Case Title: Stone v. Ritter

Citation: 

Docket Number: 93, 2006

State: delaware

Court: Delaware Supreme Court

Date: 2006-11-06T00:00:00Z

Document:
IN THE SUPREME COURT OF THE STATE OF DELAWARE 
 
WILLIAM STONE AND SANDRA §  
STONE, derivatively on behalf of 
§  
Nominal Defendant AmSOUTH  
§  
BANCORPORATION,  
 
§   No. 93, 2006 
 
 
 
 
 
 
§  
 
Plaintiffs Below,  
 
§   Court Below – Court of Chancery 
 
Appellants,  
 
 
§   of the State of Delaware, 
 
 
 
 
 
 
§   in and for New Castle County 
 
v. 
 
 
 
 
§   C.A. No. 1570-N 
 
 
 
 
 
 
§  
C. DOWD RITTER, RONALD L. 
§  
KUEHN, JR., CLAUDE B. NIELSEN,§  
JAMES R. MALONE, EARNEST W. §  
DAVENPORT, JR., MARTHA R. 
§  
INGRAM, CHARLES D.  
 
§  
McCRARY,  CLEOPHUS THOMAS, §  
JR., RODNEY C. GILBERT,   
§  
VICTORIA B. JACKSON, J.   
§  
HAROLD CHANDLER, JAMES E. §  
DALTON, ELMER B. HARRIS,  
§  
BENJAMIN F. PAYTON, and   
§  
JOHN N. PALMER, 
 
 
§  
 
 
 
 
 
 
§  
 
Defendants Below, 
 
 
§  
 
Appellees,  
 
 
§  
 
 
 
 
 
 
§  
 
and 
 
 
 
 
§  
 
 
 
 
 
 
§  
AmSOUTH BANCORPORATION, §  
 
 
 
 
 
 
§  
 
Nominal Defendant Below, 
§  
 
Appellee. 
 
 
 
§  
 
 
 
 
 
    Submitted:  October 5, 2006 
 
 
 
 
       Decided:  November 6, 2006 
 
Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS, and 
RIDGELY, Justices (constituting the Court en Banc). 
 
2
 
 
Upon appeal from the Court of Chancery.  AFFIRMED. 
 
Brian D. Long, Esquire (argued) and Seth D. Rigrodsky, Esquire, of 
Rigrodsky & Long, P.A., Wilmington, Delaware, for appellants. 
 
Jesse A. Finkelstein, Esquire, Raymond J. DiCamillo, Esquire, and 
Lisa Zwally Brown, Esquire, of Richards, Layton & Finger, Wilmington, 
Delaware, David B. Tulchin, Esquire (argued), L. Wiesel, Esquire, and 
Jacob F. M. Oslick, Esquire, of Sullivan & Cromwell LLP, New York, New 
York, for appellees.   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
HOLLAND, Justice: 
 
3
 
This is an appeal from a final judgment of the Court of Chancery 
dismissing a derivative complaint against fifteen present and former 
directors 
of 
AmSouth 
Bancorporation 
(“AmSouth”), 
a 
Delaware 
corporation.  The plaintiffs-appellants, William and Sandra Stone, are 
AmSouth shareholders and filed their derivative complaint without making a 
pre-suit demand on AmSouth’s board of directors (the “Board”).  The Court 
of Chancery held that the plaintiffs had failed to adequately plead that such a 
demand would have been futile.  The Court, therefore, dismissed the 
derivative complaint under Court of Chancery Rule 23.1. 
 
