2003 and 2007 at 16
agent locations in the Southwest Border region—Arizona and the area within 200
miles north and south of the United States–Mexico border. WUFSI admitted that it
had “reason to know” that agents at these locations had “knowingly engaged in a
pattern of money laundering violations that facilitated human smuggling from
Mexico into the United States through Arizona.” Appellants’ App. vol. 8 at 1933, ¶ 4.
To remedy these violations, the SBA imposed a $94 million fine and mandated that
WUFSI work with a court-appointed monitor to improve its AML compliance in the
Southwest Border region. The SBA set a July 2013 completion deadline for this
endeavor.
Three monitors served between 2010 and 2013, recommending a bevy of
improvements to WUFSI’s AML-compliance program. Western Union struggled to
keep apace of these mounting proposals, implementing just 18 of (then) 80 proposals
4
by September 2011, 33 of 98 proposals by October 2012, and 54 of 98 proposals by
April 2013. In July 2013—at the end of the initial monitorship—Western Union
management advised the Board of Directors that certain improvements were “at a
standstill.” Id. vol. 3 at 777–78, ¶¶ 184–85. Management also reported the disturbing
news that, in the first quarter of 2013, 28 of 335 high-risk agents in the Southwest
Border region had “confirmed instances of Human Smuggling.” Id. at 786, ¶ 214.
When Western Union failed to complete all the monitors’ proposals by the
July 2013 deadline, Arizona threatened to declare a willful and material breach of the
SBA. Instead, recognizing their “mutual goal” that Western Union develop and
maintain an effective AML-compliance program, the parties negotiated an amended
SBA, extending the monitorship through December 2017. Id. vol. 8 at 1986. The
Amended SBA also mandated more rigorous recordkeeping and reporting practices
for transactions in the Southwest Border region.
As these events unfolded, numerous federal investigations into Western
Union’s AML compliance began to ramp up. In 2012, the U.S. Attorney’s Office for
the Central District of California named Western Union a “target” in an investigation
into a California agent arrested for structuring transactions worth $65.7 million. Id.vol. 3 at 763, ¶ 137. Also in 2012, the Federal Trade Commission (FTC) began
investigating Western Union’s possible facilitation of fraudulent money transfers.
Two years later, in 2014, the U.S. Attorney’s Office for the Southern District of
Florida named Western Union a target in an investigation into allegations of money
5
laundering by agents in Central America. Meanwhile,2 the U.S. Attorney’s Offices
for the Eastern and Middle Districts of Pennsylvania started investigating Western
Union for anti-fraud and AML violations.
Against this backdrop, various Shareholders filed five derivative actions in
2014 alleging that certain of Western Union’s Directors had caused the company to
willfully violate AML laws and regulations. In 2015, the district court consolidated
these actions, and the Shareholders filed a consolidated complaint, asserting
violations of the Securities Exchange Act of 1934, breaches of fiduciary duties, and
Delaware common-law claims. The Directors moved to dismiss under Rule 23.1 of
the Federal Rules of Civil Procedure, arguing that the Shareholders had failed to
plead facts sufficient to show the futility of making a pre-suit demand on the Board
to pursue litigation. The court granted the motion but gave the Shareholders leave to
amend. Accordingly, on May 2, 2016, the Shareholders filed a first amended
complaint (FAC), asserting two breach-of-fiduciary-duties claims. The Directors
again moved to dismiss for failure to plead demand futility.
While that motion was pending, on January 19, 2017, Western Union entered
into a deferred prosecution agreement (DPA) with the U.S. Department of Justice and
the U.S. Attorney’s Offices for the Central District of California, Southern District of
Florida, and Eastern and Middle Districts of Pennsylvania. The DPA alleged that,
between 2004 and 2012, Western Union had willfully failed to implement an
2
The parties offer no evidence identifying when these investigations began.
6
effective AML-compliance program and take corrective action against agents
engaged in fraud, money laundering, and structuring schemes. Western Union
admitted these allegations, accepted responsibility, and agreed to penalties and
conditions in exchange for having criminal charges dismissed after three years. That
same day, Western Union also announced a settlement with the FTC in a related
consumer-fraud enforcement action.
In light of these developments, the district court granted the Shareholders
leave to amend their pleading. Accordingly, on March 17, 2017, the Shareholders
filed a second amended complaint (SAC), adding 13 paragraphs addressing the
settlement agreements. On April 21, 2017, the Directors filed a renewed motion to
dismiss for failure to plead demand futility, which the district court granted on
September 29, 2017. This appeal followed.
