Case Title: In re P.S.E. & G. Shareholder Litigation

Citation: 

Docket Number: a-41-01

State: new-jersey

Court: New Jersey Supreme Court

Date: 2002-07-23T00:00:00Z

Document:
In this appeal, the Court considers the proper standard of review to be applied in evaluating whether a corporation's board of directors responded properly in rejecting a shareholder's demand to commence legal action on the corporation's behalf, and whether the lower court correctly applied that standard in this case. This appeal stems from four derivative actions brought by shareholders of Public Service Enterprise Group, Incorporation (Enterprise), a public utility holding company, and its wholly-owned subsidiary, Public Service Electric & Gas Company (PSE&G)(collectively, the company). Defendants are certain directors of both entities and include current and former PSE&G officers (collectively, the Board). PSE&G operates the Salem and Hope Creek nuclear power plants (power plants) located in southern New Jersey. Based on events that took place over a period of many years, plaintiffs allege that defendants recklessly mismanaged both power plants to the company's financial detriment. On October 4, 1995, following the closing of one of the power plants, plaintiff G.E. Stricklin sent a formal demand letter to the Board asking it to institute suit against each of its officers for mismanagement of the nuclear operations. In response, the Board adopted a resolution on October 17, 1995, retaining the law firm of Kasowitz, Benson,Torres & Friedman (the Kasowitz firm) to investigate the allegations raised in the demand letter. On December 27, 1995, before the Kasowitz firm's investigation was complete, Stricklin filed a shareholder derivative complaint that raised the same allegations as the demand letter and contended that Board members should be held personally liable for the company's financial losses. Stricklin also contended that her demand on the Board had been rejected wrongfully because the Board had not acted on it. On February 28 and March 5, 1996, additional shareholders filed two more derivative actions, but they did not make a demand on the company prior to instituting suit. Instead, they assert that such demand would have been futile. Meanwhile, the Kasowitz firm reviewed over 43,000 pages of documents and conducted over thirty interviews with company personnel. After completing its investigation, the firm issued a 124-page report on February 8, 1996, and a supplemental report on March 14, 1996, concluding that there was no basis on which to institute legal action against any employee, officer, or director of Enterprise or PSE&G. On March 19, 1996, the Board adopted a resolution accepting the Kasowitz firm's recommendations. Later, in depositions or certifications, the Board members gave their reasons for rejecting the litigation, including 1) the memorandum and reports presented by counsel; 2) the inquisitiveness and preparedness of Board members at meetings during the relevant time period; 3) the open lines of communication and information in respect of the company's nuclear operations; 4) the depth of the information presented to the Board on a regular basis and its vigorous action in response to that information; and 5) the excessive cost of such litigation. On July 3, 1996, a fourth shareholder filed a complaint. The trial court consolidated the four actions and defendants moved to dismiss the complaints. In December 1996, the trial court found that all four plaintiffs had alleged sufficient facts to withstand dismissal. The trial court further excused the failure to make a demand by some of the plaintiffs because it found that they had alleged sufficient facts to create a reasonable doubt that the directors were disinterested or independent. The Appellate Division and this Court denied leave to appeal. After the consolidated cases were transferred to another judge, the cases were bifurcated according to whether a demand had been made by the plaintiffs (demand-made cases), or whether a demand had not been made by the plaintiffs (demand-futile cases). Defendants moved for summary judgment in the demand-made cases in December 1997 and in the demand-futile actions in May 1998. In deciding the motions, the judge adopted a modified version of the business judgment rule and ordered discovery on issues that included the disinterestedness of the Board and the reasonableness of its decision to terminate litigation. The trial court granted defendants' motions for summary judgment at the conclusion of discovery. The Appellate Division affirmed. HELD : The Court adopts the modified business judgment rule as the standard for evaluating whether a corporation's board of directors responded properly in rejecting a shareholder's demand or in deciding to terminate legal action on the corporation's behalf. The modified business judgment rule places an initial burden on directors to demonstrate that they acted reasonably, in good faith, and in a disinterested fashion in arriving at their decision. The lower courts properly applied that standard when dismissing the derivative litigation in this case. 1. A shareholder derivative action permits a shareholder to bring suit on behalf of the corporation and, if successful, it forces the wrongdoers to compensate the corporation for the injury they caused. Shareholder derivative litigation is an infringement on director autonomy and may have a negative effect on corporate governance if, for example, it is initiated by opportunistic shareholders. Therefore, as a prerequisite to derivative litigation, most jurisdictions require that shareholders make a demand on the corporation's board of directors to act. New Jersey's procedure is codified under Rule 4:32-5. Like most jurisdictions, New Jersey will excuse the demand requirement if the shareholder can establish that it would be futile. For shareholder plaintiffs in New Jersey to withstand a motion to dismiss for failure to make a demand, they must plead with particularity facts creating a reasonable doubt that: 1) the directors are disinterested and independent; or 2) the challenged transaction was the product of a valid exercise of business judgment. (Pp. 18 to 29). 