Bennek v. Ackerman et al
Filing
62
ORDER GRANTING Defendants' 45 Motion to Dismiss for Failure to State a Claim. Signed by Judge Thomas W. Thrash, Jr on 11/30/2016. (jkl)
IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION
IN RE THE HOME DEPOT, INC.
SHAREHOLDER DERIVATIVE
LITIGATION
CIVIL ACTION FILE
NO. 1:15-CV-2999-TWT
OPINION AND ORDER
This is a shareholder derivative action. It is before the Court on the Defendants’
Motion to Dismiss [Doc. 45]. For the reasons set forth below, the Defendants’ Motion
to Dismiss [Doc. 45] is GRANTED.
I. Background
This case arises out of the breach of Home Depot’s security systems and the
theft of their customers’ personal financial data (the “Breach”) over the course of
several months in 2014. Plaintiffs Bennek and Frohman are current Home Depot
shareholders, and held shares in Home Depot at the time of the Breach.1 The nominal
Defendant, The Home Depot, Inc. (“Home Depot”) is a multinational home
1
Compl. ¶¶ 22-23.
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improvement retailer that is incorporated in Delaware, with its principal place of
business in Georgia.2
Included as defendants in the suit are three current and former officers of Home
Depot (the “Officers”). Francis Blake was previously Chairman of the Board from
January 2007 to February 2015, and served as CEO during that time until November
2014. Matthew Carey is Home Depot’s Executive Vice President and Chief
Information Officer (“CIO”). Craig Menear served as President of Home Depot’s
retail division from February to October 2014, and was appointed as CEO, President,
and placed on the Board on November 1, 2014. On February 2, 2015, Menear was
appointed Chairman of the Board.3
Also included as defendants are a number of current and former members of
Home Depot’s Board of Directors. Home Depot’s Board currently consists of twelve
members, nine of whom are named as defendants.4 One of them is Menear, who is
also the Company’s CEO and President.5 The remaining eight current directors are
Defendants Bousbib, Brenneman, Brown, A. Carey, Codina, Foulkes, Katen, and
2
Id. ¶ 24.
3
Id. ¶¶ 25-27.
4
Id. ¶ 258.
5
Id. ¶ 27.
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Vadon, all of whom were Directors when the Breach occurred (collectively, the
“Outside Directors”).6 Defendants Hill and Ackerman are former Directors who were
on the Board during the Breach (collectively, the “Former Directors”).7
On September 2, 2014, Home Depot learned that it may have been the victim
of a criminal breach of its payment card data systems.8 After an investigation, Home
Depot confirmed that the Breach had occurred and that hackers had managed to steal
the financial data of 56 million customers between April and September of 2014.9
This followed on the heels of a number of well publicized data breaches that occurred
at major retailers like Target and Neiman Marcus the previous year.10 The hackers
used a third-party vendor’s user name and password to enter into Home Depot’s
network.11 The hackers then gained elevated rights which allowed them to access the
rest of Home Depot’s network and install a custom version of malware called
6
Id. ¶ 258.
7
Id. ¶¶ 36-37.
8
Id. ¶ 214.
9
Id. ¶ 230.
10
Id. ¶¶ 75, 77.
11
Id. ¶ 237.
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BlackPOS.12 A similar version of BlackPOS was used in the Target data breach a few
months prior, and essentially allowed the hackers to capture a customer’s financial
data every time a card was swiped at one of Home Depot’s Point of Sale (“POS”)
terminals (e.g., a cash register).13 A little over a year after the Breach occurred, Home
Depot reported that it had registered a net cost to the Company of $152 million.14
After all is said and done, the total cost to Home Depot because of the Breach has
been estimated to eventually reach nearly $10 billion.15
In August of 2015, Bennek filed a derivative complaint against Home Depot,
and Frohman’s derivative case was later consolidated with Bennek’s. The Plaintiffs
allege that the Defendants breached their duty of loyalty to Home Depot because the
Defendants failed to institute internal controls sufficient to oversee the risks that
Home Depot faced in the event of a breach and because they disbanded a Board of
Directors committee that was supposed to have oversight of those risks.16 As a result
of their alleged failure to take the risk of a data breach seriously and immediately
12
Id.
13
Id. ¶¶ 76, 219.
14
Id. ¶ 250.
15
Id. ¶ 252.
16
Id. ¶ 6.
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implement security measures, the Breach occurred.17 The Plaintiffs also allege that
the Defendants wasted corporate assets, and that the Current Directors violated
Section 14(a) of the Securities Exchange Act in their 2014 and 2015 proxy filings.18
All of the Plaintiffs’ charges against the Defendants ultimately relate to what
the Defendants knew before the Breach and what they did about that knowledge.
