for the alleged misconduct and violation of federal and state laws. (Compl. 124-126.)
Plaintiff maintains the Directors would not vote to sue themselves. (Compl. § 126.)
However, it is settled Delaware law that “demand is not excused solely because the
Directors would be deciding to sue themselves.” In re Citigroup Inc. Shareholder
Derivative Litig., 964 A.2d 106, 121 (Del. Ch. 2009) (Citigroup). “The mere threat of
personal liability for approving a questioned transaction, standing alone, is insufficient to
challenge either the independence or disinterestedness of directors.” Aronson, 473 A.2d
at 815.

Plaintiff claims CEC’s Audit Committee members, in particular, faced a
substantial likelihood of liability because those Defendants were obligated to oversee and
review CEC’s financial reporting, public disclosures, and internal control processes.
(Compl. ff 119-121). “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.” Stone, 911 A.2d at 368 (quoting Graham v. Allis—
Chalmers Mfg. Co., 188 A.2d 125, 130 (Del. 1963)). Here, the Complaint adequately
pleads a cause for suspicion, based on the multiple media reports, as well as warnings
from the DOE and the ACICS. At the pleading stage, Plaintiff need only raise a
reasonable doubt as to the disinterestedness of the Board of Directors.

Plaintiff claims the Board of Directors lacked disinterest because it forced
Defendants McCullough, Budlong, McNamara, and Williams to resign from CEC due to
their involvement in the alleged wrongdoing. (Compl. 76.) The Directors chose not to

file lawsuits against the former executives and thus have failed to protect the Company



“gainful employment” rule, requiring a for-profit educational provider seeking federal
funding to show either: (1) that 45 percent of its former students were paying off
principal on school loans or (2) that the debt burden of former students was below 8
percent of their total incomes or below 20 percent of their discretionary incomes.
(Compl. { 7.) For-profit education schools that failed to meet the minimum standard
would lose federal funding. (Id.)

Following this, CEC issued a statement, indicating its intention to work with the
DOE and acknowledging that the proposed “gainful employment” rule would affect
CEC’s Culinary and Art and Design segments. (Compl. { 87.) On November 3, 2010,
Defendant McCullough told CEC investors that it was “maintaining and improving upon
the compliance culture we developed over the past few years. This includes ensuring
students had clear information including the demands of our programs, the range of
potential outcomes, and their financial obligations.” (Compl. { 90.) Following these
statements, CEC’s stock price increased. (Compl. § 91.)

CEC’s American schools derive 82 percent of tuition revenue from federal
funding under Title IV of the Higher Education Act, 20 U.S.C § 1070, et seq. (Compl.
23, 79-81.) According to the Accrediting Counsel for Independent Colleges and Schools
(“ACICS”), to maintain accreditation and to be eligible for Title IV funding, for-profit
schools must place 65 percent of graduating students in jobs related to their field of study.
(Compl. f 11, 18.) Job placement rates below the minimum standard may subject an
institution to increased accreditation oversight and other restrictions. (Compl. fff 14, 18,

108.) “ACICS may also initiate accreditation proceedings such as a show-cause



efforts are insufficient to avoid futility. (Compl. {{ 87, 90, 98.) The facts alleged
establish that CEC’s Board of Directors failed to discharge their fiduciary duties in good
faith, publicly addressing their reporting problems and seeking to correct those problems.
Caremark, 698 A.2d at 967.

Plaintiff has alleged particularized facts which would create a reasonable doubt as
to whether or not Defendants could have properly exercised sound business judgment in
replying to her demand and, therefore, has sufficiently alleged facts to excuse her failure
to make a demand of Defendants. Thus, Plaintiff has established a basis to excuse her
lack of a pre-suit demand of Defendants, pursuant to Fed. R. Civ. P. 23.1(b)(3).