2. The Court agrees with those jurisdictions that apply a single standard of review in both demand-made case and in cases in which the demand was excused, and adopts a modified business judgment rule that imposes an initial burden on a corporation to demonstrate that in deciding to reject or terminate a shareholder's suit the members of the board 1) were independent and disinterested; 2) acted in good faith and with due care in their investigation of the shareholder's allegations, and that 3) the board's decision was reasonable. Shareholders must be permitted access to corporate documents and other discovery limited to the narrow issue of what steps the directors took to inform themselves of the shareholder demand and the reasonableness of their decision. (Pp. 29 to 33). 3. The main difference between the test for determining demand-futility and the modified business judgment rule is that a plaintiff has the burden of demonstrating demand-futility, whereas a defendant has the burden of satisfying the elements of the modified business judgment rule. If the court relieves a shareholder of the demand requirement, a defendant may later renew its motion to dismiss the litigation. At that juncture, the court would evaluate the motion by applying the burden-shifting and other aspects of the modified business judgment rule. Although the demand-futility test and the modified business judgment rule both implicate whether directors are disinterested and independent, a court applying the modified business judgment rule is not bound by any finding associated with an earlier court's decision to excuse demand. The court should consider the board's decision under the modified business judgment rule only after the parties have completed adequate discovery to enable the court to render a fully-informed decision. (Pp. 33 to 37). 4. The thrust of plaintiffs' allegations is that defendants mismanaged the company and breached their duty of care. The Court reserves for another day what the appropriate standard might be for allegations such as self-dealing, fraud, or similar bad acts. (Pp. 37 to 38). 5. The Court finds that defendants presented undisputed evidence proving that they were disinterested and independent when they decided to reject the demand and terminate the litigation. Moreover, nothing in the record demonstrated that the directors had divided loyalties, stood to receive any improper personal gain or were unduly influenced by any improper motive. Therefore, defendants satisfied the first element of the modified business judgment rule. (Pp. 38 to 41). 6. The second element of the modified business judgment rule, whether defendants acted in good faith and with due care in investigating the merits of the litigation, was met through the extensive investigation and resulting report by the Kasowitz firm, which was experienced in nuclear power matters and in shareholder litigation. (Pp. 41 to 46). 7. Finally, defendants satisfied the final element of the test by demonstrating that their decision to terminate the litigation was reasonable. By virtue of the procedures that they employed, defendants informed themselves of the substance of the shareholders' allegations and weighed those allegations against the likelihood that the litigation would succeed. The Board acted consistent with the principles articulated in the Court's opinion when relying on the Kasowitz investigation to guide its decision. (Pp. 47 to 51). The judgment of the Appellate Division is AFFIRMED. JUSTICE STEIN, concurring in the Court's opinion, agrees that the Board satisfied the legal standard for independence in this matter, but emphasizes that the de novo review undertaken by trial and appellate courts should include a scrupulous and painstaking examination of the record to ensure that the board's discretion has been exercised reasonably and responsibly. Further, Justice Stein is of the view that the Kasowitz firm's dual role as the Board's independent investigator and its brief role as the Board's litigation counsel was inappropriate, but he believes that the dual role did not render unreasonable the Board's reliance on the investigative report. CHIEF JUSTICE PORITZ and JUSTICES COLEMAN, LONG, and LaVECCHIA join in JUSTICE VERNIERO's opinion. JUSTICE STEIN filed a separate concurring opinion. JUSTICE ZAZZALI did not participate. DR. STEVEN FINK AND DR. DAVID FRIEDMAN, P.C. PROFIT SHARING PLAN, derivatively on behalf of and for the benefit of Public Service Enterprise Group, Incorporated and Public Service Electric & Gas Company, Plaintiffs-Appellants, v. LAWRENCE R. CODEY; E. JAMES FERLAND; LEON R. ELIASON; STEVEN E. MILTENBERGER; JOSEPH J. HAGAN; AND STANLEY LaBRUNA, Defendants-Respondents, and PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED and PUBLIC SERVICE ELECTRIC & GAS COMPANY, Nominal Defendants-Respondents. A. HAROLD DATZ PENSION AND PROFIT SHARING PLAN Plaintiff-Appellant, and GAIL DORFF, derivatively on behalf of and for the benefit of Public Service Enterprise Group, Incorporated and Public Service Electric & Gas Company, Plaintiff, v. LAWRENCE R. CODEY; E. JAMES FERLAND; LEON R. ELIASON; STEVEN E. MILTENBERGER; JOSEPH J. HAGAN; and STANLEY LaBRUNA, Defendants-Respondents, and PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED and PUBLIC SERVICE ELECTRIC & GAS COMPANY, Nominal Defendants-Respondents. PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED BY G. E. STRICKLIN derivatively in her capacity as a shareholder, Plaintiff-Appellant, v. E. JAMES FERLAND; IRWIN LERNER; MARILYN M. PFALTZ; RICHARD J. SWIFT; LAWRENCE R. CODEY; ERNEST H. DREW; JAMES C. PITNEY; T. J. DERMOT DUNPHY; RAYMOND V. GILMARTIN; JOSH S. WESTON and STEVEN E. MILTENBERGER, Defendants-Respondents, and SHIRLEY A. JACKSON, Defendant, and PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED, Nominal Defendant- Respondent. Argued February 26, 2002 Decided July 23, 2002 On certification to the Superior Court, Appellate Division. Ruthann Gordon, a member of the Pennsylviana bar, argued the cause for appellants Dr. Steven Fink and Dr. David Friedman, P.C. Profit Sharing Plan and A. Harold Datz Pension and Profit Sharing Plan (Cohn Lifland Pearlman Herrmann & Knopf, attorneys; Ms. Gordon and Peter S. Pearlman, on the briefs). Mark C. Rifkin, a member of the Pennsylviana and New Jersey bars, argued the cause for appellant G. E. Stricklin (Sherman, Silverstein, Kohl, Rose & Podolsky, attorneys; Mr. Rifkin and Alan C. Milstein, on the briefs). Harold G. Levison argued the cause for respondents Lawrence R. Codey, E. James Ferland, Irwin Lerner, Marilyn M. Pfaltz, Richard J. Swift, Ernest H. Drew, James C. Pitney, T. J. Dermot Dunphy, Raymond V. Gilmartin, Josh S. Weston; and Michael R. Griffinger argued the cause for respondents Steven E. Miltenberger, Leon R. Eliason, Joseph J. Hagan and Stanley LaBruna (Kasowitz, Benson, Torres & Friedman and Zazzali, Fagella & Nowak, attorneys for Lawrence R. Codey and E. James Ferland; Connell, Foley & Geiser and William E. Frese, attorneys for Public Service Enterprise Group Incorporated and Public Service Electric & Gas Company; (Gibbons, Del Deo, Dolan, Griffinger & Vecchione attorneys for Leon R. Eliason, Steven E. Miltenberger, Joseph J. Hagan and Stanley LaBruna; Mr. Levison, Mr. Griffinger, Mr. Frese, Kenneth I. Nowak and Kevin R. Gardner, on the briefs). Jason S. Feinstein submitted a letter in lieu of brief on behalf of amicus curiae, New Jersey Chamber of Commerce (Sterns & Weinroth, attorneys). The opinion of the Court was delivered by VERNIERO, J. We are called on to address certain questions of first impression regarding the law of business organizations in New Jersey. The principal issue concerns the proper standard of review to be applied when evaluating whether a corporation s board of directors has responded properly in rejecting a shareholder s demand to commence legal action on the corporation s behalf. We hold that a modified version of the business judgment rule is the appropriate legal standard in such circumstances. Unlike the traditional approach, the modified business judgment rule places an initial burden on directors to demonstrate that they acted reasonably, in good faith, and in a disinterested fashion in arriving at their decision to reject a shareholder s demand or to terminate existing litigation. We further hold that the lower courts correctly applied that standard when dismissing the derivative litigation in this case. As a result, the firm maintained its original recommendation that no litigation was necessary. On March 19, 1996, the Board adopted a resolution accepting the Kasowitz firm s recommendations. Later, in deposition testimony or in individual certifications, each Board member gave several reasons for rejecting the litigation. Collectively, they cited: (1) the memorandum and reports presented by counsel, (2) the inquisitiveness and preparedness of Board members at meetings, (3) the open lines of communication and information in respect of the company s nuclear operations, (4) the depth of the information presented to the Board on a regular basis and its vigorous action in response to that information, and (5) the excessive cost of such litigation. [Exadaktilos v. Cinnaminson Realty Co., 167 N.J. Super. 141, 151 (Law Div. 1979).] The business judgment rule is a rebuttable presumption[.] Maul, supra, 270 N.J. Super. at 614. It places an initial burden on the person who challenges a corporate decision to demonstrate the decision-maker s self-dealing or other disabling factor. Ibid. (internal quotation marks and citation omitted). If a challenger sustains that initial burden, then the presumption of the rule is [] rebutted, and the burden of proof shifts to the defendant or defendants to show that the transaction was, in fact, fair to the corporation. Stuart L. Pachman, Title 14A-Corporations at 228 (2000) (citing Maul, supra, 270 N.J. Super. at 614). [(Emphasis added).] See also In re Midlantic Corp. Shareholder Litig., 758 F. Supp. 226, 239 (D.N.J. 1990) (noting that plaintiff is required to make demand under Rule 4:32-5 unless excused from doing so under state law). Until today, this Court has not had the occasion to formulate or apply a standard for evaluating demand futility actions under Rule 4:32-5. One prior case, Escoett v. Aldecress Country Club, 16 N.J. 438 (1954), touched on that issue from the perspective of a demand made on a general body of stockholders under R.R. 4:36-2, the predecessor to Rule 4:32-5. Escoett, however, did not address the issue of when demand should be excused within the context of a board of directors. Although this Court has not spoken directly to the issue, the Chancery Division in Prudential, supra, adopted a two-part test to be applied in such circumstances. 