In Re Citigroup Inc. Shareholder Derivative Litigation
964 A.2d 106 (2009)
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Rule of Law:
Under Delaware law, director liability for a failure of oversight requires a showing of bad faith, such as a conscious disregard of known duties. Directors are not personally liable for failing to monitor or manage ordinary business risks, even if those risks result in catastrophic losses, as such decisions are protected by the business judgment rule.
Facts:
- Starting in 2005, the U.S. housing market showed signs of a speculative bubble, and house prices began to plateau and then deflate.
- Citigroup Inc., a global financial services company, engaged in subprime lending and created complex financial products like Collateralized Debt Obligations (CDOs) backed by these risky mortgages.
- Some of the CDOs created by Citigroup included "liquidity puts," which were options allowing purchasers to sell the CDOs back to Citigroup at their original value.
- Throughout 2006 and 2007, numerous public "red flags" indicated a worsening subprime market, including other lenders filing for bankruptcy and rating agencies downgrading mortgage-backed securities.
- Despite these market warnings, Citigroup continued its subprime-related activities, including purchasing $2.7 billion in subprime loans from other lenders in 2007.
- Beginning in late 2007, Citigroup announced staggering write-downs and losses, ultimately totaling tens of billions of dollars, directly attributable to its subprime market exposure.
- Citigroup was also forced to bail out seven of its affiliated Structured Investment Vehicles (SIVs) by bringing $49 billion of their assets onto its balance sheet.
- Upon his retirement as CEO in November 2007, the Citigroup board of directors approved a multi-million dollar compensation and benefits package for defendant Charles Prince.
Procedural Posture:
- Shareholders filed a derivative action in the U.S. District Court for the Southern District of New York on November 6, 2007.
- Other shareholders commenced this derivative action in the Delaware Court of Chancery (a trial court) on November 9, 2007.
- The various Delaware actions were consolidated, and plaintiffs filed a Consolidated Second Amended Derivative Complaint.
- The director and officer defendants (appellees) filed a motion in the Delaware Court of Chancery to dismiss or stay the action in favor of the New York case.
- The defendants also moved to dismiss the complaint for failure to state a claim and for failure to properly plead that a pre-suit demand on the board would have been futile, as required by Court of Chancery Rule 23.1.
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Issue:
Does a board of directors' failure to foresee and prevent massive losses from business risks, absent particularized allegations of bad faith or a conscious disregard of known duties, create a substantial likelihood of personal liability sufficient to excuse a pre-suit demand in a shareholder derivative action?
Opinions:
Majority - Chancellor Chandler
No. A board's failure to prevent losses from business risks does not, without more, create a substantial likelihood of liability sufficient to excuse demand. The core of plaintiffs' claim is that the director defendants should be personally liable for failing to recognize the risk posed by subprime securities. This is precisely the type of claim the business judgment rule is designed to prevent. The court distinguished between the duty to monitor for employee misconduct or illegality, as originally articulated in In re Caremark, and the duty to oversee business risk. While directors must implement reasonable information and reporting systems, holding them personally liable for failing to predict market downturns would constitute impermissible judicial second-guessing. The "red flags" cited by plaintiffs were merely public information about worsening market conditions, not specific evidence of internal wrongdoing that would trigger a duty to act. To establish liability for a failure of oversight, a plaintiff must plead particularized facts showing the directors acted in bad faith by consciously disregarding their known duties, a standard the plaintiffs failed to meet. The court therefore dismissed the claims for breach of fiduciary duty and failure of disclosure. However, the court found that the plaintiffs did raise a reasonable doubt as to whether the approval of CEO Charles Prince's multi-million dollar severance package constituted corporate waste, allowing that specific claim to proceed.
Analysis:
This case significantly clarifies and reinforces the high bar for establishing director oversight liability under the Caremark standard, especially in the context of business risk. The court drew a crucial distinction between a failure to monitor illegal corporate activity and a failure to accurately predict and manage market risks. By strongly reaffirming the protections of the business judgment rule, the decision makes it exceedingly difficult for shareholders to hold directors personally liable for business decisions that, in hindsight, prove disastrous. This precedent protects directors' ability to engage in risk-taking—an essential function of business—without the chilling effect of potential personal liability for negative outcomes that are not the result of bad faith or a conscious disregard of duty.
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