PARSONS, Vice Chancellor.
This case involves a stockholder challenge to the decision of two funds within the Vanguard mutual fund complex to purchase shares of allegedly illegal foreign online gambling businesses that are publicly traded in overseas capital markets. The plaintiffs allege that various defendants, including the board of trustees overseeing the two Vanguard Delaware statutory trusts whose funds purchased such shares, as well as various financial advisory firms that serviced the funds and certain of their employees, conspired to cause the funds at issue to purchase and hold the challenged securities in violation of 18 U.S.C. § 1955, which makes it a crime to "own" any part of an illegal gambling business. The plaintiffs further allege that, despite indications by the mid 2000s that U.S. law enforcement and regulatory agencies would begin to crack down on foreign online gambling businesses that targeted U.S. citizens, the defendants failed to cause the relevant mutual funds to sell the challenged securities. As a result of the step up in enforcement actions, according to the plaintiffs, the value of the shares held by the mutual funds dropped precipitously in recent years, thereby causing the funds and their stockholders to lose millions of dollars.
The plaintiffs' complaint asserts both derivative and direct claims based on their allegations that the defendants' actions constituted a violation of their fiduciary duties, negligence, and waste. All of the many defendants in this action have moved to dismiss the complaint on the grounds that: (1) this Court may not assert personal jurisdiction over the individual defendants named in the complaint; (2) all of the plaintiffs' claims are derivative in nature and, therefore, the complaint must be dismissed for the plaintiffs' failure to make demand on the board of trustees or demonstrate why a demand would be futile; and (3) the complaint fails to state a claim.
For the reasons discussed in this Opinion, I grant the defendants' motions and dismiss with prejudice all of the claims in the complaint based on the first two grounds stated above. Consequently, I do not address Defendants' additional argument that the complaint fails to state a claim.
Plaintiffs, Marylynn Hartsel and Deanna Parker, are stockholders of certain funds offered by Vanguard Horizon Funds ("VHF") and Vanguard International Equity Index Funds ("VIEIF"), respectively.
For the sake of clarity, I introduce the numerous defendants in this action by summarizing the basic structure of the mutual fund complex involved.
Nominal Defendants are part of a larger mutual fund complex in which there are thirty-four other separate registered investment companies like them (the "Vanguard Complex").
Defendant the Vanguard Group, Inc. ("Vanguard") is an investment management company organized under the laws of and headquartered in Pennsylvania. It is owned by the investment companies it manages and, importantly, the same board of trustees that oversees each separate mutual fund series in the Vanguard Complex also serves as Vanguard's board of directors. Vanguard serves as an investment adviser to approximately thirty-six investment companies, including VHF and VIEIF.
Besides Kelly, two additional Defendant-entities and certain of their employees provided investment advisory services to Vanguard Global. At all relevant times, Defendant Acadian Asset Management, LLC ("Acadian") exercised managerial or operational oversight concerning Vanguard Global's investment strategy. Acadian is a Delaware LLC with its principal place of business in Boston, Massachusetts. Defendants Ronald D. Frashure, John R. Chisholm, and Brian K. Wolahan allegedly are Acadian portfolio managers who were responsible for Vanguard Global's complained-of investment strategy (the "Acadian Individual Defendants").
Defendant Marathon Asset Management, LLP ("Marathon") is an investment advisory firm organized under the laws of the United Kingdom, which maintains an office in Mt. Kisco, New York. According to Plaintiffs, Marathon also provided investment advisory services to Vanguard Global and exercised managerial or operational control over its investments beginning around April 2006. Plaintiffs allege that, like his counterparts at Acadian, Defendant Neil M. Ostrer, a Marathon portfolio manager, was responsible for implementing certain of Vanguard Global's complained-of investment decisions.
At the heart of Plaintiffs' Complaint is 18 U.S.C. § 1955 ("§ 1955"), which, among other things, prohibits a person or entity from owning all or part of an "illegal gambling business."
Plaintiffs' chief contention is that various Defendants, as fiduciaries responsible for managing and advising the Vanguard Funds, knowingly caused the Affected Funds to purchase shares of four allegedly illegal off-shore internet gambling businesses that accepted and processed wagers from U.S. citizens (the "Challenged Securities").
As is discussed further below, Plaintiffs argue that Defendants caused Nominal Defendants, VHF and VIEIF, through their respective Affected Funds, to violate § 1955 and breach their fiduciary duties by purchasing and continuing to own shares in the Gambling Enterprises. Plaintiffs further allege that Defendants took these actions despite being aware of the illegality of their investments.
Next, I briefly summarize the details of the Affected Funds' purchases of the Challenged Securities.
During the period from April 1, 2006 until at least November 1, 2006, VIEIF, through the Vanguard European fund, purchased millions of dollars worth of Sportingbet shares.
Similarly, from January 1, 2006 and until at least January 1, 2007, VHF, through the Vanguard Global fund, purchased incrementally 68,624 Sportingbet shares.
Between May 1, 2006 and May 1, 2008, VIEIF, through the Vanguard European fund, purchased millions of dollars worth of PartyGaming shares.
Similarly, VHF, through the Vanguard Global fund, purchased 607,500 shares of PartyGaming in 2006. In particular, Plaintiffs allege that Ostrer caused Vanguard Global to purchase PartyGaming shares in approximately seven trades between April and December 2006. It continued to hold these securities until approximately the end of 2006.