According to the Complaint, Home Depot’s by-laws authorized the Board to delegate
any or all of its powers to committees to the extent allowed by law.19 The by-laws
provided for no procedure to do this, other than referencing resolutions of the
Board.20 The Company’s Governance Guidelines, however, said that the roles of
committees are defined “by the Company’s by-laws and by Committee charters
adopted by the Board.”21 When it came to overseeing the company’s information
technology (IT) and digital security, Home Depot had previously instituted what was
17
Id. ¶ 264.
18
Id. ¶¶ 299, 305.
19
Id. ¶ 170.
20
Id.
21
Id. ¶ 171.
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called the Infrastructure Committee.22 The Infrastructure Committee, however, was
dissolved by Home Depot in May 2012.23
Home Depot said in its 2012 Proxy Statement that the responsibility for IT and
data security which had previously been the domain of the Infrastructure Committee
was now being borne by the Audit Committee.24 However, the Audit Committee’s
charter was never amended to reflect this change.25 And according to the Complaint,
Home Depot’s 2014 and 2015 Proxy Statements, which were issued after the Breach
had begun, did not include any indication that the Audit Committee’s charter had not
been changed to reflect its new duties.26
In addition to raising the issue of whether anyone had proper oversight over IT
and data security, the Complaint also alleges a number of deficiencies in Home
Depot’s network security as it stood at the time of the Breach. According to the
Complaint, Home Depot’s contracts with financial institutions required them to
comply with the Payment Card Industry Data Security Standards (“PCI DSS”), which
22
Id. ¶ 174.
23
Id. ¶ 177.
24
Id. ¶ 178.
25
Id. ¶ 180.
26
Id. ¶ 183.
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established a minimum level of protection for data security.27 PCI DSS 2.0, the
version of the standards in place at the time of the Breach, required Home Depot to:
(1) install and maintain a firewall, (2) protect against malware and regularly update
its anti-virus software, (3) encrypt transmission of cardholder data, (4) not store
cardholder data beyond the time necessary to authorize a transaction, (5) limit access
to payment card data, and (6) to regularly test its data security systems.28
On multiple occasions before the Breach, the Board and the Audit Committee
were informed by M. Carey that Home Depot was out of compliance with PCI DSS
on multiple levels.29 M. Carey acknowledged that Home Depot was out of
compliance, and admitted that Home Depot would likely continue to be out of
compliance until February 2015.30 M. Carey assured the Board that there was a plan
in place, and that it was in the process of being implemented.31 During this time, the
Board continued to receive regular updates from M. Carey.32
27
Id. ¶ 68.
28
Id. ¶ 85.
29
See, e.g., id. ¶¶ 199-210.
30
Id. ¶ 207.
31
Id. ¶¶ 207-09, 229, 240, 267.
32
Id. ¶ 279.
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On September 8, 2014, Home Depot acknowledged that there had been a
breach of its network.33 At the time of the Breach, Home Depot’s security systems
were still “desperately out of date,” according to then-CEO, the Defendant Blake.34
For example, encryption technology had only been installed at twenty-five percent
of its stores by the time the Breach was discovered in September 2015.35 In response,
Home Depot accelerated its efforts to increase its security, and was able to install
encryption technology on the remaining seventy-five percent of its stores in just six
days.36
As a result of the harm caused to Home Depot by its delay in responding to
threats Home Depot acknowledged as significant, the Plaintiffs filed this derivative
suit. The Plaintiffs claim that the Defendants breached their duties of care and loyalty,
wasted corporate assets, and violated Section 14(a) of the Securities Exchange Act.
The Defendants now move to dismiss the claims against them under Rules 12(b)(6)
and 23.1(b)(3) of the Federal Rules of Civil Procedure.
33
Id. ¶ 220.
34
Id. ¶ 233.
35
Id. ¶ 124.
36
Id. ¶ 125.
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II. Legal Standard
A complaint should be dismissed under Rule 12(b)(6) only where it appears
that the facts alleged fail to state a “plausible” claim for relief.37 A complaint may
survive a motion to dismiss for failure to state a claim, however, even if it is
“improbable” that a plaintiff would be able to prove those facts; even if the possibility
of recovery is extremely “remote and unlikely.”38 In ruling on a motion to dismiss, the
court must accept the facts pleaded in the complaint as true and construe them in the
light most favorable to the plaintiff.39 Generally, notice pleading is all that is required
for a valid complaint.40 Under notice pleading, the plaintiff need only give the
defendant fair notice of the plaintiff’s claim and the grounds upon which it rests.41
However, in a shareholder derivative case, the complaint shall also allege with
37
Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009); Fed. R. Civ. P. 12(b)(6).