Fed. R. Civ. P. 12(b)(6)

Furthermore, Plaintiff's Verified Complaint survives Defendants’ Motion to
Dismiss pursuant to Fed. R. Civ. P. 12(b)(6), as Plaintiff has adequately stated a claim
upon which relief may be granted. The detailed facts alleged in Plaintiffs Complaint
clearly put Defendants on notice as to what is at issue. Plaintiff has pleaded sufficient
facts to state a claim that is plausible on its face; it is facially plausible that Defendants
may be liable for the misconduct alleged by Plaintiff, based on the facts alleged. See
Igbal, 129 S. Ct. at 1949 (citing Twombly, 550 U.S. at 570). Moreover, Defendants’
Motions and supporting memoranda fail to clearly address how Plaintiff failed to state a
claim, instead focusing almost entirely on the demand futility argument. Therefore, to
the extent Defendants move for dismissal of Plaintiff's Complaint under Fed. R. Civ. P.

12(b)(6), this motion is denied.

18



To survive a Rule 12(b)(6) motion, a complaint alleging breach of fiduciary duty
must plead facts supporting an inference of breach, not simply a conclusion to that effect.
MeSparran v. Larson, Nos. 04-C-0042, 04 C 4778, 2006 WL 2052057, at *2 (N.D. Ill.
May 3, 2006) (McSparran). Federal Rule of Civil Procedure 23.1 establishes a
heightened pleading standard for a shareholder derivative complaint. DiLeo v. Ernst &
Young, 901 F.2d 624, 627 (7th Cir. 1990) (DiLeo). The rule requires a plaintiff “to state
with particularity: (A) any effort by the plaintiff to obtain the desired action from the
directors or comparable authority and, if necessary, from the shareholders or members;
and (B) the reasons for not obtaining the action or not making the effort.” Fed. R. Civ. P.
23.1(b)(3). Pleading with particularity means that the plaintiff must include “the who,
what, when, where, and how: the first paragraph of any newspaper story.” DiLeo, 901
F.2d at 627.

Because CEC was incorporated in Delaware, that state’s law controls. See In re
Abbott Laboratories Shareholder Derivative Litigation, 325 F.3d 795, 803 (7th Cir.
2003) (Abbott) (further noting that “Illinois case law follows Delaware law in
establishing demand futility requirements . . . .”). A well-established precept of Delaware
general corporation law is that directors manage the business affairs of the corporation.
MeSparran, 2006 WL 2052057, at *2. Thus, “by its very nature [a] derivative action
impinges on the managerial freedom of directors.” Stone ex rel. AmSouth
Bancorporation v. Ritter, 911 A.2d 362, 366 (Del. 2006) (Stone). A breach of duty may
be alleged against a board of directors where a board is liable for either: (1) the poor

decisions made by the board of directors or (2) the board of directors’ failing to properly

10



On August 3, 2011, CEC admitted some of its campuses were improperly
calculating job placement rates. (Compl. { 96.) CEC had discovered the “improper
practices” when it prepared its response to the subpoena issued by the New York
Attorney General and retained outside independent counsel, Dewey & LeBoeuf LLP, to
conduct an internal investigation of CEC institutions. (Id.) CEC’s press release stated:

[The] independent counsel has been directed to review the determination

of student placements at all of the company’s domestic schools. The

company will implement remedial measures based on the results of

independent counsel’s investigation. Results of the investigation will be
reported to the New York Attorney General and other relevant accrediting

and governmental bodies, as appropriate . . We will take all steps
necessary to ensure we accurately determine and report placement rates in
the future.

(Id) CEC then issued another statement on the internal investigation, confirming “the
existence of improper practices at certain of the Company’s Health Education and Art &
Design segment schools” and that the previously reported job placement rates “lacked
sufficient supporting documentation.” (Compl. { 98.) The preliminary results relating to
New York schools were reported to the Attorney General of New York. (/d.) Further,
the statement announced that CEC, under the direction of its Board of Directors, had
“commenced corrective action” and implemented “enhanced controls and procedures” for
determining the job-placement rates. All career service employees in CEC’s Health
Education and Art & Design segment schools were trained on the newly adopted policies
and procedures. (Id.)

The Company informed ACICS that for the 2010-2011 reporting period, 13 of
CEC’s 49 ACICS-accredited Health Education and Art and Design schools met the 65

percent minimum standard for job-placement rates. (Compl. 7 98.) On November 14,



directive, an action to defer or deny action related to an institution’s application for a new
grant of accreditation or an action to suspend an institution’s accreditation if it fails to
meet” the minimum standard. (Compl. § 18.)