282 N.J. Super. at 275. The test is derived from a standard articulated by the Delaware Supreme Court in Aronson v. Lewis, 473 A.2d 805 (1984), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Under Aronson, a trial court must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. Aronson, supra, 473 A.2d at 814. Notwithstanding Aronson s use of and in its test, the Delaware Supreme Court in Brehm, supra, clarified that [t]hese prongs are in the disjunctive. Therefore, if either prong is satisfied, demand is excused. 746 A.2d at 256 (footnote omitted). Prudential provides a good illustration of these concepts. In that case, Prudential Insurance Company (Prudential) acquired Bache Group, renaming it Prudential Securities, Inc. (PSI). Prudential, supra, 282 N.J. Super. at 263. The acquired entity specialized in retail brokerage and embarked on an aggressive campaign to increase revenue by selling a package of investment products. Id. at 264. As part of its campaign, PSI marketed approximately $8 billion in limited partnership interests and other direct investments throughout the United States. Ibid. The marketing operation, known as the Limited Partnership Program, included offerings purportedly consist[ing] of illiquid and highly speculative partnerships in oil and gas investments, real estate, aircraft leasing, and horse breeding. Ibid. Although Prudential terminated its investments in oil and gas partnerships because it had considered them poor risks, PSI continued to promote energy partnerships as sound investments. Ibid. The Securities and Exchange Commission (SEC) investigated PSI s Limited Partnership Program and found that PSI had committed extensive securities fraud violations in conjunction with its marketing and sale of limited partnership interests, including misrepresenting speculative, illiquid limited partnerships as safe, income-producing investments. Id. at 265. At about the same time, PSI became the subject of thousands of legal proceedings brought by investors in the limited partnership seeking recoveries of the amounts paid and/or compensatory damages. Id. at 264. PSI incurred significant liabilities. The SEC fined PSI $10 million, various states assessed it $26 million in penalties for violations of state securities laws, and the National Association of Securities Dealers fined it $5 million for industry rule violations. Id. at 265. On those facts, two policyholders of Prudential filed a derivative suit against the executives of PSI and Prudential, the Prudential board of directors, and Prudential itself. Id. at 260-61. Their complaint alleged breach of fiduciary duty; waste, mismanagement, and gross negligence; intentional misrepresentation; and negligent misrepresentation. Id. at 261. The plaintiffs did not make a demand on Prudential s board of directors before filing suit. Id. at 262. Accordingly, the defendants moved to dismiss the derivative claims pursuant to Rule 4:32-5. Ibid. Applying the two-prong Aronson test, the Prudential court ruled in favor of defendants, holding that the plaintiffs had failed to plead with the particularity required by R. 4:32-5 why demand should be excused. Id. at 285. As to the first prong, the court found that the plaintiffs allegations that the directors were not disinterested or independent and that they [were] controlled by the defendants at the heart of the wrongdoing[,] were mere conclusory allegations[.] Id. at 277. As such, they were insufficient to excuse demand. Ibid. The court further noted that the plaintiffs complaint did not differentiate among directors and other defendants, nor did it plead any facts showing that past directors had actual knowledge of the alleged wrongdoings at the time that they were committed. Ibid. The court also rejected the plaintiffs claim that the defendants were self-interested because they [did] not want to sue themselves, their friends and their business associates. Id. at 278. The court observed: [T]he incantation that demand is excused because the directors otherwise would have to sue themselves [is a] bootstrap argument [which] has been made to and dismissed by other courts. . . . Its acceptance would . . . weaken the managerial power of directors. Unless facts are alleged with particularity to overcome the presumptions of independence and a proper exercise of business judgment, in which case the directors could not be expected to sue themselves, a bare claim of this sort raises no legally cognizable issue. [Ibid. (quoting Aronson, supra, 473 A. 2d at 818).] Applying the second prong, the court distinguished between action and inaction, explaining that the absence of board action . . . makes it impossible to perform the essential inquiry contemplated by Aronson, whether the directors have acted in conformity with the business judgment rule in approving the challenged transaction. Id. at 283 (quoting Rales v. Blasband, 634 A.2d 927, 933 (Del. 1993)). The court determined that plaintiffs complaint focused largely on director inaction, namely, the failure of the Prudential directors to supervise a subsidiary and more generally, to stop the alleged illegal actions of the executive defendants[.] Id. at 284. As a result, the court concluded that no further analysis under Aronson s second prong was required. Id. at 285. See also Aronson, supra, 473 A.2d at 813 (explaining that business judgment rule has no role where directors have either abdicated their functions, or absent a conscious decision, failed to act ); Rales, supra, 634 A.2d at 933-34 (observing in essence that Aronson s second prong does not apply where the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit ). We are satisfied that the Aronson two-prong inquiry, as illustrated in In re Prudential, represents the appropriate standard for evaluating demand futility. The test strikes the appropriate balance between director autonomy and the interests of shareholders in this context. See Pachman, supra, at 