ANALYSIS
The Shareholders concede that they made no pre-suit demand on Western
Union’s Board of Directors to pursue this litigation. Thus, we need decide only
whether such demand would have been futile. We first address the standard of review
applicable to Rule 23.1 dismissals before considering the legal sufficiency of the
Shareholders’ demand-futility allegations.
I. Standard of Review
Our circuit has yet to decide what standard of review applies to dismissals
under Rule 23.1 for failure to plead demand futility. See In re ZAGG Inc. S’holder
Deriv. Action, 826 F.3d 1222, 1227 (10th Cir. 2016) (finding the standard of review
7
immaterial to the decision). The courts of appeals are split on this question, with the
recent trend favoring de novo review over a discretionary standard.3 We tend to agree
with the trend towards plenary review, given that the issue whether demand is futile
depends on the legal sufficiency of the complaint’s allegations—a determination we
typically review de novo. See Carabajal v. City of Cheyenne, 847 F.3d 1203, 1212
(10th Cir. 2017). We see no sound reason to apply a different standard to a derivative
pleading when we have “exactly the same task as when reviewing the dismissal of
any other action.” Espinoza v. Dimon, 797 F.3d 229, 235 (2d Cir. 2015) (explaining
that an appellate court takes the complaint’s allegations as true and decides whether
3
Many circuits historically applied abuse-of-discretion review in derivative
actions, reasoning that a dismissal for failure to adequately plead demand futility is
highly fact-intensive. But the more recent trend is to apply de novo review, and at
least five circuits now use that standard. See, e.g., F5 Capital v. Pappas, 856 F.3d 61,
71 (2d Cir. 2017); Cottrell on behalf of Wal-Mart Stores, Inc. v. Duke, 829 F.3d 983,
990 (8th Cir. 2016); Union de Empleados de Muelles de Puerto Rico PRSSA Welfare
Plan v. UBS Fin. Servs., 704 F.3d 155, 162–63 (1st Cir. 2013); Westmoreland Cnty.
Emp. Ret. Sys. v. Parkinson, 727 F.3d 719, 724–25 (7th Cir. 2013); McCall v. Scott,
239 F.3d 808, 817 (6th Cir. 2001). Still, several circuits have bucked this trend and
continue to apply a discretionary standard. See, e.g., Louisiana Mun. Police Emps.’
Ret. Sys. v. Wynn., 829 F.3d 1048, 1058 (9th Cir. 2016); Freedman v. Redstone, 753
F.3d 416, 423 (3d Cir. 2014); Kammona v. Onteco Corp., 587 F. App’x 575, 581
(11th Cir. 2014); Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust ex rel.
Fed. Nat’l Mortg. Ass’n v. Raines, 534 F.3d 779, 783 n.2 (D.C. Cir. 2008).
8
they state a claim under the appropriate demand-futility standard).4 We therefore hold
that dismissals under Rule 23.1 are subject to de novo review.5
II. Demand Futility
Derivative actions empower shareholders to “enforce a corporate cause of
action against officers, directors, and third parties.” Kamen v. Kemper Fin. Servs.,
Inc., 500 U.S. 90, 95 (1991) (quoting Ross v. Bernhard, 396 U.S. 531, 534 (1970)).
Because the cause of action belongs to the corporation, shareholders, as a
“precondition for the suit,” must make a pre-suit demand on the corporation’s board
of directors to pursue the litigation, “unless excused by extraordinary conditions.” Id.
at 96 (quoting Ross, 396 U.S. at 534). Rule 23.1 requires the complaint to “state with
particularity” “any effort” to “obtain the desired action from the [corporation’s]
4
Notably, some courts of appeals have questioned the logic of deferential
review in this context—even as precedent binds them to apply it. See, e.g., Israni v.
Bittman, 473 F. App’x 548, 550 n.1 (9th Cir. Apr. 2, 2012) (“We question whether
abuse of discretion review is appropriate.”), overruled in part on other grounds by
Lightfoot v. Cendant Mortg. Corp., 137 S. Ct. 553 (2017); Raines, 534 F.3d at 783
n.2 (“We tend to agree . . . that an abuse-of-discretion standard may not be logical in
this kind of case . . . because the question whether demand is excused turns on the
sufficiency of the complaint’s allegations . . . .”).
