Calcaterra v. Garrabrants et al
Filing
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ORDER granting Defendants' 41 Motion to Dismiss; granting 42 Motion to File Documents Under Seal; granting 48 Motion to File Documents Under Seal; granting 50 Motion to File Documents Under Seal. Court will reserve ruling whether or not the motion is granted with or without prejudice until after hearing from the respective parties. Given that the related shareholder litigation, 16cv2723-GPC(KSC) is ripe for decision on the merits, Court is inclined to find that providing the sh areholders here, with leave to amend their demand futility allegations would be futile. Court orders Plaintiffs to show cause why this case should not be dismissed with prejudice. Defendants shall file a response due by 3/31/2017. Signed by Judge Gonzalo P. Curiel on 3/1/2017. (jah)
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UNITED STATES DISTRICT COURT
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SOUTHERN DISTRICT OF CALIFORNIA
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IN RE:
BofI HOLDING, INC.
SHAREHOLDER LITIGATION
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Case No. 3:15-CV-02722-GPC-KSC
ORDER:
(1) GRANTING DEFENDANTS’
MOTION TO DISMISS
[Dkt. No. 41]
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(2) GRANTING DEFENDANTS’
MOTION TO SEAL
[Dkt. No. 48]
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(3) GRANTING PLAINTIFFS’
MOTIONS TO SEAL
[Dkt. Nos. 42 & 50]
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Before the Court is Defendants’1 motion to dismiss the Consolidated Verified
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Shareholder Derivative Complaint2 (the “CSC”), Dkt. Nos. 36 & 38, filed by BofI
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shareholders Andrew Calcaterra, Robylee Doherty, and Zhang Yong. Dkt. No. 41. The
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Theodore C. Allrich, James S. Argalas, Eshel Bar-Adon, John Gary Burke, James J. Court, Uzair
Dada, Gregory Garrabrants, Paul J. Grinberg, Andrew J. Micheletti, Nicholas A. Mosich, Edward J.
Ratinoff, John C. Tolla, and Derrick K. Walsh.
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Parts of the Consolidated Verified Shareholder Derivative Complaint have been filed under seal. See
September 6, 2016 Order Granting Plaintiffs’ Motion to File Under Seal Portions of the Verified
Consolidated Shareholder Derivative Complaint. Dkt. No. 37.
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motion has been fully briefed. See Dkt. Nos. 43 & 47. The parties’ various motions to
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file documents, submitted with their briefs, under seal are also before the Court. See Dkt.
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Nos. 42, 48, & 50.
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The facts of this case are familiar to the Court. The events and allegations that
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precipitated this shareholder litigation dispute are similar in kind and in substance to
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those that underlay In re: BofI Holding, Inc. Sec. Litig., No. 3:15-cv-02324-GPC-KSC
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(S.D. Cal.) (filed Oct. 10, 2015), a related class action securities fraud suit.3
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Notwithstanding these parallels, however, the nature of this suit is distinct. The instant
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matter is a shareholder derivative suit, brought by stockholders of BofI Holding, Inc., on
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behalf of the company, against all nine members of BofI’s Board of Directors4 and
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various other company officers. Through this suit, Plaintiffs seek to protect BofI and to
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recover against the directors and officers who have allegedly caused damage to the
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company. See Response, Dkt. No. 43 at 11. Defendants, in response, argue that
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Plaintiffs lack standing to bring this shareholder derivative suit because they have failed
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to plead demand futility as to a majority of BofI’s Board of Directors. See MTD, Dkt.
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No. 41-1 at 6-7.
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There is no dispute that Plaintiffs did not make a demand upon the Board,
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requesting that the Board respond to the misconduct alleged herein, before filing the
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present suit. CSC ¶ 142. Thus, the key issue for this Court is whether or not Plaintiffs’
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failure to make a demand on the Board is rightfully excused under the Federal Rules of
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Civil Procedure. See Fed. R. Civ. P. 23.1(b)(3).
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See Defs.’ Mot. to Dismiss (“MTD”), Dkt. No. 41-1 at 6 (“This derivative action “piggy-backs on both
the “whistleblower” employment lawsuit filed by Mr. Erhart [Erhart v. BofI Holding, Inc., 3:15-cv02287-BAS-NLS] and a securities class action lawsuit filed by investors in the wake of a drop in BofI’s
stock price following the filing of the purported whistleblower lawsuit.”); see also Pls.’ Resp.
(“Response”), Dkt. No. 43 at 9-10 (citing to Erhart’s whistleblower action and the securities fraud class
action in their statement of the case).
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The members of the Board of Directors are: Allrich, Argalas, Burke, Court, Dada, Garrabrants,
Grinberg, Mosich, and Ratinoff. MTD, Dkt. No. 41-1 at 6. Dada, who joined the Board on January 22,
2015, is the only Director Defendant who did not serve on the Board throughout the relevant period.
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BACKGROUND
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Nominal Defendant BofI Holding, Inc. (“BofI”), through BofI Federal Bank,
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provides online consumer and business banking products. CSC ¶¶ 2, 14. Its deposit
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products include consumer and business checking, demand, savings and time deposit
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accounts, and its loan portfolio primarily consists of residential single family and
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multifamily mortgage loans, commercial real estate secures and commercial lending
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products, finance factoring products, and other consumer lending products. Id. ¶ 2. Of
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chief importance to BofI Federal Bank is its practice of providing mortgages to high-net-
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worth individuals for the purchase of high-end properties. Id. ¶ 3.
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A nine-member Board of Directors (“the Board”) manages BofI. See id. ¶ 29.
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Those individuals include: Theodore C. Allrich, Chairman of the Board and a member of
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the Board’s Compensation Committee; James S. Argalas, member of the Board’s Audit
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Committee and member of the Company’s Internal Asset Review Committee; John Gary
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Burke, member of the Board’s Compensation Committee and Chairman of the Internal
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Assets Review Committee of the Board; James J. Court; Uzair Dada; Gregory
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Garrabrants, BofI’s CEO, President, and Director; Paul J. Grinberg, member of the
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Board’s Compensation Committee and member of the Board’s Audit Committee;
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Nicholas A. Mosich, Vice President of the Board and member of the Board’s Audit
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Committee; and Edward J. Ratinoff, member of the Nominating Committee. Id. ¶¶ 15,
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17, 18, 19, 20, 21, 22, 23, 26. Every member of the Board is named as a Defendant
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(hereafter referred to as the “Director Defendants”). Id. ¶ 29. The other named
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Defendants are Eshel Bar-Adon, Executive Vice President and Chief Legal Officer of
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BofI; Andrew J. Micheletti, Executive Vice President and Chief Financial Officer, John
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C. Tolla, Chief Governance and Compliance Officer; and Derrick K. Walsh, Chief
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Accounting Officer and Senior Vice President. Id. ¶¶ 16, 24, 25, 27.
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In October 2015, Charles Matthew Erhart, a former BofI internal auditor who
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allegedly raised compliance issues to senior management and federal regulators, id. ¶ 5,
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filed a whistleblower action against BofI. See Erhart v. BofI Holding, Inc., Case No. 153
3:15-cv-02722-GPC-KSC
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cv-2287-BAS-NLS (S.D. Cal.) (filed Oct. 13, 2015). The whistleblower complaint
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alleged widespread wrongdoing at BofI. For example, Erhart alleged that senior officers
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at the company had instructed him to “refrain from putting anything in writing regarding
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the Company’s violations of laws” and to “label anything he did in his audit function
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which might be incriminating as “attorney work product/communication.” CSC ¶ 5.
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Other allegations faulted BofI for borrowing to foreign nationals “who should have been
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off-limits under anti-money laundering laws,” for keeping accounts without tax
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identification numbers “contrary to BofI’s representations to the Office of the
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Comptroller of the Currency (“OCC”),” and for otherwise failing to provide “full and
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timely information to regulators.” Id.
The revelation of these and other allegations included in Erhart’s complaint caused
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BofI’s shares to fall by 30.2%, or by $42.87, to $99.13 by the close of business on
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October 14, 2015. Id. ¶ 6. As mentioned above, the accusations aired in the complaint
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have also led to a class action lawsuit for securities fraud. See In re BofI Holding, Inc.
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Sec. Litig., 3:15-cv-02324-GPC-KSC (S.D. Cal.) (filed October 15, 2015).
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In response to these and other allegations, Plaintiffs, all of whom held BofI stock
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during the relevant period, brought this derivative action.5 They allege that from
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February 6, 2013 to the present, BofI’s officers engaged in misconduct by causing BofI to
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issue false or misleading statements about the company’s condition and/or by failing to
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disclose that: (1) BofI’s internal controls were inadequate and “frequently disregarded”;
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(2) that BofI’s portfolio contains loans to foreign nationals who are off-limits because of
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federal anti-money laundering laws; (3) that many of BofI’s accounts lacked tax
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identification numbers; and (4) that Defendants violated the anti-retaliation laws of the
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Sarbanes-Oxley Act of 2002 (“SOX”) and the Dodd-Frank Wall Street Reform and
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Plaintiffs filed their initial complaint on December 3, 2015 and their first amended complaint (i.e., the
CSC), which contain the same causes of action, on August 26, 2016.
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Consumer Protection Act (“Dodd-Frank Act”) by allegedly firing Erhart in retaliation for
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his whistleblowing. See CSC ¶¶ 1, 5, 11, 12, 13.
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Based on these representations of wrongdoing, Plaintiffs assert three claims
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against all the Defendants, namely, (1) breach of fiduciary duties, (2) abuse of control, (3)
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unjust enrichment, and one claim, (4) breach of duty of honest services, against
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Defendants Garrabrants, Micheletti, Bar-Adon, Tolla, and Walsh only. Id. ¶¶ 61-64.
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DEMAND FUTILITY ALLEGATIONS
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As stated previously, Plaintiffs did not make a demand on BofI’s Board of
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Directors before filing suit, urging them to institute this action against the individual
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Defendants. CSC ¶ 143. Plaintiffs allege that making such a demand would have been
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futile because a majority of the Board of Directors lacks independence or faces a
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substantial likelihood of liability for their misconduct, thus rendering them incapable of
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fairly considering a demand. See id.
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A. General Board Allegations
The following are demand futility allegations lodged against the Board of Directors
as a whole.
1. Dismissal of Erhart
The CSC avers that the entire Board is compromised, and therefore was unable to
impartially consider a demand at the time of filing the complaint, because they all face a
substantial likelihood of liability for retaliating against Erhart in violation of SOX. Id.
¶¶ 149-59. Plaintiffs contend that the entire Board is responsible for violating SOX
because it authorized and approved the firing of Erhart on June 9, 2015 with full
knowledge of Erhart’s protected status as a whistleblower. Id. ¶ 157. “All Board
members thus face a substantial likelihood of liability for breaching their fiduciary duties
by causing the Company to violate the anti-retaliation provisions of Sarbanes-Oxley,
Dodd-Frank, and other laws.” Id. ¶ 158. In addition, Plaintiffs argue, the Board also
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faces a substantial likelihood of liability for failing to act in the face of the unlawful
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activities alleged by Erhart. Id. ¶ 159.