219-222 (discussing respective rights of directors and shareholders under New Jersey law). Accordingly, for shareholder plaintiffs in New Jersey to withstand a motion to dismiss for failure to make a demand, they must plead with particularity facts creating a reasonable doubt that: (1) the directors are disinterested and independent, or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. If either prong is satisfied, demand will be excused under Rule 4:32-5. [Brehm, supra, 746 A.2d at 253.] The test under Rule 4:32-5 and the modified business judgment rule are similar in that they both implicate whether directors are disinterested and independent. Notwithstanding that similarity, a court applying the modified business judgment rule is not bound by any finding associated with an earlier court s decision to excuse demand. See Hart v. City of Jersey City, 308 N.J. Super. 487, 497-98 (App. Div. 1998) (outlining circumstances to permit second judge on same level as first judge to differ with earlier ruling without violating law of the case doctrine). In that respect, the court should consider the board s decision under the modified business judgment rule only after the parties have completed adequate discovery to enable the court to render a fully-informed decision. For completeness, we note that some commentators have proposed repealing the demand-futility doctrine, arguing that it requires courts to engag[e] in a tortured inquiry of whether demand is excused. PSE&G, supra, 315 N.J. Super. at 334. In its place, they would require a universal-demand requirement, coupled with a standard of review similar to the modified business judgment rule adopted here. Swanson, supra, 77 Minn. L. Rev. at 1387-90. In our view, the demand-futility doctrine retains its usefulness for that narrow group of cases in which the pleadings alone clearly provide a basis for a court s disposition. More broadly, we are satisfied that the demand-futility doctrine and the modified business judgment rule each serve a discrete but critical function. That is especially so in a case in which a trial court first excuses demand and then later applies the modified business judgment rule to evaluate a board s ultimate response to the litigation. The practical reality is that in many cases a shareholder will want to make a demand on the board to avoid the burden of demonstrating demand-futility. Given the salutary purposes of the demand requirement, that practical reality convinces us that our approach is proper. It preserves the most useful elements of Rule 4:32-5 while advancing an overarching standard to guide judicial review. We are also mindful that some scholars have urged courts to adopt a more intrusive standard of review than the one articulated here. See, e.g., Cox, supra, 1 982 Duke L.J. at 1008 (proposing that court should use its own independent judgment to determine whether dismissal [of derivative suit] would be in the corporation s best interest[, and] . . . court should make its decision after an adversarial proceeding ) (footnote omitted). We decline to go that far. Our standard places a burden on directors to justify their responses as provided above, and it permits shareholders to obtain certain documents and other forms of discovery. In that respect, it is less deferential than the traditional approach, yet it still embodies the fundamental principle that corporate governance should remain in the hands of those directors who act in good faith and in a reasonably informed, disinterested manner. We also emphasize that the thrust of plaintiffs allegations is that defendants mismanaged the company and breached their duty of care. We reserve for another day what the appropriate standard might be if faced with a complaint accusing directors of more serious conduct, such as self-dealing, fraud, or similar bad acts. We acknowledge that corporate executives may engage in egregious, even criminal conduct. For now, however, we need only design and apply an analytical framework within which to evaluate the Board s response to the allegations presented in the case before us. We find no persuasive evidence to contradict that testimony. More specifically, there is nothing in the record to convince us that the directors had divided loyalties, stood to receive any improper personal gain, or were unduly influenced by any improper motive. Under those circumstances, we agree with the trial court s conclusion that plaintiffs have present[ed] no evidence rebutting any aspect of any director s testimony as to why any director voted to terminate the litigation. Defendants have thus satisfied the first element of the modified business judgment rule. The Kasowitz firm made numerous, specific written and oral requests to Enterprise for relevant documents which resulted in Enterprise producing approximately 43,000 pages of documentation. The Kasowitz firm requested and received voluminous documentation relating to board-level involvement with nuclear operations, including the minutes and attachments to the minutes from the meetings of: (a) the Enterprise board of directors (as those meetings related to nuclear operations); (b) the Nuclear Committee of the Enterprise board; (c) the Enterprise Nuclear Review Board; and (d) the Enterprise Nuclear Oversight Committee. The Kasowitz firm requested and received extensive documentation relating to the review of nuclear operations by the NRC including: (a) NRC Systematic Assessment of Licensee Performance reports evaluating Enterprise s nuclear facilities; (b) NRC Notices of Violations and Enterprise s responses thereto; (c) NRC Augmented Inspection Team reports concerning events at Enterprise s nuclear facilities; (d) NRC Special Inspection Team