38
Bell Atlantic v. Twombly, 550 U.S. 544, 556 (2007).
39
See Quality Foods de Centro America, S.A. v. Latin American
Agribusiness Dev. Corp., S.A., 711 F.2d 989, 994-95 (11th Cir. 1983); see also
Sanjuan v. American Bd. of Psychiatry & Neurology, Inc., 40 F.3d 247, 251 (7th Cir.
1994) (noting that at the pleading stage, the plaintiff “receives the benefit of
imagination”).
40
See Lombard’s, Inc. v. Prince Mfg., Inc., 753 F.2d 974, 975 (11th Cir.
1985), cert. denied, 474 U.S. 1082 (1986).
41
See Erickson v. Pardus, 551 U.S. 89, 93 (2007) (citing Twombly, 550
U.S. at 555).
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particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff
desires from the directors or comparable authority and, if necessary, from the
shareholders or members, and the reasons for the plaintiff's failure to obtain the action
or for not making the effort.42
III. Discussion
Rule 23.1 clearly “contemplates both the demand requirement and the
possibility that demand may be excused...[but] it does not create a demand
requirement of any particular dimension.”43 Because the demand doctrine is a matter
of substance, the Court looks to the state of incorporation to provide the rule of
decision.44 In this case, Home Depot is incorporated in Delaware; therefore, the Court
looks to Delaware’s substantive law.
“A cardinal precept of the General Corporation Law of the State of Delaware
is that directors, rather than shareholders, manage the business and affairs of the
corporation.”45 Shareholder derivative suits restrict this managerial authority.
Therefore, as a prerequisite to a shareholder derivative suit, Delaware law requires
42
Fed. R. Civ. P. 23.1(b)(3).
43
Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 96 (1991).
44
Id. at 96-97.
45
Stepak v. Addison, 20 F.3d 398, 402 (11th Cir. 1994) (quoting Aronson
v. Lewis, 473 A.2d 805, 811 (Del. 1984)).
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an aggrieved shareholder to demand that the board take the desired action.46 This
demand requirement “insure[s] that a stockholder exhausts his intracorporate
remedies, and ... provide[s] a safeguard against strike suits.”47
It is undisputed that no demand was made in this instance. The Plaintiff
shareholder thus has the burden of demonstrating that demand is excused because it
would have been futile. In situations like this case where the Plaintiffs complain of
Board inaction and do not challenge a specific decision of the Board, a finding of
demand futility is authorized only where “particularized factual allegations of [the]
derivative stockholder complaint 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 a demand.”48
Because the independence of the Board is determined at the time of filing, the Court
only need look to the claims against the Current Directors. And further, because the
Board acts by will of the majority, the Plaintiffs’ Complaint must show that a majority
46
Id.
47
Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984), overruled on other
grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000).
48
Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993) (emphasis added);
accord In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106, 121
(Del. Ch. 2009).
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of the Directors were not independent. As such, the Court only need address the
Plaintiffs’ claims against the Outside Directors (the Defendants Bousbib, Brenneman,
Brown, A. Carey, Codina, Foulkes, Katen, and Vadon), who make up a majority of
the Board49 and are all similarly situated, to determine whether the Board of Directors
was independent.
Interest is demonstrated where a director “will receive a personal financial
benefit from a transaction that is not equally shared by the stockholders,” or “where
a corporate decision will have a materially detrimental impact on a director, but not
on the corporation and the stockholders.”50 Only the former is at issue here.
Initially, it seems obvious that the Board was interested given that a majority
of its members are named in this lawsuit. After all, very few people would choose to
sue themselves. However, as this Court previously noted, under Delaware law
“derivative action plaintiffs do not ring the futility bell merely by including a majority
of the directors as defendants.”51 To do so would eviscerate the demand requirement
49
At the time of filing, the Board consisted of twelve members. Compl. ¶
258. There are eight non-officer Current Directors, making up a majority of the
Board.
50
Rales, 634 A.2d at 936.
51
In re Coca-Cola Enterprises, Inc. Derivative Litigation, 478 F. Supp. 2d
1369, 1374 (N.D. Ga. 2007).
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entirely. Instead, Delaware law requires the Plaintiffs to show director conduct that
is “so egregious on its face that board approval cannot meet the test of business
judgment, and a substantial likelihood of director liability therefore exists.”52
The Plaintiffs plead claims against the Outside Directors for breaches of their
duty of loyalty, corporate waste, and violations of Section 14(a) of the Securities
Exchange Act. The Defendants argue that the Plaintiffs must plead particularized
facts for these claims against each defendant individually. To the Court’s knowledge,
Delaware courts have not directly addressed whether “group pleading” is sufficiently
particular for demand futility. However, a number of District Courts have, and all of
them have at least said that group pleading is not per se insufficient.53 As long as the
defendants are “similarly situated,” group pleading may be enough.