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Paragraphs 149 through 158 of the CSC discuss the circumstances leading to the
alleged termination of Erhart, and together they narrate the following sequence of events.
Erhart, “in the course of performing his duties as BofI’s Staff Internal Auditor,”
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realized and reported that certain BofI senior officers, including Director Defendant
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Garrabrants, Defendant Bar-Adon, and Defendant Tolla, had violated securities and other
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laws.6 CSC ¶¶ 77, 149. At some point, he informed those three officers of his “good-
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faith whistleblower complaint,” but Garrabrants, Bar-Adon, and Tolla each “brushed
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aside” his concerns. Id. ¶¶ 149-50. As a result, Erhart “lodged his complaints with the
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OCC and SEC.” Id. ¶ 150. He also filed a complaint with OSHA recounting the
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unlawful activities he had witnessed and the retaliation he was facing for having spoken
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out. See id. ¶ 151.
Simultaneously, news of Erhart’s allegations and audit findings were climbing
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through the company’s chain of command. In mid-December 2014, Jonathan Ball, the
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Vice President of Internal Audit (id. ¶ 61), drafted an evaluation of Erhart’s job
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performance. Id. ¶ 152. That performance was later revised by Tolla, who “downgraded
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Erhart’s performance in retaliation for his whistleblowing activities.” Id. Ball, who was
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troubled by Tolla’s actions, “directly advised the Audit Committee about Tolla’s
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downgrading of Erhart’s performance evaluation.” Id. Allegedly, however, the Audit
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Committee did not correct Tolla’s conduct and, in fact, approved of it. Id. (“Upon
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See CSC ¶ 84 (describing how Tolla instructed Erhart to “never state in an audit report that BofI had
violated a federal or state law”); id. ¶¶ 132-33 (stating that Garrabrants “was depositing third-party
checks for structured settlement annuity payments into a personal account, including nearly $100,000 in
checks made payable to third parties” and that he was “the signatory of a BofI consumer account opened
in the name of his brother, Steven Garrabrants, with a balance of approximately $4 million” who was a
“former minor league baseball player who signed . . . in 2003 for $50,000 per year and became a free
agent in 2007”); id. ¶ 83 (describing how Bar-Adon instructed Erhart to “remove evidence of the
violation of California Penal Code § 632 from the Structured Settlement and Lottery audit” or to
otherwise mark the “entire report ‘Attorney Client Privileged’”).
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information and belief, the Audit Committee ratified and approved the retaliation against
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Erhart by failing to instruct Tolla to restore Erhart’s performance grade to the level
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determined by Ball.”)
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Months later, on March 12, 2015, Erhart was approached by Bar-Adon who said
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that he sought to speak with Erhart in his capacity as “General Counsel to the Audit
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Committee.” Id. ¶ 153. Based upon this encounter, Plaintiffs allege that the Audit
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Committee had “directed Bar-Adon to meet with Erhart regarding such activities” and,
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therefore, “had actual knowledge of Erhart’s whistleblowing complaints.” Id.
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Thereafter, the Audit Committee met in San Diego for a formal meeting on April
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27, 2015. Id. ¶ 155. Grinberg, Argalas, and Mosich, the three Audit Committee
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members, were all present at the meeting, along with Micheletti, Bar-Adon, Tolla, Tony
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de la Mora, Interim FVP of Internal Audit, and other company auditors. Id. At the
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meeting, Plaintiffs allege that Grinberg presented to the Audit Committee all complaints
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received by him as Chair of the Audit Committee. Id. They further allege that “[u]pon
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information and belief, Grinberg advised the other Audit Committee members about
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Erhart’s complaints.” Id.
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A number of weeks later, on May 21, 2015, the entire Board of Directors
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convened, with all nine members present. Id. ¶ 156. According to BofI’s 2015 proxy
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statement, the Audit Committee “reports to the full Board at regular meetings concerning
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the activities of the committee and actions taken by the committee since the last regular
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meeting.” Id. ¶ 154. Plaintiffs allege that on May 21, 2015 Grinberg “presented a report
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to the full Board from the Audit Committee, which report upon information and belief
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included all details regarding Erhart’s complaints and the fact that Erhart had claimed
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whistleblower protection. The Board also met in Executive Session to discuss Erhart’s
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complaints and other matters.” Id. ¶ 156.
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Plaintiffs go on to state that three weeks after the May 21, 2015 Board meeting,
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and in spite of having “actual knowledge of Erhart’s whistleblowing activity, and despite
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knowing that Dodd-Frank, Sarbanes-Oxley, and other laws prohibit retaliation against
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employees who report alleged wrongdoing, the Board authorized and approved the firing
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of Erhart on June 9, 2015.” Id. ¶ 157
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2. False and Misleading Statements
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Plaintiffs further argue that: (1) “no reasonable stockholder would reasonably
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believe that a majority of the members of the Board would be able to independently and
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properly consider a demand in good faith” because the Board violated their fiduciary
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obligations by approving and signing the company’s SEC filings containing false and
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misleading statements. Id. ¶ 161. Specifically, the CSC avers that the entire Board
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wrongly approved and signed the Form 10-Ks dated September 4, 2013, August 28,
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2014, and August 26, 2015, all of which contained false and misleading statements about
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BofI’s compliance with securities and other laws.7 See id.
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3. Compensation & Participation in Mortgage-lending Program
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The CSC also alleges that the Director Defendants are interested for purposes of
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demand futility because they “are more interested in protecting themselves than they are
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in protecting the Company by bringing this action.” Id. ¶ 164.
In support of this allegation, Plaintiffs offer each Board member’s compensation
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for fiscal year 2015: Garrabrants, $6,310,485; Allrich, $514,598; Argalas, $188,210;
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Court, $188,210; Dada, $85,061; Grinberg, $281,133; Mosich, $253,970; and Ratinoff,
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$188,210. Id. In further support of this position, the CSC contends that the
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independence of Allrich, Argalas, Burke, Garrabrants, Grinberg, and Mosich is further
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compromised by the fact that each obtained a mortgage on their primary residence at
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below market interest rates through participation in BofI’s mortgage-lending program,
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which is made available to BofI’s directors, officers, and employees. Id. ¶ 165. “As
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such, Allrich, Argalas, Burke, Garrabrants, Grinberg, and Mosich are more interested in
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Defendant Dada only signed the August 26, 2015 Form 10-K as he was the most recent addition to the
Board.
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maintaining their lucrative positions at BofI than they are in protecting BofI by bringing
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this action.” Id.
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B. Individual Board Member Allegations
Also in furtherance of pleading demand futility, the CSC lodges a variety of
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individual demand futility allegations against specific Board members based upon their
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roles or conduct at BofI.
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1. Garrabrants
The CSC’s demand futility allegations contend that Garrabrants, notwithstanding
any allegations attributed to the Board, independently lacks independence. Id. ¶ 144.
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Garrabrants, Plaintiffs argue, lacks independence because he “prepared, signed, or
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caused the Company to issue many of the false and misleading statements” that Plaintiffs
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cite in the CSC. Id. In particular, Plaintiffs note that Garrabrants signed the company’s
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SEC filings, all of which allegedly contained false and misleading statements, including:
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the Forms 10-K dated September 3, 2013, August 28, 2014, and August 26, 2015, and the
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Forms 10-Q dated November 5, 2013, February 5, 2014, May 6, 2014, November 4,
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2014, January 29, 2015, and April 30, 2015. Id. ¶ 147.
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In addition, Plaintiffs allege that making demand upon Garrabrants would have
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been futile because he faces a substantial likelihood of liability for his misconduct.
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Garrabrants, they contend, is “a named defendant in the currently-pending federal class
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actions, alleging he violated § 10(b) of the Exchange Act and Rule 10b-5 when he
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disseminated or approved the false and misleading statements.” Id. ¶ 145. Thus, because
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“pursu[ing] these derivative claims . . . would expose his own misconduct in the class
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action for violations of the federal securities laws . . . Garrabrants is fatally conflicted
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and, therefore, unable to render a disinterested decision as to whether the Company
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should pursue these derivative claims.” Id. ¶ 146.
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Yet another fact demonstrating the likelihood that Garrabrants will face liability for
his conduct, they argue, is the fact that “Garrabrants also participated in conference calls
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with analysts and investors during the Relevant Period . . . [and] therefore faces a
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substantial likelihood of liability for breaching his fiduciary duties.” Id. ¶ 148.
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2. Audit Committee Members (Argalas, Grinberg, Mosich)
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The CSC singles out Argalas, Grinberg, and Mosich as particularly lacking in
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independence or likely to face a substantial likelihood of liability because of their
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conduct and duties as Audit Committee members. Plaintiffs contend that the Audit
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Committee defendants “had a clear duty to be kept informed about the Company’s
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accounting procedures,” but failed to do so by reviewing and approving BofI’s SEC
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filings that contained false and misleading statements. Id. ¶ 163.
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3. Grinberg
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Plaintiffs argue that Grinberg additionally lacked independence to consider a
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shareholder demand because he “breached his fiduciary duty by failing to disclose a
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related party transaction between BofI and his employer Encore Capital.” Id. ¶ 166.
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LEGAL STANDARD
A. Rule 23.1
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A derivative shareholder’s claim allows an individual stockholder to bring “suit to
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enforce a corporate cause of action against officers, directors, and third parties.” Kamen
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v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95 (1991) (quoting Ross v. Bernhard, 396 U.S.
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531, 534 (1970)). “Devised as a suit in equity, the purpose of the derivative action was to
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place in the hands of the individual shareholder a means to protect the interests of the
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corporation from the misfeasance and malfeasance of faithless directors and managers.”
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Id. (quoting Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548 (1949)) (quotations
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omitted).
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This derivative right, however, is not absolute. Before a shareholder can act on
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behalf of the corporation in this manner, he or she must demonstrate “that the corporation
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itself had refused to proceed after suitable demand, unless excused by extraordinary
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conditions.” Id. at 95-96 (quoting Ross, 396 U.S. at 534). This precondition is codified
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at Federal Rule of Civil Procedure 23.1:
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The complaint must be verified and must: . . . (3) state with particularity: (A)
any effort by the plaintiff to obtain the desired action from the directors or
comparable authority and, if necessary, from the shareholders or members;
and (B) the reasons for not obtaining the action or not making the effort.
Fed. R. Civ. P. 23.1(b)(3) (emphasis added). Rule 23.1 provides the pleading standard
for measuring the factual detail present in a complaint, but does not provide the
substantive rule for assessing what reasons are sufficient to excuse demand on the
corporation. See Rosenbloom v. Pyott, 765 F.3d 1137, 1148 (9th Cir. 2014). That rule is
supplied by the law of the state of incorporation, Kamen, 500 U.S. at 109, which in this
case is Delaware, BofI’s state of incorporation, see CSC ¶ 14.