The Court of Chancery characterized the allegations in the derivative 
complaint as a “classic Caremark claim,” a claim that derives its name from 
In re Caremark Int’l Deriv. Litig.1  In Caremark, the Court of Chancery 
recognized that:  “[g]enerally where a claim of directorial liability for 
corporate loss is predicated upon ignorance of liability creating activities 
within the corporation . . . only a sustained or systematic failure of the board 
to exercise oversight–such as an utter failure to attempt to assure a 
                                          
 
1 In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996). 
 
4
reasonable information and reporting system exists–will establish the lack of 
good faith that is a necessary condition to liability.”2   
 
In this appeal, the plaintiffs acknowledge that the directors neither 
“knew [n]or should have known that violations of law were occurring,” i.e., 
that there were no “red flags” before the directors.  Nevertheless, the 
plaintiffs argue that the Court of Chancery erred by dismissing the derivative 
complaint which alleged that “the defendants had utterly failed to implement 
any sort of statutorily required monitoring, reporting or information controls 
that would have enabled them to learn of problems requiring their attention.”  
The defendants argue that the plaintiffs’ assertions are contradicted by the 
derivative complaint itself and by the documents incorporated therein by 
reference.   
 
Consistent with our opinion in In re Walt Disney Co. Deriv Litig, we 
hold that Caremark  articulates the necessary conditions for assessing 
director oversight liability.3  We also conclude that the Caremark standard 
was properly applied to evaluate the derivative complaint in this case.  
Accordingly, the judgment of the Court of Chancery must be affirmed. 
                                          
 
2 In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d at 971; see also David B. Shaev Profit 
Sharing Acct. v. Armstrong, 2006 WL 391931, at *5 (Del. Ch.); Guttman v. Huang, 823 
A.2d 492, 506 (Del. Ch. 2003).   
3 In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del. 2006). 
 
5
Facts 
 
This derivative action is brought on AmSouth’s behalf by William and 
Sandra Stone, who allege that they owned AmSouth common stock “at all 
relevant times.”  The nominal defendant, AmSouth, is a Delaware 
corporation with its principal executive offices in Birmingham, Alabama.  
During the relevant period, AmSouth’s wholly-owned subsidiary, AmSouth 
Bank, operated about 600 commercial banking branches in six states 
throughout the southeastern United States and employed more than 11,600 
people.   
 
In 2004, AmSouth and Amsouth Bank paid $40 million in fines and 
$10 million in civil penalties to resolve government and regulatory 
investigations pertaining principally to the failure by bank employees to file 
“Suspicious Activity Reports” (“SARs”), as required by the federal Bank 
Secrecy Act (“BSA”)4 and various anti-money-laundering (“AML”) 
regulations.5  Those investigations were conducted by the United States 
                                          
 
4 31 U.S.C. § 5318 (2006) et seq.  The Bank Secrecy Act and the regulations promulgated 
thereunder require banks to file with the Financial Crimes Enforcement Network, a 
bureau of the U.S. Department of the Treasury known as “FinCEN,” a written 
“Suspicious Activity Report” (known as a “SAR”) whenever, inter alia, a banking 
transaction involves at least $5,000 “and the bank knows, suspects, or has reason to 
suspect” that, among other possibilities, the “transaction involves funds derived from 
illegal activities or is intended or conducted in order to hide or disguise funds or assets 
derived from illegal activities. . . .”  31 U.S.C. § 5318(g) (2006); 31 C.F.R. § 103.18(a)(2) 
(2006).   
5 See, e.g., 31 C.F.R. § 103.18(a)(2) (2006).   
 
6
Attorney’s Office for the Southern District of Mississippi (“USAO”), the 
Federal Reserve, FinCEN and the Alabama Banking Department.  No fines 
or penalties were imposed on AmSouth’s directors, and no other regulatory 
action was taken against them.   
The government investigations arose originally from an unlawful 
“Ponzi” scheme operated by Louis D. Hamric, II and Victor G. Nance.  In 
August 2000, Hamric, then a licensed attorney, and Nance, then a registered 
investment advisor with Mutual of New York, contacted an AmSouth branch 
bank in Tennessee to arrange for custodial trust accounts to be created for 
“investors” in a “business venture.”  That venture (Hamric and Nance 
represented) involved the construction of medical clinics overseas.  In 
reality, Nance had convinced more than forty of his clients to invest in 
promissory notes bearing high rates of return, by misrepresenting the nature 
and the risk of that investment.  Relying on similar misrepresentations by 
Hamric and Nance, the AmSouth branch employees in Tennessee agreed to 
provide custodial accounts for the investors and to distribute monthly 
interest payments to each account upon receipt of a check from Hamric and 
instructions from Nance. 
 
