In May 2012, JP Morgan Chase announced an estimated trading loss of $2 billion. After the details were finalized, actual losses exceeded $6 billion. As a result, Ernesto Espinoza brought a derivative shareholder action against JPMorgan’s directors and officers for breach of fiduciary duty and related claims.
Around the same time of the announced losses, Espinoza formally demanded the board investigate and commence proceedings against various executives involved in the incident and those responsible for risk management within the corporation. The board created a Review Committee, consisting of three outside directors, outside counsel, and an expert advisor. In addition to the Review Committee, JP Morgan’s Management Task Force conducted a separate investigation. Eight months later, the Review Committee refused Espinoza’s demand, determining that it was against the company's best interests to litigate.
After the district court dismissed Espinoza’s complaint twice, Espinoza argued that the investigation was insufficient because it failed to take into consideration the executives’ subsequent statements after the "London Whale" incident. For the third time, the district court granted JPMorgan’s motion to dismiss for failure to plead sufficient facts to rebut the business judgment rule presumption. Espinoza appealed again. (Espinoza v. Dimon, et al., 2015 U.S. App. LEXIS 21021).
On a de novo review of the complaint, the Second Circuit determined the appeal presented an unclear question of Delaware law. The court certified the following question to the Delaware Supreme Court:
If a shareholder demand that a board of directors investigate both an underlying wrongdoing and subsequent misstatements by corporate officers about that wrongdoing, what factors should a court consider in deciding whether the board acted in a grossly negligent fashion by focusing its investigation solely on the underlying wrongdoing?
In its response, the Delaware Supreme Court emphasized that review of a decision to initiate legal proceedings starts with the premise that such decision is an internal corporate matter within the board’s discretion. The merits of the board’s decision did not control the matter. In order to defeat the motion to dismiss, Espinoza had to plead sufficient facts to demonstrate the decision not to initiate legal proceedings constituted gross negligence.
Espinoza’s claims failed again. The court found JP Morgan’s investigation exhaustive, resulting in many of the demands Espinoza made on the board, as well as acknowledging many of the subsequent statements Espinoza based his latest argument upon. The Delaware Supreme Court noted that JP Morgan may have had two materially distinct categories to investigate, and that the investigation of only one could constitute gross negligence, but that the crucial question was the importance of the matter not investigated in the entire context. Espinoza’s claim as to the subsequent statements was one of five demands. The board’s decision was protected by the business judgment rule.
In addition to granting the motion to dismiss, the Second Circuit enunciated two practical considerations for refusal letters. First, that requiring boards to provide a detailed response to every issue raised in a demand letter would provide an incentive to plaintiffs to laundry list an excessive number of demands. Second, that providing a detailed refusal letter could expose the board to other legal risks, an effect contrary to the board’s duty to mitigate risk.
The court affirmed dismissal of Espinoza’s complaint.