5
As we noted in In re ZAGG, 826 F.3d at 1227, one of our earlier cases
suggested that an abuse-of-discretion standard might be appropriate for dismissals
under Rule 23.1. See deHaas v. Empire Petroleum Co., 435 F.2d 1223, 1228 (10th
Cir. 1970) (holding, in assessing demand futility, that nothing in the record “would
indicate an abuse of discretion”). But in deHaas, the demand-futility question came
before this court after a full trial, and the issue revolved around a “factual dispute.”
Id. Accordingly, deHaas does not prescribe our standard of review when a demand-
futility issue arises on a motion to dismiss the complaint. See Smith v. United States,
561 F.3d 1090, 1098 (10th Cir. 2009) (“The legal sufficiency of a complaint is a
question of law . . . [that] is reviewed de novo.”).
9
directors” and “the reasons for not obtaining the action or not making the effort.”
Fed. R. Civ. P. 23.1(b)(3). Whether the complaint’s particular allegations suffice
depends upon the substantive law of the state in which the entity is incorporated—
here, Delaware. See Kamen, 500 U.S. at 108–09.6
Because the Shareholders didn’t make a pre-suit demand on Western Union’s
Board, Rule 23.1 requires that they plead the reasons such demand would have been
futile under Delaware law. In evaluating the Shareholders’ pleading, we accept as
true all particularized allegations of fact and give the Shareholders all reasonable
inferences logically flowing from them. See City of Birmingham Ret. & Relief Sys. v.
Good, 177 A.3d 47, 55–56 (Del. 2017). But “conclusory allegations are not
considered as expressly pleaded facts or factual inferences.” White v. Panic, 783
A.2d 543, 549 (Del. 2001) (citation omitted).7
Delaware law employs two tests for demand futility, the application of which
turns on the nature of the allegations against the board. For allegations that the board
6
Rule 23.1 pertains only to the “adequacy of the shareholder representative’s
pleadings”—it doesn’t “create a demand requirement of any particular dimension.”
Kamen, 500 U.S. at 96. Rather, it “clearly contemplates” that such a requirement may
apply under state substantive law. Id.7
The Shareholders downplay Rule 23.1’s rigorous pleading requirements,
arguing that the standard is “plaintiff-friendly” and citing numerous Rule 12(b)(6)
cases to that effect. See Br. for Plaintiffs-Appellants at 38–39. Yet the Rule 23.1
inquiry is “more onerous” than Rule 12(b)(6). McPadden v. Sidhu, 964 A.2d 1262,
1269 (Del. Ch. 2008). Indeed, Delaware courts often cite Rule 23.1’s particularized-
pleading standard in contradistinction to the “plaintiff-friendly” standard of Rule
12(b)(6). See, e.g., Pfeiffer v. Toll, 989 A.2d 683, 692 (Del. Ch. 2010); In re
Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 130 n.75 (Del. Ch. 2009).
10
acted in violation of its fiduciary duties, demand is excused if a “reasonable doubt”
exists that (i) the directors are disinterested and independent or (ii) the transaction is
“otherwise the product of a valid exercise of business judgment.” Aronson v. Lewis,
473 A.2d 805, 814 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746
A.2d 244 (Del. 2000). By contrast, challenges to board inaction require a “reasonable
doubt” that, when the lawsuit was filed, the board “could have properly exercised its
independent and disinterested business judgment in responding to a demand.” Rales
v. Blasband, 634 A.2d 927, 934 (Del. 1993). The Rales test includes derivative suits
where “the subject . . . is a violation of the Board’s oversight duties.” Wood v. Baum,
953 A.2d 136, 140 (Del. 2008).
In this case, the Shareholders do not challenge any discrete, affirmative Board
action. Rather, they claim that the Board willfully failed to implement and maintain
an effective AML-compliance program despite knowing of systemic deficiencies in
Western Union’s AML compliance.8 Because this allegation describes inaction, it
8
The Shareholders try to shoehorn their claims into the Aronson framework by
using language evocative of affirmative action. The SAC, for example, characterizes
this litigation as “aris[ing] from the deliberate decision of Western Union’s board of
directors . . . to ignore its mandate” to maintain adequate AML-compliance measures.
Appellants’ App. vol. 3 at 715, ¶ 2. Similarly, on appeal, the Shareholders refer to the
Board’s “business strategy” to boost profits while “willfully violating” AML laws,
Br. for Plaintiffs-Appellants at 11–12, and argue that the Board “acted with the intent
to violate positive law” by “condon[ing] management’s efforts to hamper
compliance,” Reply Br. for Plaintiffs-Appellants at 19 n.9. Yet the SAC is wholly
devoid of allegations—particular or otherwise—that the Board was ever informed of
and affirmatively approved a deliberate course of illegal conduct. See Louisiana Mun.