The Hamric-Nance scheme was discovered in March 2002, when the 
investors did not receive their monthly interest payments.  Thereafter, 
 
7
Hamric and Nance became the subject of several civil actions brought by the 
defrauded investors in Tennessee and Mississippi (and in which AmSouth 
also was named as a defendant), and also the subject of a federal grand jury 
investigation in the Southern District of Mississippi.  Hamric and Nance 
were indicted on federal money-laundering charges, and both pled guilty. 
 
The authorities examined AmSouth’s compliance with its reporting 
and other obligations under the BSA.  On November 17, 2003, the USAO 
advised AmSouth that it was the subject of a criminal investigation.  On 
October 12, 2004, AmSouth and the USAO entered into a Deferred 
Prosecution Agreement (“DPA”) in which AmSouth agreed:  first, to the 
filing by USAO of a one-count Information in the United States District 
Court for the Southern District of Mississippi, charging AmSouth with 
failing to file SARs; and second, to pay a $40 million fine.  In conjunction 
with the DPA, the USAO issued a “Statement of Facts,” which noted that 
although in 2000 “at least one” AmSouth employee suspected that Hamric 
was involved in a possibly illegal scheme, AmSouth failed to file SARs in a 
timely manner.  In neither the Statement of Facts nor anywhere else did the 
USAO ascribe any blame to the Board or to any individual director. 
 
On October 12, 2004, the Federal Reserve and the Alabama Banking 
Department concurrently issued a Cease and Desist Order against AmSouth, 
 
8
requiring it, for the first time, to improve its BSA/AML program.  That 
Cease and Desist Order required AmSouth to (among other things) engage 
an independent consultant “to conduct a comprehensive review of the 
Bank’s AML Compliance program and make recommendations, as 
appropriate, for new policies and procedures to be implemented by the 
Bank.”  KPMG Forensic Services (“KPMG”) performed the role of 
independent consultant and issued its report on December 10, 2004 (the 
“KPMG Report”). 
 
Also on October 12, 2004, FinCEN and the Federal Reserve jointly 
assessed a $10 million civil penalty against AmSouth for operating an 
inadequate anti-money-laundering program and for failing to file SARs.  In 
connection with that assessment, FinCEN issued a written Assessment of 
Civil Money Penalty (the “Assessment”), which included detailed 
“determinations” regarding AmSouth’s BSA compliance procedures.  
FinCEN found that “AmSouth violated the suspicious activity reporting 
requirements of the Bank Secrecy Act,” and that “[s]ince April 24, 2002, 
AmSouth has been in violation of the anti-money-laundering program 
requirements of the Bank Secrecy Act.”  Among FinCEN’s specific 
determinations were its conclusions that “AmSouth’s [AML compliance] 
program lacked adequate board and management oversight,” and that 
 
9
“reporting to management for the purposes of monitoring and oversight of 
compliance activities was materially deficient.”  AmSouth neither admitted 
nor denied FinCEN’s determinations in this or any other forum.  
Demand Futility and Director Independence 
 
It is a fundamental principle of the Delaware General Corporation 
Law that “[t]he business and affairs of every corporation organized under 
this chapter shall be managed by or under the direction of a board of 
directors . . . .”6  Thus, “by its very nature [a] derivative action impinges on 
the managerial freedom of directors.”7  Therefore, the right of a stockholder 
to prosecute a derivative suit is limited to situations where either the 
stockholder has demanded the directors pursue a corporate claim and the 
directors have wrongfully refused to do so, or where demand is excused 
because the directors are incapable of making an impartial decision 
regarding whether to institute such litigation.8  Court of Chancery Rule 23.1, 
accordingly, requires that the complaint in a derivative action “allege with 
particularity the efforts, if any, made by the plaintiff to obtain the action the 
                                          
 
6 Del. Code Ann. tit. 8, §  141(a) (2006).  See Rales v. Blasband, 634 A.2d 927, 932 (Del. 
1993).  
7 Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984). 
8 Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984), overruled on other grounds by Brehm 
v. Eisner, 746 A.2d 244 (Del. 2000). 
 
