Robert Baca v. Timothy Crown , 458 F. App'x 694 ( 2011 )

FILED
NOT FOR PUBLICATION NOV 21 2011
MOLLY C. DWYER, CLERK
UNITED STATES COURT OF APPEALS U.S. COURT OF APPEALS
FOR THE NINTH CIRCUIT
ROBERT P. BACA, No. 10-16718
Plaintiff-Appellant, D.C. No. CV09-01283-PHX-SRB
v.
MEMORANDUM*
TIMOTHY A. CROWN; et al.,
Defendants-Appellees,
and
INSIGHT ENTERPRISES, INC.,
a Delaware Corporation,
Nominal Defendant-Appellee.
Appeal from the United States District Court
for the District of Arizona
Susan R. Bolton, District Judge, Presiding
Argued and Submitted October 24, 2011
San Francisco, California
Before: GRABER and IKUTA, Circuit Judges, and KAPLAN,** Senior District
Judge.
*
This disposition is not appropriate for publication and is not precedent
except as provided by 9th Cir. R. 36-3.
**
The Honorable Lewis A. Kaplan, Senior United States District Judge for
the Southern District of New York, sitting by designation.
Robert P. Baca (“Baca”), a shareholder of Insight Enterprises, Inc. (“Insight”),
appeals the district court’s dismissal of his Second Amended Shareholder Derivative
Complaint (“SAC”) for failure to plead demand futility with sufficient particularity.
This court reviews for abuse of discretion a district court’s dismissal for failure to
plead demand futility adequately. Janas v. McCracken (In re Silicon Graphics Inc.
Sec. Litig.), 183 F.3d 970, 983 (9th Cir. 1999).
In a shareholder’s derivative action, the plaintiff purports to sue in the right and
for the benefit of the corporation. Such an action implicates Federal Rule of Civil
Procedure 23.1, two aspects of which are pertinent here.
First, Federal Rule of Civil Procedure 23.1(b)(1) provides in relevant part that
the complaint in a derivative action “must . . . allege that the plaintiff was a
shareholder . . . at the time of the transaction complained of.” As plaintiff alleges that
he first purchased shares of Insight on July 19, 2002, and held them continuously until
the date of the second amended complaint, which was February 8, 2010 [ER 64], this
contemporaneous ownership rule limits the transactions of which he may complain
to those that allegedly occurred during that period.
Second, Rule 23.1(b)(3) requires, in relevant part, that a derivative plaintiff
who, like this plaintiff, alleges no demand on the board of directors to pursue the
claim that the plaintiff seeks to bring on the corporation’s behalf “state with
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particularity . . . the reasons for not . . . making the effort.” This requirement protects
the directors’ right under state corporation law to exercise their business judgment as
to whether to pursue a corporate claim and “prevent[s] abuse of t[he derivative suit]
remedy. . . [by insisting] that the shareholder demonstrate ‘that the corporation itself
had refused to proceed after suitable demand, unless excused by extraordinary
conditions.’” Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95-96 (1991) (quoting
Ross v. Bernhard, 396 U.S. 531, 534 (1970)); accord Potter v. Hughes, 546 F.3d
1051, 1058 (9th Cir. 2008). Rule 23.1, however, does not impose any demand
requirement of its own. Kamen, 500 U.S. at 96-97. It merely accommodates state-
imposed demand requirements. Thus, the question whether demand is excused,
pertaining as it does to the internal governance of the corporation, is governed by state
law. Nevertheless, the particularity requirement of Rule 23.1 “creates a federal
pleading standard regarding the specificity of efforts that the plaintiff made to have
the corporation’s directors bring an action.” 5 JAMES WM. MOORE ET AL., MOORE’S
FEDERAL PRACTICE § 23.1.08[1], at 23.1-28 (3d ed. 2011); see also, e.g., Sax v. World
Wide Press, Inc., 809 F.2d 610, 613 (9th Cir. 1987).
In Aronson v. Lewis, 473 A.2d 805 (Del. 1984), the Delaware Supreme Court
held that demand is excused if the derivative complaint adequately pleads facts
creating a reasonable doubt that “(1) the directors are disinterested and independent
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[or] (2) the challenged transaction was otherwise the product of a valid exercise of
business judgment.” Id. at 814 (followed by Potter, 546 F.3d at 1058). But that court
later made clear that the “essential predicate” for application of the Aronson rule “is
the fact that a decision of the board of directors is being challenged in the derivative
suit.” Rales v. Blasband, 634 A.2d 927, 933 (Del. 1993) (emphasis in original).
Where, in contrast, “there is no conscious decision by directors to act or refrain from
acting,” the question becomes “whether . . . 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.” Id. at 933-34.
Directors, moreover, are deemed “interested” for purposes of demand futility when
they “receive a personal financial benefit from a transaction that is not equally shared
by the stockholders” or when they face “a substantial likelihood” of liability for
approving a questioned transaction. Id. at 936.
