ASBESTOS WORKERS LOCAL 42 PENSION FUND, derivatively on behalf of Nominal Defendant
LINDA B. BAMMANN, JAMES A. BELL, CRANDALL C. BOWLES, STEPHEN B. BURKE, DAVID M. COTE, JAMES S. CROWN, JAMIE DIMON, TIMOTHY P. FLYNN, ELLEN JPMORGAN CHASE & CO., a Delaware corporation, Plaintiff,
FUTTER, LABAN P. JACKSON, MICHAEL A. NEAL, DAVID C. NOVAK, LEE R. RAYMOND, WILLIAM WELDON, DOUGLAS L. BRAUNSTEIN, MICHAEL CAVANAGH, INA DREW, IRVIN GOLDMAN, JOHN HOGAN, PETER WEILAND, JOHN WILMOT, and BARRY ZUBROW, Defendants, And JPMORGAN CHASE & CO., Nominal Defendant.
Submitted: February 3, 2015
Carmella P. Keener and P. Bradford deLeeuw, of ROSENTHAL, MONHAIT & GODDESS, P.A., Wilmington, Delaware; OF COUNSEL: Stewart L. Cohen, Robert L. Pratter, Jacob A. Goldberg, and Alessandra C. Phillips, of COHEN, PLACITELLA & ROTH, P.C., Philadelphia, Pennsylvania; Peter Safirstein and Elizabeth Metcalf, of MORGAN & MORGAN, P.C., New York, New York, Attorneys for Plaintiff.
Gregory P. Williams, Catherine G. Dearlove, and Christopher H. Lyons, of RICHARDS LAYTON & FINGER P.A, Wilmington, Delaware; OF COUNSEL: Richard C. Pepperman, II and George R. Painter IV, of SULLIVAN & CROMWELL LLP, New York, New York; Daryl A. Libow and Christopher M. Viapiano, of SULLIVAN & CROMWELL LLP, Washington, D.C., Attorneys for Defendants James Dimon, Douglas L. Braunstein, Michael Cavanagh, Ina Drew, Irvin Goldman, John Hogan, Peter Weiland, John Wilmot, Barry Zubrow and JPMorgan Chase & Co.
David C. McBride, William D. Johnston, and Kathaleen S. McCormick, of YOUNG CONAWAY STARGATT & TAYLOR LLP, Wilmington, Delaware; OF COUNSEL: Jonathan C. Dickey and Brian M. Lutz, of GIBSON DUNN & CRUTCHER LLP, New York, New York, Attorneys for Defendants Linda B. Bammann, James A. Bell, Crandall C. Bowles, Stephen B. Burke, David M. Cote, James S. Crown, Ellen V. Futter, Timothy P. Flynn, Laban P. Jackson, Jr., Michael A. Neal, David C. Novak, Lee R. Raymond, and William C. Weldon.
Sam Glasscock, III Vice Chancellor.
The C. W. Morgan is the last surviving ship of the American whaling fleet. In 1820, another ship of that fleet, the Essex, was attacked by a sperm whale, which rammed the ship repeatedly until the planking was sprung and timbers broken. The Essex foundered, utterly destroyed. In 2012, another Morgan- JPMorgan Chase & Co. ("JPMorgan, " or the "Company")-was heavily damaged by another whale-the so-called London whale. JPMorgan did not founder, but suffered losses in the billions of dollars.
The Plaintiff here is a stockholder of JPMorgan, seeking derivatively to hold those at the helm accountable for the damage caused by the London whale. It seeks to sue the directors (and certain officers) of JPMorgan under a theory based on the rationale of this Court's decision In re Caremark International Inc. Derivative Litigation.
Under our model of corporate law, the directors run the corporation as fiduciaries for its owners, the stockholders. Assets of the corporation, including choses in action, are disposed of within the discretion of the board. A stockholder who believes that the corporation should pursue legal proceedings, therefore, must request that the board take that action on behalf of the corporation. Only in circumstances where the board is not in a position to exercise its independent business judgment with respect to the litigation is demand excused and the stockholder permitted to sue derivatively on behalf of the corporation. The requirements for demonstrating that demand is excused are provided by Chancery Court Rule 23.1. The Plaintiff contends that it has satisfied this rule.