Individual and particularized facts for each defendant would be more necessary
in cases, for example, where the directors are alleged to be financially interested in
52
Aronson, 473 A.2d at 815 (emphasis added).
53
See, e.g., In re American Apparel, Inc. S'holder Deriv. Litig., No. CV
10-06576 MMM RCX, 2012 WL 9506072, at *41 (C.D. Cal. July 31, 2012)
(concluding that such “group pleading is [not] per se impermissible [under Delaware
law, in the context of derivative litigation], so long as group pleading is limited to
defendants who are similarly situated”); In re Chemed Corporation, S’holder Deriv.
Litig., No. CV 13-1854-LPS-CJB, 2015 WL 9460118, at *10-11 (D. Del. Dec. 23,
2015); In re Johnson & Johnson Deriv. Litig., 865 F. Supp. 2d 545, 563 (D.N.J.
2011).
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a proposed merger. In those cases, to determine whether a majority of the board of
directors were interested would require an individual analysis. But in this case, all of
the Plaintiffs’ claims against the non-officer Current Directors essentially allege that
they are liable because of information they received and decisions they took
collectively. There is nothing to be gained by addressing each Outside Director
individually because they are all similarly situated. As such, the Court now addresses
each of the claims against the Outside Directors and takes them together as a group.
A. Duty of Loyalty Claims
The Plaintiffs’ primary claim for liability is that the Directors breached their
duty of loyalty to the company. In cases such as this one, where the Plaintiffs allege
a failure of oversight on the part of the Board, the Plaintiffs must show that the
Directors either “knew they were not discharging their fiduciary obligations or that
the directors demonstrated a conscious disregard for their responsibilities such as by
failing to act in the face of a known duty to act.”54 When added to the general demand
futility standard, the Plaintiffs essentially need to show with particularized facts
beyond a reasonable doubt that a majority of the Board faced substantial liability
because it consciously failed to act in the face of a known duty to act. This is an
54
In re Citigroup, 964 A.2d at 123 (emphasis in original).
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incredibly high hurdle for the Plaintiffs to overcome, and it is not surprising that they
fail to do so.
The Plaintiffs first attempt to clear this hurdle by pointing to the disbanding of
the Infrastructure Committee. According to the Complaint, when the Board disbanded
the Infrastructure Committee, it failed to amend the Audit Committee’s charter to
reflect the new responsibilities for data security that had been transferred from the
Infrastructure Committee, as required by the Company’s Corporate Governance
Guidelines. The Plaintiffs argue, therefore, that the Board failed to designate anyone
with the responsibility to oversee data security, thereby leaving them without a
reporting system.
This argument is much too formal. Even if the Board’s failure to amend the
Audit Committee charter meant that it did not have authority to oversee data security,
and the Court doubts that is true, it is irrelevant here. Demand futility is a fact based
analysis. Whether or not the Audit Committee had technical authority, both the
Committee and the Board believed it did. The Complaint itself details numerous
instances where the Audit Committee received regular reports from management on
the state of Home Depot’s data security, and the Board in turn received briefings from
both management and the Audit Committee. Based on those facts alone, there can be
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no question that the Board was fulfilling its duty of loyalty to ensure that a reasonable
system of reporting existed.
The Plaintiffs then argue that the Board “failed to ensure that a plan was in
place to immediately remedy the deficiency [in Home Depot’s data security], and that
the proposed remedy complied with PCI DSS.”55 Importantly, the Plaintiffs repeatedly
acknowledge that there was a plan, but that in the Plaintiffs’ opinion it moved too
slowly.56 Under Delaware law, however, directors violate their duty of loyalty only
“if they knowingly and completely failed to undertake their responsibilities.”57 In
other words, as long as the Outside Directors pursued any course of action that was
reasonable, they would not have violated their duty of loyalty. The Court suspects that
is why the Plaintiffs awkwardly try to reframe their argument to say that the Board
“failed to take any action to remediate the problems.”58 But the Plaintiffs cannot
escape the facts in their Complaint and their own contradictory arguments. At the end
of the day, the Plaintiffs are alleging that the Board’s plan was not good enough.
55
Compl. ¶ 204 (emphasis added).
56
See, e.g., Compl. ¶¶ 87, 117-18, 200, 203-04.
