Brautigam v. Rubin et al

Filing 51

OPINION re: 40 MOTION to Dismiss the Second Amended Consolidated Verified Shareholder Derivative Complaint. filed by William S. Thompson, Jr., C. Michael Armstrong, Ernesto Zedillo, Judith Rodin, Lawrence R. Ricciardi, Diana L. Taylor , Vikram Pandit, Richard D. Parsons, Timothy C. Collins, Robert E. Rubin, Michael E. O'Neill, Alain J.P. Belda, Robert L. Ryan, Robert L. Joss, Anthony M. Santomero, Jerry A. Grundhofer, Anne M. Mulcahy, Andrew N. Liveris, John M. Deutch. As se t forth within the motion to dismiss is granted. This opinion resolves the motion listed as document number 40 in this case. The clerk of the court is instructed to close this case and the consolidated case, 11-cv-2822. SO ORDERED. (Signed by Judge Thomas P. Griesa on 9/24/2014) (ajs)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
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MICHAEL G. BRAUTIGAM,
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Plaintiff,
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– against –
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ROBERT E. RUBIN, et al.,
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Defendants.
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11-CV-2693 (TPG)
OPINION

This is a derivative action brought on behalf of nominal defendant Citigroup, Inc.
against several corporate directors. Plaintiff Michael Brautigam alleges that these
defendants breached their fiduciary duties to the company and its shareholders by failing
to properly oversee the company’s mortgage-servicing operations. This failure of
oversight, plaintiff alleges, caused Citigroup to suffer liability and reputational harm. In
addition, plaintiff contends that the board’s recommendation to reject a shareholder
proposal without disclosure of certain facts constitutes a breach of its duty of disclosure.
Defendants move to dismiss the complaint. The motion is granted.
Procedural Background
Plaintiff filed this action on April 20, 2011. The court consolidated this case with
another, and on February 14, 2012, plaintiff filed a consolidated complaint. Plaintiff
amended that complaint on May 15, 2012. On March 29, 2013, the court dismissed
plaintiff’s amended consolidated complaint with leave to amend. On September 19,
2013, plaintiff filed the second amended consolidated complaint.

The Complaint
The Parties
Plaintiff Michael Brautigam, a citizen of Ohio, is currently a Citigroup
shareholder who purchased his shares in the company before the events described in the
complaint.
Nominal defendant Citigroup is a Delaware corporation with its principal place of
business in New York City. Citigroup is a holding company for a global portfolio of
financial-services companies. The Citigroup corporate charter contains the following
exculpation provision:
No director of the Corporation shall be liable to the Corporation or its
stockholders for monetary damages for breach of fiduciary duty as a
director, except for liability (i) for any breach of the director’s duty of
loyalty to the Corporation or its stockholders, (ii) for acts or omissions not
in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) under Section 174 of the Delaware General
Corporation Law, or (iv) for any transaction from which the director
derived an improper personal benefit.
Individual defendants are Robert E. Rubin, C. Michael Armstrong, John M.
Deutch, Anne M. Mulcahy, Vikram Pandit, Alain J.P. Belda, Timothy C. Collins, Jerry
A. Grundhofer, Robert L. Joss, Andrew N. Liveris, Michael E. O’Neill, Richard D.
Parsons, Lawrence R. Ricciardi, Judith Rodin, Robert L. Ryan, Anthony M. Santomero,
Diana L. Taylor, William S. Thompson, and Ernesto Zedillo. All are current or former
Citigroup directors. None are citizens of Ohio.
Plaintiff has not demanded that the current Citigroup board institute litigation against
defendants.
Citigroup’s Mortgage-Servicing Business