B. Demand Futility Under Delaware Law
In order to show demand futility under Delaware law, a shareholder must satisfy
one of two tests. Rosenbloom, 765 F.3d at 1149-50. The Aronson test applies when a
shareholder challenges a decision made, or a transaction entered into, by the
corporation’s board of directors. See Rales v. Blasband, 634 A.2d 927, 932-33 (Del.
1993). To satisfy the Aronson test a shareholder must allege particularized facts giving
rise to a reasonable doubt that, at the time the suit was filed, (1) the directors were
disinterested and independent or (2) the underlying transaction was the product of a valid
exercise of business judgment. See In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970,
990 (9th Cir. 1999) (citing Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984), overruled
on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000)).
Alternatively, if the shareholder does not challenge a board decision, but board
inaction, for instance, then the Rales test applies. Rosenbloom, 765 F.3d at 1150. The
Rales test requires a stockholder to put forth particularized factual allegations that “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 demand.” Rales, 634 A.2d at 934. Stated differently, the Rales test
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requires the shareholder to satisfy the first prong of the Aronson test. In re Bidz.com
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Deriv. Litig., 773 F. Supp. 2d 844, 852 (C.D. Cal. 2011).
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1. Particularity Requirement
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Delaware Rule 23.1, like is federal counterpart, requires a shareholder to plead
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facts with particularity, which is a more stringent standard than that required by ordinary
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notice pleading. See Brehm, 746 A.2d at 255 (“[t]hose pleadings must comply with
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stringent requirements of factual particularity that differ substantially from the permissive
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notice pleadings”). The rationale behind Rule 23.1’s heightened pleading standard, the
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Delaware Supreme Court has noted, is two-fold:
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Aronson and its progeny is designed to create a balanced environment which
will: (1) on the one hand, deter costly, baseless suits by creating a screening
mechanism to eliminate claims where there is only a suspicion expressed
solely in conclusory terms; and (2) on the other hand, permit suit by a
stockholder who is able to articulate particularized facts showing that there is
reasonable doubt either that (a) a majority of the board is independent for
purposes of responding to the demand, or (b) the underlying transaction is
protected by the business judgment rule.
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Id. at 255 (citing Grimes v. Donald, 673 A.2d 1207, 1216-17 (Del. 1996)). Cast in this
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light, Delaware’s particularity requirement is seen not just as a rigid procedural
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requirement but as a substantive rule of Delaware law that requires plaintiffs to make a
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strong, threshold showing that making a pre-suit demand would have been futile. See In
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re Sonus Networks, Inc., S’holder Deriv. Litig., 499 F.3d 47, 66 (1st Cir. 2007) (applying
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Delaware law on demand futility).
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Accordingly, when assessing a motion to dismiss for failure to comply with the
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requirements of Federal Rule 23.1 and Delaware law, a court should credit a plaintiff
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with “all reasonable factual inferences that logically flow from the particularized facts
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alleged.” Rosenbloom, 765 F.3d at 1148. A court should not, however, take as true
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“conclusory allegations of facts or law not supported by allegations of specific fact.” In
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re Countrywide Fin. Corp. Deriv. Litig., 554 F. Supp. 2d 1044, 1079 (C.D. Cal. 2008)
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(quoting Levine v. Smith, 591 A.2d 194, 207 (Del. 1991)) (internal quotations omitted).
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“Conclusory allegations” are those that add “no, or only de minimis, substance to the
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Court’s demand-futility inquiry.” See Khanna v. McMinn, 2006 WL 1388744, *14 (Del.
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Ch. May 9, 2006). By contrast, particularized facts are “substantive allegations that are
4
by themselves insufficient but, when viewed in toto, may push the analysis over the
5
threshold of “reasonable doubt” and thereby excuse [ ] demand.” Id.
6
DISCUSSION
7
Before reaching the merits of the case, the Court will first address Defendants’
8
multiple requests for judicial notice, as those requests inform the scope of the Court’s
9
review on a motion to dismiss.
10
In support of their motion to dismiss, Defendants have requested that the Court
11
take judicial notice of excerpts of 1) BofI’s Schedule 14A Definitive Proxy Statement
12
filed with the SEC; 2) the complaint in Erhart v. BofI Holding, Inc., Case No. 15-cv-
13
2287-BAS-NLS (S.D. Cal); and 3) BofI’s Certificate of Incorporation. Dkt. No. 41-2. In
14
their reply brief, Defendants additionally ask the Court to notice 4) the minutes of the
15
May 21, 2015 BofI Board meeting and 5) BofI’s Form 8-K dated March 14, 2016. Dkt.
16
No. 47-1.8 Because the Court does not rely on the contents of the first, third, fourth, and
17
fifth requests in its reasoning or in reaching its ultimate opinion, the Court DENIES
18
those four requests as moot. But, for the reasons that follow, the Court GRANTS
19
Defendants’ request to take judicial notice of the complaint filed in Erhart’s
20
whistleblower action.
21
It is apodictic that a court may take judicial notice of facts outside the pleadings on
22
a motion to dismiss. See, e.g., Mack v. Bay Beer Distribs., 798 F.2d 1279, 1282 (9th Cir.
23
1986), overruled on other grounds by Astoria Fed. Sav. & Loan Ass’n v. Solimino, 501
24
U.S. 104 (1991). A court may consider matters that are: 1) authenticated documents that
25
have been incorporated by the complaint or 2) facts subject to judicial notice. Lee v. City
26
27
Plaintiffs filed a response to Defendant’s second request for judicial notice that is not properly before
the Court. See Dkt. No. 52.
8
28
13
3:15-cv-02722-GPC-KSC
1
of Los Angeles, 250 F.3d 668, 689-90 (9th Cir. 2001). Here, Defendants have asked the
2
Court to take judicial notice of Erhart’s whistleblower complaint. Plaintiffs’ allegations
3
rely heavily on the contents of Erhart’s complaint and incorporate them throughout the
4
CSC. See generally CSC. In fact, Plaintiffs even suggested, without arguing, that the
5
Court could take judicial notice of Erhart’s complaint. See id. ¶ 149 (“As alleged in
6
detail by Erhart in a whistleblower complaint pending in this District (and of which the
7
Court can take judicial notice)”). Thus, because Erhart’s complaint is incorporated
8
throughout Plaintiffs’ allegations, and because it is a matter of public record, capable of
9
accurate and ready authentication, it is the proper subject of judicial notice. See, e.g.,
10
Headwaters Inc. v. U.S. Forest Serv., 399 F.3d 1047, 1051 n.3 (9th Cir. 2005) (taking
11
judicial notice of a judicial docket). Accordingly, the Court GRANTS Defendants’
12
request to take judicial notice of Defendants’ Exhibit B. Dkt. No. 41-4 at 2.
13
14
Demand Futility
Defendants move to dismiss the CSC because it fails to plead demand futility with
15
particularity as required by Rule 23.1 and Delaware law. In their opposition to
16
Defendants’ motion to dismiss, Plaintiffs advance three main theories of demand futility.
17
One, that it would have been futile to make a demand on the Board because the entire
18
Board engaged in bad-faith conduct by firing Charles Matthew Erhart, an alleged
19
whistleblower, in violation of the Sarbanes-Oxley Act and other laws protecting
20
whistleblowers. Response, Dkt. No. 43 at 15. Two, that demand would have been futile
21
because all of the Director Defendants face a substantial likelihood of liability for causing
22
BofI to disseminate false or misleading statements. Id. at 22. And three, that demand
23
would have been futile because a majority of the Board was conflicted because of their
24
compensation and because a majority of them received a mortgage from BofI at below-
25
26
27
28
14
3:15-cv-02722-GPC-KSC
1
market rates. For the following reasons, the Court rejects each of these arguments and
2
concludes that Plaintiffs have failed to meet their demand futility burden.9
I. Board’s Dismissal of Erhart
3
4
A. Whether Aronson or Rales Applies
5
The parties agree that Plaintiffs’ allegation that the Board terminated Erhart is
6
governed by the Aronson standard. See MTD, Dkt. No. 41-1 at 16; see also Response,
7
Dkt. No. 43 at 15. Accordingly, in order for demand to be excused, Plaintiffs must have
8
plead particularized facts giving rise to a reasonable doubt that the Board is independent
9
and disinterested or that the decision to terminate Erhart was a valid exercise of business
10
judgment. Defendants contend that Plaintiffs’ Erhart-related allegations fail under both
11
the first and second prong of Aronson. See MTD, Dkt. No. 41-1 at 17-20. In their
12
opposition, however, Plaintiffs only argue that the Board’s decision to terminate Erhart
13
satisfies Aronson’s second prong, addressing business judgment. See Response, Dkt. No.
14
43 at 15-17. The Court’s analysis, therefore, will measure the sufficiency of Plaintiffs’
15
allegations under the second prong of Aronson.10
16
////
17
////
18
19
The Court’s analysis focuses exclusively on these three arguments because they are the only demand
futility allegations and argument directed at the Board as a whole. Although Plaintiffs’ complaint and
opposition contain other arguments as to why certain Board members — namely, Garrabrants, Grinberg,
Mosich, and Argalas — are conflicted for demand purposes, those arguments are insufficient to carry
Plaintiffs’ burden because they only individually address four of the nine board members. In other
words, because Plaintiffs do not lodge any specific demand futility allegations against Allrich, Court,
Burke, Dada, or Ratinoff (with the exception of a minor compensation-related contention made as to
Allrich), and because demand futility requires that Plaintiffs demonstrate that a majority of BofI’s Board
of Directors were not independent or disinterested, the Court’s inquiry must necessarily focus on
whether Plaintiffs’ generalized Board allegations meet the demand futility standard. See Rosenbloom,
765 F.3d at 1151 n.13 (observing that it is appropriate for courts to evaluate demand futility by looking
at the “whole board rather than by going one by one through its ranks”).
10
Although the Court has chosen to address Plaintiffs’ whistleblower-related demand futility allegations
under the second prong of Aronson, because the Court ultimately concludes, see infra, that Plaintiffs
have failed to plead sufficient particularized facts demonstrating that the Board fired Erhart, Plaintiffs’
allegations would also fail under the first prong of Aronson.
9
20
21
22
23
24
25
26
27
28
15
3:15-cv-02722-GPC-KSC
1
B. Business Judgment Protection under Delaware Law
2
Plaintiffs contend that their particularized pleadings raise a reasonable doubt that
3
the Board’s decision to fire Erhart was a valid exercise of business judgment. See
4
Response, Dkt. No. 43 at 15-17. In making this argument, Plaintiffs rely on the fact that
5
“board action that violates the law” is never protected by the business judgment rule and
6
thus, always demonstrates demand futility. See id. at 15.
7
Delaware’s business judgment rule embodies the “acknowledgement of the
8
managerial prerogatives of Delaware directors” and the “presumption that in making a
9
business decision the directors of a corporation acted on an informed basis, in good faith
10
and in the honest belief that the action taken was in the best interests of the company.”
