Securities Regulation Daily Court upholds dismissal of claims against Wal-Mart directors over bribe cover up
Friday, July 22, 2016

Court upholds dismissal of claims against Wal-Mart directors over bribe cover up

By Kevin Kulling, J.D.

The Eighth Circuit Court of Appeals has affirmed the dismissal of a shareholder derivative action against directors of Wal-Mart that alleged the directors allowed and covered up bribery committed on behalf of Wal-Mart’s Mexican subsidiary, Wal-Mex. Shareholders failed to adequately show in their pleadings that a majority of the board knew about the bribery and that the threat of personal liability rendered a majority of the company’s board incapable of fairly considering whether to pursue the corporate causes of action the shareholders sought to enforce, according to the court (Cottrell v. Duke, July 22, 2016, Riley, W.).

Bribery allegations. In September 2005, a former Wal-Mex executive provided the company’s general counsel with information that Wal-Mex had regularly bribed Mexican officials in order to clear Mexican regulatory and bureaucratic hurdles. Wal-Mart uncovered evidence consistent with the executive’s claims, including evidence of payments. Investigators also found evidence of complicity at the highest levels of Wal-Mex.

Company investigators concluded in a draft report that there was reasonable suspicion to believe that Mexican and United States laws had been violated. However, there was no indication who received a copy of the draft investigative report.

Shareholders alleged that the findings and suspicions were reported to the chair of Wal-Mart’s audit committee. Despite the report’s preliminary findings, Wal-Mex officials wrapped up the investigation and closed the inquiry.

Later, after several New York Times articles were published about the alleged bribery, Wal-Mart reopened the investigation and informed the SEC that it was looking into possible violations of the FCPA.

Shareholder claims. Shareholders alleged that several officers and directors breached their fiduciary duties to the corporation by allowing the bribery at Wal-Mex, covering it up, and closing the internal investigation. As the court noted, although the causes of action accrued to Wal-Mart, the shareholders did not demand that the corporation pursue the claims itself. The shareholders alleged it would have been pointless to go through the motions of making a demand on the board, because the board could not make that decision impartially. The district court in Arkansas dismissed the complaint for failing to show that the director defendants faced a substantial likelihood of personal liability for the purposes of establishing demand futility.

Procedural requirements. Federal law requires that shareholders seeking to enforce a corporation’s rights through a derivative action must state with particularity any effort they took to obtain the desired action from the corporation’s directors and the reasons for not obtaining the action or not making the effort.

According to the law of Delaware, Wal-Mart’s incorporation state, shareholders who did not make a demand on the board cannot bring a derivative suit unless their "particularized factual allegations create a reasonable doubt that as of the time the complaint was filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to the demand," according to the court.

Theories of board’s knowledge. Shareholders advanced several theories about how the board may have learned of the bribery and subsequent investigation. Their first theory asserted that during the initial investigation, Wal-Mart’s investigators reported their preliminary findings to the chairman of the audit committee, who alerted the rest of the board. Shareholders pointed to the stated intention of the draft report to report the findings to the audit committee chairman. Although there was no specific allegation that the audit committee chairman received the report, the court said that it was satisfied that the combination of the stated intention to report to the audit chairman on the progress of the investigation and the preparation of such a report, is enough to make it reasonable to infer the chairman received the report.

But the court said that the suit depended upon passing that information to the rest of the board. Shareholders alleged that the audit committee had a duty to make regular reports to the board about legal and regulatory requirements. While there may have been a reporting relationship, there were no allegations establishing that he did in fact report to specific directors. Shareholders did not identify any particular meetings or reporting between the chairman and the committee and the rest of the board, individually or as a whole.

The appellate court said that under Delaware law, it was not reasonable to infer the board learned what the chairman allegedly read in the in house investigators’ draft because there was a duty to report.

Other theories. The court also rejected alternate theories of how the board may have become aware of the contents of the internal report. Shareholders theorized that other senior officers told the board. Other than reporting obligations, the court said, shareholders did not plead any facts supporting the inference that the officers actually shared their knowledge.

Another theory—that the bribery at Wal-Mex was so massive that the board must have known about it—was also rejected. The court said that there was no authority to establish that the severity of misconduct committed at a corporation, by itself, can be enough to infer board knowledge.

Even considering the theories together was insufficient for the appellate court. "The reason the shareholders’ theories fail is not that we think they are unbelievable or do not make sense, but because the shareholders have not pled the sort of concrete facts Delaware law requires to substantiate enough of the details," the court said.

The case is No. 15-1869.

Attorneys: Donald Broggi (Scott + Scott LLP) for John Cottrell. Jess Askew, III (Kutak Rock LLP) for Michael T. Duke.

Companies: Wal-Mart Stores, Inc.

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