Police Emps.’ Ret. Sys. v. Pyott, 46 A.3d 313, 340–41 (Del. Ch. 2012) (plaintiffs
must “allege with particularity actual board involvement in a decision that violated
positive law”), rev’d on other grounds, 74 A.3d 612 (Del. 2013). As the district court
11
implicates the Rales test. See Rales, 634 A.2d at 933–34 (observing that Aronson is
inapposite where the derivative action doesn’t challenge a “business decision”).9
To prevail under Rales, “a derivative complaint must plead facts specific to
each director[] demonstrating that at least half of them could not have exercised
disinterested business judgment in responding to a demand.” Desimone v. Barrows,
924 A.2d 908, 943 (Del. Ch. 2007). A director is considered interested10 if filing suit
would operate to his or her “personal benefit or detriment.” Beam ex rel. Martha
Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1049 (Del. 2004). For
that reason, a director who is sued may have a disabling interest for pre-suit demand
explained, the SAC’s allegations reduce to the singular contention that the Board
“was confronted with deficiencies in . . . management’s conduct as to AML
compliance” and that it “either condoned the deficiencies or remained consciously
passive.” Appellants’ App. vol. 8 at 2163. In short, the Shareholders allege failures of
oversight, not affirmative misconduct.
9
In any event, the distinction between Aronson and Rales is immaterial in this
case because the Shareholders claim that the Directors face liability from suit and are
therefore incapable of impartially acting on a demand. See Aronson, 473 A.2d at 815(reasoning that, if the challenged conduct is so “egregious” that it fails the business-
judgment test, then “a substantial likelihood of director liability” excusing demand
exists); Rales, 634 A.2d at 934 (excusing demand if the directors’ risk of liability for
failing to act renders them incapable of exercising their impartial business judgment);
see also Rosenbloom v. Pyott, 765 F.3d 1137, 1150 (9th Cir. 2014) (noting that both
tests excuse demand if the “particularized allegations create a reasonable doubt as to
whether a majority of the board of directors faces a substantial likelihood of personal
liability for breaching the duty of loyalty”); In re SAIC Inc. Derivative Litig., 948 F.
Supp. 2d 366, 382 (S.D.N.Y. 2013) (explaining that the two tests “may blur in cases
like this one” where the risk of personal liability “may also implicate the question
whether the Board can avail itself of business judgment protections”), aff’d sub nom.
Welch v. Havenstein, 553 F. App’x 54 (2d Cir. 2014).
10
The Shareholders do not challenge any Director’s independence.
12
purposes. Ryan v. Gifford, 918 A.2d 341, 355 (Del. Ch. 2007). But a director’s mere
status as a defendant isn’t sufficient to compromise the director’s impartiality. See
Aronson, 473 A.2d at 814 (rejecting this “bootstrap” argument). Rather, the director
must face a “substantial likelihood” of personal liability.11 Guttman v. Huang, 823
A.2d 492, 501 (Del. Ch. 2003).
Directors owe fiduciary duties of care and loyalty to the corporation and its
shareholders. Mills Acq. Co. v. Macmillan, Inc., 559 A.2d 1261, 1280 (Del. 1989).
Where, as here,12 the corporate charter exculpates directors from liability for duty-of-
care violations, a “substantial likelihood” of liability requires allegations showing
that the directors have breached their non-exculpated duty of loyalty. That duty
entails, as a “subsidiary element,” an obligation to act in good faith. Stone v. Ritter,
911 A.2d 362, 370 (Del. 2006). Liability for failure to act in good faith requires
“qualitatively more culpable” conduct than gross negligence. In re Walt Disney Co.
11
The Shareholders misstate this standard, asserting that demand is excused if
a “reasonable doubt” exists that the Directors face “potential liability.” Br. for
Plaintiffs-Appellants at 3, 8–9, 35, 47, 50. In essence, they argue that the necessary
quantum of liability risk is anything more than zero. Yet a “mere threat of personal
liability . . . is insufficient to challenge either the independence or disinterestedness
of directors.” Aronson, 473 A.2d at 814. Instead, a “reasonable doubt” as to directors’
impartiality “should only be found where a substantial likelihood of personal liability
exists.” Wood, 953 A.2d at 141 n.11 (citation omitted).
