A New York federal district court recently dismissed two derivative actions brought in connection with “unprecedented losses” suffered by Merrill Lynch, Inc. (“Merrill”) due to “aggressive investments” in collateralized debt obligations (“CDOs”) and similar mortgage-backed securities in the time period prior to Merrill’s acquisition by Bank of America (“BofA”). In re Merrill Lynch & Co., Inc., Securities, Derivative and ERISA Litigation and Lambrecht v. O’Neal, Case Nos. 07 Civ. 9696, 09 Civ. 8259 (S.D.N.Y. Mar. 29, 2011). The two actions — a consolidated case referred to as the “Derivative Action” and a later-filed case Lambrecht v. O’Neal (“Lambrecht”) — were brought by plaintiffs who were shareholders of Merrill at the time of Merrill’s “allegedly reckless investments” and who later became shareholders of BofA as a result of Merrill’s acquisition by BofA. The key factual distinction between the two cases is that the plaintiff in the Derivative Action argued that a demand upon the BofA Board to pursue the claims would be futile, whereas the Lambrecht plaintiff made the demand upon the BofA Board (and the pre- and post-Merger Merrill Boards) which was rejected. Despite this distinction, the court dismissed both cases in their entirety holding that the demand was not excused in the Derivative Action and that the BofA Board did not wrongfully reject the Lambrecht plaintiff’s demands.  

Facts

The Derivative Action and the Lambrecht action both sought to require the BofA Board to force its Merrill subsidiary to bring claims against certain of Merrill’s officers and directors in connection with the “allegedly reckless investments” in CDOs and mortgage-backed securities. Both complaints contain similar factual allegations. The court’s discussion and analysis focuses on: (i) whether the Derivative Action plaintiff demonstrated that a demand upon the BofA Board would be futile and (ii) whether the Lambrecht plaintiff’s demands upon the Board were properly rejected by the Board.  

The Derivative Action

With respect to demand futility, the court explained that the Delaware Supreme Court held in Rales v. Blasband, 634 A.2d 927 (Del. 1993) that a demand is futile in the context of a double derivative suit — being a suit where the stockholder of a parent corporation seeks recovery for a cause of action belonging to the subsidiary corporation — if “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.” The Delaware Supreme Court further explained that the “mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterested of directors, but must rise to a substantial likelihood.” In this case, plaintiff alleged that the BofA Board “could not make a disinterested and independent assessment of a demand” to bring claims against the Merrill officers and directors because a majority of the BofA Board faced a “substantial likelihood” of liability related to the Merger. In support of that allegation, plaintiff argued that at the time of the filing the operative complaint the BofA Board consisted of 16 individuals (two of which were also on Merrill’s pre-Merger Board and 10 of which were on BofA’s pre-Merger Board). Therefore, plaintiff alleged “the vast majority of the current members of the BofA Board approved the Merger . . . and have potential liability resulting from that approval.”

In response to plaintiff’s arguments, the court explained that “[t]he legal adequacy of a complaint’s allegations of demand futility must be assessed on a claim-by-claim basis.” The court went on to explain that as all of the claims in the operative complaint (except one) relate to pre-Merger activity “the overwhelming majority of the members of the BofA Board have no potential liability.” Specifically, “[p]laintiff fails to explain why the BofA Board would be incapable of performing a disinterested assessment of a demand to sue the Merrill Defendants for their pre-Merger conduct (mostly relating to CDO underwritings undertaken in 2006-2007 and stock repurchases or sales also made in 2007).” Therefore, the court determined that plaintiff failed to demonstrate demand futility with respect to the pre-Merger claims alleged in the complaint.  

With respect to the one allegation in the complaint that expressly related to Merger-related activities, the court determined that plaintiff had also failed to demonstrate demand futility. Specifically, plaintiff alleged corporate waste with respect to bonus payments to Merrill employees and argued that the BofA Board approved the payments without first determining the amount of such payments or to whom they would be given. The court explained, however, that “[i]t is undisputed that the BofA directors received no personal benefit from Merrill’s approval of bonuses for Merrill employees” and that “a lack of diligence without a personal interest in the bonus payments is insufficient to establish a breach of duty subjecting any member of the BofA Board to liability.” Accordingly, the court determined that plaintiff “failed to state allegations sufficient to create a reason to doubt that the BofA Board was capable of properly exercising its independent and disinterested business judgment in responding to a demand” to pursue the claim for corporate waste in connection with Merger-related activities.