reports concerning inspections at Enterprise s nuclear facilities; and (e) NRC Monthly Inspection Reports of Enterprise s nuclear facilities. The Kasowitz firm requested and received voluminous documentation prepared by INPO, including INPO evaluations of Enterprise s nuclear facilities and Enterprise s responses thereto[.] In addition to all of this documentation, the Kasowitz firm requested and received the following voluminous documentation relating to Enterprise s nuclear operations: (a) proceedings before the New Jersey Board of Public Utilities (the principal state regulator of Enterprise s nuclear facilities); (b) Enterprise s Significant Event Response Team (internal investigation teams convened following significant events at the nuclear facilities to determine the root causes of the events) reports; (c) Enterprise s Licensee Event Reports (reports submitted to the NRC by licensee concerning events that occur in violation of a plant s technical specifications); and (d) Quality Assurance/Nuclear Safety Review (an internal department) monthly reports. Moreover, in addition to the documentation referred to above, the Kasowitz firm requested and received voluminous documentation concerning specific events referenced in plaintiffs complaints, including the (a) May 25, 1993 Rod Control Event; (b) April 7, 1994 Marsh Grass Event; (c) April 5, 1995 Hope Creek Radiological Release event; (d) June 6, 1995 Residual Heat Removal System Event; and (e) July 8, 1995 Hope Creek Shutdown Cooling Partial Bypass Event. The undisputed evidence is that Enterprise dedicated extensive resources to review the Kasowitz firm s requests for documents and to compile and produce responsive documentation. For example, at Enterprise s nuclear facilities located at Artificial Island, New Jersey, Enterprise dedicated Mr. Ross J. Bell, a business specialist in the External Affairs Group of PSE&G s Nuclear Business Unit; Mr. Bryan Gorman, a senior staff employee in the Nuclear Business Unit; and Mr. Dennis Lougeay, an outside consultant to gather the documents requested by the Kasowitz firm, with Mr. Bell dedicating 50 to 75 percent of [his] time to the document production. In addition, at Enterprise s Newark, New Jersey headquarters, Enterprise dedicated several individuals to provide documents responsive to the Kasowitz firm s requests, including Mr. Edward J. Biggins, Jr., Enterprise s Corporate Secretary, Mr. R. Edwin Selover, Enterprise s General Counsel and Mr. William E. Frese, Enterprise s General Litigation Counsel. The Kasowitz firm interviewed dozens of witnesses in connection with its investigation. For example, the February Report prepared by the Kasowitz firm states that: We have also conducted over thirty interviews, including interviews of present and former directors, officers, and employees of Enterprise and its subsidiaries, in connection with our investigation. We selected for interviews those persons most likely to have knowledge about the management of [PSE&G s] nuclear operations, and about certain specific events examined during our investigation. (February Report at 3.) Similarly, the March Report notes that in connection with the preparation of that report, the Kasowitz firm conducted further interviews of PSE&G officers and employees. (March Report at 13.) The Kasowitz firm interviewed each of the Enterprise directors and among others, Leon Eliason (Chief Nuclear Officer), Clay Warren (General Manager of the Salem facilities), Stanley LaBruna (Vice President of Nuclear Engineering), Dr. Shirley Jackson (former member of the Enterprise board of directors, former chair of Enterprise s Nuclear Oversight Committee and Enterprise s Nuclear Committee, and, at the time of the investigation, Chairperson of the United States Nuclear Regulatory Commission), Robert Dougherty (Senior Vice President of the Electrical Business Unit), and Steven E. Miltenberger (former Vice President and Chief Nuclear Officer). Based on the procedures employed and the seriousness by which the Kasowitz firm approached its task, we are satisfied that defendants have satisfied their burden of demonstrating that they acted in good faith and with due care in evaluating the litigation. We agree substantially with the Appellate Division. By virtue of the procedures that it employed, the Board informed itself of the substance of the shareholders allegations and weighed those allegations against the likelihood that the litigation would succeed. The Board s judgment is reflected in its March 19, 1996, resolution, which states that any such litigation would not be meritorious, would constitute a wasting of assets and diversion of management resources of this Corporation, and would result in a loss of morale and unwarranted unfavorable publicity, with little likelihood of success[.] As previously mentioned, in deciding to terminate the litigation, the directors relied on a provision in the company s certificate of incorporation that provides that directors and officers shall not be personally liable to the corporation or its shareholders for breach of any duty owed to the corporation or its shareholders. That provision is based on N.J.S.A. 14A:2-7(3), which was enacted in 1987 and amended in 1989. The statute states: The certificate of incorporation may provide that a director or officer shall not be personally liable, or shall be liable only to the extent therein provided, to the corporation or its shareholders for damages for breach of any duty owed to the corporation or its shareholders, except that such provision shall not relieve a director or officer from liability for any breach of duty based upon an act or omission (a) in breach of such person s duty of loyalty to the corporation or its