12
Western Union’s charter exculpates its Directors from liability “for breach
of fiduciary duty . . . to the fullest extent permitted by Delaware law.” Appellants’
App. vol. 7 at 1872. Delaware law permits exculpation from monetary liability for
breach of the duty of care but not for breach of the duty of loyalty. Del. Code Ann.
tit. 8, § 102(b)(7). Accordingly, Western Union’s charter exculpates liability only for
duty-of-care violations.
13
Deriv. Litig., 906 A.2d 27, 66 (Del. 2006). Indeed, it requires intentional bad-faith
conduct, such as acting in pursuit of a disloyal purpose, acting with the “intent to
violate applicable positive law,” or consciously failing to act “in the face of a known
duty to act.” Stone, 911 A.2d at 369 (citation omitted).
Claims alleging failures of board oversight fall within the latter category and
are considered “possibly the most difficult theory in corporation law upon which a
plaintiff might hope to win a judgment.” In re Caremark Int’l Inc. Deriv. Litig., 698
A.2d 959, 967 (Del. Ch. 1996). A Caremark claim requires particularized allegations
that the board (i) “utterly failed to implement any reporting or information system or
controls” or (ii) “having implemented such a system or controls, consciously failed to
monitor or oversee its operations thus disabling themselves from being informed of
risks or problems requiring their attention.” Stone, 911 A.2d at 370. Under either
theory, the directors must have consciously and in bad faith failed to discharge their
fiduciary obligations. Id.; see also Rich ex rel. Fuqi Int’l, Inc. v. Yu Kwai Chong, 66
A.3d 963, 980–82 (Del. Ch. 2013) (“The essence of a Caremark claim is a breach of
the duty of loyalty arising from a director’s bad-faith failure to exercise oversight
over the company.”).
Here, the Shareholders don’t appear to allege that Western Union’s Board
utterly failed to implement any reporting or information systems or controls. Nor
could they credibly make such an argument, as nearly every settlement that Western
Union has reached with federal and state authorities since 2002 has acknowledged
Western Union’s progress towards implementing an effective AML-compliance
14
program.13 Instead, the Shareholders seem to argue that the Board consciously failed
to monitor Western Union’s AML compliance, thereby disabling itself from being
informed of deficiencies requiring attention.
To prevail on such a claim under Caremark’s second prong, the Shareholders
must plead with particularity that the Board was presented with “red flags” alerting it
to misconduct at the company, see Stone, 911 A.2d at 373, and that it “consciously
disregarded” those red flags, see Good, 177 A.3d at 59. Red flags serve as proxies for
Board knowledge. Hence, the Shareholders must identify “obvious and problematic
occurrences” supporting an inference that the Board knew of, but consciously
ignored, material weaknesses in Western Union’s internal AML policies. See Rich,
66 A.3d at 983.
Of course, whether the Board consciously ignored such red flags depends on
which Board counts for purposes of evaluating demand futility. The Shareholders
contend that the relevant Board is the 12-member Board that was constituted when
13
See Appellants’ App. vol. 7 at 1875 (New York: “[Western Union] has
undertaken immediate corrective action.”); id. at 1880 (Department of the Treasury:
“[Western Union] promptly instituted comprehensive national corrective actions . . .
.”); id. at 1886 (California: “[Western Union] has proactively taken corrective steps .
. . .”); id. vol. 8 at 1919, ¶ 3 (SBA: “Western Union has developed and implemented
a risk-based . . . [AML] compliance program.”); id. at 1987, ¶ 2 (amended SBA:
“Western Union has expended significant resources and has made substantial
progress in completing the Monitor’s Recommendations.”); id. vol. 4 at 880, ¶ 100
(DPA: “Western Union took remedial measures and implemented compliance
enhancements to improve its anti-fraud and anti-money laundering programs.”).
15
they filed the FAC in May 2016.14 Meanwhile, the Directors urge us to focus on the
11-member Board that was in place when the SAC was filed in March 2017.
Ordinarily, courts assess demand futility based on “the directors in office when
[the shareholders] initiated [the] action.” Teamsters Union 25 Health Servs. & Ins.
Plan v. Baiera, 119 A.3d 44, 57 (Del. Ch. 2015). If the shareholders amend their
complaint, the relevant board becomes the one in place when the amended complaint
is filed. See Braddock v. Zimmerman, 906 A.2d 776, 779 (Del. 2006). But the
existence of a new board at that time “is relevant to a Rule 23.1 demand inquiry”
only as to derivative claims in the amended complaint that are “not already validly in
litigation.” Id. at 785.