10
plaintiff desires from the directors [or] the reasons for the plaintiff’s failure 
to obtain the action or for not making the effort.”9   
 
In this appeal, the plaintiffs concede that “[t]he standards for 
determining demand futility in the absence of a business decision” are set 
forth in Rales v. Blasband.10  To excuse demand under Rales, “a court must 
determine whether or not the particularized factual allegations of a 
derivative stockholder complaint create a reasonable doubt that, as of the 
time the complaint is filed, the board of directors could have properly 
exercised its independent and disinterested business judgment in responding 
to a demand.”11  The plaintiffs attempt to satisfy the Rales test in this 
proceeding by asserting that the incumbent defendant directors “face a 
substantial likelihood of liability” that renders them “personally interested in 
the outcome of the decision on whether to pursue the claims asserted in the 
complaint,” and are therefore not disinterested or independent.12   
                                          
 
9 Ch. Ct. R. 23.1.  Allegations of demand futility under Rule 23.1 “must comply with 
stringent requirements of factual particularity that differ substantially from the permissive 
notice pleadings governed solely by Chancery Rule 8(a).”  Brehm v. Eisner, 746 A.2d at 
254.    
10 Rales v. Blasband, 634 A.2d 927 (Del. 1993). 
11 Id. at 934. 
12 The fifteen defendants include eight current and seven former directors.  The 
complaint concedes that seven of the eight current directors are outside directors who 
have never been employed by AmSouth.  One board member, C. Dowd Ritter, the 
Chairman, is an officer or employee of AmSouth. 
 
11
Critical to this demand excused argument is the fact that the directors’ 
potential personal liability depends upon whether or not their conduct can be 
exculpated by the section 102(b)(7) provision contained in the AmSouth 
certificate of incorporation.13  Such a provision can exculpate directors from 
monetary liability for a breach of the duty of care, but not for conduct that is 
not in good faith or a breach of the duty of loyalty.14  The standard for 
assessing a director’s potential personal liability for failing to act in good 
faith in discharging his or her oversight responsibilities has evolved 
beginning with our decision in Graham v. Allis-Chalmers Manufacturing 
Company,15 through the Court of Chancery’s Caremark decision to our most 
recent decision in Disney.16  A brief discussion of that evolution will help 
illuminate the standard that we adopt in this case. 
Graham and Caremark 
 
Graham was a derivative action brought against the directors of Allis-
Chalmers for failure to prevent violations of federal anti-trust laws by Allis-
Chalmers employees.  There was no claim that the Allis-Chalmers directors 
knew of the employees’ conduct that resulted in the corporation’s liability.  
Rather, the plaintiffs claimed that the Allis-Chalmers directors should have 
                                          
 
13 Del. Code Ann. tit. 8, § 102(b)(7) (2006). 
14 Id.; see In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del. 2006). 
15 Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125 (Del. 1963). 
16 In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del. 2006). 
 