11
Aronson, 472 A.2d at 812. Courts should not assume that a Board-approved transaction
12
“is a wrong to the corporation.” Id. at 814. In fact, “[a] hallmark of the business
13
judgment rule is that a court will not substitute its judgment for that of the board if the
14
latter’s decision can be attributed to any rational business purpose.” Unocal Corp. v.
15
Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985) (quotations omitted). It is,
16
therefore, incumbent upon the shareholders challenging board action to rebut the
17
presumption that a board transaction is the result of sound judgment. See Aronson, 472
18
A.2d at 812.
19
The business judgment rule is not, however, unqualified. Maldonado v. Flynn, 413
20
A.2d 1251, 1257 (Del. Ch. 1980), overruled on other grounds by Zapata Corp. v.
21
Maldonado, 430 A.2d 779 (Del. 1981). Notably, it does not protect fraudulent, illegal, or
22
reckless decisions made by the board’s directors. Id. This is because “it is utterly
23
inconsistent with one’s duty of fidelity to the corporation to consciously cause the
24
corporation to act unlawfully.” Desimone v. Barrows, 924 A.2d 908, 934 (Del. Ch.
25
2007); see also In re Goldman Sachs Grp., Inc. S’holder Litig., 2011 WL 4826104, *20
26
(Del. Ch. Oct. 12, 2011) (“Illegal corporate conduct is not loyal corporate conduct.”)
27
Accordingly, a board’s decision to act illegally will always satisfy the demand futility
28
16
3:15-cv-02722-GPC-KSC
1
standard because such a decision does not enjoy business judgment protection, as it
2
necessarily contravenes the board’s duty of loyalty to the company.
3
C. Demand Futility Analysis
4
In applying the second prong of Aronson, the key inquiry for the Court is whether
5
or not Plaintiffs’ particularized allegations give rise to a reasonable doubt that the Board
6
fired Erhart and, therefore, acted illegally. Indeed, Defendants vehemently challenge the
7
sufficiency of Plaintiffs’ allegations supporting that very conclusion. They argue that
8
Plaintiffs have not alleged any particularized facts showing that the Board discussed
9
Erhart’s employment, nevertheless that they actually voted to terminate Erhart. MTD,
10
Dkt. No. 47 at 7-8, 17-18. Defendants also contest the reasonableness of inferring that
11
the Board would involve itself in authorizing the termination of a low-level employee and
12
thus urge the Court to dismiss the inference as implausible. See id. at 18-19.
13
The Court begins by observing that it disagrees with Defendants insofar as they
14
insist that it is generally unreasonable to infer that the Director Defendants would have
15
fired Erhart given his “low-level” position at the company. To the contrary, it seems
16
more than reasonable to infer that the Board would have approved the dismissal of Erhart
17
given that he had allegedly found and reported widespread wrongdoing and illegality
18
occurring at the bank. The nature of Erhart’s allegations suggest that the growth of
19
BofI’s loan portfolio (i.e., the essence if its business) was improperly propelled by
20
lending to individuals who should not have received loans, that is, persons who are
21
designated as off-limits by federal anti-money-laundering laws and persons without tax
22
identification numbers. See CSC ¶¶ 108-09; see also id. ¶ 114 (quoting BofI’s 2015 Q2
23
Investor Presentation as boasting that BofI’s “Asset Growth has been Driven by Strong
24
and Profitable Organic Loan Production.”). Erhart’s allegations, moreover, indicate that
25
Garrabrants, BofI’s CEO, and other high-ranking officers were direct participants in
26
unlawful business and reporting practices. Thus, it does not strain credulity to believe
27
that Erhart’s conduct reached the boardroom given that he had questioned the legality of
28
17
3:15-cv-02722-GPC-KSC
1
BofI’s primary source of business, directly implicated the company’s CEO and other
2
managerial officers in instances of wrongdoing, and reported his doubts to regulators.
3
The Court likewise disagrees with Defendants’ contention that the complaint fails
4
to plead particularized facts demonstrating that the Board had knowledge of Erhart’s
5
complaint and audit findings. The CSC alleges with particularity how Erhart’s
6
complaints travelled up the corporate chain and into the boardroom. According to the
7
complaint, Erhart, in his capacity as a Staff Internal Auditor, uncovered and witnessed
8
several alleged violations of the law committed by CEO Gregory Garrabrants, Eshel Bar-
9
Adon, and John Tolla, Erhart’s manager. Id. ¶ 149. Erhart related his concerns to
10
Garrabrants, a board member, Bar-Adon, and Tolla, but they were “brushed aside.” Id.
11
The Audit Committee, comprised of three members of the Board, later became aware of
12
Erhart’s complaints when his supervisor alerted the Committee to the downgrading of
13
Erhart’s job performance. That the Audit Committee was apprised of Erhart’s allegations
14
was further reinforced by the fact that Bar-Adon “met with Erhart and told him he was
15
acting as General Counsel to the Audit Committee.” Id. ¶ 153.
16
These allegations, when viewed in toto, lead to the reasonable inference that
17
Garrabrants and the three Director Defendants on the Audit Committee were aware of
18
Erhart’s whistleblowing activities and complaints. These allegations are particularized
19
because they describe the “transaction specifics or individual board member
20
participation” that connects the dots between Erhart’s alleged whistleblower activities
21
and how four of the Director Defendants became aware of them. See In re Computer
22
Scis. Deriv. Litig., 244 F.R.D. 580, 584 (C.D. Cal. 2007).
23
The Court also finds that that are sufficient particularized facts from which it can
24
reasonably infer that the entire Board had knowledge of Erhart’s complaint and
25
whistleblowing activities. Plaintiffs allege that at a Board meeting on May 21, 2015,
26
“Grinberg presented a report to the full Board from the Audit Committee, which report
27
upon information and belief included all details regarding Erhart’s complaints and the
28
fact that Erhart had claimed whistleblower protection.” CSC ¶ 156 (emphasis added).
18
3:15-cv-02722-GPC-KSC
1
Defendants argue that because this allegation is conclusory, Plaintiffs have failed to show
2
that the entire Board was even aware of Erhart’s whistleblower complaint or audit
3
findings. See MTD, Dkt. No. 41-1 at 17-18. The Court, however, finds that this
4
allegation is sufficiently substantiated by the fact that, according to BofI’s 2015 Proxy
5
Statement, the Audit Committee “reports to the full Board at regular meetings concerning
6
the activities of the committee and actions taken by the committee since the last regular
7
meeting.” Id. ¶ 154. Thus, because BofI’s own disclosures indicate that the Audit
8
Committee reports to the full Board concerning all actions taken since the last Board
9
meeting, the Court finds it reasonable to infer that the Audit Committee informed the
10
Board about what it had learned about Erhart’s audit findings, his complaints, and the
11
downgrading of his job performance.
12
But even taking as true the allegation that the entire Board became aware of
13
Erhart’s complaint and whistleblowing activities on May 21, 2015, it is nonetheless
14
unreasonable to infer, based on the particularized facts alleged, that the majority of the
15
Board — much less the entire Board — collectively decided to fire Erhart. The only
16
Erhart-related allegations attributed to the entire Board state the following:
17
25
1) “[t]he full Board met a few weeks later, on May 21, 2015”
2) “[a]ll nine members of the Board were present in person”
3) “Grinberg presented a report to the full Board from the Audit Committee
. . . includ[ing] all details regarding Erhart’s complaints and the fact that
Erhart had claimed whistleblower protection.”
4) “[t]he Board also met in Executive Session to discuss Erhart’s complaints
and other matters”
5) “less than three weeks later, despite having actual knowledge of Erhart’s
whistleblowing activity, and despite knowing that Dodd-Frank, SarbanesOxley, and other laws prohibit retaliation against employees who report
alleged wrongdoing, the Board authorized and approved the firing of
Erhart on June 9, 2015.”
CSC ¶¶ 156-57. The conclusion that the Board of Directors fired Erhart on June 9, 2015
26
does not “logically flow,” Rosenbloom, 765 F.3d at 1148, from particularized facts
27
demonstrating that the Board was aware of Erhart’s complaint and whistleblowing
28
activities. The CSC contains no particularized allegations detailing what occurred after
18
19
20
21
22
23
24
19
3:15-cv-02722-GPC-KSC
1
the Board allegedly learned of Erhart’s whistleblowing activities. They do no state what,
2
if any, actions were taken by the Board, or point to any pattern of behavior occurring
3
after May 21, 2015 that would indicate that the Board remained consciously inactive after
4
learning of Erhart’s findings or, to use Plaintiffs’ words, that they “declined to inform
5
themselves of the misconduct” alleged by Erhart, see CSC ¶ 162. Rather, the CSC is
6
completely silent as to what occurred after May 21, 2015 and how the Board responded
7
to Erhart’s allegations. Such a paucity of particularized facts is not enough for the Court
8
to reasonably infer that a majority of the Board, upon learning of Erhart’s allegations,
9
acted in bad faith by firing him.
10
Stated differently, it is not reasonable to infer that all nine members of the Board of
11
Directors fired Erhart just because they had knowledge of his whistleblowing activities
12
and allegations. Unlike other cases, such as Rosenbloom (discussed in greater detail in
13
infra Section IV), where the court found that the board’s knowledge of illegal activities
14
made it reasonable to infer that the Board participated in — or at the very least ratified —
15
those illegal activities, here, Plaintiffs are asking the Court to infer that the Board’s
16
knowledge of Erhart’s complaint necessarily made them act illegally, that is, by firing
17
him. Even assuming that the complaint pleads enough to conclude that Director
18
Defendants Garrabrants, Grinberg, Mosich, and Argalas had motivation to fire Erhart, the
19
complaint contains no specific allegations whatsoever as to Allrich, Court, Dada, Burke
20
or Ratinoff (i.e., a majority of the Board of Directors). Other than their knowledge that
21
Erhart had filed a whistleblower complaint and accused the company of statutory
22
violations, there is no evidence suggesting that these five board members were, or should
23
be suspected as, active participants in any illegal decision to fire Erhart. See Jones ex rel.
24
CSK Auto Corp. v. Jenkins, 503 F. Supp. 2d 1325, 1334 (D. Ariz. 2007) (refusing to hold
25
an Audit Committee liable for participating in the issuance of false financial statements
26
because the complaint did not detail how the committee learned of the challenged
27
transaction, who presented the information to them, when, and “how the committee
28
members’ response or lack thereof rendered them active participants in . . .