57
Lyondell Chemical Co. v. Ryan, 970 A.2d 235, 243-44 (Del. 2009).
58
Pls.’ Resp. to Defs.’ Mot. to Dismiss, at 23.
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The Plaintiffs may be right, but Delaware courts have held that “[b]ad faith
cannot be shown by merely showing that the directors failed to do all they should
have done under the circumstances.”59 Rather, they use language like “utterly” and
“completely” to describe the failure necessary to violate the duty of loyalty by
inaction.60 The cases cited in the Plaintiffs’ Response to the Defendants’ Motion to
Dismiss [Doc. 52] work against their argument on this point. In Abbott Labs., the
Seventh Circuit found demand excused where the complaint sufficiently alleged that
in the face of numerous known violations of law, the directors “took no steps in an
effort to prevent or remedy the situation...”61 In Pfizer, the court held that demand was
futile because the directors received numerous warnings of illegal marketing
practices, but they “chose to disregard it.”62 And in Veeco Instruments, the company
failed to do anything for more than a year to address deficiencies in its accounting
59
Wayne Cty. Employees' Ret. Sys. v. Corti, No. CIV.A. 3534-CC, 2009
WL 2219260, at *14 (Del. Ch. July 24, 2009), aff'd, 996 A.2d 795 (Del. 2010).
60
See Lyondell, 970 A.2d at 243-44 (“knowingly and completely failed to
undertake their responsibilities,” and “the inquiry should have been whether those
directors utterly failed to attempt to obtain the best sale price.”).
61
In re Abbott Labs. Deriv. S’holders Litig., 325 F.3d 795, 809 (7th Cir.
2003).
62
In re Pfizer Inc. S’holder Deriv. Litig., 722 F. Supp. 2d 453, 460
(S.D.N.Y. 2010).
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department.63 Though the board acted in that case, the court found demand excused
because the board failed to act until after the harm had occurred.
But in this case, the Complaint acknowledges that the Board acted before the
Breach occurred. The Board approved a plan that would have fixed many of Home
Depot’s security weaknesses and it would be fully implemented by February 2015.
With the benefit of hindsight, one can safely say that the implementation of the plan
was probably too slow, and that the plan probably would not have fixed all of the
problems Home Depot had with its security. But the “Directors' decisions must be
reasonable, not perfect.”64 While the Board probably should have done more,
“[s]imply alleging that a board incorrectly exercised its business judgment and made
a ‘wrong’ decision in response to red flags…is not enough to plead bad faith.”65
Therefore, the Court finds that the Plaintiffs have failed to show beyond a
reasonable doubt that a majority of the Board faced substantial liability because it
consciously failed to act in the face of a known duty to act. As such, demand is not
excused on the basis of the Plaintiffs’ duty of loyalty claims.
63
Veeco Instruments, Inc. v. Braun, 434 F. Supp. 2d 267 (S.D.N.Y. 2006).
64
Lyondell, 970 A.2d at 243.
65
Melbourne Mun. Firefighters' Pension Trust Fund on Behalf of
Qualcomm, Inc. v. Jacobs, C.A. No. 10872-VCMR, 2016 WL 4076369, at *9 (Del.
Ch. Aug. 1, 2016).
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B. Corporate Waste
The Plaintiffs also allege that the Board wasted corporate assets. Under
Delaware law, corporate waste is “an exchange that is so one sided that no business
person of ordinary, sound judgment could conclude that the corporation has received
adequate consideration.”66 Because waste claims entail an action on the part of the
Board, they are evaluated under the Aronson test.67 To show demand futility under
Aronson, the Plaintiffs “must provide particularized factual allegations that raise a
reasonable doubt that ‘(1) the directors are disinterested and independent [or] (2) the
challenged transaction was otherwise the product of a valid exercise of business
judgment.’”68 The Plaintiffs do not challenge the independence of the Board, but
rather their allegations fall under the second prong of Aronson.
The Plaintiffs first maintain that the Board’s insufficient reaction to the threat
posed by the holes in Home Depot’s data security caused significant losses to the
Company, which they claim is a waste of Home Depot’s assets. The problem with the
Plaintiffs’ argument is that there is no transaction. Corporate waste claims typically
66
Brehm, 746 A.2d at 263 (quoting In re Walt Disney Co. Derivative
Litig., 731 A.2d 342, 362 (Del. Ch. 1998)).
67
Aronson, 473 A.2d at 805.
68
In re Citigroup, 964 A.2d at 120 (quoting Brehm, 746 A.2d at 253).
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involve situations where there has been an exchange of corporate assets for no
corporate purpose or for no consideration; in effect, waste is a gift.69 The Plaintiffs
cite no case law to suggest anything to the contrary.