The term “validly in litigation” means “a proceeding that can or has survived a
motion to dismiss.” Id. at 779. Claims in an amended pleading meet this definition if
(i) “the original complaint was well pleaded as a derivative action”; (ii) “the original
complaint satisfied the legal test for demand excusal”; and (iii) “the act or transaction
complained of . . . is essentially the same as the act or transaction challenged in the
original complaint.” Id. at 786. The first and second prongs are relevant to whether
the proceeding survived dismissal, while the third prong examines the continuity
between the pleadings.
14
In their opening brief, the Shareholders appear to argue that the relevant
Board is the one that was in place when this action first commenced in 2014. In their
reply brief, however, they argue for the May 2016 Board.
16
Here, because the original complaint didn’t survive dismissal, the Rule 23.1
demand inquiry reset when the Shareholders filed the FAC. See id. (“[A] complaint
that has been dismissed is not validly in litigation.”). The inquiry again reset when
the Shareholders filed the SAC, at least for derivative claims that weren’t validly
stated in the FAC. See In re Affiliated Computer Servs., Inc. S’holders Litig., No.
2821-VCL, 2009 WL 296078, at *8 (Del. Ch. Feb. 6, 2009) (analyzing whether
claims in a second amended complaint were validly in the first amended complaint).
The district court, of course, didn’t dismiss the FAC—the Shareholders filed the SAC
before it could. But the test for validity also asks whether a claim can survive
dismissal, and the district court, in dismissing the SAC, explicitly stated that it would
have dismissed the FAC for failure to plead demand futility. The FAC therefore
wasn’t valid under Braddock’s second prong.15
We see no error in this result. When the Shareholders filed the FAC in May
2016, Western Union’s Board consisted of 12 Directors. Six of those Directors joined
the Board in 2012 or later, well after most of the red-flag events that the Shareholders
allege should have alerted the Board to AML-compliance issues—i.e., settlements
with federal and state authorities between 200216 and 2010. The FAC doesn’t
15
The Shareholders insist that the SAC added no additional claims from those
in the FAC but instead merely “supplemented” the FAC’s well-pleaded allegations.
Reply Br. for Plaintiffs-Appellants at 20. Yet the continuity between the pleadings
doesn’t render the FAC valid. The FAC must have also satisfied the legal test for
demand excusal, and the district court determined that the FAC failed that test.
16
Of course, the Directors couldn’t incur liability for failing to act on red flags
occurring before 2006, when Western Union became a public company. Nonetheless,
17
mention the three newest Directors: Jeffrey Joerres (2015), Martin Cole (2015), and
Robert Selander (2014). As for the other three—Francis Townsend (2013), Richard
Goodman (2012), and Solomon Trujillo (2012)—the FAC alleges a general
awareness of systemic deficiencies in Western Union’s AML compliance. But it
pleads no facts showing that any of those directors consciously disregarded any
contemporaneous violations of specific requirements imposed by past settlements.
At most, the FAC alleges that Townsend, Goodman, and Trujillo attended
numerous meetings at which management17 apprised the Board of setbacks related to
the ongoing SBA settlement. The FAC asserts that the collective Board remained
“wholly passive” in the face of these setbacks, see, e.g., Appellants’ App. vol. 3 at
602, ¶ 9; id. at 688, ¶ 260, but it pleads no particularized facts showing how
Townsend, Goodman, and Trujillo consciously and in bad faith failed to take
remedial action, see Orman v. Cullman, 794 A.2d 5, 22 (Del. Ch. 2002) (requiring
facts specific to the “individual members of th[e] board”). In fact, the FAC’s own
account suggests that, under these Directors’ oversight, the company improved its
compliance with the SBA. Compare Appellants’ App. vol. 3 at 645, ¶ 131 (alleging
the Shareholders seem to allege that these earlier settlements alerted the Board to a
longstanding pattern of AML violations and structural deficiencies in the company’s
internal AML-compliance policies.
17
The FAC is replete with allegations concerning “management’s” supposed
resistance to implementing AML-compliance measures in accordance with the SBA.
But the FAC lacks details about who constituted the “management” team tasked with
implementing the SBA or why those specific individuals desired to thwart AML
compliance. We cannot ascribe malicious motives to a nebulous, unnamed group of
“managers.”
18
that one of 91 monitor proposals were complete as of February 2012), with id. at 666,
¶ 199 (54 of 98 proposals as of April 2013). Though Western Union didn’t achieve
full compliance by the July 2013 deadline, the record belies the notion that
Townsend, Goodman, and Trujillo had wholly abdicated their oversight duties.