20
3:15-cv-02722-GPC-KSC
1
wrongdoing.”) (emphasis added); Desimone, 924 A.2d at 939 (disregarding plaintiffs’
2
allegation that the CEO was involved in granting illegal stock options because no
3
particularized factual allegations supported the notion that the CEO was involved); Yaw
4
v. Talley, 1994 WL 89019, *10 (Del. Ch. Mar. 2, 1994) (rejecting the contention that an
5
alleged wrongdoer acted “with the complicity of the directors” because the statement
6
lacked factual support in the complaint). For instance, Plaintiffs have presented no
7
evidence indicating that Allrich, Burke, Court, Dada, or Ratinoff had a reason to ignore
8
or bury Erhart’s audit findings. They have also failed to present any evidence
9
demonstrating that Allrich, Court, Dada, Burke or Ratinoff actually voted to terminate
10
Erhart, ratified a decision to terminate Erhart, or remained consciously inactive with
11
regards to Erhart’s impending dismissal. In other words, the CSC’s complete failure to
12
lodge allegations against Allrich, Court, Dada, Burke or Ratinoff and to offer
13
particularized facts demonstrating that they participated, in bad faith, in the decision to
14
fire Erhart is fatal to their demand futility argument.
15
Although the CSC’s lack of allegations as to Allrich, Court, Dada, Burke and
16
Ratinoff, alone, is sufficient to reject Plaintiffs’ argument, the Court also finds that other
17
reasons further counsel against accepting, as reasonable, the inference that the Board
18
fired Erhart. One, Erhart’s complaint does not implicate the Board of Directors in the
19
decision to fire him. See generally Defs.’ Exhibit B, Erhart Complaint, Dkt. No. 41-4.
20
Erhart’s whistleblower complaint does not state, let alone suggest, that the Board of
21
Directors had anything to do with his termination. In fact, Erhart’s complaint repeatedly
22
describes BofI’s upper management, not the Board of Directors, as the culprits of
23
wrongdoing, and even suggests that upper management’s misconduct was carried out in
24
the Board of Directors’ blind spot. See id. at ¶ 25, ¶¶ 19-21, (alleging that the signatures
25
of the board of directors were copied and pasted to approve a document that they had not
26
reviewed). Notably, Erhart’s complaint also does not even mention Allrich, Court, Dada,
27
Burke or Ratinoff (again, a majority of the Board), nevertheless implicate their
28
participation in his dismissal in any way. See generally id. Two, the timeline presented
21
3:15-cv-02722-GPC-KSC
1
in Erhart’s complaint casts further doubt on the reasonableness of Plaintiffs’ conclusory
2
assertion that the Board authorized Erhart’s dismissal on June 9, 2015. Although Erhart,
3
in his complaint, states that he was fired on June 9, 2015, he also alleges that a BofI
4
employee in compliance processed his termination paperwork on March 6, 2015, almost
5
three months before Plaintiffs allege that the Board terminated Erhart. See id. ¶ 70. That
6
Erhart’s own timeline suggests that a decision to terminate Erhart had taken place months
7
before the Board learned of Erhart’s complaints and whistleblowing activities in May
8
2015, further belies Plaintiffs’ argument that it is reasonable to infer that the Board
9
dismissed Erhart on June 9, 2015.
10
Finally, it is also worth noting that it is conspicuous that Plaintiffs allege that the
11
Board fired Erhart on June 9, 2015 when there is nothing in the complaint to suggest that
12
the Board of Directors actually met on June 9, 2015 or that they sat in executive session
13
to discuss Erhart’s findings beforehand. Delaware courts have oft-observed that
14
Plaintiffs who file shareholder derivative suits should take advantage of 8 Del. C. § 220,
15
“which permits a stockholder . . . to obtain in a summary proceeding an order permitting
16
inspection of specific books and records,” in order to file complaints that meet
17
Delaware’s particularized pleading standard. Rales, 634 A.2d at 931 n.4; see also Brehm,
18
746 A.2d at 266-67. Here, Plaintiffs followed such advice and filed a demand to inspect
19
BofI’s books and records. See Dkt. No. 43 at 10. Given Plaintiffs’ “thorough pre-filing
20
investigation,” they have little excuse for not including details that would support the
21
conclusion that the Board of Directors met, or otherwise communicated, on June 9, 2015
22
to fire Erhart. See Guttman v. Huang, 823 A.2d 492, 507 (faulting plaintiffs for relying
23
on a separately-filed federal complaint to implicate the Board of Directors, when they
24
could have made a demand for books and records under 8 Del. C. § 220 to support their
25
demand futility allegations). Or, stated differently, given that Plaintiffs have made a
26
books and record demand on Defendants, the Court finds it unreasonable, and
27
circumspect, to accept as true conclusory allegations that the Board met or conferred
28
22
3:15-cv-02722-GPC-KSC
1
outside of board meetings, without meeting minutes, and with no paper trail of what was
2
discussed.
In sum, Plaintiffs’ conclusion that the Board fired Erhart on June 9, 2015 is not
3
4
supported by substantive, particularized allegations that, when viewed in toto,
5
demonstrate that the Director Defendants engaged in bad-faith and illegal conduct. It is
6
not enough, as Plaintiffs suggest, that they have pled “the who, what, when, where, and
7
how” of the Director Defendants’ knowing violations of the law. See Response, Dkt. No.
8
43 at 20. As Aronson indicates, absent particularized allegations demonstrating that the
9
defendants breached an underlying fiduciary duty (in this case the duty of loyalty) it is
10
not enough to simply plead that the director defendants knowingly participated in illegal
11
activities. See Aronson, 473 A.2d at 817. Here, other than learning of Erhart’s
12
whistleblower allegations, there is no evidence to suggest that a majority of the Director
13
Defendants breached their duties of loyalty to the corporation by firing Erhart in violation
14
of SOX and other laws. Plaintiffs do not discuss what occurred after May 21, 2015, and
15
point to no facts, let alone particularized facts, from which the Court can reasonably infer
16
that a majority of the Board responded to the news of Erhart by acting illegally and in bad
17
faith by firing him. Accordingly, Plaintiffs’ allegation that the Board fired Erhart is
18
conclusory and is insufficient to plead demand futility.
19
II.
Issuance of False and Misleading Statements
20
Plaintiffs alternatively argue that demand is futile because all of the Director
21
Defendants face a substantial likelihood of liability for causing BofI to disseminate false
22
and misleading statements regarding BofI’s internal controls and risk management. See
23
Response, Dkt. No. 43 at 22.
24
A. Whether Aronson or Rales applies
25
Defendants argue that the Rales test applies to Plaintiffs’ assertion that the Director
26
Defendants face liability for disseminating false and misleading statements. See MTD,
27
Dkt. No. 41-1 at 16. By contrast, Plaintiffs seem to suggest that the Aronson test would
28
apply. See Response, Dkt. No. 43 at 25 n.16 (noting that certain precedent cited by
23
3:15-cv-02722-GPC-KSC
1
Defendants was distinguishable because the Rales test applied); id. at 22 (summarizing
2
the demand futility inquiry as whether the Director Defendants face substantial liability
3
for “causing BofI to issue materially false and misleading statements”) (emphasis added).
4
Notwithstanding Plaintiffs’ framing of the relevant analysis, however, the Court
5
concludes that the Rales test should apply. Plaintiffs are not challenging a decision made
6
by the Board, but the Board’s failure to correct SEC disclosures after they allegedly
7
learned of Erhart’s complaint and allegations on May 21, 2015. See Jones ex rel. CSK
8
Auto Corp., 503 F. Supp. 2d at 1132 (applying Rales test to contention that the Board’s
9
audit committee had actively participated in publishing false financial statements); see
10
also In re Countrywide, 554 F. Supp. 2d at 1080 n.39 (concluding that the Rales test
11
applied where specific Board decisions were not directly challenged and where the
12
“overwhelming majority” of the claims did not relate to a business decision). Here,
13
Plaintiffs have not pointed to any business decision made by the Board to purposefully
14
omit material information in its regulatory disclosures. As such, the Rales inquiry is the
15
proper one.
16
That said, whether or not Aronson or Rales applies is not dispositive, here, because
17
a finding that the Board of Directors faces a substantial likelihood of liability for
18
publishing false or misleading statements would satisfy both tests. See Rosenbloom, 765
19
F.3d at 1150 (“it does not matter whether Aronson or Rales applies. Under either
20
approach, demand is excused if Plaintiffs’ particularized allegations create a reasonable
21
doubt as to whether a majority of the board of directors faces a substantial likelihood of
22
personal liability for breaching [their fiduciary duty].”). As such, the Court will analyze
23
the sufficiency of Plaintiffs’ allegations under the substantial likelihood of liability rubric.
24
B. Substantial Likelihood of Liability For Violating Duty of Candor
25
In order to demonstrate that a board faces a substantial likelihood of liability
26
sufficient to excuse demand, the shareholders must make a “threshold showing, through
27
the allegation of particularized facts, that their claims have some merit.” Rosenbloom,
28
765 F.3d at 1149 (citing Rales, 634 A.2d at 934). Here, the underlying claim is that the
24
3:15-cv-02722-GPC-KSC
1
Board breached their duty of candor by knowingly issuing false and misleading
2
statements in its regulatory disclosures. See Response, Dkt. No. 43 at 22. Accordingly,
3
Plaintiffs are required to show that their claim that the Board breached their duty of
4
candor has some merit.
5
The duty of candor, derived from the fiduciary duties of care, loyalty and good
6
faith, requires boards of directors to disclose all material facts when seeking stockholder
7
action. See Malone v. Brincat, 722 A.2d 5, 11 (Del. 1998). “The essential inquiry in
8
such an action is whether the alleged omission or misrepresentation is material” and
9
“[m]ateriality is determined with respect to the shareholder action being sought.” Id.
10
In cases where a board’s allegedly misleading disclosures do not relate to a
11
specific shareholder action, a shareholder plaintiff can demonstrate a breach of fiduciary
12
duty by showing that the directors “deliberately misinformed shareholders about the
13
business of the corporation, either directly or by a public statement.” In re Citigroup Inc.
14
S’holder Deriv. Litig., 964 A.2d 106, 133 (Del. Ch. 2009) (emphasis in original). What a
15
shareholder must prove in a suit against director defendants protected by an exculpatory
16
provision is even more exacting. See id. at 124-25. Delaware law authorizes
17
corporations to include clauses in their charters that limit director liability for breaches of
18
fiduciary duty to only those acts or omissions that are made intentionally, in bad faith, or
19
in knowing violation of the law. See id. Here, the parties do not dispute that the
20
exculpatory provision in BofI’s Certificate of Incorporation insulates the Director
21
Defendants from non-intentional breaches of their fiduciary duties. See Response, Dkt.
22
No. 43 at 29; MTD, Dkt. No. 41-1 at 20. Accordingly, “because the [D]irector
23
[D]efendants are exculpated from liability for certain conduct, then a serious threat of
24
liability may only be found to exist if the [P]laintiff[s] plead[ ] a non-exculpated claim
25
against the [D]irectors based on particularized facts.” In re Citigroup, 964 A.2d at 124-
26
25. Accordingly, for present purposes, in order to demonstrate demand futility, Plaintiffs
27
must have sufficiently plead particularized factual allegations “support[ing] the inference
28
that the disclosure violation was made in bad faith, knowingly or intentionally.” Id.; see
25
3:15-cv-02722-GPC-KSC
1
also In re Polycom, Inc., 78 F. Supp. 3d 1006, 1016 (N.D. Cal. 2015); In re First Solar
2
Deriv. Litig., 2016 WL 3548758, *6 (D. Ariz. June 30, 2016).