In CEC’s 2011 10-K form filed with the Security and Exchange Commission
(“SEC”), it disclosed, “[i]f any one of our campuses were to lose state authorization, it
would be unable to offer educational programs . . . and the lack of Title IV eligibility
would likely require us to close a campus.” (Compl. {| 82.) Further, “[a]ny loss of
institutional accreditation would result in a loss of Title IV Program funds for the affected
school and its students.” (Id.)

On November 5, 2010, another CEC school, the Sanford Brown Institute,
received notice from the State of Florida Office of the Attorney General that it had
commenced an investigation into possible unfair and deceptive trade practices at certain
CEC schools for the period from January 1, 2007 to the present. (Compl. {J 63, 84.)

The Florida campus has appeared to comply with the subpoena, providing the documents
requested by the Florida Attorney General. (/d.) The results of the investigation have not
yet been made public. (/d.)

Next, on May 17, 2011, CEC received a Subpoena Duces Tecum from the
Attorney General of the State of New York requesting documents and detailed
information about the Company’s business practices for the time period May 17, 2005 to
the present. (Compl. §] 85, 95.) The subpoena indicated that the New York Attorney
General was investigating whether CEC and its academic institutions complied with New

York law. (/d.)



CONCLUSION

For the reasons stated above, Defendants’ Motion to Dismiss and Nominal

—T
Defendant’s Motion to Dismiss are denied. VA Al
o AV, bak.
Date: O7 (3 -I2
had DARRAH. =. casas Li"

United States District Court Judge

19



receipt of federal funding; and (3) “[CEC] failed to maintain adequate systems of internal
operational and financial controls.” (Compl. {ff 49, 52.)
LEGAL STANDARD

In reviewing a motion to dismiss pursuant to Fed. R. Civ. P. 12(b)(6), all factual
allegations in the complaint are considered, and any reasonable inferences are drawn in
the light most favorable to the plaintiff. Fener v. Gallagher, No. 04 C 8093, 2005 WL
2234656, at *4 (N.D. Ill. Sept. 8, 2005).

To properly assert a claim in a complaint, the plaintiff must present “a short and
plain statement of the claim showing that the pleader is entitled to relief and a demand for
the relief sought.” Fed. R. Civ. P. 8. A defendant may file a motion to dismiss a claim
under Federal Rule 12(b)(6) for failure to state a claim upon which relief may be granted.
Rule 8 “does not require ‘detailed factual allegations,” but it demands more than an
unadorned, the-defendant-unlawfully-harmed-me accusation.” Ashcroft v. Iqbal, 129 S.
Ct. 1937, 1949 (2009) (Iqbal) (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555
(2007) (Twombly)). While a court is to accept all allegations contained in a complaint as
true, this principle does not extend to legal conclusions. Iqbal, 129 S. Ct. at 1949. To
defeat a motion to dismiss under Rule 12(b)(6), a plaintiff must plead sufficient factual
matter to state a claim for relief that is “plausible on its face.” Iqbal, 129 S. Ct. at 1949
(citing Twombly, 550 U.S. at 570). A claim is facially plausible “when the plaintiff
pleads factual content that allows the court to draw the reasonable inference that the

defendant is liable for the misconduct alleged.” Jgbal, 129 S. Ct. at 1949.



UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION

AMY COOK, derivatively on behalf of
CAREER EDUCATION CORP.,

Plaintiff,

)

)

)

)

)

v. ) Case No. 11-CV-9119

)

GARY E. MCCULLOUGH, ) Judge John W. Darrah

STEVEN H. LESNIK, )

LESLIE T. THORNTON, )

DENNIS H. CHOOKASZIAN, )

DAVID W. DEVONSHIRE, )

PATRICK W. GROSS, )

GREGORY L. JACKSON, )

MICHAEL J. GRAHAM, )

THOMAS B. LALLY, )

BRIAN R.WILLIAMS, )

THOMAS G. BUDLONG, )

and THOMAS A. MCNAMARA, )
)
)
)
)
)
)
)
)

Defendants,
and
CAREER EDUCATION CORP.,

Nominal Defendant.