12
known of the illegal conduct by the corporation’s employees.  In Graham, 
this Court held that “absent cause for suspicion there is no duty upon the 
directors to install and operate a corporate system of espionage to ferret out 
wrongdoing which they have no reason to suspect exists.”17   
 
In Caremark, the Court of Chancery reassessed the applicability of 
our holding in Graham when called upon to approve a settlement of a 
derivative lawsuit brought against the directors of Caremark International, 
Inc.  The plaintiffs claimed that the Caremark directors should have known 
that certain officers and employees of Caremark were involved in violations 
of the federal Anti-Referral Payments Law.  That law prohibits health care 
providers from paying any form of remuneration to induce the referral of 
Medicare or Medicaid patients.  The plaintiffs claimed that the Caremark 
directors breached their fiduciary duty for having “allowed a situation to 
develop and continue which exposed the corporation to enormous legal 
liability and that in so doing they violated a duty to be active monitors of 
corporate performance.”18   
 
In evaluating whether to approve the proposed settlement agreement 
in Caremark, the Court of Chancery narrowly construed our holding in 
Graham “as standing for the proposition that, absent grounds to suspect 
                                          
 
17Graham v. Allis-Chalmers Mfg. Co., 188 A.2d at 130 (emphasis added). 
18 In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del. Ch. 1996). 
 
13
deception, neither corporate boards nor senior officers can be charged with 
wrongdoing simply for assuming the integrity of employees and the honesty 
of their dealings on the company’s behalf.”19  The Caremark Court opined it 
would be a “mistake” to interpret this Court’s decision in Graham to mean 
that: 
corporate boards may satisfy their obligation to be reasonably 
informed concerning the corporation, without assuring 
themselves that information and reporting systems exist in the 
organization that are reasonably designed to provide to senior 
management and to the board itself timely, accurate information 
sufficient to allow management and the board, each within its 
scope, to reach informed judgments concerning both the 
corporation’s 
compliance 
with 
law 
and 
its 
business 
performance.20 
 
 
To the contrary, the Caremark Court stated, “it is important that the 
board exercise a good faith judgment that the corporation’s information and 
reporting system is in concept and design adequate to assure the board that 
appropriate information will come to its attention in a timely manner as a 
matter of ordinary operations, so that it may satisfy its responsibility.”21  The 
Caremark Court recognized, however, that “the duty to act in good faith to 
be informed cannot be thought to require directors to possess detailed 
                                          
 
19 Id. at 969. 
20 Id. at 970.   
21 Id. 
 
14
information about all aspects of the operation of the enterprise.”22  The Court 
of Chancery then formulated the following standard for assessing the 
liability of directors where the directors are unaware of employee 
misconduct that results in the corporation being held liable: 
Generally where a claim of directorial liability for corporate 
loss is predicated upon ignorance of liability creating activities 
within the corporation, as in Graham or in this case,  . . . only a 
sustained or systematic failure of the board to exercise 
oversight–such as an utter failure to attempt to assure a 
reasonable information and reporting system exists–will 
establish the lack of good faith that is a necessary condition to 
liability.23 
 
Caremark Standard Approved 
As evidenced by the language quoted above, the Caremark standard 
for so-called “oversight” liability draws heavily upon the concept of director 
failure to act in good faith.  That is consistent with the definition(s) of bad 
faith recently approved by this Court in its recent Disney24 decision, where 
we held that a failure to act in good faith requires conduct that is 
qualitatively different from, and more culpable than, the conduct giving rise 
to a violation of the fiduciary duty of care (i.e., gross negligence).25  In 
                                          
 
22 Id. at 971. 
23 In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d at 971. 
24 In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del. 2006). 
25 Id. at 66.  
 
15
Disney, we identified the following examples of conduct that would 
establish a failure to act in good faith: 
A failure to act in good faith may be shown, for instance, where 
the fiduciary intentionally acts with a purpose other than that of 
advancing the best interests of the corporation, where the 
fiduciary acts with the intent to violate applicable positive law, 
or where the fiduciary intentionally fails to act in the face of a 
known duty to act, demonstrating a conscious disregard for his 
duties.  There may be other examples of bad faith yet to be 
proven or alleged, but these three are the most salient.26 
 
 
The third of these examples describes, and is fully consistent with, the 
lack of good faith conduct that the Caremark court held was a “necessary 
condition” for director oversight liability, i.e., “a sustained or systematic 
failure of the board to exercise oversight–such as an utter failure to attempt 
to assure a reasonable information and reporting system exists . . . .”27  
Indeed, our opinion in Disney cited Caremark with approval for that 
proposition.28  Accordingly, the Court of Chancery applied the correct 
standard in assessing whether demand was excused in this case where failure 
to exercise oversight was the basis or theory of the plaintiffs’ claim for 
relief. 
 
