Opinion ID: 2826720
Heading Depth: 2
Heading Rank: 1

Heading: The London Whale

Text: The London Whale story begins in JPMorgan’s Chief Investment Office (“CIO”), which manages and invests the excess cash from JPMorgan’s other businesses. J.A. 10. Before 2009, the CIO invested primarily in conservative securities, with the goal of limiting JPMorgan’s exposure to structural risks such as shifts in interest rates or foreign‐exchange rates. J.A. 29. Beginning in 2008 and 2009, however, Defendant‐Appellee Jamie Dimon, the Chief Executive Officer of JPMorgan, began transforming the CIO from a conservative risk‐management unit into a more aggressive proprietary‐trading desk, with the aim of generating additional profit. J.A. 30. 5 Seeking to satisfy this new emphasis on profits, the CIO began taking riskier positions in synthetic credit derivatives. In particular, a group of London traders led by Bruno Iksil—later known by the nom de finance “the London Whale”—made larger and larger bets in these markets. J.A. 32–33. But when these bets began to sour, the CIO doubled down by investing even more money in risky derivatives in an attempt to shore up these investments. J.A. 33–34. To conceal the losses, JPMorgan modified its “Variance at Risk” (“VaR”) model in a way that gave the misleading impression that JPMorgan’s overall risk had stayed constant; an unmodified VaR model would have shown that JPMorgan’s risk had in fact doubled. J.A. 35. The model’s modification was overseen and approved by Dimon. As losses mounted, the markets and the press began to catch wind of JPMorgan’s troubles. On April 6, 2012, Bloomberg reported that the CIO’s positions in the credit derivative market had become so large that they were driving price moves in that market. J.A. 36. Shortly thereafter, Dimon, along with Defendant‐ Appellee Douglas Braunstein, JPMorgan’s then‐Chief Financial Officer, held a conference call with analysts and investors to discuss JPMorgan’s earnings for the 6 first quarter of 2012. During this conference call, Dimon and Braunstein repeatedly claimed that the CIO was conservatively investing in safe securities. J.A. 36–40. For example, Braunstein stated that “[w]e invest . . . in high grade, low‐risk securities” and “[a]ll of [the CIO’s investment] decisions are made on a very long‐term basis . . . to keep the Company effectively balanced from a risk standpoint.” J.A. 37–38. Similarly, Dimon characterized the mounting publicity over the CIO’s losses as “a complete tempest in a teapot.” J.A. 39. But on May 10, 2012, JPMorgan was forced to reveal to investors the scale of the CIO’s losses. J.A. 40. Dimon disclosed, for the first time, that JPMorgan had modified its VaR model to minimize the scale of the risks taken by the CIO. Id. Dimon acknowledged that the CIO’s investments had been “flawed, complex, poorly reviewed, poorly executed, and poorly monitored.” J.A. 41. After all the dust settled, JPMorgan divulged that its total losses from the CIO exceeded $6.25 billion. J.A. 42. The debacle prompted a number of regulatory and Congressional investigations into JPMorgan’s inadequate oversight of the CIO. J.A. 45–49. 7 B. Espinoza’s Demand and the Board’s Investigation On May 23, 2012, Espinoza, a shareholder of JPMorgan, sent a letter to the JPMorgan Board of Directors demanding that the Board investigate the London Whale debacle. J.A. 51. This demand asked the Board to investigate (1) the failure of JPMorgan’s risk‐management policies, (2) the dissemination of false or misleading information about the scandal, and (3) the extent to which JPMorgan had repurchased stock at inflated prices due to the failure to disclose the losses. J.A. 69. Espinoza also demanded that, following the investigation, JPMorgan sue the responsible individuals and claw back previously‐awarded salary and bonuses. J.A. 69–70. Espinoza also demanded that JPMorgan improve corporate governance and implement better risk controls. J.A. 70. In response to Espinoza’s demand, which was joined by similar demands from other JPMorgan shareholders, the JPMorgan Board established a “Review Committee” composed of Defendants‐Appellees Laban Jackson, Jr., Lee Raymond, and William Weldon, all members of the Board. J.A. 52–53. This committee would oversee JPMorgan’s internal “Management Task Force,” which had been assembled to investigate the London Whale debacle, and consider what 8 actions, if any, JPMorgan should take in response. J.A. 53. The task force was led by Defendant‐Appellee Michael Cavanagh. J.A. 54. The Board rejected Espinoza’s demand by letter dated February 5, 2013. J.A. 83–86. The letter outlined the Review Committee and task force’s extensive investigation, which included (1) 22 interviews of current and former JPMorgan employees, (2) a review of roughly 300,000 documents, (3) meetings with regulators, (4) an analysis of relevant news reports, and (5) a survey of industry best practices. J.A. 83–84. The Board stated that, in its judgment, further litigation was not in the best interests of JPMorgan. J.A. 86. In support of this conclusion, the letter identified various remedial measures that had already been taken, including a revamp of the CIO leadership and mandate, improved risk controls, reduced salary for certain senior management and CIO personnel, clawbacks of previously awarded bonuses, and the departure or reassignment of certain individuals involved in the debacle. J.A. 85. The Board also cited various factors that it weighed in deciding to not pursue litigation, including the cost of litigation, the low likelihood of success, the cost of bogging employees down in lawsuits, and the effect on employee morale. J.A. 85–86. 