shareholders, (b) not in good faith or involving a knowing violation of law or (c) resulting in receipt by such person of an improper personal benefit. As used in this subsection, an act or omission in breach of a person s duty of loyalty means an act or omission which that person knows or believes to be contrary to the best interests of the corporation or its shareholders in connection with a matter in which he has a material conflict of interest. [N.J.S.A. 14A:2-7(3).] The respective bill statements that accompanied the statute and its subsequent amendment are illuminating. The statement to the 1987 enactment provides, in part: The proposed changes will permit directors and officers to be protected against liability for damages to the corporation or its shareholders unless they have been guilty of breach of loyalty, bad faith or a knowing violation of law or through a breach of duty have received an improper personal benefit. [Senate Labor, Industry, and Professions Committee, Statement to Senate Bill No. 2510, reprinted in N.J.S.A. 14A:2-7.] The statement accompanying the 1989 amendment states, in part: One of the breaches of duty for which a director or officer cannot be protected against under P.L.1987, c.35 is an act or omission in breach of such person s duty of loyalty to the corporation or its shareholders. This bill defines such act or omission as one which that person knows or believes to be contrary to the best interests of the corporation or its shareholders in connection with a matter in which he has a material conflict of interest. This definition will prevent plaintiffs in shareholder suits from getting around the statute by characterizing actions or omissions which are normally considered negligence as breaches of the duty of loyalty. [Senate Labor, Industry and Professions Committee, Statement to Senate Bill No. 2673 (emphasis added), reprinted in N.J.S.A. 14A:2-7.] Plaintiffs contend that shareholders amended the company s charter in 1987 to include the limitation of liability provision without being informed of alleged mismanagement of the board members then serving. They further assert that the provision cannot protect defendants from what plaintiffs allege were acts of recklessness and bad faith. In our view, the record demonstrates no recklessness, gross neglect of duties, or manifest disloyalty to the company by defendants. Moreover, for today s purposes we do not have to engage in a lengthy discussion of the process by which the shareholders adopted the limitation of liability provision. The relevant inquiry under the modified business judgment rule is whether the directors reasonably relied on that provision in deciding to terminate the litigation. Apart from mere conclusory allegations, the gist of plaintiffs complaint is that defendants breached their duty of care as opposed to the more serious duty of loyalty. Given the straightforward language of N.J.S.A. 14A:2-7(3), as amplified by the two bill statements quoted above, the Kasowitz firm informed the Board that the limitation of liability provision would apply in these circumstances. We conclude that it was reasonable for the Board to rely on that advice in evaluating plaintiffs allegations. In sum, we are satisfied that the Board s judgment was reasonable under the totality of the circumstances, and that the Board acted consistent with the principles articulated in this opinion when relying on the Kasowitz investigation to guide its decision. CHIEF JUSTICE PORITZ and JUSTICES COLEMAN, LONG, and LaVECCHIA join in JUSTICE VERNIERO s opinion. JUSTICE STEIN filed a separate concurring opinion. JUSTICE ZAZZALI did not participate. DR. STEVEN FINK AND DR. DAVID FRIEDMAN, P.C. PROFIT SHARING PLAN, derivatively on behalf of and for the benefit of Public Service Enterprise Group, Incorporated and Public Service Electric & Gas Company, Plaintiffs-Appellants, v. LAWRENCE R. CODEY; E. JAMES FERLAND; LEON R. ELIASON; STEVEN E. MILTENBERGER; JOSEPH J. HAGAN; AND STANLEY LaBRUNA, Defendants-Respondents, and PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED and PUBLIC SERVICE ELECTRIC & GAS COMPANY, Nominal Defendants-Respondents. A. HAROLD DATZ PENSION AND PROFIT SHARING PLAN Plaintiff-Appellant, and GAIL DORFF, derivatively on behalf of and for the benefit of Public Service Enterprise Group, Incorporated and Public Service Electric & Gas Company, Plaintiff, v. LAWRENCE R. CODEY; E. JAMES FERLAND; LEON R. ELIASON; STEVEN E. MILTENBERGER; JOSEPH J. HAGAN; and STANLEY LaBRUNA, Defendants-Respondents, and PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED and PUBLIC SERVICE ELECTRIC & GAS COMPANY, Nominal Defendants-Respondents. PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED BY G. E. STRICKLIN derivatively in her capacity as a shareholder, Plaintiff-Appellant, v. E. JAMES FERLAND; IRWIN LERNER; MARILYN M. PFALTZ; RICHARD J. SWIFT; LAWRENCE R. CODEY; ERNEST H. DREW; JAMES C. PITNEY; T. J. DERMOT DUNPHY; RAYMOND V. GILMARTIN; JOSH S. WESTON and STEVEN E. MILTENBERGER, Defendants-Respondents, and SHIRLEY A. JACKSON, Defendant, and PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED, Nominal Defendant- Respondent. STEIN, J., concurring. I join in the Court s thoughtful and well-reasoned disposition of this appeal. I especially endorse the Court s determination that trial and appellate courts, in reviewing under the modified business judgment rule a Board of Directors decision not to maintain a directive shareholders suit, must conduct that review de novo on the record. Ante at ___ (slip op. at 35). That inquiry, as the Court emphasizes, requires a higher level of scrutiny than would be necessary under an abuse of discretion standard. Ibid. The de novo standard requires