VIEIF, through the Vanguard European fund, purchased tens of thousands of shares of Bwin from April 1, 2006 through at least May 1, 2008.
Finally, from July 1, 2005 until at least July 1, 2006, VHF, through the Vanguard Global fund, purchased 64,859 NETeller shares, allegedly in several separate transactions.
Plaintiffs allege that by mid-2006, authorities in the U.S. began to crackdown, so to speak, on internet gambling website companies which accepted wagers from U.S. bettors in violation of U.S. law. The number of criminal and civil prosecutions increased with regard to such entities. For example, a U.S. grand jury in Missouri indicted the London-based BetOnSports PLC ("BetOnSports"), an entity in which the Nominal Defendants did not invest, for racketeering, mail fraud, and running an illegal gambling enterprise based on its operations in U.S. markets. The same grand jury indicted BetOnSports's founder, CEO, and twelve others. Additionally, Sportingbet's chairman, Peter Dicks, was arrested on a Louisiana state warrant on gambling-related charges. Moreover, federal prosecutors charged NETeller's founder, Stephen Lawrence, with conspiracy to violate certain gambling-related laws, including § 1955.
In another manifestation of this crackdown, Congress enacted the Unlawful Internet Gambling Enforcement Act of 2006 ("UIGEA") in October 2006.
The Complaint alleges that "[s]oon after passage of the [UIGEA], PartyGaming, Sportingbet, and Bwin withdrew from the U.S. market completely." This resulted in a precipitous decline in each of the Gambling Enterprises' share prices.
Bwin, for its part, took an approximately $685 million impairment charge, based on the applicable exchange ratio, as a result of the increased U.S. law enforcement focus on its industry beginning in 2006. In addition, Bwin's share price, which hovered around $129 per share in May 2006, declined to about $17 by October 2006. Finally, the Complaint alleges that Vanguard Global's last valuation of its NETeller holdings before Lawrence was arrested "implied a per-share price of approximately $11."
On August 29, 2008, Plaintiffs filed a substantially identical suit, McBrearty v. Vanguard Group, Inc., against the present Defendants in the Federal District Court for the Southern District of New York ("S.D.N.Y.").
While the McBrearty petition for certiorari was pending, Plaintiffs filed their Complaint in this Court on April 7, 2010, alleging three derivative counts (Counts I-III) and two individual and class counts (Counts IV-V). Specifically, Count I asserts that Defendants breached their fiduciary duties by causing Nominal Defendants, through the Affected Funds, to invest in purportedly illegal gambling businesses. Counts II and III accuse Defendants of negligence and waste, respectively, based on the same conduct. Counts IV and V parallel Counts I and II, respectively, but are brought by Plaintiffs individually and on behalf of "a Class of investors in any of the [Affected] Funds who purchased one or more shares in the [Affected] Funds during the Class Period."
On July 30, 2010, all Defendants moved to dismiss the Complaint.
Defendants raise a myriad of deficiencies with Plaintiffs' Complaint, which fall within three principal categories. First, Defendants Frashure, Chisholm, Wolahan, Ostrer, Sauter, and Kelly contend that there is no basis for this Court to exercise in personam jurisdiction over them, either under the Delaware long-arm statute or the Due Process Clause of the Fourteenth Amendment. Next, Defendants assert that all of Plaintiffs' claims are derivative, rather than direct, and, thus, should be dismissed under Rule 23.1 because Plaintiffs were required to, but did not, make a demand on the Board of Trustees. In particular, Defendants aver that Plaintiffs failed to plead particularized facts demonstrating that demand would have been futile. Finally, Defendants argue that the Complaint fails to state a claim on the merits for breach of fiduciary duty, negligence, or waste.
Plaintiffs strenuously dispute virtually all aspects of Defendants' motions to dismiss. I address Defendants' primary arguments and Plaintiffs' counterpoints in the next section.
Individual Defendants, all of whom are nonresidents of Delaware, object to this Court's exercise of personal jurisdiction over them, arguing that there is no basis for such jurisdiction under Delaware's long-arm statute, any other statute, or the Due Process Clause of the Fourteenth Amendment.
Before considering the merits of Defendants' motion to dismiss under Rule 12(b)(6), the Court first must address the Individual Defendants' motions to dismiss for lack of personal jurisdiction under Rule 12(b)(2).
The plaintiff has the burden to offer affirmative proof that these two steps are satisfied as to each defendant.
In addition to Delaware's long-arm statute, discussed infra, Plaintiffs argue that Frashure, Chisholm, and Wolahan are subject to this Court's jurisdiction under the Delaware Limited Liability Company Act's implied consent statute, 6 Del. C. § 18-109(a), because they serve as officers of a Delaware LLC, Acadian. Plaintiffs contend that because the Individual Acadian Defendants shared responsibility for implementing the challenged investments and such investments involve or relate to Acadian's business, they qualify as LLC managers and, therefore, have consented to this Court's jurisdiction under the statute. Defendants assert that Plaintiffs misapprehend § 18-109(a), and, specifically, its requirement that an action "involve[e] or relat[e] to the business of the [LLC]."
Section 18-109(a) states, in pertinent part:
It, therefore, is an implied consent statute, but it applies only to a manager of an LLC, which is defined as either a manager fixed under the operative LLC agreement or a "person who participates materially in the management of the limited liability company."