With respect to plaintiff’s additional allegations that the BofA Board and the Merrill defendants allegedly shared liability for other wrongdoing in connection with the Merger, the court again stressed that “demand futility must be assessed with respect to the particular causes of action that the board would otherwise be asked to consider if demand were made.” Therefore, the shared liability for alleged wrongdoing in connection with the Merger is insufficient to excuse the demand requirement with respect to the claims alleged in the complaint. As the court explained, “were it otherwise, a plaintiff could always avoid having to make a demand in a double derivative situation by merely alleging that the members of the board of the acquiring company had some knowledge at the time of acquisition of the prior wrongdoings alleged against the officers and directors of the acquired company.” The court further explained that Delaware law “requires far more than such boot-strapping to excuse the obligation of a demand.” Accordingly, the court rejected plaintiff’s argument — which it characterized as a “variation on such boot-strapping” — that the demand would be futile because the BofA Board caused BofA to indemnify and hold harmless the directors and officers of Merrill from liability from the Merger “to the fullest extent provided by applicable law” and to maintain Merrill’s directors’ and officers’ insurance policies (or equivalent policies) for six years after the Merger.  

The court rejected all of the plaintiff’s demand futility arguments holding that “plaintiffs have failed to make a legally adequate showing that the BofA Board was so involved in the underlying wrongdoing alleged in the Derivative complaint that it could not impartially consider a demand to pursue claims against the Merrill officers and directors.”  

The Lambrecht Action

Unlike the plaintiff in the Derivative Action, the plaintiff in the Lambrecht action made several demands upon the various Boards to pursue the claims. The court explained that “[a] board’s decision to reject a demand is entitled to the benefit of the business judgment rule.” The court further explained that “[u]nder Delaware law, the directors’ decision will be shielded by the business judgment rule unless the shareholder plaintiff can carry the considerable burden of showing that the decision not to bring the lawsuit was made in bad faith or was based on an unreasonable investigation.”

The plaintiff primarily argued that the refusal was wrongful because the Board did not seriously consider the demand. Plaintiff pointed to the fact that consideration of the demand was held in a single meeting and that the Board responded to the demand in a boilerplate rejection letter. Plaintiff further argued that some of the Board members were not independent and challenged the substance of the Board’s decision not to pursue the claims. The court easily dispensed of these arguments stating “[i]t is well-established that where a shareholder instead chooses to make a demand upon a board of directors, she concedes the independence of a majority of the board” and “Delaware law does not permit a plaintiff to overcome the business judgment rule simply by asserting that the substance of a board of director’s decision was wrong.”

The court further explained that the balance of plaintiff’s allegations were conclusory and failed to satisfy the Federal Rules of Civil Procedure which requires that the plaintiff “state with particularity” “legally sufficient reasons to call into question the validity of the Board of Directors’ exercise of business judgment.” In addition, the court pointed out that the Board’s rejection letter was not in fact “inadequate boilerplate” as the plaintiff asserted but explained the reasons for rejecting the demand. Accordingly, the court determined that “it does not appear that the investigation and analysis described in the BofA rejection letter was unreasonable or conducted in bad faith.” Therefore, the court held that plaintiff’s conclusory assertions that the Board’s investigation was inadequate “are insufficient to overcome the presumption of the business judgment rule.”  

Conclusion

As the court concluded that the demand in the Derivative Action was not excused and that the BofA Board did not wrongfully reject the demand in the Lambrecht action, the court dismissed both complaints in their entirety. Although the court dismissed both actions, the court made clear that it was keenly aware of the impact of the allegedly “risky” behavior of Merrill’s officers and directors — if true — in creating the economic crisis. The court explained:  

“The Court does not take this step lightly, for the allegations of the complaints, if true, describe the kind of risky behavior by high-ranking financiers that helped create the economic crisis from which so many Americans continue to suffer. But a derivative action is brought for the benefit of the company, and nothing here alleged in the complaints raises a reason to doubt that the board of the relevant company, BofA, was at all times fairly positioned to determine whether bringing an action against Merrill’s former officers and directors was in the company’s interest.”