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December 7, 2015
  Espinoza v. Dimon
Headline: Second Circuit Dismisses Derivative Suit Accusing JPMorgan Chase Directors of Insufficiently Investigating the "London Whale" Trading Incident

Area of Law: Corporate

Issue Presented: When a shareholder demands that a board of directors investigate both an underlying wrongdoing and subsequent misstatements by corporate officers about that wrongdoing, what factors should a court consider in deciding whether the board acted in a grossly negligent fashion by focusing its investigation solely on the underlying wrongdoing?

Brief Summary: This shareholder derivative action arose out of the "London Whale" trading incident. Ernesto Espinoza, a shareholder of JPMorgan Chase & Co. ("JPMorgan"), sent a letter to JPMorgan demanding that the board investigate the London Whale incident. The board rejected Espinoza's demand letter, but pursued its own investigation into the incident. Espinoza, however, alleged that JPMorgan's investigation was improperly executed because it focused only on the underlying incident and not the alleged misstatements later made by its executives. Espinoza's derivative suit alleged that his demand letter had been wrongfully refused. The United States District Court for the Southern District of New York dismissed the complaint, finding that Espinoza had not pleaded sufficient facts to rebut the strong presumption that the board's decision reflected a valid exercise of its business judgment. On appeal, the Second Circuit certified the following question of law to the Delaware Supreme Court: "If a shareholder demands that a board of directors investigate both an underlying wrongdoing and subsequent misstatements by corporate officers about that wrongdoing, what factors should a court consider in deciding whether the board acted in a grossly negligent fashion by focusing its investigation solely on the underlying wrongdoing?" Based on the Delaware Supreme Court's answer, the Second Circuit explained that to survive a motion to dismiss, a plaintiff alleging wrongful refusal of a demand must plead facts supporting a plausible inference that the board's decision not to take further action was the result of gross negligence. Here, the Second Circuit concluded that the plaintiff had not done so, and affirmed the dismissal of the complaint. To read the full opinion, please visit: http://www.ca2.uscourts.gov/de...2d5c1fed9b4/1/hilite/

Extended Summary: This decision reflected the Second Circuit's third writing on Ernesto Espinoza's derivative suit, which alleges that the board of JPMorgan improperly failed to investigate alleged misstatements made by JPMorgan executives regarding the "London Whale" incident. In earlier opinions, the Second Circuit concluded that the dismissal of Espinoza's complaint should be reviewed de novo, and that it was appropriate to certify the above-described question to the Delaware Supreme Court.

In this opinion, the court noted that the Delaware Supreme Court had provided helpful guidance. "As the Delaware Supreme Court emphasized in its response, our review of a wrongful refusal suit starts from the premise that the decision to initiate a lawsuit is an internal corporate matter within the board's discretion," the Second Circuit wrote. Accordingly, a plaintiff bringing this sort of derivative suit bears a difficult burden.

Here, the Second Circuit noted that JPMorgan's board, in response to the London Whale trading incident, engaged in an extensive review. The board created a Review Committee consisting of three outside board members, who in turn used independent counsel and an expert advisor. The Review Committee also oversaw a management Task Force. These efforts resulted in the publication of two extensive written reports, and led to many of the changes sought by Espinoza in his demand letter, including clawbacks of payments, reductions in compensation, and reformed internal guidelines and controls. The court distinguished this response from other derivative suits that were allowed to go forward based on insufficient board responses.

Moreover, the Second Circuit explained that JPMorgan was not legally required to submit a detailed point-by-point response to Espinoza's demand letter. The court identified two practical considerations here. First, to require boards to reply in full detail to a plaintiff's demand letter might incentivize plaintiffs to include a laundry list of potential claims. Second, providing too much detail in a refusal letter might expose the corporation to regulatory or other legal risks, which would be at odds with the board's obligation to mitigate such risks. Here, JPMorgan's board made clear in its response that they did not want to pursue litigation because of the potential harm to JPMorgan's long-term strategic interests. Accordingly, the Second Circuit affirmed the dismissal of this lawsuit.

Panel: Chief Circuit Judge Katzmann, Circuit Judges Pooler and Carney

Argument Date: April 1, 2015

Date of Issued Opinion:
December 3, 2015

Docket Number: 14-1754

Decided: Affirmed

Case Alert Author: Brad Landau

Counsel: George C. Aguilar (Jay N. Razzouk, on the brief), Robbins Arroyo LLP, San Diego, California; Thomas G. Amon, Law Offices of Thomas G. Amon, New York, New York, for Plaintiff‐Appellant; Richard C. Pepperman, II, Sullivan & Cromwell LLP, New York, New York (Daryl A. Libow, Christopher Michael Viapiano, Sullivan & Cromwell LLP, Washington, D.C., on the brief), for Defendants‐Appellees James Dimon, Douglas L. Braunstein, Michael J. Cavanagh, Ina R. Drew, and Nominal Defendant‐Appellee JPMorgan Chase & Co; Jonathan C. Dickey, Gibson, Dunn & Crutcher LLP, New York, New York, for Defendants‐Appellees Ellen V. Futter, James S. Crown, David M. Cote, Laban P. Jackson, Jr., Crandall C. Bowles, James A. Bell, Lee R. Raymond, Stephen B. Burke, William C. Weldon, and David C. Novak.

Author of Opinion: Chief Judge Katzmann

Case Alert Circuit Supervisor: Emily Gold Waldman

    Posted By: Emily Waldman @ 12/07/2015 05:32 PM     2nd Circuit  

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