Federal Rule of Civil Procedure 23.1 requires that a shareholder derivative action be dismissed “if it appears that the plaintiff does not fairly and adequately represent the interest of shareholders.” Fed. R. Civ. P. 23.1(a). In a recent strongly-worded opinion by the United States District Court for the Southern District of New York, the district court dismissed a shareholder derivative action based on the plaintiff’s failure to satisfy this basic requirement of Rule 23.1. See JPMorgan Chase & Co. Shareholder Derivative Litig., No. 08 Civ. 974(DLC), 2008 WL 4298588, at *1 (S.D.N.Y. Sept. 19, 2008).
Originally, two identical shareholder suits were filed against certain officers and directors of JP Morgan alleging breaches of their fiduciary duties through “various acts and omissions related to the recent subprime mortgage crisis.” Id. These cases were consolidated and lead counsel appointed to oversee proceedings going forward. The court subsequently held a pretrial conference during which it inquired as to the basic background information on the lead plaintiff. Plaintiff’s counsel was, however, forced to admit that he had never met the plaintiff, did not know his occupation, and did not know when he purchased JP Morgan shares. Id.
Relying on the above-quoted passage from Rule 23.1, the court ordered lead counsel to provide documentation regarding its qualifications as well as the plaintiff’s qualifications to serve as lead plaintiff. Id. In response, the lawyers submitted a declaration on their firm, but stated in a letter accompanying that submission that they could not procure a declaration from the plaintiff due to “scheduling difficulties.” Id. at *2. A week later, the attorneys submitted a second letter stating that they no longer intended to submit a declaration on behalf of the plaintiff and would instead move to dismiss him from the action. The letter explained that the plaintiff was elderly and did not have the necessary time to devote to the litigation. Id. Lead counsel then proposed another individual to serve as lead plaintiff.
At this stage in the case, the court had become skeptical about the ability of plaintiff and plaintiff’s counsel to satisfy the Rule 23.1 requirements. Making matters worse, the court, through its own research, discovered an opinion issued by the Superior Court of North Carolina, which dismissed another shareholder derivative action brought by the same counsel because these attorneys “knew absolutely nothing about” their client. Id. at *3 (citing Egelhof v. Szulik, No. 04 CVS 11746, 2008 WL 352668, at *2 (N.C. Super. Ct. Feb. 4, 2008)). Based on this discovery, the court entered an order: (1) requiring the defendants to depose the new proposed lead plaintiff regarding his qualifications; (2) allowing the former proposed lead plaintiff to be deposed; and (3) requiring lead counsel to submit a list of cases in which the lawyers at issue or their firm had been sanctioned in the last ten years. Id. at *4.
More damaging information was uncovered during the depositions of the plaintiffs ordered by the court. The original proposed plaintiff testified that he did not understand what a derivative lawsuit was. Id. at *4. Furthermore, he testified that he had not withdrawn from the suit because, as his counsel suggested, he did not have enough time to devote to the litigation. Rather, he withdrew “[b]ecause [he] didn’t think the subprime rational[e] was valid.” Id. The deposition of the second proposed lead plaintiff revealed that, unlike his predecessor, he did actually understand how derivative actions worked, and that he understood the factual basis of the claims at issue. He testified, however, that he had been a named plaintiff in roughly twenty-five other actions and could not recall basic details of those cases.
After completing these depositions, the court set a schedule for the defendants’ motion to dismiss and stayed the previously scheduled date for filing the consolidated complaint. In response, plaintiff’s counsel requested leave to withdraw from the case, which the court granted. Thereafter, the plaintiff retained new counsel, and the defendants filed their motion to dismiss.
The court granted defendants’ motion, holding that, “[f]rom the start, this litigation has been controlled by counsel with absentee plaintiffs.” Id. at *8. The court determined that lead counsel had initiated the litigation and put forth an elderly plaintiff, who “understood neither the nature of the derivative action nor his duties as the named plaintiff in such litigation.” Id. Making matters worse, once the court discovered these inadequacies, counsel offered “a professional plaintiff” who was “appallingly ignorant of the many derivative actions that have been filed in his name.” Id. at *9.
The court concluded its opinion with an analysis of the Private Securities Litigation Reform Act of 1995 (“Reform Act”). The court noted that the same abuses that led to the passage of the Reform Act — the increasing frequency of professional plaintiffs and lawyer-driven securities litigation — “permeate the world of derivative litigation as well.” Id. at *10. This case, according to the court, was exemplary of such abuses and required dismissal of all the pending claims.