Rather, the Plaintiffs’ claim is fundamentally a challenge to the Directors’
exercise of their business judgment. To paraphrase the Delaware Chancery Court,
what the Plaintiffs are asking the Court to conclude from the presence of these “red
flags” is that the Directors failed to see the extent of Home Depot’s security risk and
therefore made a “wrong” business decision by allowing Home Depot to be exposed
to the threat of a security breach.70 With hindsight, it is easy to see that the Board’s
decision to upgrade Home Depot’s security at a leisurely pace was an unfortunate
one. But this decision falls squarely within the discretion of the Board and is under
the protection of the business judgment rule.
Perhaps recognizing that their first claim of corporate waste does not quite fit,
the Plaintiffs try to argue for the first time in their Response to the Defendants’
69
See Lewis v. Vogelstein, 699 A.2d 327, 336 (Del. Ch. 1997) (“Most
often the claim is associated with a transfer of corporate assets that serves no
corporate purpose; or for which no consideration at all is received. Such a transfer is
in effect a gift.”).
70
In re Citigroup, 964 A.2d at 130 (not excusing demand where the
defendants’ exposure to the subprime mortgage market led to significant losses for
the company).
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Motion to Dismiss [Doc. 52] that the Board also wasted corporate assets through its
compensation package to M. Carey.71 But as this Court has said previously, a
“plaintiff cannot amend the complaint by arguments of counsel made in opposition
to a motion to dismiss.”72 On that ground alone this argument should fail, but it also
fails on the merits.
A board’s decision on compensation “is entitled to great deference. It is the
essence of business judgment for a board to determine if a particular individual
warrant[s] large amounts of money, whether in the form of current salary or severance
provisions.”73 That is not to say that a board’s discretion is unlimited, of course; there
is an “outer limit,” at which point the compensation is “so disproportionately large
as to be unconscionable and constitute waste.”74 As the Plaintiffs point out, Delaware
courts did excuse demand where a company gave $68 million, as well as an office,
an administrative assistant, and a car and driver for up to five years, to its outgoing
CEO who was allegedly responsible in part for billions of dollars in losses to the
71
Pls.’ Resp. to Defs.’ Mot. to Dismiss, at 25.
72
In re Androgel Antitrust Litig. (No. II), 687 F. Supp. 2d 1371, 1381
(N.D. Ga. 2010).
73
Brehm, 746 A.2d at 263.
74
Id. at 262 n. 56 (citing Saxe v. Brady, 184 A.2d 602, 610 (Del. Ch.
1962)).
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company.75 But that is certainly the exception to the rule. Much more often, Delaware
courts have given significant deference to boards’ decisions on executive
compensation.76
This case is also very different than Citigroup. M. Carey is still an employee
of the company, and Home Depot is still receiving substantial consideration through
M. Carey’s continued employment. By contrast, Citigroup had just given three times
the amount of money paid to M. Carey to a former CEO who no longer worked for
it. Though the Court understands the Plaintiffs are not happy with M. Carey’s
performance, the Board is in charge of executive compensation. For these reasons,
demand is not excused on the basis of corporate waste.
C. Violations of Section 14(a) of the Securities Exchange Act
The Plaintiffs lastly assert that the Current Director Defendants violated
Section 14(a) of the Securities Exchange Act when they issued their 2014 and 2015
Proxy Statements. The Plaintiffs and the Defendants disagree on whether these claims
are subject to the demand requirement. The Plaintiffs cite one case, Vides v. Amelio,
75
See In re Citigroup, 964 A.2d at 138.
76
See, e.g., Espinoza v. Zuckerberg, 124 A.3d 47 (Del. Ch. 2015)
(“allegations that compensation is excessive or even lavish, as pleaded here, are
insufficient as a matter of law to meet the standard required for a claim of waste.”)
(internal citations omitted).
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265 F. Supp. 2d 273, 276 (S.D.N.Y. 2003), for the claim that Delaware does not
impose a demand requirement for Section 14(a) claims. The Vides court argued that
the decision to include or omit information in a proxy statement did not require an
exercise in business judgment. But as other courts have noted, while that may be true,
directors must still use their business judgment in determining whether to pursue a
lawsuit on account of those proxy statements.77 Because the business judgment rule
is the foundation for the demand requirement, most courts have held that Vides was
mistaken and that the demand requirement applies equally to Section 14(a) claims,
including another court in the Southern District of New York.78 Though the Eleventh
Circuit has not yet weighed in on the issue, this Court similarly finds the Vides
court’s reasoning to be incorrect, and holds that Section 14(a) claims are subject to
the demand requirement.