Baca alleges two types of claims here. First, he alleges that Tim Crown
received backdated options and that Gunning, Jones, Fisher, and Dorrance – as
members of Insight’s Compensation Committee – approved the issuance of backdated
options (“Backdating Claims”). As the Backdating Claims do not challenge a board
decision, they are analyzed under Rales. Second, he alleges that the Insight board
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committed waste by not attempting to recover the allegedly excessive compensation
generated by the backdated options (“Refusal to Pursue Recovery Claim”). This
challenges a board decision and thus is analyzed under Aronson.
To pursue either claim, Baca must allege that at least half of the Insight board
could not impartially and independently consider a demand. See, e.g., Beam ex rel.
Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1046 n.8 (Del.
2004).
The Backdating Claims
As Baca concedes that five of the ten directors at the time he filed the second
amended complaint are disinterested with respect to the Backdating Claims, that
aspect of his complaint cannot stand unless it pled adequately that all five of the others
are “interested.” The complaint sought to do so first by alleging that Tim Crown is
interested under Rales because he was issued backdated options and thus “receive[d]
a personal financial benefit from a transaction that is not equally shared by the
stockholders.” Rales, 634 A.2d at 936. It went on to allege also that Gunning, Jones,
Fisher, and Dorrance, members of the Compensation Committee, are interested under
Rales because they face “a substantial likelihood” of liability for allegedly approving
the issuance of backdated options. Id.5
In support of his claim that Tim Crown received backdated options, Baca relies
on Insight’s 2006 Form 10-K, which stated that Insight’s top three executives,
including Crown, received some options with incorrect measurement dates between
1996 and 2005. [ER 121] The incorrect measurement dates were said to have resulted
from inadequate documentation or, in some cases, favorable retrospective date
selection – i.e., backdating. [Id.] In relying solely on the Form 10-K, however, Baca
fails to identify: (1) whether any options that Crown received were backdated as
opposed, for example, to having lacked adequate documentation, and (2) whether any
backdated options that he did receive were given between 2002 and 2005, which was
the relevant period during which Baca owned Insight stock. In other words, Baca
does not plead with particularity either that Crown actually received a backdated stock
option or, if he did, whether that occurred while Baca was a stockholder. Baca thus
does not allege that Crown “receive[d] a personal financial benefit from a [challenged]
transaction that is not equally shared by the stockholders,” Rales, 634 A.2d at 936, or,
even if he did, that the benefit arose from a transaction of which Baca has standing to
complain. Accordingly, the complaint does not adequately plead facts which, if true,
would justify a conclusion that demand is excused as to Crown with respect to the
Backdating Claims.
Baca again depends on the 2006 Form 10-K in alleging that Gunning, Jones,
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Fisher, and Dorrance face “a substantial likelihood” of liability for approving the
issuance of backdated options as members of the Compensation Committee. Id.Although Insight’s Form 10-K noted “instances of inadequate documentation, or
retrospective date selection” for certain options that required Compensation
Committee approval, Baca does not allege that any backdated option was approved
in 2004 or 2005, the only years during the relevant period when all four of these
directors served on the committee together. [ER 121] Accordingly, he fails to allege
with particularity that all of these four members of the Compensation Committee
actually approved the stock options in question. See In re CNET Networks, Inc., 483
F. Supp. 2d 947, 965 (N.D. Cal. 2007). Baca therefore does not plead with
particularity that all of these four members of the Compensation Committee will face
“a substantial likelihood” of liability. Rales, 634 A.2d at 936.
To prevail on his Backdating Claims, Baca had to allege that Crown and all four
members of the Compensation Committee were disabled from passing on a demand,
as the ability of any of the five of them to act with the five concededly disinterested
directors would have left a qualified board majority. But his allegations fall short as
to each of the five.
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The Refusal to Pursue Recovery Claim
Baca’s Refusal to Pursue Recovery Claim is that the Insight board’s decision
not to seek recovery of excessive compensation generated by any backdated options
constituted waste and was not the “product of a valid exercise of business judgment.”
Aronson, 473 A.2d at 814.
Although Baca alleges that the decision not to pursue claims against those who
received excessive compensation is not entitled to the presumptive validity afforded
by the business judgment rule, he does not question that there are numerous valid
business justifications why a corporation might choose to forego legal action in these
circumstances. See Allison v. Gen. Motors Corp., 604 F. Supp. 1106, 1113 (D. Del.
1985) (“[T]he GM Board’s knowledge of wrongs and failure to institute suit, without
more, is inadequate to excuse demand. A general allegation that the Board acquiesced,
as signified by its failure to file remedial litigation, is not sufficiently particular to
demonstrate demand futility.”) (citations omitted); see also Halpert Enters., Inc. v.
Harrison, No. 06 Civ. 2331(HB), 2007 WL 486561, at *3 (S.D.N.Y. Feb. 14, 2007)
(applying Delaware law and noting that a company’s refusal to bring claims against
directors was protected by the business judgment rule because, among other reasons,
“the potential costs of litigation against the directors greatly outweighed the potential
benefits”). He has not alleged with particularity any reason to doubt that a majority
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of the board was disinterested or that their action was not a valid exercise of business
judgment. Baca thus fails to satisfy the Aronson standard.
Accordingly, we affirm the district court’s dismissal of both of Baca’s claims
for failure to allege demand futility.
AFFIRMED.
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