Opinion ID: 182919
Heading Depth: 2
Heading Rank: 1

Heading: Demand Requirement

Text: [2] Section 16(b) provides in relevant part that all insider short-swing trading profits “shall inure to and be recoverable by the issuer,” and “[s]uit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter . . . .” 15 U.S.C. § 78p(b). The issuing company’s right to recover the insider’s trading profits “is simply an application of an old principle in the law that if you are an agent and you profit by insider information concerning the affairs of your principal, your profits go to your principal.” Stock Exchange Regulation: Hearing Before the H. Comm. on Interstate and Foreign Commerce, 73d Cong. 133 (1934) (statement of Thomas Corcoran, Counsel, Reconstruction Fin. Corp.).7 7 Certain courts and commentators have suggested that Section 16(b) actions are not true derivative actions. E.g., Dottenheim v. Murchison, 227 F.2d 737, 738 (5th Cir. 1956); Schaffer v. CC Investments, LDC, 286 F. Supp. 2d 279, 281-82 (S.D.N.Y. 2003); 4 Hazen, supra, § 13.2 n.41; Peter SIMMONDS v. CREDIT SUISSE SECURITIES 869 [3] Section 16(b) does not set forth any additional details regarding the nature and scope of this statutory demand requirement. In light of this Congressional silence, we turn to state law for guidance. The Supreme Court has explained that “where a gap in the federal securities laws must be bridged by a rule that bears on the allocation of governing powers within the corporation, federal courts should incorporate state law into federal common law unless the particular state law in question is inconsistent with the policies underlying the federal statute.” Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 108 (1991). Applying this broad principle in the context of the Investment Company Act of 1940, the Kamen Court held that “the contours of the demand requirement” (in that case, the standards governing demand futility) must be determined by the law of the state of incorporation. Id. at 101. [4] Here, the adequacy of Simmonds’s Section 16(b) demand letters is disputed in the thirty cases involving the Moving Issuers, all of which are Delaware corporations.8 In J. Romeo & Alan L. Dye, Section 16 Treatise and Reporting Guide, § 9:03[1][a] (3d ed. 2008) (hereinafter Romeo & Dye.) We refrain from examining this question more closely because it is not relevant to the issues at hand. We note that derivative and quasi-derivative actions are generally governed by the procedural requirements of Fed. R. Civ. P. 23.1. See Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 533-34 (1984). However, two of our sister circuits have suggested that Rule 23.1 does not apply in Section 16(b) actions. Portnoy v. Kawecki Berylco Indus., Inc., 607 F.2d 765, 767 n.3 (7th Cir. 1979); Dottenheim, 227 F.2d at 738. We refrain from deciding this question because it is not relevant to our analysis. 8 Our analysis of Simmonds’s demand letters is limited to the thirty cases in which the Moving Issuers contested the adequacy of Simmonds’s demand. Although we have no reason to doubt Simmonds’s assertion that she submitted “similar demands” to the twenty-four issuing companies that did not join the Motion to Dismiss, these letters are not currently part of the record and must be examined by the district court in the first instance. Accordingly, our analysis does not involve the twenty cases involving Delaware issuers who did not join the Moving Issuers’ Motion to Dismiss, the two cases involving California issuers (Critical Path, Inc., and Openwave Systems, Inc.), or the cases involving a Washington issuer (Airspan Networks, Inc.) and a Bermuda issuer (Marvell Technology Group, Ltd.). 870 SIMMONDS v. CREDIT SUISSE SECURITIES light of the principles articulated in Kamen, these thirty demand letters must be analyzed in accordance with Delaware law, unless there is a conflict between Delaware law and federal law that “would frustrate specific objectives” of Section 16 and the Exchange Act. Kamen, 500 U.S. at 98 (citation, internal quotation marks, and alterations omitted). Our task under Kamen is the same as in any case decided under state law after Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938). We must “ ‘approximate state law as closely as possible in order to make sure that the vindication of the state right is without discrimination because of the federal forum.’ ” Orkin v. Taylor, 487 F.3d 734, 741 (9th Cir. 2007) (quoting Ticknor v. Choice Hotels Int’l, Inc., 265 F.3d 931, 939 (9th Cir. 2001)). Accordingly, we must follow the Delaware Supreme Court’s pronouncements, or, if the Delaware Supreme Court has not addressed the question, “we must predict how the Court will decide the issue, based on decisions of Delaware courts, decisions from other jurisdictions, treatises and restatements.” Matsuura v. Alston & Bird, 166 F.3d 1006, 1008 n.3 (9th Cir. 1999) (per curiam). In other contexts, we have relied on the Delaware Court of Chancery’s decisions as accurate statements of Delaware law, id. at 1008, and we note that there are particularly compelling reasons for following the Delaware Court of Chancery’s decisions because it is widely recognized as the nation’s leading authority on corporate law issues, see, e.g., William H. Rehnquist, The Prominence of the Delaware Court of Chancery in the State-Federal Joint Venture of Providing Justice, 48 Bus. Law. 351 (1992). The Delaware Supreme Court has explained that the demand requirement exists “first to insure that a stockholder exhausts his intracorporate remedies, and then to provide a safeguard against strike suits.” Aronson v. Lewis, 473 A.2d 805, 811-12 (Del. 1984), overruled en banc on other grounds by Brehm v. Eisner, 746 A.2d 244, 253 & n.13 (Del. 2000). “The purpose of pre-suit demand is to assure that the stockholder affords the corporation the opportunity to address an alleged wrong without litigation, to decide whether to invest SIMMONDS v. CREDIT SUISSE SECURITIES 871 the resources of the corporation in litigation, and to control any litigation which does occur.” Spiegel v. Buntrock, 571 A.2d 767, 773 (Del. 1990).9 These justifications are not unique to Delaware. The Supreme Court has repeatedly highlighted these points, Kamen, 500 U.S. at 101; Daily Income Fund, 464 U.S. at 533, as have our sister circuits,10 and leading commentators have approved.11 As we have previously stated, the demand rule “is not merely a technical or unimportant requirement.” Potter, 546 F.3d at 1058. Rather, it flows from “the general rule of American law . . . that the board of directors controls a corporation.” Id. Indeed, the policies animating shareholder demands are particularly relevant in the Section 16(b) context. “Anecdotal evidence suggests that well over 90 percent of all Section 16(b) claims are settled privately, without any lawsuit being filed.” Romeo & Dye, supra, § 9.01[7][c] (footnote omitted). This figure would almost certainty be lower if Section 16(b) did not contain a 9 Another justification for the demand requirement is that the demand allows the corporation to exercise its business judgment and decide not to pursue the claim. See Aronson, 473 A.2d at 812 (noting that business judgment rule permits “independent disinterested directors to dismiss the action as inimical to the corporation’s best interests”). This justification is inapplicable in Section 16(b) litigation because “[a]ny stockholder has a right to institute suit if the corporation fails to do so, regardless of the good faith or reasonable business judgment of the board of directors.” Pellegrino v. Nesbit, 203 F.2d 463, 467 (9th Cir. 1953). 10 E.g., Grossman v. Johnson, 674 F.2d 115, 125 (1st Cir. 1982); Lewis v. Graves, 701 F.2d 245, 247-48 (2d Cir. 1983); Shaev v. Saper, 320 F.3d 373, 377 (3d Cir. 2003); Hoffman v. Kramer, 362 F.3d 308, 317 n.4 (5th Cir. 2004); In re Ferro Corp. Derivative Litig., 511 F.3d 611, 618 (6th Cir. 2008); Boland v. Engle, 113 F.3d 706, 712 (7th Cir. 1997); Allright Missouri, Inc. v. Billeter, 829 F.2d 631, 638 (8th Cir. 1987); Stepak v. Addison, 20 F.3d 398, 402 (11th Cir. 1994); Gaubert v. Fed. Home Loan Bank Bd., 863 F.2d 59, 65 (D.C. Cir. 1988). 11 13 William Meade Fletcher, Fletcher Cyclopedia of the Law of Corporations § 5963 (Supp. 2010); American Law Institute, Principles of Corporate Governance § 7:03 cmt. c. (1992 & Supp. 2010); Daniel R. Fischel, Comment, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U. Chi. L. Rev. 168, 171-72 (1976). 