77
Bader v. Blankfein, No. 07-CV-1130 (SLT)(JMA), 2008 WL 5274442,
at *6 (E.D.N.Y. Dec. 19, 2008) (The Vides court “ignored the fact that directors must
still use their business judgment in deciding what course of action to take when
alerted to a materially false statement in a corporate proxy statement.”).
78
See, e.g., St. Clair Shores Gen. Emps’ Ret. Sys. v. Eibeler, No. 06 Civ.
688(SWK), 2006 WL 2849783, at *4-6 (S.D.N.Y. Oct. 4, 2006) (expressly rejecting
Vides and holding that Section 14(a) claims are subject to the demand requirement);
Washtenaw Cty. Emps. Ret. Sys. v. Wells Real Estate Inv. Trust, Inc., Civil Action
No. 1:07-CV-862-CAP, 2008 WL 2302679, at *15 (N.D. Ga. Mar. 31, 2008); Bader,
2008 WL 5274442, at *5-7 (collecting cases).
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The decision to include or omit statements in a proxy is not a business decision;
it is a legal one. Demand futility, therefore, is evaluated under Aronson’s first prong,
which excuses demand if the complaint provides particularized factual allegations
that raise a reasonable doubt that the directors are disinterested and independent.79
The primary way to show this is to show that a majority of the directors faced a
substantial likelihood of liability on the underlying claims.80 However, a “mere threat
of personal liability...is insufficient....”81
Section 14(a) and Rule 14-A-9 promulgated thereunder require that proxy
statements not be false or misleading with regard to any material statement, nor omit
to state any material fact necessary in order to make the statements therein not false
or misleading.82 A fact or statement is material if “there is a substantial likelihood that
a reasonable shareholder would consider it important in deciding how to vote.”83 The
Plaintiffs do not allege that the Defendants made any false or misleading statements,
only that the Defendants omitted important information. As such, the Plaintiffs must
79
Brehm, 746 A.2d at 253 (quoting Aronson, 473 A.2d at 814).
80
Aronson, 473 A.2d at 815.
81
Id.
82
See 17 C.F.R. § 240.14-A-9; 15 U.S.C. § 78n(a)
83
Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1084 (1991).
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show that the Board had a duty to disclose the omitted material fact, which is
determined by whether “the SEC regulations specifically require disclosure of the
omitted information in a proxy statement, or the omission makes other statements in
the proxy statement materially false or misleading.”84
Claims under Section 14(a) are also subject to the heightened pleading
requirements of the Private Securities Litigation Reform Act (the “PSLRA”). The
Plaintiffs argue that the PSLRA only applies when there are allegations of fraud,
based solely on Washtenaw Cty. Emps. Ret. Sys. v. Wells Real Estate Inv. Trust, Inc.,
Civil Action No. 1:07-CV-862-CAP, 2008 WL 2302679, at *10 (N.D. Ga. March 31,
2008). The Supreme Court, however, has stated that the PSLRA “impose[s]
heightened pleading requirements and a loss causation requirement upon ‘any private
action’ arising from the Securities Exchange Act.”85 Though it is true that the
subsection title for the PSLRA is labeled as “Requirements for securities fraud
actions,” that does not mean that the Act requires fraudulent intention to apply.86
Section (b)(1) states that the PSLRA applies in “any private action arising under this
84
Resnik v. Swartz, 303 F.3d 147, 151 (2d Cir. 2002)
85
Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, 165
(2008).
86
See 15 U.S.C. § 78u-4(b)(1).
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chapter...”87 “Chapter” refers back to the 15 U.S.C. Ch. 2B, which is the code location
for the Securities Exchange Act. Since Section 14(a) falls under this chapter in the
Code, it is clear that the heightened pleading requirements of the PSLRA do apply to
Section 14(a) claims.
When taken together, Section 14(a), Rule 14-A-9 and the PSLRA require the
Plaintiffs to specify with particularity: (1) omissions in the Proxy Statements that
made other statements either false or misleading, (2) how those omissions were
material, (3) each statement in the Proxy Statements that was made false or
misleading, (4) the reason or reasons why the statement is misleading, and (5) how
the omission caused the loss complained of.
The Plaintiffs allege that the Defendants failed to disclose in their 2014 Proxy
Statement that Home Depot had known, specific threats to its data security, and that
neither the 2014 nor the 2015 Proxy Statements disclosed that the Audit Committee’s
charter was not amended. As to the latter claim, the Court has already stated that this
argument is much too formal. Regardless of whether the charter was amended,
everyone believed and acted as if the Committee did have oversight over data security
during the relative time period. So the fact that the Board did not disclose that the
charter had not been amended could not possibly be material.
