A recent decision by the Second Circuit Court of Appeal seeks to clarify the distinction between direct and derivative standing under Delaware law.
In AHW Inv. P'ship v. Citigroup, Inc. (806 F.3d 695), the plaintiffs brought claims for various false statements that resulted in losses over $800 million. The plaintiffs were numerous investment entities organized by Arthur L. Williams, that held nearly 18 million shares of Citibank stock. Prior to the financial crash, Williams planned to sell all of his shares. The first million sold for $55/share, but Williams stopped there, based mostly on direct assurances from senior officers. Ultimately, the shares plummeted and Williams sold at $3.09 per share.
Under the various entities, Williams brought suit for negligent misrepresentation and fraud. On a motion to dismiss brought by Citibank, the court held the claims direct, but granted the motion for failure to state a claim. Both parties appealed.
On appeal, Citibank argued that the court erred holding the claims direct. Thus, as derivative claims, the Plaintiffs lacked standing and all other arguments were irrelevant. Applying the well-known Tooley v. Donaldson, Lufkin & Jenrettte, Inc. (845 A.2d 1031), and its more recent progeny, the Second Circuit found no clear answer. Under Tooley, the distinction between direct or derivative standing turns on two factors: (1) who suffered the alleged harm (the corporation or the individual stockholder); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the individual stockholder). As alleged, the Williams based their harm on the direct statements made after the damage to Citibank occurred. The senior officers were concealing the harm to Citibank at that point, delaying the inevitable for Williams to hold his shares. The Court found both factors in the Williams' favor. Under Tooley the claim was direct.
The analysis did not end there however. More recent decisions interpreting Tooley indicate that when a claim is based upon any dilution in value of the corporation’s stock, the claim is generally derivative (See Gentile v. Rossette [906 A.2d 91]; In re J.P Morgan Chase & Co. Shareholder Litigation [906 A.2d 808]; Feldman v. Cutaia [951 A.2d 727]. The court struggled with the fact that, regardless of the individualized aspect of what caused the William’s injury – the direct statements from senior officers – the actual harm they suffered was dilution of their stock. Harm no different than that suffered by all Citibank stockholders.
Examining Second Circuit law for the answer, the question remained whether the harm alleged, based upon retention of stock, rather than purchase or sale, makes the claims direct or derivative. Here the Williams were “Holders” when their injury occurred. No precedent authority existed, so the Second Circuit certified the following question to the Delaware Supreme Court:
Are the claims of a plaintiff against a corporate defendant alleging damages based on the plaintiff’s continuing to hold the corporation’s stock in reliance on the defendant’s misstatements as the stock diminished in value properly brought as direct or derivative claims.
Based on the particularity of the question, it is likely that the answer will be narrowly applied.