The FAC thus fails to allege that Western Union’s six newest Directors face a
substantial likelihood of personal liability for consciously disregarding red flags of
AML noncompliance. To validly state a Caremark claim, then, the FAC must create a
reasonable doubt about the other six Directors’ impartiality. See Beam, 845 A.2d at1046 n.8 (explaining that demand to a board with an even number of members is
futile if at least half are compromised). The FAC doesn’t meet this threshold.
Aside from the six Directors discussed above, the Board in May 2016 included
Hikmet Ersek (2010), Jack Greenberg (2006), Betsy Holden (2006), Linda Levinson
(2006), Roberto Mendoza (2006), and Michael Miles (2006). Even assuming the FAC
creates a reasonable doubt as to these Directors’ impartiality,18 its allegations about
18
Though we needn’t reach the issue, we doubt the FAC states a Caremark
claim against the remaining six Directors. The FAC avers that the SBA alerted these
Directors to ongoing AML violations, which they ignored. This mischaracterizes the
SBA, which concerned past unlawful conduct occurring between 2003 and 2007 and
not ongoing illegality. In fact, the SBA expressly recognized that, in the years since
the violations, Western Union had “dedicated substantial resources” to improving its
AML compliance. Appellants’ App. vol. 8 at 1919, ¶ 3. The SBA thus supports the
inference that Western Union’s compliance was improving during these Directors’
tenure on the Board.
The FAC also alleges failures of oversight related to the SBA, including that
the Board had permitted management to oppose and thwart the court-appointed
monitors’ recommendations for improved AML compliance. For example, the FAC
faults the Board for supporting a disagreement between management and the monitor
over proposals for front-line associate sign-on controls and background checks. But
19
Levinson are immaterial to the demand-futility inquiry. On March 30, 2016, over a
month before the FAC’s May 2, 2016, filing, Levinson publicly disclosed that she
would retire as of Western Union’s May 12, 2016, annual meeting. Delaware courts
have likewise excluded from the inquiry directors who have announced their
the mere existence of such isolated disagreements over the course of a multi-year
relationship doesn’t support an inference that management designed to thwart AML
compliance. More important, the SBA obligated Western Union to collaborate with
the monitor on AML-compliance issues, not simply to acquiesce to all the monitor’s
demands. Disagreements over how to approach AML compliance don’t necessarily
evince bad-faith opposition to AML compliance.
Similarly, the FAC urges an inference of conscious bad faith based on Western
Union’s failure to achieve full compliance with the SBA by the July 2013 deadline.
This ignores that Western Union had implemented a majority of the monitors’
proposals during the three years of the SBA’s initial iteration. Such substantial
progress belies the notion that the Board had consciously failed to monitor
management’s AML-compliance efforts. Presumably, a conscious failure of oversight
would have resulted in a compliance rate much closer to zero, especially with a
management team allegedly bent on thwarting such efforts.
In fact, the FAC details how management routinely reported to the Board on
implementation progress and setbacks throughout the SBA’s initial term, and how it
presented plans for addressing open issues—demonstrating a functioning oversight
system. The FAC emphasizes that early reports exhibited limited progress and that
“major issues” remained open throughout the initial term. See id. vol. 3 at 667, ¶ 205.
But this portrayal misleadingly omits that the SBA contemplated a three-year period
for implementation. Partial implementation at the mid-stages of that period suggests
meaningful efforts at compliance, not bad faith. Indeed, though early reports showed
sluggish progress, management informed the Board in late 2012 that it was on track
to full compliance by the July 2013 deadline. The Board properly relied on this
healthy forecast and allowed management to continue its efforts.
Ultimately, the insistence on inferring bad faith from Western Union’s failure
to achieve full implementation by the initial deadline improperly “equate[s] a bad
outcome with bad faith.” See Stone, 911 A.2d at 373. Particularized allegations must
support such an inference, not speculative deduction. The Shareholders’ protestation
that inferring the Board’s good faith is improper inverts their burden: they must
proffer particularized facts sufficient to support an inference of bad faith. Such an
inference doesn’t logically flow from the conclusory allegation that Western Union’s
failure to achieve compliance stemmed from bad faith.
20
impending retirement. See Park Emps.’ Annuity & Benefit Fund of Chicago v. Smith,
No. 11000-VCG, 2016 WL 3223395, at *1, *8-11 (Del. Ch. May 31, 2016), aff’d,
175 A.3d 621 (Del. 2017). As the court in Smith explained, demand futility should be
determined by reference to “the board that would actually be tasked with determining
whether or not the corporation will pursue the litigation.” Id. at *9.