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One of Citigroup’s many enterprises was mortgage servicing—essentially,
collecting mortgage payments from the mortgagors and distributing the proceeds. This
service included default management (taking defaulted residential loans through
foreclosure) and loss mitigation (negotiating alternatives to foreclosure, such as
repayment plans and loan modifications). The collapse of the residential mortgage
market in 2007 caused Citigroup to shift its mortgage-servicing business to focus on
default management and loss mitigation.
The essence of the complaint is that the director defendants were aware of, but
failed to heed, red flags that would have alerted them to problems in Citigroup’s
mortgage-servicing business. Plaintiff asserts that Citigroup’s directors wrongfully
permitted Citigroup to engage in unlawful foreclosure practices and failed to ensure
adequate internal controls in its mortgage-servicing business.
The Red Flags
In the lead-up to the relevant period for this suit—February 18, 2008 through
April 25, 2011—Citigroup allegedly received warnings about problems with its mortgage
servicing. But the bulk of the warnings alleged before 2008 relate to general deterioration
in the housing market and Citigroup’s financial exposure as the originator of risky
subprime loans. For example, in August 2007, Citigroup’s former CEO Charles Prince
warned Citigroup about the bleak state of the credit markets, and in September 2007,
Citigroup officials attended meetings discussing the fallout in the real estate market.
These warnings were all unrelated to Citigroup’s mortgage-servicing. But the complaint
does identify three communications from the Federal Reserve Board that implicated the
mortgage-servicing industry. These letters explained the Board’s expectations for proper

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residential-loan servicing. But no letter was specifically directed at or specifically about
Citigroup; rather, the letters were published by the Board to “encourage federally
regulated financial institutions and state-supervised entities” to pursue certain strategies.
According to the complaint, the most important red flags came in the form of
letters from two regulatory bodies. First, on February 14, 2008, the Office of the
Comptroller of the Currency delivered a letter summarizing its examination of director
and management oversight at Citigroup during the second half of 2007. The letter
pointed to risk-management failures at Citigroup. Two months later, in April 2008, the
Federal Reserve Bank similarly criticized Citigroup’s weak risk-management practices
and internal-control failures. The complaint, however, does not allege that these letters
were about the specific risk-management failings that form the basis for plaintiff’s
lawsuit—i.e., failures in Citigroup’s residential mortgage servicing.
In 2008, Citigroup also received two communications from the Department of
Housing and Urban Development (HUD). First, HUD issued results of its audit of
Citigroup’s mortgage underwriting, determining that 30% of Citigroup’s loans were not
in compliance with federal underwriting standards. This audit did not address mortgage
servicing. Second, in December 2008, HUD issued “Mortgagee Letters,” which advised
all HUD-approved mortgagees regarding pre-foreclosure-sale requirements. Although
this letter related to Citigroup’s mortgage-servicing activities, the letter was addressed to
many mortgage servicers and did not identify any deficient mortgage-servicing or
foreclosure practices at Citigroup.
Also in 2008, Citigroup participated in the federal government’s Troubled Asset
Relief Program (TARP) and Asset Guarantee Program (AGP). TARP was designed to

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ensure the stability of major financial institutions by authorizing the United States
Treasury to purchase troubled assets and provide guarantees for assets left on financial
institutions’ balance sheets. As a participant in TARP, Citigroup was required to offer a
loan-modification process to mortgage-service consumers. Additionally Citigroup was
required to put in place effective controls to ensure that it was providing mortgage
services in compliance with consumer-protection and fair-lending laws. The Asset
Guarantee Program was similar to TARP and required Citigroup to create a special
internal oversight body, the Senior Oversight Committee, to oversee the management of
the guaranteed assets and other aspects of compliance with the Program. It also required
the designation of a “covered assets CEO” who would personally monitor the
management of the guaranteed assets and report to the broader Senior Oversight
Committee. Citigroup negotiated its exit from TARP and AGP in December 2009.
Governmental Industry-Wide Review of Foreclosure Practices
Beginning in October 2010, the nation’s major mortgage servicers came under
scrutiny because of alleged irregularities in foreclosure processes across the industry.
These investigations included allegations of “robo-signing”—employees signing large
numbers of affidavits submitted in support of foreclosure claims without any personal
knowledge of the information contained in the affidavits. Numerous governmental
entities, including several federal agencies and state attorneys general, commenced
investigations or proceedings against most major financial institutions. Also in late 2010,
the Office of Inspector General commenced a nationwide review of the foreclosure
practices of the five largest Federal Housing Administration mortgage servicers,
including Citigroup.