The plaintiff in Vichi argued that this Court could assert personal jurisdiction over Ho, a businessman who at the time of the actions giving rise to the suit was Vice President and Global Treasurer for LG.Philips Displays Holding B.V. ("LPD"). Pursuant to a financing transaction with the plaintiff, Ho signed notes issued in Delaware on behalf of LG.Philips Displays Finance LLC ("Finance"), a Delaware LLC and subsidiary of LPD. He signed in his capacity as an employee of LG.Philips Displays International Ltd. ("International"), which was the sole member and manager of Finance. After LPD defaulted on notes it had issued to the plaintiff, the plaintiff sued Ho, among others, and asserted that this Court had personal jurisdiction over him pursuant to § 18-109(a).
In Vichi, after holding that Ho did not qualify as a "manager" under the statute, I also found that the plaintiff's lawsuit did not constitute an action "involving or relating to the business" of Finance.
Citing several cases, I held that "Delaware courts interpret the `rights, duties and obligations as a manager of a Delaware LLC' to refer to rights, duties, and obligations a manager owes to his organization."
Plaintiffs dispute Defendants' reading of Vichi and § 18-109(a). In particular, they argue that § 18-109(a) is drafted in the disjunctive so that it applies in two distinct situations: first, with regard to an LLC manager who breaches a fiduciary duty to the LLC, which Plaintiffs concede is not alleged here; and second, with regard to "any claim that arises out of the business of a Delaware [LLC] for which they work."
The literal language of § 18-109(a) provides some support for Plaintiffs' argument.
As the Court in Assist Stock Management explained, however, broadly reading the "involving or relating to" language in the clause on which Plaintiffs rely could lead to the assertion of personal jurisdiction in circumstances that do not meet the minimum contacts requirements of the Due Process Clause.
Thus, for Plaintiffs to invoke the "involving or relating to" clause of § 18-109(a), they must establish that the exercise of personal jurisdiction over the Acadian Individual Defendants would not offend traditional notions of fair play and substantial justice. Due process would not be offended if Plaintiffs can show that (1) the allegations against the defendant-manager focus centrally on his rights, duties and obligations as a manager of a Delaware LLC; (2) the resolution of the matter is inextricably bound up in Delaware law; and (3) Delaware has a strong interest in providing a forum for the resolution of the dispute relating to the manager's ability to discharge his managerial functions.
Here, Plaintiffs' claims do relate to Frashure, Chisholm, and Wolahan's involvement in Acadian's business of providing financial advisory services to mutual funds. The allegations do not focus, however, on the duties and obligations those Defendants owed to Acadian. Rather, Plaintiffs allege that these Defendants' actions constituted breaches of fiduciary duties owed to Plaintiffs and Nominal Defendants. As was the case in Vichi, and even assuming the Acadian Individual Defendants are "managers" under § 18-109(a), I find that Plaintiffs' claims do not involve or relate to Acadian's business in the sense of its internal business as required by the statute and the Due Process Clause.
Plaintiffs next argue that the Individual Defendants are subject to jurisdiction in Delaware because they conspired with the entity Defendants in this matter, through their financial advisory services, to cause Nominal Defendants to invest in purportedly illegal gambling businesses, which caused Plaintiffs to suffer resulting losses.
The "conspiracy theory" of personal jurisdiction does not constitute an independent basis for subjecting an out-of-state resident to personal jurisdiction. Rather, it rests upon the notion that, in appropriate circumstances, a defendant's conduct that either occurred or had a substantial effect in Delaware, and thus would make him subject to personal jurisdiction in Delaware, may be attributed to another defendant who would not otherwise be amenable to jurisdiction in this State, if that defendant is a co-conspirator.
Delaware courts construe this test narrowly and require a plaintiff to assert specific facts, not conclusory allegations, as to each element.
While Plaintiffs' Complaint mentions the word conspiracy several times,
Because of the paucity of detail about an alleged conspiracy, it is difficult to discern its purported parameters. To the extent Plaintiffs argue that a conspiracy existed between certain Individual Defendants and their respective corporate employers, e.g., between Sauter and Vanguard, these claims are legally deficient because "a corporation generally cannot be deemed to have conspired with its officers and agents for purposes of establishing jurisdiction under the conspiracy theory."
An important premise of all of Plaintiffs' claims, however, is that it was illegal to purchase or hold the Challenged Securities. Yet, as discussed infra, Plaintiffs have not shown that their allegations of illegality are well-founded. Therefore, those allegations cannot serve as the basis for a conspiracy.
Similarly, because the first two elements of the Istituto Bancario test for establishing jurisdiction based on a conspiracy theory are not met here, I need not address the remaining elements of that test.
Next, Plaintiffs advance several theories in support of their contention that all Individual Defendants are susceptible to the jurisdiction of this Court under the Delaware long-arm statute.
In particular, this Court may exercise specific jurisdiction
Plaintiffs contend that all three subsections of § 3104(c) quoted above provide a basis for personal jurisdiction over some or all Individual Defendants. I address each of these theories in turn.