872 SIMMONDS v. CREDIT SUISSE SECURITIES demand requirement, as shareholder demands allow boards to investigate the allegations and resolve matters without resorting to costly and burdensome litigation. [5] To give effect to these general policies, the Delaware Chancery has required that demand letters “specifically state: (i) the identity of the alleged wrongdoers, (ii) the wrongdoing they allegedly perpetrated and the resultant injury to the corporation, and (iii) the legal action the shareholder wants the board to take on the corporation’s behalf.” Yaw v. Talley, Civ. A. No. 12882, 1994 WL 89019, at  (Del. Ch. Mar. 2, 1994) (unpublished opinion), reprinted in 20 Del. J. Corp. L. 454.12 Furthermore, “the party asserting that a demand was made . . . bear[s] the burden of proof . . . .” Id. These requirements flow directly from the underlying justifications for the demand requirement: “[i]t is essential that the communication contain these three elements to enable the board to perform its duty to make a good faith investigation of claims of alleged wrongdoing, and, where appropriate, to rectify the misconduct.” Id. We believe that this is a correct statement of Delaware law as it would be decided by the Delaware Supreme Court. This standard was announced by a vice chancellor who was later elevated to the state supreme court, see Gatz v. Ponsoldt, No. Civ. A. 174-N, 2004 WL 3029868, at  (Del. Ch. Nov. 5, 2004) (unpublished opinion), and, more importantly, this standard has been uniformly followed in subsequent Chancery decisions.13 Accordingly, under Kamen and our general Erie jurisprudence, we apply this legal standard (and the Delaware courts’ applications of it) except where it “frustrate[s] specific 12 Delaware rules of court allow citation to unpublished chancery decisions. 1 David A. Drexler, et al., Delaware Corporation Law and Practice § 2.05 (2009). 13 FLI Deep Marine LLC v. McKim, No. Civ. A. 4138-VCN, 2009 WL 1204363, at  n.6 (Del. Ch. Apr. 21, 2009) (unpublished opinion); Khanna v. McMinn, No. Civ. A. 20545-NC, 2006 WL 1388744, at  (Del. Ch. May 9, 2006) (unpublished opinion); Gatz, 2004 WL 3029868, at . SIMMONDS v. CREDIT SUISSE SECURITIES 873 objectives” of Simmonds’s federal cause of action. See Kamen, 500 U.S. at 98.14 Here, the thirty demand letters at issue in the Moving Issuers’ motion (all of which were identical in all material respects) stated the following pertinent facts.15 “[T]he Company’s IPO underwriters, in addition to certain of its officers, directors and principal shareholders, as identified in the IPO prospectus . . . coordinated their efforts for the purpose of acquiring, holding, and/or disposing of securities of the Company,” obtained beneficial ownership of shares amounting to more than 10% of the company’s outstanding common stock in the year following the IPO, “engaged in purchases and sales of Company within periods of less than six months during” that year, and failed to report those transactions as required by Section 16(a). Simmonds “demand[ed] that the 14 The federal district court in Delaware has articulated a similar standard regarding the demand requirement: “At a minimum, a demand must identify the alleged wrongdoers, describe the factual basis of the wrongful acts and the harm caused to the corporation, and request remedial relief. In most instances, the shareholder need not specify his legal theory, every fact in support of that theory, or the precise quantum of damages.” Allison v. Gen. Motors Corp., 604 F. Supp. 1106, 1117 (D. Del.), aff’d mem., 782 F.2d 1026 (3d Cir. 1985). Many federal courts, including the district court in this case, have relied on Allison or its federal progeny when addressing the adequacy of a demand under Delaware law. See, e.g., Richelson v. Yost, __ F. Supp. 2d __, No. 10-1342, 2010 WL 3563108, at  (E.D. Pa. Sept. 9, 2010); Dreiling v. Am. Express Co., 351 F. Supp. 2d 1077, 1085 (W.D. Wash. 2004), rev’d on other grounds, 458 F.3d 942 (9th Cir. 2006); Levner v. Saud, 903 F. Supp. 452, 456 (S.D.N.Y. 1994), aff’d sub nom. Levner v. Prince Alwaleed, 61 F.3d 8, 9 (2d Cir. 1995); Rubin v. Posner, 701 F. Supp. 1041, 1045 (D. Del. 1988). We believe, however, that the better approach is to rely on Delaware state courts to the greatest extent possible. Under Kamen, we give preference to the state courts’ approach. 15 The demand letters were identified in the Complaints, and the thirty letters sent to the Moving Issuers were submitted to the district court as part of their Motion to Dismiss. Because the parties did not dispute the authenticity of these documents, we may consider them without converting the motion to dismiss into a motion for summary judgment. See Knievel v. ESPN, 393 F.3d 1068, 1076 (9th Cir. 2005). 