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In late 2010, New York and New Jersey state courts flagged problems in
Citigroup’s mortgage-servicing processes. In October 2010 New York’s Chief
Administrative Judge ordered Citigroup’s attorneys to submit affirmations that they had
inspected pending foreclosure documents and that they were complete and correct. As
one of the company’s lawyers informed the court, Citigroup “did not have in place, prior
to November 8, 2010, procedures to comply with the Administrative Order.” In
December 2010 the New Jersey court system directed Citigroup to show cause why
pending New Jersey foreclosures should not be suspended. Citigroup responded by
admitting that over one third of its foreclosure affidavits were faulty and that it would
dismiss those actions.
On November 18, 2010, a congressional committee held a hearing on robosigning and other issues in mortgage servicing. Among others, Harold Lewis, a
CitiMortgage executive, provided testimony, explaining that in the late 2009, Citigroup
had identified issues in its foreclosure processes and took steps to address them. Among
other things, Citigroup centralized its foreclosure operations into a single unit, added staff
and enhanced training, required greater accountability, and undertook a review of tens of
thousands of foreclosure files.
In January 2011, a coalition of pension funds, led by New York Comptroller John
C. Liu, called on the boards of directors of Bank of America, Citigroup, JPMorgan and
Wells Fargo to undertake independent examinations of the banks’ mortgage and
foreclosure practices. All four banks recommended against the proposal. As Citigroup’s
management explained in its proxy statement dated March 10, 2011, “the independent
Audit Committee has [already] conducted independent reviews, through its independent

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audit function . . . of Citigroup’s internal controls relating to loan modifications,
foreclosures and securitizations.”
On April 13, 2011, the Office of the Comptroller of the Currency announced that
Citibank and 13 other financial institutions had entered into consent agreements to
resolve enforcement actions coordinated among the federal banking regulators.
(Citigroup’s directors had signed the agreement on March 27 and 29, 2011.) The consent
order required mortgage servicers to address deficiencies identified by the regulators
during the course of their review. In addition, each financial institution was required to
engage an independent firm to conduct a review of foreclosure actions taken during 2009
and 2010.
A week later, on April 21, 2011, Citigroup hosted its annual meeting, at which the
Liu Shareholder Proposal was put to a vote and overwhelmingly rejected. Plaintiff does
not allege that he cast a vote in favor of, or against, the Liu Shareholder Proposal. Nor
does plaintiff allege that he, or any other shareholder, took any steps to change his vote
on the Liu Shareholder Proposal or otherwise contest the rejection of the proposal at the
annual meeting based on the Office of the Comptroller of the Currency Consent Order
that was made public in March 2011.
On February 9, 2012, Citigroup announced that CitiMortgage, along with other
major mortgage servicers, had reached an agreement with the United States and with the
attorneys general for 49 states and the District of Columbia to settle a number of related
investigations into residential loan servicing and origination practices. The board had
rejected a prior settlement offer in this action on March 3, 2011. In addition to