Plaintiffs assert that Acadian and Marathon each contracted with VHF to provide advisory services to Vanguard Global and specified in their respective contracts that Delaware law would govern the construction of the contracts. According to Plaintiffs, this Court should infer from those facts and the likelihood that VHF would act on the advice supplied by its investment advisors, that the parties intended Acadian and Marathon's advisory services to have been supplied in Delaware by Individual Defendants.
Under § 3104(c)(2), this Court may obtain jurisdiction over an out-of-state defendant if that defendant contracted to supply services in Delaware. As Plaintiffs acknowledge, a contractual choice of law provision in favor of Delaware, on its own, generally does not warrant the exercise of personal jurisdiction over an out-of-state defendant for conduct arising from that contract.
Thus, I hold that § 3104(c)(2) provides no basis for asserting personal jurisdiction over Frashure, Chisholm, Wolahan, or Ostrer.
Plaintiffs next argue that Vanguard, Acadian, and Marathon caused a tortious injury in Delaware by providing advisory services regarding the Challenged Securities, discussed further infra, and that each regularly does or solicits business in Delaware and derives substantial revenue from their services rendered for the benefit of Delaware entities, including VHF and VIEIF.
First, Plaintiffs emphasize that their claims arise out of the services rendered by Individual Defendants in their capacity as employees of Vanguard, Acadian, and Marathon, and those entities derive substantial revenue from providing such services. Plaintiffs argue, therefore, that the Court has jurisdiction over Individual Defendants because they conspired with their employers to provide the challenged financial advice to Nominal Defendants. As discussed supra, however, the Complaint does not plausibly allege that the Individual Defendants conspired with each other or any other Defendants, including Vanguard, Acadian, or Marathon. Thus, I reject this argument for jurisdiction.
Plaintiffs' second contention is that, even if there was no conspiracy, each Individual Defendant satisfies § 3104(c)(4)'s revenue requirement because Individual Defendants are high-level officers and portfolio managers of their respective Defendant-employers, and "it is reasonable to infer that the Individual Defendants also derive substantial revenue from the fees that the entit[y Defendants] charge Nominal Defendants for their services."
Moreover, Plaintiffs' argument is unpersuasive both as a matter of law generally and as a matter of fact in the circumstances of this case. Analytically, it would be prohibitively difficult for a court to attempt to trace an employee's salary back to each of its financial and geographic sources based on the customers for which the employee worked.
Therefore, Plaintiffs have not shown that § 3104(c)(4) provides a basis for subjecting Individual Defendants to this Court's jurisdiction.
Finally, Plaintiffs argue that Individual Defendants are subject to jurisdiction under § 3104(c)(3), because they caused Nominal Defendants to own allegedly illegal gambling securities in Delaware and Nominal Defendants suffered resulting losses in Delaware. Specifically, they assert that a corporation is "injured," in a metaphysical sense, where it is incorporated and, thus, when share prices declined for securities held by the Affected Funds within Nominal Defendants, those entities suffered an "injury" in Delaware. Plaintiffs also contend that the relevant "acts" required by the statute, which include causing Nominal Defendants to own shares in the allegedly illegal gambling businesses, occurred in Delaware because that is where such shares are owned.
Under § 3104(c)(3), this Court may exercise personal jurisdiction over an out-of-state defendant if the plaintiff demonstrates that the nonresident-defendant has caused a tortious injury in Delaware and such injury was due to an act or omission by the defendant in Delaware.
As to the "injury" part of the analysis, Plaintiffs contend that Nominal Defendants were injured by the decline in the prices of the Challenged Securities that the Affected Funds held and, because they are Delaware trusts, they incurred that injury in Delaware. Although the concept is somewhat metaphysical, when a Delaware business entity is injured financially by allegedly "faithless conduct of its directors," or in this case trustees, this Court has held that the entity may be said to be injured in its "legal home," Delaware, for purposes of § 3104(c)(3).
Still, plausibly alleging an injury in Delaware is only half of what Plaintiffs must show to satisfy subsection (c)(3). They also must establish that the out-of-state Defendants committed an act or omission in Delaware, as well.
Plaintiffs claim that they have made the requisite showing of an act in Delaware here because Individual Defendants provided advisory services which facilitated Vanguard Global and Vanguard European's purchases of the Challenged Securities. While they acknowledge that these Funds purchased the shares in foreign jurisdictions, Plaintiffs argue that the Funds' "ownership" of those shares within the meaning of 18 U.S.C. § 1955 occurred in Delaware where the Nominal Defendants are domiciled.
Although this Court has recognized financial harm to a Delaware business entity as a form of injury that has occurred in Delaware, it nonetheless has required, consistent with notions of due process, a factual showing that a tangible act or omission actually took place in Delaware.
The Complaint avers that various Individual Defendants provided portfolio management and investment advisory services to Vanguard Global and Vanguard European, which caused those funds to purchase the Challenged Securities. But, these services were provided by nonresident individuals, from their employers' out-of-state locations,
Therefore, I agree with Defendants that Plaintiffs have failed to allege conduct occurring in Delaware, on behalf of any Individual Defendant, which would satisfy the act or omission requirement of § 3104(c)(3). Accordingly, that statute provides no basis for asserting jurisdiction over any Individual Defendant.