87
Id. (emphasis added).
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As for the alleged omission regarding data security threats, the Plaintiffs also
fail to sufficiently plead their claims on a number of fronts. They first fail to
specifically identify which statements in the 2014 Proxy Statement were rendered
false or misleading as a result of the omission. As the Court discussed above, for a
Section 14(a) claim to be successful, directors must have had a duty to disclose the
omitted information. “Disclosure of an item of information is not required...simply
because it may be relevant or of interest to a reasonable investor.”88 By not showing
specific statements in the proxy that were rendered misleading or false, the Plaintiffs
have failed to demonstrate a duty on the part of the Board to disclose the information,
as well as failing to satisfy the requirements of the PSLRA.
On that reason alone, the Court could dismiss the Section 14(a) claim. But the
Plaintiffs also fail to plead with particularity how the omissions caused the loss
complained of. In order to succeed under Section 14(a), the Plaintiffs must show “that
the proxy solicitation itself, rather than the particular defect in the solicitation
materials, was an essential link in the accomplishment of the transaction.”89 The
Eleventh Circuit has said that Section 14(a) claims must show two types of causation:
88
Resnik v. Swartz, 303 F.3d 147, 151 (2d Cir. 2002).
89
Edward J. Goodman Life Income Trust v. Jabil Circuit, Inc., 594 F.3d
783, 796 (11th Cir. 2010) (citing Mills v. Elec. Auto–Lite Co., 396 U.S. 375, 385
(1970)).
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transaction and loss causation.90 In other words, the shareholders must have voted for
the 2014 Proxy Statement because of the omission (i.e., transaction causation), and
the losses to the company must have resulted directly from the 2014 Proxy Statement
vote, not from the omission itself (i.e., loss causation).91
Assuming for the sake of argument that the Plaintiffs’ allegations of materiality
are sufficient to show transaction causation, the Plaintiffs still fail to show loss
causation. The Plaintiffs make no statement showing that the security breaches to the
company would not have occurred but for the Defendants being reelected to the
Board. In fact, the Plaintiffs acknowledge in the Complaint that “[b]y the time the
2014 Proxy Statement was issued...the 2014 Data Breach had likely begun.”92
Regardless of the election, the Breach had already started.
Courts have also regularly dismissed Section 14(a) claims based on the election
of directors because the losses are indirect. The Eleventh Circuit, in a case in which
corporate insiders made misrepresentations about compensation policy, dismissed the
plaintiffs’ claim because “damages suffered by the shareholders were caused not by
90
Id. at 796-97.
91
Id. at 796 (“The transaction at issue must be the source of the plaintiff's
injury.”).
92
Compl. ¶ 183.
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the policies that they approved via proxy, but by management's failure to follow those
policies.”93 In making its decision, the Eleventh Circuit looked to a Third Circuit case,
in which a shareholder claimed he would not have voted for the reelection of the
directors if they would have disclosed information about criminal activity and
mismanagement at the company.94 The Third Circuit dismissed the shareholder
complaint because, again, the election of the directors did not cause the harm.95
Nothing is different about this case. The election of directors based on the 2014 Proxy
Statement did not cause the harm alleged; rather, the insufficient urgency of the
Board to correct the holes in Home Depot’s security did.
The Plaintiffs have failed to specify which statements in the 2014 or 2015
Proxy Statements were rendered misleading or false by the omissions, have failed to
show the materiality of the Audit Committee omission, and have failed to show
causation. The claim is insufficiently pleaded under the PSLRA, and does not
demonstrate the necessary duty to disclose required under Section 14(a). As a result,
the Plaintiffs have not shown beyond a reasonable doubt that the Defendants would
have been interested in the litigation because they have not demonstrated a substantial
93
Jabil, 594 F.3d at 797.
94
General Electric Co. v. Cathcart, 980 F.2d 927 (3d Cir.1992).
95
Id. at 933.
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likelihood that the Defendants would have been liable for a Section 14(a) violation.
The Court therefore finds that demand was not futile for the Section 14(a) claims.
IV. Conclusion
For the foregoing reasons, the Plaintiffs have failed to show that demand was
futile on any of the claims alleged. Because the pleading requirements of Rule 23.1
are more demanding than those under 12(b)(6), the Court need not address the
Defendants’ 12(b)(6) argument. The Defendants’ Motion to Dismiss [Doc. 45] is
GRANTED.
SO ORDERED, this 30 day of November, 2016.
/s/Thomas W. Thrash
THOMAS W. THRASH, JR.
United States District Judge
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