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committing to provide financial relief to homeowners, Citigroup also agreed to
implement certain mortgage-servicing standards.
On March 12, 2012, the HUD Office of the Inspector General issued a report
entitled “CitiMortgage, Inc. Foreclosure and Claims Process Review.” That report
concluded that, due to a “flawed control environment,” Citigroup had misrepresented its
claims to HUD and, therefore, may be liable for False Claims Act violations.
Damage to Citigroup
In sum, Citigroup’s settlements resulted in fines and fees of more than $2 billion.
Additionally, plaintiff alleges that Citigroup also suffered reputational harm.
Based on these assertions, the complaint alleges that the director defendants
breached their fiduciary duties in two ways. First, plaintiff asserts that Citigroup’s
directors wrongfully permitted Citigroup to engage in unlawful foreclosure practices and
failed to ensure adequate internal controls in its mortgage-servicing business. Second,
plaintiff contends that defendants breached their duty of disclosure by recommending that
shareholders reject a proposal to conduct an independent review of Citigroup’s mortgageservicing and foreclosure internal controls without disclosing a pending investigation by
the Office of the Comptroller of the Currency into Citigroup’s foreclosure practices. In
addition, the complaint asserts a claim for contribution and indemnification.
Discussion
To survive a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), a
complaint must plead sufficient facts to state a claim for relief that is plausible on its face.
Ashcroft v. Iqbal, 556 U.S. 662, 677–78 (2009); Bell Atl. Corp. v. Twombly, 550 U.S.
544, 570 (2007). In deciding a motion under Rule 12(b)(6), a court must accept as true
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the facts alleged in the complaint. Id. The court’s review is limited to facts stated in the
complaint and in documents appended to the complaint or incorporated in the complaint
by reference. Allen v. WestPoint–Pepperell, Inc., 945 F.2d 40, 44 (2d Cir. 1991).
Duty-of-Loyalty Claim
Demand Requirement
Defendants argue that plaintiff was required to make a demand on the board that
the company bring this suit itself against defendants. Plaintiff contends that, because it
would have been futile, demand is excused. Here, because Citigroup is a Delaware
corporation, Delaware law governs the issue of whether demand is excused. See Rahbari
v. Oros, 732 F. Supp. 2d 367, 376 (S.D.N.Y. 2010). A court must assess demand futility
with respect to the board of directors as of the time the plaintiff filed its complaint.
Braddock v. Zimmerman, 906 A.2d 776, 785 (Del. 2006). Thus, plaintiff must show that
his demand is excused based on the board as of September 19, 2013, the date on which
the current complaint was filed.
To establish that he is excused from making a demand, a plaintiff must make
specific, particularized allegations showing that it would have been futile to do so. See
Lewis v. Graves, 701 F.2d 245, 250 (2d Cir. 1983); In re Citigroup Inc. S’holder
Derivative Litig., 964 A.2d 106, 121 (Del. Ch. 2009). Thus, plaintiff is held to “a
pleading standard higher than the normal standard applicable to the analysis of a pleading
challenged under Rule 12(b)(6).” Fink v. Weill, No. 02-cv-10250, 2005 WL 2298224, at
*3 (S.D.N.Y. Sept. 19, 2005). Accordingly, vague or conclusory allegations do not
suffice to challenge the presumption of a director’s capacity to consider demand.” In re
INFOUSA, Inc. S’holders Litig., 953 A.2d 963, 985 (Del. Ch. 2007).

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Where a plaintiff bases his complaint on board action, demand is excused if there
is 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. Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984); Seminaris v. Landa, 662
A.2d 1350, 1354 (Del. Ch. 1995). Where a plaintiff bases his complaint on board
inaction, the analysis focuses on the first prong of Aronson. See In re Am. Int’l Grp., Inc.
Derivative Litig., 700 F. Supp. 2d 419, 430–31 (S.D.N.Y. 2010) (citing Rales v.
Blasband, 634 A.2d 927, 934 (Del. 1993)).
Failure to Oversee Mortgage-Servicing Activities
The parties disagree about whether plaintiff bases this claim on board action or
inaction, and accordingly, whether Aronson or Rales applies. Under both Rales and
Aronson, reasonable doubt as to the board’s ability to exercise its business judgment can
be established by alleging that the members of the board faced a substantial risk of
personal liability as a result of the suit. Rahbari, 732 F. Supp. 2d at 378. But “the mere
threat of personal liability” is insufficient to challenge the disinterestedness of directors.
Rales, 634 A.2d at 936. It is a rare case “where defendants’ actions were so egregious
that a substantial likelihood of director liability exists.” Rahbari, 732 F. Supp. 2d at 378.
In this case, the analysis is somewhat complicated by the additional protections
given to Citigroup’s board under the corporate charter. Board members are exculpated
from personal liability for breaches of fiduciary duty subject to certain exceptions.
Because the board is “exculpated from liability except for claims based on fraudulent,
illegal or bad-faith conduct, plaintiff must also plead particularized facts that demonstrate