In addition to demonstrating a statutory basis for personal jurisdiction as to each Individual Defendant, Plaintiffs also must show that the Court's exercise of jurisdiction over them meets the so-called minimum contacts analysis. This analysis "seeks to determine the fairness of subjecting a nonresident defendant to suit in a distant forum by considering all of the connections among the defendant, the forum and the litigation. . . . [and] ensures that `the States through their courts, do not reach out beyond the limits imposed on them by their status as coequal sovereigns in a federal system.'"
Having concluded that there is no statutory basis on which to assert personal jurisdiction over any Individual Defendant, I need not reach Plaintiffs' due process arguments.
In sum, Plaintiffs have not shown that Individual Defendants have the requisite minimum contacts with Delaware to justify haling them into court here. While those Defendants actively may have facilitated the Funds' purchases of the Challenged Securities and overseen their management, Plaintiffs failed to demonstrate that they undertook any action in Delaware or otherwise have sufficient contacts with this State to support the exercise of personal jurisdiction over them.
In the alternative, Plaintiffs argue that "if any doubt exists concerning jurisdiction as to any Defendant, Plaintiff[s] should be afforded jurisdictional discovery."
In the circumstances of this case, however, I consider Plaintiffs' request for additional time to take jurisdictional discovery unwarranted. First, the Court never stayed discovery in this action and Plaintiffs had over ten weeks between the filing of Defendants' opening briefs in support of their motions to dismiss and the filing of Plaintiffs' answering brief. Yet, Plaintiffs evidently did not attempt to take any discovery during that time period or the additional period before the motions were argued. Second, Plaintiffs counsel have extensively litigated similar claims in other jurisdictions in the past and are well aware of their potential jurisdictional discovery needs. Finally, the parties do not seriously dispute the nature of Individual Defendants' contacts with Delaware, i.e., they provided advisory services to Delaware trusts whose principal places of business are in Pennsylvania. Instead, their disagreements focus on the legal import of those contacts and are not fact intensive. For all of these reasons, I am not persuaded that additional factual discovery would benefit the parties' jurisdictional dispute or that the attendant delay would be justified. Therefore, I deny Plaintiffs' request for leave to take jurisdictional discovery.
The parties next dispute a host of issues relating to whether Plaintiffs needed to make a pre-suit demand regarding some or all of the counts in the Complaint. Specifically, Defendants claim that all of the counts are derivative in nature and subject to a demand requirement. They further assert that Plaintiffs have failed to satisfy the applicable demand requirements as articulated under Delaware statutory and common law. Plaintiffs counter that they properly have stated direct claims in Counts IV and V. Moreover, regarding Counts I-III, Plaintiffs aver that they adequately have pled facts from which the Court reasonably can infer that making a demand on the Board of Trustees would have been futile and, thus, their failure to do so is excusable. I begin by addressing whether Plaintiffs may proceed on their direct claims for breach of fiduciary duty and negligence arising from Defendants' challenged conduct here. Finding that all of their claims are derivative in nature, I then examine Plaintiffs' arguments for why demand should be excused as to their derivative claims.
Plaintiffs contend that, under the governing Delaware standard found in Tooley v. Donaldson, Lufkin & Jenrette, Inc.,
In Tooley, the Supreme Court explained that to determine whether a claim is direct or derivative, a court must look exclusively to (1) who suffered the alleged harm and (2) who would receive the benefit of any recovery or other remedy.
Plaintiffs argue that they suffered individual injuries separate and distinct from the injuries suffered by Nominal Defendants. Specifically, they argue that Nominal Defendants did not suffer an actual loss at the time their Affected Funds purchased the Challenged Securities, but rather would suffer one when they sold them and realized a loss. Pointing to the unique structure of series mutual funds and the fact that the NAV of each of the Affected Funds was recalculated on a daily basis, Plaintiffs contend that they suffered an additional, direct harm in that "[e]very day that there was a downward adjustment based on a decline in the market value of the [Challenged Securities], Plaintiffs suffered actual injury — a reduction in the calculated value of their shares — even though the Funds had not necessarily realized any loss at all."
Except for Gentile v. Rossette, discussed infra, Plaintiffs cited no Delaware authority for this proposition. Instead, they rely on Strigliabotti v. Franklin Resources, Inc., a case from the Federal District Court for the Northern District of California. There, plaintiffs, stockholders in several mutual funds in the Franklin Templeton fund complex, brought suit against various defendant-investment advisors who provided services to such mutual funds. The plaintiffs claimed that, among other things, the defendants had charged the funds excessive fees in violation of § 36(b) of the ICA.
The holding in Strigliabotti is not controlling in this case for at least three reasons. First, as a decision from a California federal court, it is not binding on this Court.
I concur with these courts' interpretations of Delaware law and find, on the facts pled in the Complaint, that Plaintiffs have failed to allege an injury separate and distinct from an injury alleged to have been suffered by the Affected Funds of Nominal Defendants. The unlawful conduct asserted by Plaintiffs in relation to the Trustee Defendants essentially involves Trustee mismanagement in purchasing and then holding the Challenged Securities. Under Delaware law, allegations of trustee or director mismanagement regarding securities portfolio investments generally are considered derivative in nature.