the reviewing court to satisfy itself, based on the record, that the members of the board were independent and disinterested, that they acted in good faith and with due care in their investigation, and that their decision to dismiss the suit was a reasonable one. Ante at ___-___ (slip op. at 33-35). Although I agree with the standard of review adopted by the Court, I consider it appropriate to remind trial and appellate courts that a heavy dose of pragmatism is indispensable in reviewing the reasonableness of a Board s decision to terminate derivative shareholder litigation. Notwithstanding our prior conclusion, ante at ___ (slip op. at 38-41), that these directors satisfied the legal standard for independence in deciding to terminate the litigation, courts should fully appreciate the distinction between that tolerant legal standard and complete impartiality. As the Court observes, ante at ___, (slip op. at 48), [d]irectors understandably are not likely to be enthusiastic about approving the prosecution of a derivative stockholder s suit against members of management with whom the Directors maintain an ongoing relationship, especially when members of management initially may have recommended appointment of one or more members of the Board. As one commentator observed: Structural bias is an attitude that attaches to a directorship and rests on cultural ties that antedate the director s election or appointment, which combine to draw the directors to the defendants side. James D. Cox, Searching for the Corporation s Voice in Derivative Suit Litigation: A Critique of Zapata and the ALI Project, 1 982 Duke L.J. 959, 1010. Moreover, we note that the recent disclosures of flagrant irregularities in corporate financial statements has focused renewed attention on the objectivity and responsibility of corporate directors. See Cleaning Up the Boardroom, N.Y. Times, Mar. 8, 2002, at A20 ( One of the most important lessons of Enron is the havoc that can result when oversight by corporate boards of directors breaks down. ) Accordingly, the exercise of de novo review by trial and appellate courts of the reasonableness of a corporate board s decision to terminate stockholder derivative litigation should be conducted with a realistic awareness that only a scrupulous and painstaking examination of the record will be sufficient to assure the court that the board s discretion has been exercised reasonably and responsibly. I also must record my concern with the following observation by the Court: We are aware of no facts that would lead us to conclude that the Kasowitz firm had a disabling conflict that would have tainted its investigation. Ante at ___, (slip op. at 42.) Although my concern does not lead me to a different result, I believe that the Court should not so readily excuse the overlapping and inconsistent roles exercised by the Kasowitz law firm, with the Board s concurrence. The record reveals that on October 17, 1995 the Board adopted a resolution authorizing the retention of the Kasowitz firm to investigate the allegations asserted in the Stricklin demand. The Stricklin complaint was filed on December 27, 1995. The Kasowitz firm submitted its one hundred twenty-four page report to the Board on February 8, 1996. However, in January 1996, before its report was completed, an attorney at the Kasowitz firm determined that the firm would, on behalf of the Board, request an extension of time to respond to the complaint. One of the Board members testified to his understanding that the Kasowitz firm was authorized on January 16, 1996 to represent the Board in the ensuing litigation. On February 13, 1996, five days after the report was submitted, a stipulation was entered into extending defendants time to answer the complaint, and the Kasowitz firm was designated as counsel to the director defendants. However short its duration, the conflict of interest between the role of the Kasowitz firm as the Board s independent investigator, and its role as the Board s litigation counsel in a suit that would implicate the reasonableness of the Boards decision to terminate the litigation, is too obvious for debate. Whatever redundancy or expense might have resulted, the Board clearly was obligated to retain independent litigation counsel that was not involved in the investigation. In another context, the Eleventh Circuit Court of Appeals in Stepak v. Addison, 20 F.3d 398, 405 (1994), highlighted the potential conflict at issue here: [W]hen a board chooses to entrust its investigation to a law firm--and it is unquestionably the board=s prerogative to do so--the directors must ensure that counsel is capable of independently evaluating the corporation=s interests. Selection of a law firm that has actually represented the alleged wrongdoers in proceedings related to the very subject matter that the law firm is now asked to neutrally investigate reaches, in our opinion, the level of gross negligence and is incompatible with a board=s fiduciary duty to inform itself Aof all material information reasonably available@ prior to making a business decision. Because the briefly overlapping roles of the Kasowitz firm did not necessarily render unreasonable the Board s reliance on the investigative report, I would not disturb the Court s affirmance of the conclusion below that the Board acted in good faith and with due care. Nevertheless, in my view the Board s authorization of the dual role of the Kasowitz firm clearly was inappropriate. NO. A-41/42 SEPTEMBER TERM 2001 ON CERTIFICATION TO Appellate Division, Superior Court IN RE: PSE&G SHAREHOLDER LITIGATION DECIDED July 23, 2002 Chief Justice Poritz PRESIDING OPINION BY Justice Verniero CONCURRING OPINION BY Justice Stein DISSENTING OPINION BY