874 SIMMONDS v. CREDIT SUISSE SECURITIES board of directors prosecute a claim against” those persons “for violations of § 16(b) of the Securities Exchange Act of 1934,” in order to “compel[ ] [them] to disgorge the profits they made through purchases and sales of Company stock.” In response to twenty-five of the thirty Moving Issuers’ requests for additional information, Simmonds explained that “the challenged transactions involved the activities of the lead underwriters, the other IPO underwriters, and the officers, directors and principal shareholders of the Company . . . related to improper IPO allocation (so-called ‘laddering’ and ‘spinning’) and research and stock rating activities during the Relevant Period. As you are aware, information regarding these activities is readily available at court, law firm and SEC websites.”16 [6] Simmonds’s initial demand letters satisfied the first part of the Delaware test for demand adequacy, which requires the shareholder to state “the identity of the alleged wrongdoers.” Yaw, 1994 WL 89019, at . In FLI Deep Marine v. McKim, the plaintiff’s demand letter stated that 16 These follow-up letters were not mentioned in the Complaints or submitted by any of the Defendants in connection with the various motions to dismiss. Rather, they were submitted by Simmonds in opposition to the Moving Issuers’ Motion to Dismiss. Ordinarily such extrinsic evidence may not be considered at this stage of the litigation. See Knievel, 393 F.3d at 1076. The district court determined, however, that these documents could be considered as part of the defendants’ challenge to subject matter jurisdiction under Fed. R. Civ. P. 12(b)(1). See In re Section 16(b) Litig., 602 F. Supp. 2d 1202, 1210 (W.D. Wash. 2009) (“A jurisdictional challenge under [Rule 12(b)(1)] may be made on the face of the pleadings or by presenting extrinsic evidence.” (citing Warren v. Fox Family Worldwide, Inc., 328 F.3d 1136, 1139 (9th Cir. 2003)). Because we are proceeding under Fed. R. Civ. P. 12(b)(6) rather than Fed. R. Civ. P. 12(b)(1), we do not have the benefit of going beyond the pleadings as the district court did. However, we may consider Simmonds’s follow-up letters to support our conclusion that Simmonds’s thirty Complaints involving the Moving Issuers must be dismissed with prejudice. See Broam v. Bogan, 320 F.3d 1023, 1026 n.2 (9th Cir. 2003). SIMMONDS v. CREDIT SUISSE SECURITIES 875 “ ‘certain employees, officers and directors of [the company] and others’ ” had diverted and misappropriated the company’s assets. FLI Deep Marine, 2009 WL 1204363, at  (quoting demand letter). The Court of Chancery stated that this letter was sufficient to satisfy the first prong of Yaw. Id. at  n.6. Simmonds’s demand letters identify the alleged wrongdoers with a similar level of precision as in the FLI Deep Marine plaintiff’s demand letter. Specifically, Simmonds’s letters identified “the Company’s IPO underwriters, in addition to certain of its officers, directors and principal shareholders, as identified in the IPO prospectus.” Although the Moving Issuers contend that their respective prospectuses listed between eleven and fifty-one underwriters, officers, and directors, and we acknowledge that this is a close question, we follow the Court of Chancery’s approach in FLI Deep Marine.17 Because Simmonds’s demand letters identified a closed set of alleged wrongdoers, we agree with the district court that “the demand letters in this case sufficiently identify the alleged wrongdoers.” In re Section 16(b) Litig., 602 F. Supp. 2d at 1212. [7] Simmonds’s letters failed, however, to satisfy the second and third prongs of the Delaware test for demand adequacy, which require the shareholder to identify the “wrongdoing . . . allegedly perpetrated” and “the legal action the shareholder wants the board to take on the corporation’s behalf.” Yaw, 1994 WL 89019, at .18 Simply put, Sim17 The Court of Chancery’s approach is in tension with the Third Circuit’s holding in Shlensky v. Dorsey, 574 F.2d 131, 140-41 (3d Cir. 1978), in which the court held that demand letters were inadequate where they alleged that the “responsible individuals” should be held accountable. 