Plaintiffs argue, however, that the "series" structure of the Nominal Defendants makes investors in Vanguard Global and Vanguard European "essentially a minority class of shareholders of Nominal Defendants" who share no common interests with investors in the other seven series of funds offered by Nominal Defendants"
The focus of Plaintiffs' argument is wrong and inconsistent with the distinction drawn between direct and derivative claims. I consider it more appropriate to compare the alleged injury suffered by Plaintiff-stockholders with that allegedly suffered by the Affected Fund in which they invested, rather than with the alleged harm to the Nominal Defendants. For one thing, each series within a series mutual fund complex acts as a completely segregated fund in the business of investing in securities.
Against this background, I find that each stockholder who held shares in Vanguard European and Vanguard Global suffered an alleged injury based on their pro rata ownership of shares in those Funds. The decline in the share prices of the Challenged Securities would have exerted downward pressure on the NAV of each Affected Fund, which, in turn, allegedly caused a concomitant negative effect on the redemption value of each stockholder's Affected Fund investment. Thus, any injury to Plaintiffs based on a diminution of the value of their shares is secondary and derivative to the alleged injury suffered by the Funds themselves.
Even if I compare the alleged injury of investors in the Affected Funds to the alleged injury suffered by Nominal Defendants, and not solely to the relevant Affected Funds, I still would find that Plaintiffs failed to allege an independent injury. Plaintiffs assert that only they, and not stockholders in the other seven series of funds in Nominal Defendants, were harmed by the Challenged Securities purchases here. Nevertheless, the injury of which they complain was caused by a diminution in the Affected Funds' share values unconnected to any violation of voting rights or allegation that the Affected Funds were singled out to have their share values diminished to benefit one or more of the other series. In this situation, harm can be said to have fallen directly on Nominal Defendants, as the umbrella entity controlling the Affected Funds, and only indirectly in pro rata fashion on stockholders who owned shares in those Funds.
Turning to the second prong of Tooley, I must consider who would receive the benefit of any remedy obtained as a result of Defendants' alleged wrongdoing. Assuming that Plaintiffs succeed in proving that, for example, Defendants breached their fiduciary duties to the Affected Funds, it is logical to assume that the remedy for that breach would go to those Funds only, and not the other series within Nominal Defendants. Such a remedy would not be inconsistent with the provisions of the DSTA or Nominal Defendants' respective Declarations. Moreover, Plaintiffs have not cited any case law or other authority or reasoning that would preclude imposition of a remedy that would flow to the Affected Funds only. Such a remedy would support my conclusion that Counts IV and V are not properly pleaded as direct claims.
Plaintiffs posit that perhaps the remedy would flow to Nominal Defendants and, in that case, benefit all of their series of funds, and not just the Affected Funds. Defendants concede, however, that any remedy obtained as a result of injury to the Affected Funds would "flow to the [Affected] Funds directly and only indirectly to [their] shareholders on a pro rata basis."
Moreover, Plaintiffs do not argue that their claims for breach of fiduciary duty and negligence in Counts IV and V are exclusively direct. Rather, as reflected in the substantively identical claims in Counts I and II, they argue that under Gentile those claims are simultaneously both derivative and direct. Plaintiffs' reliance on Gentile is misplaced, however. In that case, the Supreme Court identified a situation in which minority stockholders may bring both derivatively and directly a claim for breach of fiduciary duties based on "a species of corporate overpayment claim."
Having carefully considered Plaintiffs' arguments that Counts IV and V of their Complaint qualify as direct claims under Tooley, I find they are without merit and hold that Plaintiffs have stated derivative claims only. Thus, I will dismiss with prejudice Counts IV and V of the Complaint.
Having concluded that Plaintiffs' claims are all derivative, I now address Defendants' argument that Plaintiffs were required to make a demand on the Board of Trustees or demonstrate that such a requirement was excused. Plaintiffs concede that they did not make a demand, but argue that the Complaint pleads sufficient facts from which I may infer that their failure to do so was excused.
Under Court of Chancery Rule 23.1, a derivative complaint must "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors . . . and the reasons for the plaintiff's failure to obtain the action or for not making the effort."
The Rales test, on the other hand, applies in lieu of the Aronson test where the subject of a derivative suit is not a board decision but rather a board's inaction leading to a violation of its oversight duties.
Plaintiffs argue that demand is excused here under Rales because the Complaint pleads facts that create a reasonable doubt that a majority of the Trustee Defendants are disinterested or independent. In particular, they point to the fact that the Trustee Defendants failed to take appropriate action after becoming aware of the other Defendants' wrongdoing in causing the Affected Funds to purchase and hold the Challenged Securities. Defendants quibble with Plaintiffs' assertion that Rales governs this case and, instead, argue that Aronson applies because the Complaint alleges that Trustee Defendants, with the other Defendants, "knowingly caused, and participated in a scheme to cause, the [Affected Funds] to purchase stock in one or more illegal gambling businesses," which Defendants characterize as allegations of "affirmative board action."
I need not resolve this dispute, however, because, as discussed below, I find that the Complaint does not allege particularized facts sufficient to cast reasonable doubt on the independence or disinterestedness of Trustee Defendants under either Aronson or Rales.
As Nominal Defendants are Delaware trusts and, thus, creatures of statute, I look first to the DSTA for the applicable standard for independence and disinterestedness. A stockholder-plaintiff may bring a derivative action on behalf of the statutory trust in which they own shares without making a pre-suit demand "if an effort to cause [the trust's trustees] to bring the action is not likely to succeed."
The DSTA defines "independent trustee" as any trustee who is not an "interested person" of the trust, as that term is defined in the ICA.