MEMORANDUM OPINION AND ORDER

Plaintiff Amy Cook, derivatively on behalf of Career Education Corp. (“CEC”),
filed a four-count Verified Shareholder Derivative Complaint against individual
Defendants Gary E. McCullough, Steven H. Lesnik, Leslie T. Thornton,

Dennis H. Chookaszian, David W. Devonshire, Patrick W. Gross, Gregory L. Jackson,

Michael J. Graham, Thomas B. Lally, Thomas A. McNamara, Thomas G. Budlong, and



claim as “possibly the most difficult theory in corporation law upon which a plaintiff
might hope to win a judgment.” Jd. at 967. Defendants argue Plaintiff's Complaint
should be dismissed for lack of a pre-suit demand on CEC’s Board of Directors.
Plaintiffs defense for her failure to make a pre-suit demand is that any such demand
would have been futile.

Delaware law is applicable in determining if Plaintiff is excused from making a
demand upon CEC’s Board of Directors prior to filing a derivative suit. See Kamen, 500
USS. at 98-99, Under Delaware law, a pre-suit demand is only excused when “facts are
alleged with particularity which create a reasonable doubt that the directors’ action was
entitled to the protection of the business judgment rule.” Aronson v. Lewis, 473 A.2d
805, 808 (Del. 1984) (Aronson), overruled on other grounds by Brehm v. Eisner, 746
A.2d 244, 253 (Del. 2000).

In Aronson, the Delaware Supreme Court established a two-prong test to assess
demand futility. 473 A.2d at 814. The test determines whether the alleged particularized
facts create a reasonable doubt that: “(1) the directors are disinterested or independent
and (2) the challenged transaction was otherwise the product of a valid exercise of
business judgment.” Jd. “Hence, the Court . . . must make two inquiries, one into the
independence and disinterestedness of the directors and the other into the substantive

nature of the challenged transaction and the board's approval thereof.” Jd. A plaintiff

? The business judgment rule provides some protection to corporate boards in
their decision-making process; shielding “the deliberations and conclusions of the chosen
representatives of the board only if they possess a disinterested independence and do not
stand in a dual relation which prevents an unprejudicial exercise of judgment.” Auerbach
y, Bennett, 393 N.E. 2d 994, 1001 (N.Y. 1979).

12



monitor the operations of the company. Abbott, 325 F.3d 795, 805 (citing In re
Caremark Int'l Inc. Derivative Litigation, 698 A.2d 959, 967 (Del. Ch. 1996)
(Caremark). Therefore, a board of directors might be found to have breached a duty by
its poor decision-making and by its failure to act.

A shareholder seeking to bring a lawsuit on behalf of a corporation must either
make a pre-suit demand on the board of directors or otherwise establish that demand is
excused “because the directors are incapable of making an impartial decision regarding
whether to institute such litigation.” Stone, 911 A.2d at 367. “The purpose of the
demand requirement is to afford the directors an opportunity to exercise their reasonable
business judgment and waive a legal right vested in the corporation in the belief that its
best interests will be promoted by not insisting on such right.” Kamen v. Kemper Fin.
Servs. Inc., 500 U.S 90, 96 (1991) (Kamen). However, the pre-suit demand requirement
is excused when a demand would be futile. Kamen, 500 U.S. at 102. While Fed. R. Civ.
P, 23.1 requires a plaintiff to allege its efforts to make a demand with particularity, “the
requirement of a shareholder demand is more than a pleading requirement, it is a
substantive right of the shareholder and the directors.” Abbott, 325 F.3d at 803-804
(citing Kamen, 500 U.S. at 97). Delaware law “controls these substantive rights and
governs what excuses are adequate for failure to make demand.” Jd.

ANALYSIS

Though Plaintiff does not characterize it as such, she appears to pursue a

Caremark claim: a derivative claim, alleging a board's failure to exercise corporate

oversight. Caremark, 698 A.2d at 967. The court in Caremark characterized such a

11



2011, ACICS issued a “show-cause directive” letter, requiring CEC to show cause as to
why current accreditation grants for 49 of its ACICS-accredited institutions in the Health
and Art & Design segments should not be withdrawn by way of suspension. (Compl.
14, 18, 108.) The ACICS intended to review “the actions the Company has taken to date
to report accurate placement rates and the controls and procedures it has implemented to
ensure the accurate determination and reporting of placement rates going forward.”
(Compl. ff 18, 108.) The 49 CEC campuses implicated by ACICS represent
approximately 40 percent of CEC’s revenues. (Compl. { 109.)