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that the directors acted with scienter.” Wood v. Baum, 953 A.2d 136, 141 (Del. 2008);
see also Fed. R. Civ. P 9(b).
Failure of oversight is “possibly the most difficult theory in corporation law upon
which a plaintiff might hope to win a judgment.” In re Caremark Int’l Inc. Derivative
Litig., 698 A.2d 959, 967 (Del. Ch. 1996). In order to establish a failure-of-oversight
claim, a plaintiff must show that “(a) the directors utterly failed to implement any
reporting or information system or controls; or (b) having implemented such a system or
controls, consciously failed to monitor or oversee operations thus disabling themselves
from being informed of risks or problems requiring their attention.” Stone ex rel.
AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006).
Here, plaintiff has not sufficiently pleaded a claim that Citigroup’s directors failed
to oversee its mortgage-servicing operations. Plaintiff concedes that Citigroup had
“governance and reporting systems” that ensured the directors “were always sufficiently
armed or had access to information necessary to perform their duties.” The complaint
alleges that the board tasked numerous committees with the responsibility of assisting in
its oversight—reviewing compliance issues, auditing Citigroup’s internal controls,
reviewing risk-management activities, etc. There is no real dispute that Citigroup’s board
had sufficient reporting controls and procedures to perform its oversight function during
the relevant period.
Instead, plaintiff’s theory is that the internal controls themselves establish that the
board must have had knowledge of the wrongful conduct relating to the mortgageservicing and foreclosure practices. But courts have repeatedly rejected the attempt to
use the fact that a company had internal controls as proof that the board must have been

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aware of alleged wrongdoing. See In re Goldman Sachs Mortgage Servicing S’holder
Derivative Litig., No. 11-cv-4544, 2012 WL 3293506 (S.D.N.Y. Aug. 14, 2012).
Likewise, the allegation that a director’s membership on a standing committee is
sufficient to establish knowledge or a likelihood of liability is simply contrary to
established law. Id. Instead, plaintiff must point to “specific red flags of such
prominence that defendants must necessarily have examined and considered them in the
course of their committee oversight duties.” Id.
But plaintiff has failed to allege red flags sufficient to show that the board
consciously failed to monitor operations related to Citigroup’s mortgage servicing.
Plaintiff’s alleged red flags fall into three categories, and none—considered collectively
or independently—is sufficient.
First, plaintiff alleges many red flags in the form of general guidance issued by
government agencies. For example, the three letters from 2007 issued by the Federal
Reserve Board generally described best practices within the mortgage-servicing industry.
The same is true of HUD’s 2008 industry-wide “Mortgagee Letters” and the general
directives in the TARP and AGP agreements. These industry-wide communications, not
specifically directed at Citigroup or describing Citigroup’s practices, are insufficient as a
matter of law. See In re Mut. Funds Inv. Litig., 384 F. Supp. 2d 873, 879 (D. Md. 2005).
None of this information would have alerted the directors that Citigroup was engaged in
wrongful conduct within its mortgage-servicing business.
Second, general statements about the real estate market or Citigroup’s unrelated
financial enterprises are insufficient to alert the directors about problems in its mortgageservicing processes. For example, statements about Citigroup’s financial exposure