In interpreting the interplay between the relevant portions of the DSTA and the ICA, one federal court explained that a trustee is an "interested person" under the ICA if he is an "affiliated person," which means that the trustee is "controlled" by or "controls" its investment advisor.
To rebut this presumption, Plaintiffs, again, point the Court to the "unique structure" of series mutual funds as placing the Trustee Defendants in a web of "multiple, serious, actual, and irreconcilable conflicts."
Preliminarily, I find no merit in Plaintiffs suggestion that the Trustees' service on multiple boards of statutory trusts within the same series mutual fund complex makes them interested persons for purposes of the ICA. First, the ICA makes clear that "no person shall be deemed to be an interested person of an investment company solely by reason of . . . his being a member of its board of directors . . . ."
Moreover, neither the ICA nor the SEC prohibits the use of multi-board membership within mutual fund complexes.
Plaintiffs argue, however, that they have pled more than the Trustees' mere service on multiple investment company boards within the same complex. They emphasize that the same Board of Trustees that oversees Nominal Defendants and other trusts within the Vanguard Complex also serves as the board of Vanguard itself, a principal Defendant here.
This additional fact, however, does not automatically make the Trustee Defendants interested persons under the ICA. Under § 80a-2a(3)(E), for example, a company that is an "investment advisor," such as Vanguard, generally is an "affiliated person" and, as such, an "interested person" of the company it advises (i.e., Nominal Defendants).
Another basis on which Plaintiffs arguably might rely to demonstrate an affiliation between Nominal Defendants and Vanguard is § 80a-2(a)(3)(C), which provides that a person is an affiliate of another if he or she directly or indirectly controls, is controlled by, or is under common control with such other person.
This type of control arguably still qualifies as an affiliation between Nominal Defendants and Vanguard under § 80a-2(a)(3)(C). Having carefully considered the Complaint, however, I find that Plaintiffs have failed to plead particularized facts from which I reasonably could infer that Nominal Defendants have sufficient net assets in relation to the other approximately thirty-four trusts in the Vanguard Complex to be able to exercise a controlling influence over Vanguard's management or policies. In fact, other than a brief mention of Vanguard's wholly-owned status, the Complaint does not address the degree of control, if any, that Nominal Defendants exert over Vanguard. Conclusory allegations that Trustee Defendants were appointed or controlled by, or that they control, a trust's investment advisor, without more, are insufficient to excuse demand under the ICA and, therefore, the DSTA.
Moreover, Plaintiffs have offered little else in the way of particularized factual allegations to create a reasonable doubt as to any of the Trustees' disinterestedness or independence. Under this Court's demand futility jurisprudence, "disinterested" generally means "that directors can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing, as opposed to a benefit which devolves upon the corporation or all stockholders generally."
The Complaint did not allege that one Trustee dominated the others or that the Trustees collectively were dominated by any other Defendant. It similarly did not allege that any of the Challenged Securities purchases were self-interested transactions for any of the Trustees in that they would receive a financial benefit from such purchases that would not be shared by the Affected Funds or their stockholders. Rather, the Complaint avers that Trustee Defendants are interested persons because of the unusually complicated structure of the series mutual fund complex in which they operate. This structure involves the Trustee Defendants in numerous interlocking relationships. Consequently, a demand by Plaintiffs essentially would ask Trustee Defendants to sue themselves in their capacity as Vanguard directors.
This Court is mindful of the importance of considering the facts alleged to determine whether Trustee Defendants would be able to exercise their business judgment in considering a stockholder demand. Having said that, Delaware law does not excuse demand on grounds of self-interest when a plaintiff's argument essentially boils down to a claim that director defendants generally are not inclined to sue themselves.
Plaintiffs also argue that Trustee Defendants lack independence and disinterestedness because they face a substantial likelihood of liability arising from their actions with respect to the Challenged Securities and because the conduct at issue was so egregious that it likely was not the product of an exercise of valid business judgment. Plaintiffs appear to concede that these arguments do not satisfy the terms of Nominal Defendants' Declarations or the ICA.
The first of these arguments wholly depends on Plaintiffs' repeated contentions that § 1955 makes passive minority public ownership of gambling enterprises illegal and that the Trustees committed criminal wrongdoing by permitting the Affected Funds in Nominal Defendants to purchase and continue to own the Challenged Securities. This argument seeks to establish demand excusal under the second prong of Aronson as well as Rales.
Under Rales, directors who face a "substantial likelihood of personal liability are deemed to be interested and, thus, cannot make an impartial decision regarding demand."
Plaintiffs have failed to plead sufficient particularized facts either to permit this Court to infer that Trustee Defendants acted or failed to act with regard to the Challenged Securities in bad faith or that they face a substantial likelihood of liability because of their actions or inactions. Again, Plaintiffs' arguments essentially hinge on whether purchasing or owning the Challenged Securities is a crime under § 1955. Having carefully considered the allegations in the Complaint and the submissions and arguments of the parties, I am not convinced that this conduct is criminal.
I begin with the proposition that for demand to be excused on the ground that challenged corporate actions or inactions constituted illegal conduct, the Complaint must plead particularized facts that raise a reasonable doubt about the legality of the conduct or inaction at issue.