Defendants exposed CEC to several lawsuits, which, in turn, “resulted in lower
profit margins, declining enrollment, and a tarnished reputation.” (Compl. § 16.) On
November 2, 2011, Defendant CEO Lesnik spoke to investors, admitting that in the
previous quarter, CEC spent approximately $2 million on outside legal fees relating to the
New York Attorney General's subpoena requests and $3 million to conduct an internal
placement rate review. (Compl. 4 105.) Following this, CEC’s stock dropped 55 percent,
from $15.85 per share to $7.37 per share. (Compl. {| 106.)

Defendants breached their fiduciary duties and acted in bad faith, causing CEC to
“purposely, recklessly, or negligently” make false statements and concealing that: (1)
[CEC] overstated its growth prospects by engaging in illegal and improper recruiting
activities which also artificially inflated [CEC]’s reported results and future growth
prospects”; (2) CEC overstated its financial results because the student loan repayment

rates and job placement rates at CEC schools were well below the levels required for



Defendant Thomas G. Budlong resigned as Senior Vice President of International
Operations and Chief Administrative Officer in October 2011. (Compl. { 34.) Defendant
Michael J. Graham is, and at all relevant times was, Chief Financial Officer and
Executive Vice President of CEC. (Compl. § 28.)

On January 31, 2007, the New York Times reported that the New York State
Education Department threatened to close CEC’s Katherine Gibbs School in New York
City “if certain deficiencies were not corrected.” (Compl. { 131(d).) Katherine Gibbs’
President, Wynn Blanton, stated that he accepted many of the findings, which were
largely based on a peer review conducted the previous summer, but thought some of the
findings were “highly subjective, clearly unsubstantiated and objectionable.” (d.)
Lynne Baker, a CEC spokesperson, told the New York Times that the School had since
“implemented substantial changes that directly address its problems.” (Id.) In June 2007,
the SF Weekly wrote an article about the misrepresentation of job prospects at CEC’s
California Culinary Academy. (Compl. § 131(e).) The article identified eight lawsuits
filed against different CEC schools for “misrepresentation and consumer fraud” and
“false statements regarding admission criteria and job placement rates.” (/d.) Since that
article, additional class-action lawsuits were filed against CEC schools in California;
some are still pending. (Compl. { 73.)

On August 13, 2010, the Department of Education (“DOE”) released data,
showing that the student loan repayment rate at many of CEC’s campuses was below 20
percent. (Compl. § 10.) At CEC’s Sanford Brown College-Hazelwood in Missouri, 9

percent of student federal loans were being repaid. (Compl. 9.) The DOE proposed a



from further damages. (Compl. { 128.) In addition, Defendants received “unusually
large severance agreements” to buy their silence and “to preclude [them from] testifying
against the Company.” (Compl. § 117.) These facts alleged by Plaintiff support her
assertion that the members on the Board of Directors were not disinterested parties.

Plaintiff has pled sufficient facts to establish reasonable doubt as to the Directors’
independence. Independence turns on whether “a director is, for any substantial reason,
incapable of making a decision with only the best interests of the corporation in mind.”
MeSparran, 2006 WL 2052057 at *3, (quoting Parfi Holding AB v. Minor Image
Internet, Inc., 794 A.2d 1211, 1232 (Del. Ch. 2001) (emphasis in original)). On this basis,
it would have been futile for Plaintiff to make a pre-suit demand on Defendants because
Plaintiff has established reasonable doubt as to Defendants’ independence.

Business Judgment Rule

Even if Plaintiff had failed to plead the futility in a pre-suit demand due to
Defendants’ alleged lack of independence, the second prong of the Aronson test would
support Plaintiff's claim of pre-suit demand futility. This requires a determination as to
whether there is reasonable doubt that the challenged transactions were the product of a
valid exercise of business judgment. If reasonable doubt exists, a pre-suit demand by
Plaintiff would be deemed futile. Aronson, 473 A.2d at 814.