9 Espinoza then filed this lawsuit, arguing that his demand had been wrongfully refused. On March 31, 2014, the district court dismissed the complaint for failure to state a claim because the complaint did not show that the Board had failed to exercise appropriate business judgment in rejecting the demand. See Espinoza v. Dimon, No. 13‐cv‐2358, 2014 WL 1303507, at  (S.D.N.Y. Mar. 31, 2014). Although Espinoza asked for leave to amend if his complaint were dismissed, the district court did not grant leave to amend and instead entered judgment for the defendants immediately. See id.; Special App. 12–13. LEGAL FRAMEWORK
“The derivative form of action permits an individual shareholder to bring ‘suit to enforce a corporate cause of action against officers, directors, and third parties.’” Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95 (1991) (quoting Ross v. Bernhard, 396 U.S. 531, 534 (1970)) (emphasis omitted). “Devised as a suit in equity, the purpose of the derivative action [is] to place in the hands of the individual shareholder a means to protect the interests of the corporation from 10 the misfeasance and malfeasance of ‘faithless directors and managers.’” Id. (quoting Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548 (1949)). “[A] shareholder seeking to assert a claim on behalf of the corporation must first exhaust intracorporate remedies by making a demand on the directors to obtain the action desired.” Scalisi v. Fund Asset Mgmt., L.P., 380 F.3d 133, 138 (2d Cir. 2004) (internal quotation marks omitted). If the board refuses the shareholder’s demand, the derivative suit may proceed only if the shareholder shows that the board’s refusal was “wrongful.” Abramowitz v. Posner, 672 F.2d 1025, 1030 (2d Cir. 1982). Accordingly, Rule 23.1 of the Federal Rules of Civil Procedure requires a complaint in a derivative action to “state with particularity . . . 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 . . . the reasons for not obtaining the action or not making the effort.” Fed. R. Civ. P. 23.1(b)(3). Although Rule 23.1 sets forth the pleading standard for federal court, the substance of the demand requirement is a function of state law—here, Delaware law. See RCM Sec. Fund, Inc. v. Stanton, 928 F.2d 1318, 1326 (2d Cir. 1991). 11 Under Delaware law, these allegations of wrongful refusal are reviewed under the business‐judgment rule, which creates “a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Importantly, “[t]he ultimate conclusion of the [board] . . . is not subject to judicial review.” Spiegel v. Buntrock, 571 A.2d 767, 778 (Del. 1990) (ellipsis in original) (quoting Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (Del. 1981)). Instead, when evaluating wrongful refusal, “[t]he issues are solely the good faith and the reasonableness of the committee’s investigation.” Id. “[F]ew, if any, plaintiffs surmount [the] obstacle” of rebutting the presumption created by the business‐judgment rule and showing that a demand was wrongfully refused. RCM Sec. Fund, Inc., 928 F.2d at 1328.
Ordinarily, we review dismissals de novo. See, e.g., Muto v. CBS Corp., 668 F.3d 53, 56 (2d Cir. 2012). But traditionally, there has been an exception to this general rule for derivative actions. In our Circuit, a line of cases dating back more 12 than three decades has “held that determination of the sufficiency of allegations [under Rule 23.1] depends on the circumstances of the individual case and is within the discretion of the district court . . . [and] [c]onsequently, our standard of review is abuse of discretion.” Kaster v. Modification Sys., Inc., 731 F.2d 1014, 1018 (2d Cir. 1984); see also Lewis v. Graves, 701 F.2d 245, 248 (2d Cir. 1983) (“[T]he decision as to whether a plaintiff’s allegations of futility are sufficient to excuse demand depends on the particular facts of each case and lies within the discretion of the district court.”); Elfenbein v. Gulf & W. Indus., Inc., 590 F.2d 445, 450–51 (2d Cir. 1978) (per curiam). The holding of these older cases has been reiterated several times by more recent decisions. See Halebian v. Berv, 590 F.3d 195, 203 (2d Cir. 2009); Scalisi, 380 F.3d at 137. Over the past few years, however, numerous courts have expressed doubts about the wisdom of reviewing Rule 23.1 dismissals for abuse of discretion rather than de novo. Seeing no reason to treat derivative actions differently than any other dismissed case, the First and Seventh