It is important, in this context, to clarify a doctrinal issue that is 
critical to understanding fiduciary liability under Caremark as we construe 
                                          
 
26 Id. at 67.  
27 In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 971 (Del. Ch. 1996). 
28 In re Walt Disney Co. Deriv. Litig., 906 A.2d at 67 n.111. 
 
16
that case.  The phraseology used in Caremark and that we employ here—
describing the lack of good faith as a “necessary condition to liability”—is 
deliberate.  The purpose of that formulation is to communicate that a failure 
to act in good faith is not conduct that results, ipso facto, in the direct 
imposition of fiduciary liability.29  The failure to act in good faith may result 
in liability because the requirement to act in good faith “is a subsidiary 
element[,]” i.e., a condition, “of the fundamental duty of loyalty.”30  It 
follows that because a showing of bad faith conduct, in the sense described 
in Disney and Caremark, is essential to establish director oversight liability, 
the fiduciary duty violated by that conduct is the duty of loyalty.   
This view of a failure to act in good faith results in two additional 
doctrinal consequences.  First, although good faith may be described 
colloquially as part of a “triad” of fiduciary duties that includes the duties of 
care and loyalty,31 the obligation to act in good faith does not establish an 
independent fiduciary duty that stands on the same footing as the duties of 
care and loyalty.  Only the latter two duties, where violated, may directly 
result in liability, whereas a failure to act in good faith may do so, but 
                                          
 
29 That issue, whether a violation of the duty to act in good faith is a basis for the direct 
imposition of liability, was expressly left open in Disney.  906 A.2d at 67 n.112.  We 
address that issue here.   
30 Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003). 
31 See Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993). 
 
17
indirectly.  The second doctrinal consequence is that the fiduciary duty of 
loyalty is not limited to cases involving a financial or other cognizable 
fiduciary conflict of interest.  It also encompasses cases where the fiduciary 
fails to act in good faith.   As the Court of Chancery aptly put it in Guttman, 
“[a] director cannot act loyally towards the corporation unless she acts in the 
good faith belief that her actions are in the corporation’s best interest.”32  
 
We hold that Caremark articulates the necessary conditions predicate 
for director oversight liability:  (a) the directors utterly failed to implement 
any reporting or information system or controls; or (b) 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.  In either case, imposition of liability 
requires a showing that the directors knew that they were not discharging 
their fiduciary obligations.33  Where directors fail to act in the face of a 
known duty to act, thereby demonstrating a conscious disregard for their 
responsibilities,34 they breach their duty of loyalty by failing to discharge 
that fiduciary obligation in good faith.35 
 
                                          
 
32 Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003). 
33 Id. at 506. 
34 In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 67 (Del. 2006). 
35 See Guttman v. Haung, 823 A.2d at 506. 
 
18
Chancery Court Decision 
The plaintiffs contend that demand is excused under Rule 23.1 
because AmSouth’s directors breached their oversight duty and, as a result, 
face a “substantial likelihood of liability” as a result of their “utter failure” to 
act in good faith to put into place policies and procedures to ensure 
compliance with BSA and AML obligations.  The Court of Chancery found 
that the plaintiffs did not plead the existence of “red flags” – “facts showing 
that the board ever was aware that AmSouth’s internal controls were 
inadequate, that these inadequacies would result in illegal activity, and that 
the board chose to do nothing about problems it allegedly knew existed.”  In 
dismissing the derivative complaint in this action, the Court of Chancery 
concluded: 
This case is not about a board’s failure to carefully 
consider a material corporate decision that was presented to the 
board.  This is a case where information was not reaching the 
board because of ineffective internal controls. . . . With the 
benefit of hindsight, it is beyond question that AmSouth’s 
internal controls with respect to the Bank Secrecy Act and anti-
money laundering regulations compliance were inadequate.  
Neither party disputes that the lack of internal controls resulted 
in a huge fine--$50 million, alleged to be the largest ever of its 
kind.  The fact of those losses, however, is not alone enough for 
a court to conclude that a majority of the corporation’s board of 
directors is disqualified from considering demand that 
AmSouth bring suit against those responsible.36   
 