The business judgment rule is “a presumption that directors of a corporation make
business decisions on an informed basis, in good faith, and with the honest belief that the
course taken was in the best interest of the corporation.” F.D.L.C. ex rel. Wheatland Bank

v. Spangler, 10-CV-04288, 2011 WL 6754022, at *7 (N.D. Ill. Dec. 22, 2011) (quoting

15



ACICS; and as members of the Audit and Compliance Committees. (Compl. ff] 8, 9, 18.)
Plaintiff claims the Directors recognized that misrepresenting the loan repayment and
job-placement rates would jeopardize accreditation at CEC campuses and federal
financial aid. (Compl. §§ 82, 83.) Despite this, the Directors purposefully, and with a
reckless disregard for their fiduciary duties, caused CEC to release falsified statements.
(Compl. { 40.) Defendants acknowledged that the newly proposed, more stringent
gainful employment rule would impact CEC’s Culinary and Art and Design segments.
(Compl. 87.) An SEC disclosure form stated that for the 2010-2011 reporting period,
52 of CEC’s ACICS-accredited Health Education and Art and Design schools had job
placement rates below the minimum standard. (Compl. ff 13, 98.) It may be reasonably
inferred that Defendants properly monitored these problems or implemented a plan to
correct them.

In support of her argument that the Directors’ “conscious disregard” for improper
practices on CEC campuses established the lack of good faith necessary to claim director-
oversight liability, Plaintiff relies on the Seventh Circuit’s opinion in Abbott. In Abbott,
the Seventh Circuit held that there was an intentional “sustained and systematic failure of
the board to exercise oversight” because “the directors knew of the violations of law,
took no steps in an effort to prevent or remedy the situation, and that failure to take any
action for such an inordinate amount of time resulted in substantial corporate losses,
establishing a lack of good faith.” Abbott, 325 F.3d at 809.

Although Defendants here did take some ostensible remedial measures, such as

disclosing job-placement and loan-repayment numbers, Plaintiff pleads these remedial

17



Defendant Steven H. Lesnik has been a Director of CEC since 2006, Chairman of
the Board since 2008, and served as President and Chief Executive Officer of CEC in
November 2011. (Compl. 425.) Defendant Leslie T. Thornton has been a Director of
CEC since 2005, and Thornton currently serves as the Chairperson of the Compliance
Committee. (Compl. 26.) Defendant Dennis H. Chookaszian has been a Director of
CEC since 2002 and currently serves as the Chairperson of the Audit Committee and a
member of the Compliance Committee. (Compl. § 27.) Defendant David W. Devonshire
has been a Director of CEC since 2008 and currently serves as a member of the Audit
Committee. (Compl. § 29.) Defendant Patrick W. Gross has been a Director of CEC
since 2005 and currently serves as a member of the Audit Committee. (Compl. § 30.)
Defendant Gregory L. Jackson has been a director of CEC since 2008 and currently
serves on the Compliance Committee. (Compl. § 31.) Defendant Thomas B. Lally has
been a Director of CEC since 1998. (Compl. { 32.)

On October 31, 2011, Defendant Gary E. McCullough resigned as President,
Chief Executive Officer, and Board Member. (Compl. 24.) Defendant Thomas A.
McNamara joined CEC in February 2001 as Controller and Director of Operations for the
International Academy of Design and Technology (““IADT”). (Compl. | 35.) McNamara
resigned as Senior Vice President of Art and Design in October 2011, after holding this
position since November 2010. (/d.) Defendant Brian R. Williams resigned as Senior
Vice President of Culinary Arts in October 2011; he began serving in this position in
September 2008. (Compl. 33.) Williams previously served as Vice President of

Admissions for American InterContinental University Online from 2006 to 2008. (/d.)



Brian R. Williams (collectively, the “Defendants”), and against CEC as a nominal
defendant. Counts I, II and III of the Complaint allege claims of a breach of Defendants’
fiduciary duties as directors and/or officers of CEC, abuse of control, and gross
mismanagement. Count IV is a claim against Defendants McCullough, McNamara,
Williams, Budlong, and Graham for unjust enrichment.