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because of its underwriting of subprime mortgages are irrelevant to the board’s
knowledge about its mortgage-servicing problems. Likewise, the 2008 letters from the
Office of the Comptroller and the Federal Reserve Board are insufficient because they
describe risk-management problems with Citigroup’s structured-credit products, not its
mortgage-servicing business. The same is true of the 2008 HUD audit of Citigroup’s
underwriting—not mortgage-servicing—activities. Accordingly, these allegations cannot
support plaintiff’s claim for demand excusal.
Third, plaintiff points to after-the-fact settlements as proof that the board must
have known about the mortgage failings at the time the misconduct occurred. But an
allegation that the board was aware of these settlements when they were executed
suggests nothing about what it knew at the time of the alleged misconduct. See In re
Johnson & Johnson Derivative Litig., 865 F. Supp. 2d 545, 552 (D.N.J. 2011).
Moreover, the complaint does not contain any allegations about what the board did or
failed to do in response to any of the settlements—at the time when the board certainly
had knowledge of the mortgage-servicing problems. It is the board’s response when it
has knowledge that is relevant for the failure-of-oversight claim. Without that kind of
allegation, the complaint falls far short of pleading that the directors faced a substantial
likelihood of litigation by acting in bad faith.
In fact, contrary to the supposed red flags, the complaint contains allegations that
Citigroup was proactively responding to revelations about problems in its mortgageservicing failures. For example, in 2010, Harold Lewis testified before Congress that
Citigroup had identified problems in its foreclosure processes and was taking steps to
correct them. It cannot be said that the directors faced a substantial likelihood of liability

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where the complaint “explicitly states that Director defendants took affirmative actions
with respect to the robo-signing practices.” City of Roseville Emps.’ Ret. Sys. v. Dimon,
Index No. 650294/2012, slip op. at 14 (N.Y. Sup. Ct. July 11, 2012).
Liu Shareholder Proposal
Plaintiff also alleges that the board breached its duty by recommending in March
2011 that shareholders reject the Liu proposal without disclosing (1) that the board
rejected a March 3, 2011, proposal to settle a number of related governmental
investigations into its mortgage-servicing practices (later resolved in February 2012) and
(2) the consent order announced by the Office of the Comptroller of the Currency on
April 13, 2011. Because this claim challenges an affirmative action of the board, demand
futility must be evaluated under both prongs of Aronson: plaintiff must plead
particularized facts sufficient to create a reasonable doubt as to whether (1) a majority of
the directors are disinterested and independent or (2) the challenged transaction was the
product of a valid exercise of business judgment. 473 A.2d at 814.
Under Delaware law, a director is not liable for an omitted disclosure unless the
director withheld facts knowingly and the omission was material. Here, information that
Citigroup had entered settlements regarding wrongful conduct in its mortgage-servicing
processes was certainly material in determining whether an outside audit of those
activities should be conducted. But even if that information was material, the settlement
with Office of the Comptroller—signed after Citigroup issued its proxy statement—was
public information before the April 2011 shareholders meeting, so plaintiff cannot
contend that he did not have the ability to cast an informed vote at the meeting.
Moreover, plaintiff’s claim fails because the board was under no duty to disclose the

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settlements before they were finalized; disclosure at any earlier point would have been
premature and speculative. See In re W. Nat’l Corp. S’holders Litig., No. 15927, 2000
WL 710192, at *28 (Del. Ch. May 22, 2000).
Likewise, plaintiff cannot carry his “heavy burden” of showing that the
recommendation to reject Liu’s proposal was not based on business judgment. White v.
Panic, 783 A.2d 543, 551 (Del. 2001). If the board’s judgment can be “attributed to any
rational business purpose,” the court “will not substitute its own notions of what is or is
not sound business judgment.” Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del.
1971). Here, the board explained that the Liu proposal should not be adopted because the
Audit Committee already had undertaken and independent review of Citigroup’s internal
controls relating to loan modifications, foreclosures, and securitizations. This
explanation is sufficient to bring the board’s action within the business-judgment rule.
Accordingly, plaintiff has failed to state a claim for breach of fiduciary duty based on the
board’s recommendation.
Contribution and Indemnification
Because plaintiff has failed to establish that demand is excused, Plaintiff’s
contribution and indemnification claims are also dismissed. See In re Goldman Sachs
Mortgage Servicing S’holder Derivative Litig., 2012 WL 3293506.
Conclusion
The motion to dismiss is granted. This opinion resolves the motion listed as
document number 40 in this case. The clerk of the court is instructed to close this case
and the consolidated case, 11-cv-2822.

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SO ORDERED

Dated: New York, New York
September 24, 2014

omas P. Griesa
U.S. District Judge

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