3
C. Demand futility analysis
4
Plaintiffs argue that all of the Director Defendants face a substantial likelihood of
5
liability for causing BofI to disseminate false and misleading statements regarding BofI’s
6
internal controls and risk management in violation of their duty of candor. Response,
7
Dkt. No. 43 at 22. In taking this position, they rely on the fact that (1) “this Court has
8
already upheld [BofI’s false and misleading statements] as actionable under the
9
heightened pleading standard of the PSLRA [Private Securities Litigation Reform Act] in
10
the related securities-fraud class action” and (2) that the complaint alleges with great
11
detail the “involvement of a majority of the Board in causing BofI to issue materially
12
false and misleading statements.” Id. For the reasons stated below, however, the Court
13
finds neither of these arguments persuasive.
14
For one, the parallel that Plaintiffs draw between this shareholder demand suit and
15
the related securities litigation lawsuit brought against BofI is misplaced. Plaintiffs rely
16
on In re Countrywide to demonstrate that where, as here, a shareholder derivative suit is
17
accompanied by a properly-plead securities fraud suit — that is, one that pleads with
18
particularity that the corporate defendant knowingly made a false and misleading
19
statement, see Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 990 (9th Cir. 2009)
20
— demand is excused. See Response, Dkt. No. 43 at 22. In In re Countrywide, however,
21
the court had found that the plaintiffs had demonstrated a strong inference of scienter, for
22
purposes of proving a securities violation, with respect to eleven of the thirteen board of
23
directors. 554 F. Supp. 2d at 1082. It is, therefore, no surprise that the In re Countrywide
24
court would import their discussion of securities fraud scienter into its analysis of
25
demand futility, because it had already found that the plaintiffs had plead knowledge of
26
wrongdoing as to a majority of the board of directors.
27
Here, by contrast, this Court did not find that a strong inference of scienter
28
attached to a majority of BofI’s board of directors for purposes of pleading a securities
26
3:15-cv-02722-GPC-KSC
1
fraud claim. In fact, the Court only held that the plaintiffs had plead scienter with
2
particularity as to Garrabrants. See In re: BofI Holding, Inc. Sec. Litig., 2016 WL
3
5390533, *12-14 (S.D. Cal. Sept. 27, 2016). Accordingly, the securities fraud suit
4
pending against BofI proves very little, here, because it only found that a single board
5
member knowingly issued false and misleading statements, as opposed to a majority of
6
them. Thus, because the BofI securities fraud suit did not find that a strong inference of
7
scienter attached to any of the eight remaining director defendants, the outcome of that
8
suit has virtually no probative value in the demand futility context, except as to
9
Garrabrants. Accordingly, Plaintiffs’ argument fails.
10
Two, contrary to what Plaintiffs argue, they have not plead “in great detail” that a
11
majority of the Board was involved in the issuance of false or misleading statements. Not
12
only have Plaintiffs failed to identify any relevant disclosure that was false or misleading,
13
but they have also failed to demonstrate that a majority of the Board of Directors made
14
any misstatement knowingly, intentionally, or in bad faith. See In re Citigroup, 964 A.2d
15
at 124-25.
16
Plaintiffs argue that all of the Director Defendants approved and signed the Form
17
10-Ks dated September 4, 2013, August 28, 2014, and August 26, 2015, all of which
18
allegedly contained false and misleading statements about BofI’s condition, the adequacy
19
of its internal controls and the risk of its investments. See Response, Dkt. No. 43 at 23.
20
Plaintiffs, however, have not pointed to any evidence suggesting that Allrich, Burke,
21
Court, Dada, or Ratinoff would have known that there were false and misleading
22
statements contained in the 2013 or 2014 10-K. See Defs.’ Reply to Response, Dkt. No.
23
47 at 13 (pointing out that “BofI’s Forms 10-K for 2013 and 2014 are irrelevant to this
24
Court’s demand futility analysis because they predate May 21, 2015, the date the Board
25
allegedly became aware of Mr. Erhart’s claims.”). Plaintiffs nonetheless suggest that all
26
of the Director Defendants knew that they were making false and misleading statements
27
in the 2013 and 2014 publications because Erhart’s audit findings revealed that “BofI’s
28
27
3:15-cv-02722-GPC-KSC
1
internal controls were frequently disregarded” during that time frame. Response, Dkt.
2
No. 43 at 23.
3
The Court rejects Plaintiffs’ attempt to rely on the mere existence of wrongdoing
4
occurring somewhere at the company as evidence of the Board’s knowledge or
5
complicity in that wrongdoing. There is no evidence that any of that alleged wrongdoing
6
“pierced the confines of the Boardroom,” see Gulbrandsen ex rel. Wells Fargo & Co. v.
7
Stumpf, 2013 WL 1942158, *6 (N.D. Cal. May 9, 2013), until the May 21, 2015 Board
8
meeting, when Grinberg allegedly informed the Board about Erhart’s whistleblower
9
complaint and audit findings. Moreover, Delaware courts have routinely rejected the
10
notion that board members can be presumed substantially liable for misconduct occurring
11
at the company absent particularized allegations evidencing that the Board knew about
12
the illicit activities. See Guttman v. Huang, 823 A.2d at 504; In re Citigroup, 964 A.2d at
13
134; see also Jones ex rel. CSK Auto Corp., 503 F. Supp. 2d at 1334; In re First Solar
14
Deriv. Litig., 2016 WL 3548758, *10 (D. Ariz. June 30, 2016); Gulbrandsen, 2013 WL
15
1942158, at *6; In re Verifone Holdings, Inc. S’holder Deriv. Litig., 2009 WL 1458233,
16
*8 (N.D. Cal. May 29 2009) (“It is conclusory to state that the directors knew about the
17
internal problems in accounting. . . [t]hese facts suggest at most that there were
18
weaknesses in the accounting division . . . not that the directors were conscious of the fact
19
that they were not doing their jobs.”). Thus, because Plaintiffs have not set forth any
20
allegations demonstrating that the majority of the Board should have known about any
21
wrongdoing before May 21, 2015, whether a majority of the Board faces liability
22
associated with the issuance of false statements depends on whether a majority of the
23
Board faces a substantial likelihood of liability based upon disclosures made in the 2015
24
Form 10-K.
25
The Court, however, cannot reasonably conclude that a majority of the Board faces
26
a substantial likelihood of liability for making false or misleading statements in the 2015
27
Form 10-K because Plaintiffs have failed to identify, much less particularly plead, any
28
false or misleading statement present in the 2015 Form 10-K. See In re Citigroup, 964
28
3:15-cv-02722-GPC-KSC
1
A.2d at 133-34 (finding, in part, that plaintiffs failed to meet the factual particularity
2
standard because they did not “allege with particularity which disclosures were
3
misleading . . . what specifically the Company was obligated to disclose, and how the
4
Company failed to do so.”). The complaint discusses the alleged disclosures made in
5
BofI’s 2015 Form 10-K at ¶¶ 124-27. One of the alleged disclosures concerns BofI’s
6
acknowledgement that it was subject to extensive federal regulation. See CSC ¶ 125.
7
Quoting the 2015 Form 10-K for the proposition that BofI is subject to federal regulation,
8
however, does not demonstrate that BofI made a material false and misleading statement
9
about the adequacy of BofI’s internal controls or the risk of its investments. The other
10
allegations concerning the contents of BofI’s 2015 Form 10-K are similarly devoid of any
11
actionable false or misleading statements. For instance, Plaintiffs also fail to identify any
12
false or misleading statement by pleading that the 2015 Form 10-K cross-references the
13
Form 8-K filed on July 30, 2015. See CSC ¶ 124. Because the only information
14
identified by the CSC in the July 30, 2015 Form 8-K concerns the company’s “financial
15
and operating results,” which include a description of net income, net revenue, and price
16
per share, the Court cannot conclude that the 2015 Form 10-K contained a false or
17
misleading statement about BofI’s internal controls, regulatory compliance, or risk. See
18
id. at ¶ 121. Finally, the Court concludes that it is also not sufficient, for demand futility
19
purposes, to rely on SOX certifications signed by Defendants Garrabrants and Micheletti.
20
While the SOX certifications are relevant insofar as they state that “the Company has
21
disclosed all significant deficiencies and material weaknesses in the design or operation
22
of the Company’s internal controls over financial reporting,” they are not enough to plead
23
demand futility because they were not signed by the majority of the Board. See id. ¶ 126.
24
As such, the Court cannot conclude that a majority of the Board is likely to face a
25
substantial likelihood of liability for violating their duty of candor.
26
Yet even if Plaintiffs had identified a statement in the 2015 Form 10-K that was
27
rendered false or misleading by Erhart’s audit findings, that would still not be enough
28
because the CSC also lacks the particularized facts needed to reasonably infer that a
29
3:15-cv-02722-GPC-KSC
1
majority of the Board issued such statements knowingly, intentionally or in bad faith. In
2
order for a board member to face a substantial likelihood of liability for violating his duty
3
of candor, he or she must have deliberately misinformed shareholders. See Citigroup,
4
964 A.2d at 133. But as the Court previously stated, the Court rejects the notion that a
5
majority of the Board, and particularly Allrich, Burke, Court, Dada or Ratinoff, can be
6
held liable for deliberately concealing material weaknesses in BofI’s internal controls and
7
risk procedures based solely upon the conclusory allegation that they fired Erhart or that
8
they were aware of his allegations.
9
By way of comparison, in In re Veeco Instruments, Inc. Sec. Litig., the plaintiffs
10
successfully argued that the audit committee would face a substantial likelihood of
11
liability for failing to investigate a whistleblower complaint by pointing to the fact that
12
violations raised by the whistleblower continued to occur after they were brought to the
13
committee’s attention. 434 F. Supp. 2d 267, 277-78 (S.D.N.Y. 2006). Such repeated
14
violations, the court concluded, supported the inference that the committee permitted the
15
additional violations to occur because a later violation suggests that the whistleblower
16
reports had been disregarded. Id. at 278. Here, however, the complaint does not
17
particularly allege that any of the violations that Erhart raised in his whistleblower
18
complaint continued to occur after the Board became aware of his audit findings. It also
19
does not offer allegations suggesting that the Board failed to investigate Erhart’s
20
complaint or that they declined to inform themselves of the misconduct. Accordingly,
21
absent some indication that the Board did nothing about Erhart’s audit findings after it
22
learned of them, the Court cannot reasonably conclude that a majority of the Board
23
knowingly and in bad faith made false and misleading statements in the 2015 Form 10-K,
24
issued months after they learned of Erhart’s audit findings.