Defendants move to dismiss all Counts against them for failure to make a demand
on the Company’s Board, pursuant to Rule 23.1 of the Federal Rules of Civil Procedure
(“Rule 23.1”), and for failure to state a claim, pursuant to Federal Rule of Civil Procedure
12(b)(6). A separate motion to dismiss was also filed by Nominal Defendant Career
Education Corp: CEC adopts Defendants’ arguments.’ Based on the analysis below, the
motions are denied.

BACKGROUND

The following alleged facts are taken from Plaintiff's Verified Complaint. CEC, a
publicly traded Delaware corporation, is a for-profit provider of post-secondary education
services in the United States and Europe. (Compl. § 54, 56.) CEC operates more than
90 campuses, offering doctoral, masters, bachelors, and associate degrees, and certificate
programs in various career-oriented disciplines. (/d.) In addition to its physical
locations, nearly 40 percent of CEC’s approximately 100,000 students attend its web-

based virtual campuses. (/d.)

' Additionally, Nominal Defendant CEC moved for an interim stay of discovery because
of a pending class-action suit in Illinois: see Ross v. Career Education Corporation, No.
12-CV-00276 (N.D. Ill). CEC and two individual defendants are named in the Ross case.



must state with particularity why a demand is futile; it is insufficient to merely state “in
conclusory terms that he made no demand because it would have been futile.” Abbott,
325 F.3d at 804 (quoting Starrels v. First Nat'l Bank of Chicago, 870 F.2d 1168, 1170
(7th Cir. 1989)).

Here, Plaintiff asserts four bases for demand futility: (1) that the Directors were
reckless in not establishing adequate controls that complied with accreditation
requirements and federal law; (2) that the Directors intentionally caused CEC to
disseminate false and misleading information; (3) that, when given the opportunity to
investigate the extent of the recruiting violations and the potential loss of accreditation at
CEC schools, the Directors commenced an incomplete and “needlessly restricted and
ineffective investigation”; and (4) that the Directors have demonstrated their
unwillingness to sue themselves, other former executives, and company officers directly
responsible for the misconduct. (Compl. ff 1, 65, 123, 126, 129.) Given these
allegations, it is necessary to employ the Aronson test to determine if a pre-suit demand
made by Plaintiff would have been futile.

Disinterest or Independence

“A director is considered interested where he or she will receive a personal
financial benefit from a transaction that is not equally shared by the stockholders” or
“where a corporate decision will have a materially detrimental impact on a director, but
not on the corporation and the stockholders.” Rales v. Blasband, 634 A.2d 927, 936.
(Del. 1993) (citing Aronson, 473 A.2d at 812). Plaintiff argues Defendants are interested

parties because there was a “substantial likelihood” they would be held personally liable

13



Ferris Elevator Co., Inc. v. Neffco, Inc., 285 Ill. App. 3d 350, 354 (Ill. App. 1996)). At
this stage in the proceedings, Plaintiff has the burden of establishing facts that rebut the
presumption created by the business judgment rule. Aronson, 473 A.2d at 812.

“A sustained or systematic failure of the board to exercise oversight will . . .
establish the lack of good faith necessary to establish [director liability].”. Caremark, 698
A.2d at 971. The Delaware Supreme Court has stated that bad-faith conduct may occur
where a director “intentionally acts with a purpose other than that of advancing the best
interests of the corporation, where the fiduciary intentionally acts with the intent to
violate applicable positive law, or intentionally fails to act in the face of a known duty to
act, demonstrating a conscious disregard for his duties.” In re Walt Disney Co.
Derivative Litig., 906 A.2d 27, 67 (Del. 2006). The Caremark standard for assessing
conduct that results in director-oversight liability has been characterized as a finding that:

(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.

Stone, 911 A.2d at 370.

The breach of fiduciary duty claims in this case focus on the latter part of the
Caremark standard, as they arise from the CEC’s Board of Directors’ “knowing and
culpable violation of their obligations” under the circumstances. (Compl. { 40.) Plaintiff
alleges the Directors were aware of state and federal law violations, providing evidence
of their direct knowledge through: the 2010 Department of Education data, which

showed loan repayment rates at CEC were below 20 percent; annual reporting to the

16