Circuits recently adopted a de novo standard. See Unión de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan v. 13 UBS Fin. Servs. Inc. of Puerto Rico, 704 F.3d 155, 162 (1st Cir. 2013)3; Westmoreland Cnty. Emp. Ret. Sys. v. Parkinson, 727 F.3d 719, 724–25 (7th Cir. 2013). Judges in the Ninth and District of Columbia Circuits, although bound to abuse‐of‐discretion review by their precedents, have both questioned the wisdom of deferential review in this context. See Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust ex rel. Fed. Nat’l Mortg. Ass’n v. Raines, 534 F.3d 779, 783 n.2 (D.C. Cir. 2008) (Kavanaugh, J.) (“We tend to agree with plaintiffs that an abuse‐of‐discretion standard may not be logical in this kind of case . . . because the question whether demand is excused turns on the sufficiency of the complaint’s allegations; and the legal sufficiency of a complaint’s allegations is a question of law we typically review de novo.”); Rosenbloom v. Pyott, 765 F.3d 1137, 1159–60 (9th Cir. 2014) (Reinhardt, J., specially concurring). The Delaware Supreme Court, known for its corporate law jurisprudence, expressly discarded abuse‐of‐discretion review of dismissals under the substantively identical Delaware Chancery Court Rule 23.1. 3 The Supreme Court granted certiorari in Unión de Empleados to resolve the circuit split over the proper standard of review, see 133 S. Ct. 2857 (2013), but dismissed the case after the parties settled, see 134 S. Ct. 40 (2013). 14 See Brehm, 746 A.2d at 253–54 (Del. 2000).4 Last but not least, several decisions in our Circuit have voiced puzzlement over the abuse‐of‐discretion holdings of Kaster, Lewis, and Elfenbein. See Scalisi, 380 F.3d at 137 n.6; see also Gamoran v. Neuberger Berman LLC, 536 F. App’x 155, 157 (2d Cir. 2013); Kautz v. Sugarman, 456 F. App’x 16, 18 (2d Cir. 2011). We are persuaded by the reasoning of those courts that have chosen to review these dismissals de novo. In reviewing the dismissal of a derivative claim, an appellate court performs exactly the same task as when reviewing the dismissal of any other action: the court reads the facts alleged in the complaint, assumes the truth of those facts, and decides whether those facts state a claim under the applicable legal standard. No evidence is considered, no credibility determinations are made, and none of the other usual justifications for deferring to a district court are in play. Or, as the Delaware Supreme Court put it in Brehm: The nature of our analysis of a complaint in a derivative suit is the same as that applied by the [lower court] in making its decision in the first instance[:] . . . this Court[] is merely reading the English language of a pleading and applying to that pleading statutes, case 4 Following Delaware’s Brehm decision, several other state courts have also endorsed de novo review of dismissals of derivative actions. See, e.g., In re PSE & G S’holder Litig., 801 A.2d 295, 313 (N.J. 2002); Harhen v. Brown, 730 N.E.2d 859, 866 (Mass. 2000). 15 law and Rule 23.1 requirements. To that extent, our scope of review is analogous to that accorded a ruling under Rule 12(b)(6). 746 A.2d at 253–54 (footnotes omitted)5; see also Pierre N. Leval, Judging Under the Constitution: Dicta About Dicta, 81 N.Y.U. L. Rev. 1249, 1273 (2006) (explaining that our abuse‐of‐discretion precedents are “surely wrong” because “[i]t cannot be a matter of a district judge’s discretion whether a complaint is legally sufficient to state a claim”). And while it is surely true that, as the defendants point out in their brief, the sufficiency of a complaint’s demand allegations will “depend[] on the particular facts of each case,” Lewis, 701 F.2d at 248, that alone is not enough to justify deferential review. Many other legal questions turn on the specific context of a given case, and yet they remain purely legal questions subject to de novo review. For example, when a district court dismisses a fraud claim for lacking the particularized allegations required by Fed. R. Civ. P. 9(b), we review that dismissal de novo even though the adequacy of particularized allegations under Rule 9(b) is just as case‐ and context‐specific as the adequacy of particularized 5 Because so many derivative actions arise under Delaware law, we pay special heed to the Delaware Supreme Court’s decision in Brehm. By aligning our standard of review with the standard used by the Delaware appellate courts, we minimize any “anomalies resulting from separate federal and state demand requirements.” RCM Sec. Fund, Inc., 928 F.2d at 1329. 16 demand allegations under Rule 23.1. See, e.g., S.Q.K.F.C., Inc. v. Bell Atl. TriCon Leasing Corp., 84 F.3d 629, 633 (2d Cir. 1996). Accordingly, we discard the deferential standard articulated by Kaster, Lewis, and Elfenbein, and hold that dismissals under Rule 23.1 are reviewed de novo.6 In reaching this conclusion, we further note that the defendants conceded at oral argument that, were we writing on a blank slate, it would make sense for dismissals under Rule 23.1 to be reviewed de novo.7