25
In reaching this conclusion, the Court rejects Plaintiffs’ reliance on In re
26
Countrywide and In re Cendant Corp. Deriv. Action Litig., 189 F.R.D. 117, 129 (D.N.J.
27
1999) for the proposition that it is proper to hold director defendants, who know of
28
ongoing illegal conduct, liable for signing the company’s false and misleading financial
30
3:15-cv-02722-GPC-KSC
1
statements. See Response, Dkt. No. 43 at 24-25. The plaintiffs in In re Countrywide and
2
In re Cendant presented the court with substantial and probative evidence of the
3
defendants’ knowledge of illegal conduct. See In re Countrywide, 554 F.Supp.2d at 1082
4
(finding that the board’s audit committee and financial committee had made false and
5
misleading statements with scienter because they were responsible for overseeing the
6
company’s risk exposure and financial performance of its loan portfolio and yet had done
7
nothing in the face of increased delinquency and nonperformance in the company’s
8
riskiest loans); see also In re Cendant, 189 F.R.D. at 128 (concluding that because the
9
director defendants directly benefitted from making false and misleading statements with
10
regards to a merger, which led to lucrative compensation packages, fees, and stock
11
options for the board, they were substantially likely to face liability for knowingly issuing
12
such statements). Here, by contrast, Plaintiffs have not presented the Court with any
13
particularized allegations evincing that the majority of the Board of Directors knew of
14
illegal conduct occurring at the time of the issuance of the 2015 Form 10-K. Plaintiffs
15
claim that the Board learned of Erhart’s audit findings on May 21, 2015, but they do not,
16
for instance, allege any facts demonstrating that a majority of the Board failed to
17
investigate Erhart’s audit findings or deliberately refused to act upon them, such that the
18
Court can infer that they knowingly or intentionally misled the public about the
19
company’s condition months later.
20
In sum, Plaintiffs have not plead enough as to the Board as a whole for the Court to
21
conclude that a majority of them face a substantial likelihood of liability for breaching
22
their duty of candor by publishing false or misleading statements. The complaint alleges
23
that the Board learned of Erhart’s whistleblower complaint and audit findings on May 21,
24
2015, but they do not identify any statement made in BofI’s 2015 10-K, published in
25
August 2015, that the Court could reasonably conclude was rendered false or misleading
26
by Erhart’s findings concerning BofI’s internal controls and risk procedures. Absent
27
evidence that a disclosure violation actually occurred, the Court cannot conclude that the
28
Board faces a substantial likelihood of liability. Furthermore, even if Plaintiffs had
31
3:15-cv-02722-GPC-KSC
1
adequately identified misleading statements made in the 2015 Form10-K, they have still
2
failed to demonstrate that any misstatements were made by a majority of the Board in bad
3
faith. There are no particularized allegations demonstrating that the majority of the
4
Board deliberately turned a blind eye to Erhart’s audit findings, failed to investigate
5
them, or allowed the wrongdoing to continue. As such, the Court cannot conclude that a
6
majority of the Board is substantially likely to face liability for violating its duty of
7
candor and for deliberately misinforming investors.
8
9
III.
Other Demand Futility Arguments
Plaintiffs further argue that there is reason to doubt the Director Defendants’
10
ability to impartially consider a demand because of their compensation packages and
11
other job-related emoluments. Response, Dkt. No. 43 at 32.
12
A. Director Independence and Disinterestedness
13
To return to the basics, under the first prong of Aronson, a plaintiff can establish
14
demand futility by showing that a majority of the board of directors are not disinterested
15
and independent. “Directorial ‘interest’ exists whenever divided loyalties are present, or
16
where the director will receive a personal financial benefit from a transaction that is not
17
equally shared by the stockholders, or when a corporate decision will have a ‘materially
18
detrimental impact’ on a director but not the corporation or its stockholders.” In re
19
Computer Scis. Deriv. Litig., 244 F.R.D. at 586 (citing Rales, 634 A.2d at 936).
20
Shareholders may also demonstrate that a director lacks independence by demonstrating
21
that the director is “controlled” by another individual or entity. See In re Sagent Tech.,
22
Inc. Deriv. Litig., 278 F. Supp. 2d 1079, 1088 (N.D. Cal. 2003).
23
24
25
26
27
A director may also be considered “controlled” if he or she is beholden to the
allegedly controlling entity, as when the entity has the direct or indirect
unilateral power to decide whether the director continues to receive a benefit
upon which the director is so dependent or is of such subjective material
importance that its threatened loss might create a reason to question whether
the director is able to consider the corporate merits of the challenge transaction
objectively.
28
32
3:15-cv-02722-GPC-KSC
1
Telxon Corp. v. Meyerson, 802 A.2d 257, 264 (Del. 2002) (citations omitted). When
2
making this inquiry, courts should be guided by “a kind of realism in analyzing the
3
human dynamics at play in a director’s relationships.” See Union de Empleados de
4
Muelles de Puerto Rico PRSSA Welfare Plan v. UBS Fin. Servs. Inc. of Puerto Rico, 704
5
F.3d 155, 164 (1st Cir. 2013). As such, the proper inquiry is whether or not any given
6
compensation or emolument would make a director defendant “so personally or
7
financially beholden to an interested person, or an interested entity” such that “his or her
8
discretion [is] sterilized.” Beam ex rel Martha Stewart Living Omnimedia, Inc. v.
9
Stewart, 845 A.2d 1040, 1050 (Del. 2004).
10
B. Demand Futility Analysis
11
The Court finds that Plaintiffs’ compensation-related allegations are insufficient to
12
establish demand futility. As Plaintiffs themselves concede, it is not enough, for demand
13
futility purposes, to rely on the amount that a director is compensated as evidence of
14
nonindependence. See In re Countrywide, 554 F. Supp. 2d at 1078 (“While these
15
numbers [$358,966 to $538,824] may be substantial, the Court cannot conclude, without
16
more, that they are “so lavish that a mechanical application of the [presumption of
17
director independence] would be totally at variance with reality”) (quoting Grobow v.
18
Perot, 526 A.2d 914, 923 n.12 (Del. Ch. 1987) aff’d 539 A.2d 180 (Del. 1988)).
19
Nonetheless, Plaintiffs argue that they have plead enough to question the board members’
20
independence because a majority of the Board (namely, Allrich, Argalas, Burke,
21
Garrabrants, Grinberg, and Mosich) not only received substantial compensation, but also
22
received mortgages on their primary residences at below-market rates. Id. at 23.
23
Plaintiffs, however, have failed to adequately plead or explain how the receipt of a
24
single loan on a primary residence at below-market rates, is of such subjective materiality
25
to the Board members that a majority of them could not consider a shareholder demand.
26
For one, the benefit that the Board members received does not arise from the challenged
27
transaction, a fact that diminishes any inference of partiality. Rales, 634 A.2d at 933. By
28
way of example, in Mizel v. Connelly, the only case cited by Plaintiffs to support their
33
3:15-cv-02722-GPC-KSC
1
argument, the court found that a majority of the board of directors were interested
2
because one board member directly benefitted from the transaction challenged by the
3
shareholders. 1999 WL 550369 (Del. Ch. July 22, 1999). The shareholders in Mizel
4
brought suit against President Casinos, a corporation, for having bought a nearby resort at
5
an excessive price. Id. at *2. Because one of President Casinos’ director defendants was
6
the sole owner of the purchased resort, the court concluded that that director could not
7
have impartially considered a demand because he had a direct personal interest in the
8
challenged transaction. Id. The court further concluded that because the remaining
9
director defendants were beholden to that director, “who does possess such a self-interest,
10
11
[ ] they c[ould not] consider the demand solely on the merits.” Id. at *3.
The instant matter could not be more different from the facts of Mizel. There is no
12
obvious connection between the conduct that the shareholders challenge (i.e., Erhart’s
13
dismissal and the violations he uncovered) and the fact that the board members can take
14
advantage of a company-wide policy regarding loan rates. Moreover, the emolument at
15
issue, here, was taken advantage of only once, on each of the above-mentioned Director
16
Defendants’ primary residences, and contrary to what Plaintiffs’ argue, there is no basis
17
for reasonably concluding that a loan, a contract, would somehow be rescinded or
18
modified just because the Director Defendants decided to consider the shareholders’
19
demand. As such, the Court rejects Plaintiffs’ cursory conclusion that the board members
20
would be “jeopardizing the mortgages on their primary residences” by considering a
21
shareholder demand.” Response, Dkt. No. 43 at 33.
22
Put plainly, Plaintiffs have failed to plead facts upon which the Court can
23
reasonably conclude that the Board members’ judgment is impaired by the receipt of a
24
single loan at below-market rates and their board-related compensation. To satisfy the
25
heightened pleading standard for demand futility, Plaintiffs must demonstrate via
26
particularized facts that the majority of the Board of Directors are impartial. Merely
27
saying that the majority of the Board once took advantage of a company-wide program
28
that provided them with a favorable mortgage on their primary residence, without
34
3:15-cv-02722-GPC-KSC
1
alleging how that seemingly one-time benefit would indefinitely disqualify certain Board
2
members from exercising independent judgment, is not enough. While the Court
3
recognizes that certain employee benefits may be sufficiently material to raise an
4
inference that board members are beholden to the company, the Court rejects Plaintiffs’
5
argument that the receipt of a single mortgage at a below-market interest rate, without
6
more, is one of them. Accordingly, the Court concludes that Plaintiffs’ compensation-
7
related allegations fail to satisfy Aronson.11
8
IV.
9
Summary and the Rosenbloom framework
In their opposition to Defendants’ motion to dismiss, Plaintiffs rely heavily on the
10
Ninth Circuit’s decision in Rosenbloom v. Pyott to support the sufficiency of their
11
demand futility allegations. See Response, Dkt. No. 43 at 18-19. Rosenbloom provides
12
courts with guidance on how to review the adequacy of shareholder demand futility
13
pleadings and, specifically, Rosenbloom instructs lower courts to (1) read the factual
14
allegations as a whole, rather than in isolation; (2) credit the plaintiff’s reasonable
15
interpretations of the allegations rather than draw inferences in favor of the Defendants;
16
and (3) not insist on a “smoking gun of Board knowledge.” 765 F.3d at 1155-56. Yet
17
while Plaintiffs rely upon these three tenets to defend against the Defendants’ motion to
18
dismiss, the Court concludes that Plaintiffs’ demand futility allegations are equally
19
insufficient even when viewed within the Rosenbloom framework.
As identified above, each of Plaintiffs’ demand futility arguments suffer from fatal
20
21
flaws that cannot be cured by reading the factual allegations as a whole or by drawing
22
reasonable inferences in favor of Plaintiffs, including reasonable inferences of Board
23
knowledge. First, the complaint offers no particularized facts demonstrating that the
24
entire Board fired Erhart. Plaintiffs would have the Court infer that the Board fired
25
26
11
27
28
The Court notes that Plaintiffs also make specific arguments concerning the independence of
Garrabrants and Grinberg. However, because these arguments are not directed at a majority of the
Board, it is not necessary for the Court to reach them as they are insufficient for demand-futility
purposes.