                                          
 
36 Stone v. Ritter, C.A. No. 1570-N (Del. Ch. 2006) (Letter Opinion). 
 
19
This Court reviews de novo a Court of Chancery’s decision to dismiss a 
derivative suit under Rule 23.1.37 
Reasonable Reporting System Existed 
The KPMG Report evaluated the various components of AmSouth’s 
longstanding BSA/AML compliance program.  The KPMG Report reflects 
that AmSouth’s Board dedicated considerable resources to the BSA/AML 
compliance program and put into place numerous procedures and systems to 
attempt to ensure compliance.  According to KPMG, the program’s various 
components exhibited between a low and high degree of compliance with 
applicable laws and regulations.   
 
The KPMG Report describes the numerous AmSouth employees, 
departments and committees established by the Board to oversee AmSouth’s 
compliance with the BSA and to report violations to management and the 
Board:   
BSA Officer.  Since 1998, AmSouth has had a “BSA Officer” 
“responsible for all BSA/AML-related matters including 
employee training, general communications, CTR reporting and 
SAR reporting,” and “presenting AML policy and program 
changes to the Board of Directors, the managers at the various 
lines of business, and participants in the annual training of 
security and audit personnel[;]” 
 
                                          
 
37 Beam ex rel. Martha Stewart Living Omnimedia Inc. v. Stewart, 845 A.2d 1040, 1048 
(Del. 2004).   
 
20
BSA/AML Compliance Department.  AmSouth has had for 
years a BSA/AML Compliance Department, headed by the 
BSA Officer and comprised of nineteen professionals, 
including a BSA/AML Compliance Manager and a Compliance 
Reporting Manager;  
 
Corporate Security Department.  AmSouth’s Corporate 
Security Department has been at all relevant times responsible 
for the detection and reporting of suspicious activity as it relates 
to fraudulent activity, and William Burch, the head of 
Corporate Security, has been with AmSouth since 1998 and 
served in the U.S. Secret Service from 1969 to 1998; and 
 
Suspicious Activity Oversight Committee.  Since 2001, the 
“Suspicious 
Activity 
Oversight 
Committee” 
and 
its 
predecessor, the “AML Committee,” have actively overseen 
AmSouth’s BSA/AML compliance program.  The Suspicious 
Activity Oversight Committee’s mission has for years been to 
“oversee the policy, procedure, and process issues affecting the 
Corporate Security and BSA/AML Compliance Programs, to 
ensure that an effective program exists at AmSouth to deter, 
detect, and report money laundering, suspicious activity and 
other fraudulent activity.” 
 
 
The KPMG Report reflects that the directors not only discharged their 
oversight responsibility to establish an information and reporting system, but 
also proved that the system was designed to permit the directors to 
periodically monitor AmSouth’s compliance with BSA and AML 
regulations.  For example, as KPMG noted in 2004, AmSouth’s designated 
BSA Officer “has made annual high-level presentations to the Board of 
Directors in each of the last five years.”  Further, the Board’s Audit and 
Community Responsibility Committee (the “Audit Committee”) oversaw 
 
21
AmSouth’s BSA/AML compliance program on a quarterly basis.  The 
KPMG Report states that “the BSA Officer presents BSA/AML training to 
the Board of Directors annually,” and the “Corporate Security training is 
also presented to the Board of Directors.”   
 