18 Although the Delaware courts require the demand to describe “the resultant injury to the corporation,” Yaw, 1994 WL 89019, at , this requirement “frustrate[s] specific objectives” of Section 16(b) by adding an additional element to the Section 16(b) cause of action. See Kamen, 500 U.S. at 98. Section 16(b) exists to remedy harms suffered by the general investing public, not harms suffered by issuing corporations. See Kern County, 411 U.S. at 591-92; Champion Home Builders Co. v. Jeffress, 490 F.2d 611, 619 (6th Cir. 1974) (“the absence of corporate damage is not a factor in assessing § 16(b) liability”). Accordingly, a shareholder’s demand letter need not identify any corporate injury in order to satisfy the demand requirement of Section 16(b). 876 SIMMONDS v. CREDIT SUISSE SECURITIES monds’s demand letters presented factual theories that vary significantly from the facts alleged in the Complaints. Her demand letters claimed that the Underwriters directly bought and sold the Issuing Companies’ shares, and accordingly requested that the Issuing Companies seek disgorgement of the Underwriters’ trading profits. In contrast, her Complaints do not allege that the Underwriters directly participated in buying and selling the Issuing Companies’ stock, and instead seek disgorgement of the profits the Underwriters received through their investment banking operations.19 [8] According to the Complaints, the Underwriters violated Section 16(b) when they profited indirectly through their customers’ purchases and sales of the Issuing Companies’ shares. Specifically, the Complaints allege that the Underwriters engaged in “Short-Swing Transactions” when (1) their existing customers purchased and sold the issuing company’s stock, (2) they obtained new banking customers in exchange for giving other companies’ insiders favorable consideration in the issuing company’s IPO, and (3) they obtained additional banking business from the issuing company in exchange for helping the issuing company’s insiders profit from their own company’s IPO. The Complaints assert that these “Short-Swing Transactions” violated Section 16(b), and request disgorgement of profits obtained through these “Short-Swing Transactions.” None of these alleged transactions is referenced in any way in the original demand letters submitted to the Moving Issuers. The garden-variety Section 19 In Simmonds v. Morgan Stanley & Co., Inc., No. 09-35352, Simmonds alleges that Morgan Stanley and J.P. Morgan (the successor-ininterest to Hambrecht & Quist LLC) respectively sold $46.5 million and $34.6 million in shares of Internap Network Services Corporation as part of a secondary offering. Although Simmonds identified these transactions in her Complaint, she failed to allege that these transactions violated Section 16(b) and she failed to seek disgorgement of any profits obtained from these transactions. Accordingly, her demand letter to Internap Network Services Corporation (which is one of the Moving Issuers), was defective for the same reasons as in the other cases. SIMMONDS v. CREDIT SUISSE SECURITIES 877 16(b) claim made out in these demand letters bears no resemblance to the elaborate scheme described in Simmonds’s Complaints. [9] Even if we consider Simmonds’s follow-up letters to twenty-five of the Moving Issuers, she failed to identify the wrongful acts “clearly and specifically.” Yaw, 1994 WL 89019, at . The follow-up letters noted that the “challenged transactions . . . [are] related to improper IPO allocation (socalled ‘laddering’ and ‘spinning’) and research and stock rating activities.” Simmonds’s conclusory references to “laddering,” “spinning,” and “research and stock rating,” were vague and ambiguous, as was her open ended reference to “court, law firm and SEC websites,” and completely failed to provide sufficiently detailed information to permit the boards to conduct a good faith inquiry into the alleged wrongdoing. [10] Moreover, because the demand letters and the Complaints contain distinct factual assertions, the demand letters also failed to set forth “the legal action the shareholder wants the board to take on the corporation’s behalf.” Yaw, 1994 WL 89019, at . The demand letters requested that the Moving Issuers “compel[ ]” the Underwriters and other group members to “disgorge the profits they made through purchases and sales of [the issuing company’s] stock.” The Complaints, on the other hand, do not mention the Underwriters’ direct trading profits, and instead seek disgorgement of the profits the Underwriters received through their investment banking operations. [11] The Court of Chancery has noted that demand letters must be sufficiently specific to “enable the board to perform its duty to make a good faith investigation of claims of alleged wrongdoing[ ] and . . . to rectify the misconduct” at issue in a subsequent lawsuit. Yaw, 1994 WL 89019, at . The court further noted that “to require a board to investigate claims asserted ambiguously . . . would not be an efficient use of corporate resources, because the board would lack the 878 SIMMONDS v. CREDIT SUISSE SECURITIES information necessary to make a good faith inquiry.” Id. Simmonds’s demand letters were particularly inadequate because they described a different course of conduct than the one she described in her Complaints. And clearly, Simmonds’s demand letters could have led directors to investigate facts (the Underwriters’ purchases and sales of Issuing Company stock) that were only marginally related to the issues ultimately raised in the Complaints (the Underwriters’ customers’ purchases and sales of Issuing Company stock, and associated profit-sharing agreements between the Underwriters and their customers). We are not persuaded by Simmonds’s argument that the Moving Issuers subjectively understood what she meant in her demand letters. Delaware case law sets forth an objective standard for assessing the adequacy of a demand and does not inquire whether the board of directors had independent knowledge of relevant information. To the extent that Simmonds’s argument has been addressed by any courts, it has been soundly rejected. For example, the Third Circuit has rejected a shareholder’s argument that a conclusory demand was adequate because “the directors were in a better position than the shareholders to make the investigation necessary to uncover wrongdoers.” Shlensky, 574 F.2d at 141. In the related context of demand refusal, the Delaware Supreme Court rejected the argument that “[t]he board has better access to the relevant facts” and plaintiffs should therefore be relieved of their burden to show that the board’s refusal was improper. Levine v. Smith, 591 A.2d 194, 209 (Del. 1991) (internal quotation marks omitted), overruled en banc on other grounds by Brehm, 746 A.2d at 253 & n.13. Simmonds’s argument is an end-run around Delaware’s requirement that shareholders make reasonably specific demands, and were we to adopt Simmonds’s proposed approach, Delaware’s demand standard would be eviscerated. Plaintiffs in derivative actions often seek relief for a corporate insider’s wrongdoing. If the demand requirements were SIMMONDS v. CREDIT SUISSE SECURITIES 879 relaxed on account of insiders’ subjective knowledge, then shareholders would never have to “clearly and specifically” describe their assertions in a demand letter. See Yaw, 1994 WL 89019, at . To the extent that Simmonds believed that relevant information was “readily available at court, law firm and SEC websites” as she claimed in her follow-up letters, it was her burden under Delaware law to distill the relevant facts and present them to the board. Delaware law does not allow shareholders to forego pre-suit investigations in an attempt to shift information-gathering costs onto the corporation, and this rule is not clearly incompatible with Section 16 and the Exchange Act. As an alternative to her argument that her demand letters were adequate, Simmonds contends that the demand requirement should be excused as futile. However, Delaware courts have repeatedly held that a shareholder concedes that a demand is not futile by submitting a demand to the board. “Delaware law could hardly be clearer” in holding that shareholders may not invoke the futility exception after submitting a demand to the board. FLI Deep Marine, 2009 WL 1204363, at ; see also id. at  n.17 (collecting cases). [12] We hold that the thirty demand letters in the record fail to satisfy the demand requirement under Delaware law. Accordingly, we affirm the district court’s order granting the Moving Issuers’ motions to dismiss the thirty cases to which they are parties.