35
3:15-cv-02722-GPC-KSC
1
Erhart just because they had knowledge of his allegations, but that conclusion does not
2
follow from the particularized facts alleged.
3
Second, the complaint does not identify any false or misleading statement for
4
which a majority of the Board could be held liable. Plaintiffs contend that the entire
5
Board can be held responsible for the violations of law that Erhart uncovered, but
6
Delaware law has made clear that the mere existence of wrongdoing or the mere fact that
7
certain public statements were false or misleading, does not make a board liable absent
8
evidence that the board was aware of the misconduct. Plaintiffs have alleged with
9
sufficient particularity that the Board became aware of Erhart’s allegations on May 21,
10
2015. They have not, however, identified any statement in the 2015 Form10-K that was
11
rendered false or misleading by Erhart’s audit findings or set forth any allegations
12
demonstrating that the Board approved the disclosure knowing that it contained
13
misinformation about the company’s condition.
14
Third, Plaintiffs have not set forth enough particularized pleadings for the Court to
15
infer that a majority of the Board is partial because of their board compensation and
16
because they received a favorable mortgage on their primary residence. Plaintiffs
17
contend that the Board members who participated in the Mortgage-lending Program
18
would have been “jeopardizing the mortgages on their primary residences” if they were
19
to have responded to Plaintiffs’ demand allegations. Yet that conclusion strains credulity.
20
Plaintiffs’ demand futility allegations have nothing to do with the mortgage lending
21
program and, moreover, there is no evidence to suggest that BofI raises the interest rates
22
on such loans when an employee or board member departs.
23
And finally, the Court is also not convinced that there are sufficient parallels
24
between the facts of Rosenbloom and the facts of the present case to warrant finding that
25
Plaintiffs have adequately pled demand futility. The wrongdoing at issue in Rosenbloom
26
was the alleged promotion of Botox for off-label purposes — meaning, for the care of
27
symptoms other than the ones that the FDA approved the drug to treat. Rosenbloom, 765
28
F.3d at 1141. There was no question that Botox was being prescribed for off-label (i.e.,
36
3:15-cv-02722-GPC-KSC
1
illegal purposes) and, thus, the case’s central dispute concerned whether the board was
2
rightfully deemed responsible for the illegal use of its product. Accordingly, for purposes
3
of pleading demand futility, the Rosenbloom inquiry focused on whether the plaintiffs
4
had adequately alleged scienter such that that the court could reasonably infer that the
5
board participated or tacitly ratified the off-label scheme, thus making them incapable of
6
impartially considering a shareholder demand. Id. at 1151.
7
Ultimately, the Ninth Circuit held that plaintiffs had met their burden by pleading
8
“a battery of particularized factual allegations” that raised red flags sufficient to “support
9
an inference at this stage of the litigation that the Board knew of and did nothing about
10
illegal activity.” Id. at 1152. Those red flags included: (1) the Board’s decision to adopt
11
strategic plans to maximize sales of the drug for off-label use before the FDA was slated
12
to approve the drug for such uses; (2) that the Board closely and regularly monitored off-
13
label Botox sales; (3) the Board’s decision to fund organizations under their control that
14
promoted off-label use of Botox; (4) Allergan’s acquisition of a company that afforded
15
Botox sales specialists access to physicians who would prescribe Botox for off-label
16
purposes; (5) the Board’s interest in Allergan’s off-label sales programs that were
17
spearheading the unlawful marketing; (6) the Board’s receipt of data “directly linking
18
Allergan’s sales programs to fluctuations in off-label sales”; (7) the fact that the Board
19
had received repeated FDA warnings about the illegal promotion of Botox; (8) the fact
20
that “the illegal conduct in th[e] case involved one of the most important drugs at
21
Allergan”; and (9) the fact that the illegal conduct persisted for over a decade and
22
involved several divisions at Allergan. Id. at 1152-54.
23
Here, however, we do not have a “battery of particularized allegations that
24
strongly supported an inference . . . that the Board knew of and did nothing about illegal
25
activity.” Rosenbloom, 765 F.3d at 1152 (emphasis added). All that Plaintiffs have
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alleged with particularity is that the Board became aware of Erhart’s audit findings and
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whistleblower complaint on May 21, 2015. Based on that allegation alone, Plaintiffs
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argue that the Court can infer that the Board fired Erhart, that the Board deliberately
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1
disregarded or negligently did not investigate his audit findings, and that the Board
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knowingly misled the public to believe that the company was on sound legal footing
3
when in fact it was aware that Erhart was correct when he reported that illegal activity
4
was rampant at the bank. But Plaintiffs have plead no facts demonstrating that the BofI
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Board did nothing about Erhart’s audit findings, much less that they fired him. Unlike
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the shareholders in Rosenbloom, Plaintiffs have not demonstrated that the alleged illegal
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conduct persisted for any meaningful time after the Board became aware of it, or that the
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Board failed to address such illegality despite receiving repeated warnings from
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regulators addressing such misconduct. See In re First Solar, 2016 WL 3548758, at *13
10
(refusing to find that plaintiffs were entitled to demand under Rosenbloom because they
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did not allege enduring or pervasive misconduct or that that board was warned by
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government agencies about the alleged misconduct). Absent such allegations, the Court
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can only speculate about how the Board reacted to Erhart’s audit findings and his alleged
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whistleblower complaint and whether their reaction rendered them interested for demand
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futility purposes.
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Perhaps the Board did fire Erhart. Perhaps they have ignored all of his audit
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reports and misled the public as to BofI’s regulatory compliance. But the Court cannot
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reasonably infer any of these conclusions based on the particularized allegations
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contained in the complaint. The only key fact that the complaint pleads with particularity
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is that the Board became aware of Erhart’s whistleblower complaint on May 21, 2015.
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What happened after May 21, 2015 is entirely unclear, and thus it would be improper for
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the Court to make any reasonable inferences about the Board’s scienter or bad-faith
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reaction to Erhart’s complaint. Accordingly, the Court finds that Plaintiffs have failed to
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adequately demonstrate that they are entitled to demand futility.
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MOTIONS TO SEAL
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The parties have filed various motions to seal documents submitted in support of
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their respective briefs. Plaintiffs have moved to seal portions of their opposition brief,
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Dkt. No. 42; Defendants moved to seal an unredacted version of Board meeting minutes
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3:15-cv-02722-GPC-KSC
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from May 21, 2015 in support of their reply brief, Dkt. No. 48-1; and Plaintiffs moved to
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seal portions of their response to Defendants’ request to seal and take judicial notice of
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the May 21, 2015 minutes, Dkt. No. 50-1. For the following reasons, the Court
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GRANTS each of these motions to seal.
5
Courts have recognized a “general right to inspect and copy public records and
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documents, including judicial records and documents.” Nixon v. Warner Commc'ns, Inc.,
7
435 U.S. 589, 597 & n. 7 (1978). Nonetheless, access to judicial records is not absolute.
8
A narrow range of documents is not subject to the right of public access at all because the
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records have “traditionally been kept secret for important policy reasons.” Times Mirror
10
Co. v. United States, 873 F.2d 1210, 1219 (9th Cir.1989). A party seeking to seal a
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judicial record then bears the burden of overcoming this strong presumption by meeting
12
the “compelling reasons” standard. Id. at 1135. That is, the party must “articulate[ ]
13
compelling reasons supported by specific factual findings,” id. (citing San Jose Mercury
14
News, Inc. v. U.S. Dist. Ct., 187 F.3d 1096, 1102-03 (9th Cir. 1999)), that outweigh the
15
general history of access and the public policies favoring disclosure, such as the “public
16
interest in understanding the judicial process,” id. (quoting Hagestad v. Tragesser, 49
17
F.3d 1430, 1434 (9th Cir. 1995)). After considering these interests, if the court decides to
18
seal certain judicial records, it must “base its decision on a compelling reason and
19
articulate the factual basis for its ruling, without relying on hypothesis or conjecture.”
20
Hagestad, 49 F.3d at 1434 (citing Valley Broadcasting Co. v. U.S. Dist. Ct., 798 F.2d
21
1289, 1295 (9th Cir. 1986)).
22
In common to all three motions to seal, here, is the confidentiality agreement
23
entered into between Plaintiffs and BofI in connection with BofI’s response to the
24
shareholder inspection demand made upon the company. See Dkt. Nos. 42-1, 48, 50-1.
25
On December 2, 2015, Plaintiff Calcaterra served BofI with a demand to inspect its books
26
and records under Section 1601 of the California Corporations Code. Plaintiff’s demand
27
sought to inspect BofI’s Board meeting minutes from February 6, 2013 onward and any
28
presentations or documents displayed at those meetings. Dkt. No. 50-1 at 3. As a
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3:15-cv-02722-GPC-KSC
1
condition of complying with this shareholder demand, BofI requested that any documents
2
it produced remain confidential because they contain non-public, proprietary, or
3
commercially sensitive information about BofI. Id. To that end, the parties entered into a
4
confidentiality agreement on March 8, 2016, which designated all documents produced
5
from the shareholder demand as confidential. Id.
6
Pursuant to this agreement, Plaintiffs moved to file portions of the CSC under seal.
7
See Dkt. No. 34-1. On August 30, 2016, the Court granted said request, finding that
8
compelling reasons existed to seal the information subject to the confidentiality
9
agreement. Dkt. No. 33. In accordance with the Court’s August 30, 2016 ruling, the
10
Court finds that similar compelling reasons exist, here, to grant the requested motions.
11
Each of the parties’ motions requests that the Court seal documents, or information
12
obtained from documents, which are subject to the parties’ confidentiality agreement.
13
See Dkt. Nos. 42-1, 50-1, and 48. The scope of information subject to the confidentiality
14
agreement concerns proprietary business information shared between BofI and its
15
shareholders. Because the Court finds that the disclosure of such information runs the
16
risk of harming BofI’s competitive standing, the Court finds that there is a sufficient,
17
compelling basis for sealing those records and excerpts that are subject to the
18
confidentiality agreement. Accordingly, the Court GRANTS Plaintiffs’ motions to seal,
19
Dkt. Nos. 42-1 & 50-1, and Defendants’ motion to seal, Dkt. No. 48.
20
21
CONCLUSION
The Court GRANTS Defendants’ motions to dismiss. The Court will reserve
22
ruling on whether or not the motion is granted with or without prejudice until after
23
hearing from the respective parties. Given that the related shareholder litigation of
24
Deyoung v. Micheletti et al., 3:16-cv-02723-GPC-KSC is ripe for decision on the merits,
25
the Court is inclined to find that providing the shareholders, here, with leave to amend
26
their demand futility allegations would be futile. The Court therefore ORDERS that
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Plaintiffs show cause why this case should not be dismissed with prejudice by March 17,
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2017. Defendants shall file a response by March 31, 2017.
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IT IS SO ORDERED.
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Dated: March 1, 2017
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