The Shareholders attempt to distinguish Smith, arguing that the plaintiffs in
that case filed a complaint just four days before an uncontested election to replace a
majority of the directors, who were retiring. They note that here, by contrast, they
asserted allegations against Levinson in their original complaint in January 2014—
over two years before she declared her intent to retire. Yet demand futility is assessed
as of the filing of the complaint that first states valid claims, and the original
complaint wasn’t valid because it didn’t survive a motion to dismiss. See Braddock,
906 A.2d at 779. Thus, assuming, arguendo, the FAC’s validity, the relevant
comparison is between the FAC’s filing just ten days before Levinson’s retirement
and the complaint’s filing four days before the directors’ retirement in Smith.
The Shareholders also highlight that they filed the FAC within 30 days of the
district court’s order dismissing the original complaint, “a date that was not within
Plaintiffs’ control.” Reply Br. for Plaintiffs-Appellants at 22. This, too, is irrelevant.
Levinson’s impending retirement was a matter of public record in Western Union’s
SEC filings as early as March 30, 2016—well before the Shareholders filed the FAC
and even before the district court dismissed the original complaint. Regardless of the
21
district court’s disposition of the motion to dismiss, the Shareholders had ample
notice that Levinson would be disabled from considering any litigation demand.
Thus, excluding Levinson from the analysis, the FAC alleges—at most—that
five of 11 Directors on the Board at the time of the FAC’s filing risked personal
liability. Demand to a board with an uneven number of members is futile only if a
majority is disabled from considering the demand. See Aronson, 473 A.2d at 817.
Allegations impugning the impartiality of five of 11 Directors fail to meet this
threshold, meaning the FAC wasn’t validly in litigation because it would have been
dismissed for failing to satisfy the “legal test for demand excusal.” See Braddock,
906 A.2d at 786.
The relevant Board for demand-futility purposes, then, is the 11-member
Board in place when the SAC was filed in March 2017. Yet, with the exception of
Levinson, the Board in March 2017 was identical to the Board in May 2016, and the
SAC alleges no additional facts that would render demand to that Board futile. The
SAC primarily adds allegations concerning the DPA, which addresses criminal AML
violations that occurred between 2004 and 2012. The SAC seems to allege that the
Directors as of March 2017 risked personal liability for those violations because they
all had served for at least part of the period during which the violations occurred. Yet
the SAC doesn’t particularly allege that the Board was aware of these violations
when they happened, much less that any individual Director consciously and in bad
22
faith had failed to take corrective action.19 Rule 23.1’s rigorous pleading standard
isn’t satisfied absent particularized allegations as to what each Director knew and
how they acted on that knowledge.20
The criminal misconduct that the DPA describes is certainly troubling, but the
SAC fails to establish that a majority of Western Union’s Board in March 2017 faced
a substantial risk of personal liability for consciously disregarding that misconduct.
See Guttman, 823 A.2d at 501. Thus, because the Board could have impartially acted
on a pre-suit demand to pursue litigation, we hold that the Shareholders’ obligation to
make such a demand wasn’t excused. See Rales, 634 A.2d at 934.
CONCLUSION
For the above reasons, we affirm the district court.
19
Indeed, the only Director that the SAC purports to connect to the DPA is
Ersek, and even then, it does so only implicitly. See Appellants’ App. vol. 3 at 801, ¶
265 (alleging that Western Union admitted its “Chief Executive Officer . . . knew
about AML violations”).
20
The DPA itself doesn’t supply such allegations. It describes how Western
Union “employees” willfully failed to discipline agents who knew of, but failed to
address, consumer fraud complaints related to transactions at foreign agent locations.
Appellants’ App. vol. 4 at 852, ¶ 2. It further describes failures to take corrective
action against four domestic agents who violated Western Union’s own policies
against structuring transactions. The DPA doesn’t attribute knowledge of this
criminal misconduct either to the Board or to any individual Director. Nor does it
support an inference that the Board consciously disregarded the misconduct. In fact,
it notes that between 2010 and 2012, Western Union terminated the agents engaged
in structuring transactions. It also notes that, in the wake of these terminations,
Western Union undertook “remedial measures and implemented compliance
enhancements” which demonstrate its “commitment to maintaining and enhancing
the effectiveness of its compliance program.” Id. at 880, ¶ 100. Such steps hardly
evince a Board that is consciously blind to AML violations.
23