In its simplicity, Plaintiffs' argument has some superficial appeal. There are no factual allegations, however, that stock in gambling businesses was publicly traded when § 1955 originally was enacted in 1970. Moreover, the history of the application of § 1955 shows that Plaintiffs' interpretation of it is anything but clear and unambiguous. Despite having been enacted more than forty years ago and the fact that U.S. investors have been able to passively invest as stockholders in offshore gambling enterprises since the mid 2000s, the Complaint contains no allegation that any law enforcement authority or court has interpreted § 1955 to apply to passive public stockholders.
The Complaint does allege that a number of individuals associated with offshore gambling enterprises recently have been arrested, prosecuted, or convicted for their conduct relating to those enterprises. These individuals, however, founded or managed directly such enterprises and none of them was penalized solely because he was a stockholder in those entities.
For purposes of the pending motions to dismiss, I need not determine definitively whether or not passive public stock ownership in an illegal gambling business violates § 1955. Rather, I hold that the Complaint fails to allege sufficient particularized facts to raise a reasonable doubt about the legality of owning publicly traded securities of offshore gambling enterprises. Based on the evidence in the record at this preliminary stage, I find that Plaintiffs have not shown the existence of a reasonable basis to conclude that the word "own" in § 1955 includes passive public minority stockholders.
Therefore, to the extent Plaintiffs argue that Trustees caused the Affected Funds to purchase the Challenged Securities and consciously decided to continue to own them despite reports of a U.S. crackdown on offshore illegal betting enterprises, I find that Trustees did not act in bad faith or in a way that could not possibly have been a legitimate exercise of business judgment. Similarly, I am not persuaded that, to the extent Plaintiffs argue that because Trustees failed to act to sell the securities once they were apprised of the step up in enforcement actions in the mid-2000s, they face a substantial likelihood of liability. This is so because I am not convinced that purchasing or owning securities in publicly traded gambling enterprises is illegal under § 1955. In that regard, to the extent that Plaintiffs argue the media reports and other news of prosecutions and the like under § 1955 in the mid-2000s constituted red flags that the Trustees ignored, I disagree. As previously discussed, these reports and prosecutions did not involve owners of securities in illegal gambling enterprises. As such, they did not make clear that passive stock ownership also was illegal.
For the foregoing reasons, therefore, I hold that demand is not excused in this case under either the second prong of Aronson or under Rales.
Plaintiffs also argue that demand is excused here because Trustee Defendants not only have failed to take action to prosecute Plaintiffs' claims since they first were served in the McBrearty action in 2008, they also asserted and caused Nominal Defendants to assert in formal court filings in that action that the plaintiffs' complaint should be dismissed with prejudice. This conduct, according to Plaintiffs, demonstrates that Trustee Defendants "have already committed themselves to the position that Nominal Defendants' claims should not be enforced and therefore foreclosed any possibility of acceding to a demand."
Mere inaction on the part of a board after a corporation's claim accrues does not relieve the plaintiffs of the requirement to make demand.
Preliminarily, the fact that Defendants have moved to dismiss this action does not mean that demand would have been futile.
As such, Plaintiffs' argument that Trustee Defendants' motion to dismiss the related McBrearty action establishes that they already had committed themselves to denying a demand before this action is not convincing. Specifically, actions taken in a previous litigation do not establish that the Board of Trustees would have opposed Plaintiffs' claims had demand been made before filing this action. Plaintiffs have cited no authority or reasons to find that Defendants' arguments about the merits of the McBrearty action are binding on them to such an extent that they could not change their minds about pursuing the claims in the current Complaint. Plaintiffs have not argued, for example, that Trustee Defendants would be judicially estopped by their motion to dismiss the McBrearty action on the merits from deciding to allow Plaintiffs to proceed with the claims in this action.
Therefore, I reject Plaintiffs' argument that the defensive litigation positions taken by Trustee Defendants in the McBrearty action, without more, are sufficient to establish that demand would be futile.
Plaintiffs' arguments for excusing demand focus exclusively on Trustee Defendants as well as their purported conflicts with Vanguard. As such, the non-Vanguard Defendants, including Sauter, Kelley, Acadian, Frashure, Chisholm, Wolahan, Marathon, and Ostrer, contend that demand is not excused as to them because the Complaint fails to plead particularized facts suggesting that Trustee Defendants would be unable to consider impartially a demand to pursue claims against those other Defendants as third-parties. Plaintiffs' only response is that demand is excused with regard to all Defendants because they "allege a conspiracy in which all Defendants were involved."
For the reasons discussed supra Part II.A.3, Plaintiffs have failed to adequately plead the requisite elements of a conspiracy. As such, this argument fails. Furthermore, in the absence of a conspiracy, Plaintiffs have failed to articulate a basis as to why Trustee Defendants would be unable to consider bringing suit against these third-party companies and their employees. Therefore, the Complaint must be dismissed as to all Defendants based on Plaintiffs' failure to make a pre-suit demand on the Board of Trustees.
Having found that the Complaint is entirely derivative and that Plaintiffs failed adequately to plead demand excusal, I hold that Defendants are entitled to a dismissal with prejudice of all the claims in the Complaint. Accordingly, I need not address Defendants' challenges to the merits of Plaintiffs' claims under Rule 12(b)(6).
For the reasons stated in this Opinion, I grant Defendants' motions to dismiss the Complaint in its entirety with prejudice.