The KPMG Report shows that AmSouth’s Board at various times 
enacted written policies and procedures designed to ensure compliance with 
the BSA and AML regulations.  For example, the Board adopted an 
amended bank-wide “BSA/AML Policy” on July 17, 2003–four months 
before AmSouth became aware that it was the target of a government 
investigation.  That policy was produced to plaintiffs in response to their 
demand to inspect AmSouth’s books and records pursuant to section 22038 
and is included in plaintiffs’ appendix.  Among other things, the July 17, 
2003, BSA/AML Policy directs all AmSouth employees to immediately 
report suspicious transactions or activity to the BSA/AML Compliance 
Department or Corporate Security. 
Complaint Properly Dismissed 
In this case, the adequacy of the plaintiffs’ assertion that demand is 
excused depends on whether the complaint alleges facts sufficient to show 
that the defendant directors are potentially personally liable for the failure of 
                                          
 
38 Del. Code Ann. tit. 8, § 220 (2006). 
 
22
non-director bank employees to file SARs.  Delaware courts have recognized 
that “[m]ost of the decisions that a corporation, acting through its human 
agents, makes are, of course, not the subject of director attention.”39  
Consequently, a claim that directors are subject to personal liability for 
employee failures is “possibly the most difficult theory in corporation law 
upon which a plaintiff might hope to win a judgment.”40 
For the plaintiffs’ derivative complaint to withstand a motion to 
dismiss, “only a sustained or systematic failure of the board to exercise  
oversight–such as an utter failure to attempt to assure a reasonable 
information and reporting system exists–will establish the lack of good faith 
that is a necessary condition to liability.”41  As the Caremark decision noted:  
Such a test of liability–lack of good faith as evidenced by 
sustained or systematic failure of a director to exercise 
reasonable oversight–is quite high.  But, a demanding test of 
liability in the oversight context is probably beneficial to 
corporate shareholders as a class, as it is in the board decision 
context, since it makes board service by qualified persons more 
likely, while continuing to act as a stimulus to good faith 
performance of duty by such directors.42 
 
The KPMG Report–which the plaintiffs explicitly incorporated by 
reference into their derivative complaint–refutes the assertion that the 
                                          
 
39 In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d at 968. 
40 Id. at 967.   
41 Id. at 971. 
42 Id. (emphasis in original). 
 
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directors “never took the necessary steps . . . to ensure that a reasonable BSA 
compliance and reporting system existed.”  KPMG’s findings reflect that the 
Board received and approved relevant policies and procedures, delegated to 
certain employees and departments the responsibility for filing SARs and 
monitoring compliance, and exercised oversight by relying on periodic 
reports from them.  Although there ultimately may have been failures by 
employees to report deficiencies to the Board, there is no basis for an 
oversight claim seeking to hold the directors personally liable for such 
failures by the employees.   
With the benefit of hindsight, the plaintiffs’ complaint seeks to equate 
a bad outcome with bad faith.  The lacuna in the plaintiffs’ argument is a 
failure to recognize that the directors’ good faith exercise of oversight 
responsibility may not invariably prevent employees from violating criminal 
laws, or from causing the corporation to incur significant financial liability, 
or both, as occurred in Graham, Caremark and this very case.  In the 
absence of red flags, good faith in the context of oversight must be measured 
by the directors’ actions “to assure a reasonable information and reporting 
system exists” and not by second-guessing after the occurrence of employee 
conduct that results in an unintended adverse outcome.43  Accordingly, we 
                                          
 
43 Id. at 967-68, 971. 
 
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hold that the Court of Chancery properly applied Caremark and dismissed 
the plaintiffs’ derivative complaint for failure to excuse demand by alleging 
particularized facts that created reason to doubt whether the directors had 
acted in good faith in exercising their oversight responsibilities.   
Conclusion 
 
The judgment of the Court of Chancery is affirmed.