This identical issue-whether the Board is unable to exercise its independent business judgment with respect to a lawsuit against certain directors and officers arising out of the losses caused by the London whale trading episode, has been heard, and rejected, by two New York Courts. The Plaintiff here is collaterally stopped from relitigating the issue, and the Defendants' Motion to Dismiss is granted on that ground.
I. BACKGROUND FACTS
The basic factual background to this action has been widely publicized. The Synthetic Credit Portfolio ("SCP"), a portfolio managed by traders in the Chief Investment Office ("CIO") of JPMorgan Chase & Co. ("JPMorgan" or the "Company") lost approximately $6.3 billion in 2012 as a result of complex, high- risk trading, and despite the public representations that the CIO was engaging in hedging activity. Even before the losses became apparent, the head trader of the SCP, Bruno Iksil, was nicknamed the "London whale" for the large credit default swap trades he was making on behalf of the Company.
Concern about the whale's trading activity was at one point infamously characterized by the Company's CEO as a "tempest in a teapot." Eventually, however, the full extent of the Company's losses was revealed. The loss and the belatedly-recognized events leading to it were covered extensively in the press; examined by the United States Senate Permanent Subcommittee on Investigations; studied by academics; and were the subject of a number of agency investigations and stockholder lawsuits.
In connection with the trading losses and aftermath, the Plaintiff alleges, on the part of the Board, "a sustained and systemic failure to institute and maintain proper control or oversight of the Company's accounting and financial reporting practices as related to the operation of the CIO" and that the Board "improperly transformed or permitted the transformation of its function from hedging the bank's investment risk to highly leveraged speculative trading." The Plaintiff seeks to pursue its derivative claim without having made demand on the Board, alleging that demand would be futile because the majority of the Board is interested or not independent. The Plaintiff alleges that a majority of the Board could not impartially consider demand because they face a substantial likelihood of personal liability in connection with alleged breaches of the duty of loyalty for failure in their oversight function, as well as for material misstatements or omissions in SEC filings between 2009 and 2011. The Plaintiff also alleges a lack of independence due to the compensation and benefits connected with the directors' service on the Board.
A. The Parties
The Plaintiff has continuously held stock in the Company at all relevant times. The Defendants in this action include current and former members of the Board, and current and former officers, discussed below.
1. Director Defendants
Seven of the named defendants who are currently on the Board joined the Board prior to January 1, 2009: Crandall C. Bowles, Stephen B. Burke, James S. Crown, Jamie Dimon, Laban P. Jackson, Jr., Lee R. Raymond, and William C. Weldon (the "2009 Director Defendants"). James A. Bell joined the Board prior to May 10, 2012, when the CIO losses were revealed (together with the 2009 Director Defendants, the "CIO Director Defendants").
Three of the named defendants were members of the Board at the time of the complained-of actions, but are no longer on the Board: David M. Cote, Ellen V. Futter and David C. Novak (together, the "Former Director Defendants"). Additionally, three of the named defendants joined the Board after the events leading to the CIO losses occurred: Linda B. Bammann, who joined the Board in September 2013, Timothy P. Flynn, who joined the Board in May of 2012, and Michael A. Neal, who joined the Board in January 2014 (together with the CIO Director Defendants and the Former Director Defendants, the "Director Defendants").
2. Officer Defendants
Douglas L. Braunstein was the Company's Executive Vice President and CFO from June 22, 2010 to January 1, 2013, at which time he became Vice Chairman.
Michael J. Cavanagh served as the Company's Executive Vice President and CFO from 2004 until May 2010, at which time he became CEO of the Company's Treasury and Securities Services Business until May 2012, at which time he became Co-CEO of the Company's Corporate & Investment Bank, which position he currently holds. He was on the Company's Operating Committee at all relevant times.
Ina Drew was the Company's Chief Investment Officer from February 2005 until May 13, 2012. She was also a member of the Operating Committee at all relevant times.
Irvin Goldman was the CIO's Chief Risk Officer ("CRO") from January 2012 through May 2012, at which time, Plaintiff alleges, he was stripped of his duties prior to his resignation in July 2012. He previously served as the CIO's Head of Strategy.
John Hogan was the Company's CRO from January 2012 through early 2013. Upon returning from a brief leave of absence, he was named Chairman of Risk. He is also a member of the Company's Operating Committee, and has been since January 2012.
Peter Weiland was the CIO's Head of Market Risk, its most senior risk officer, from late 2008 through early 2012. He reported to Barry Zubrow and to Drew from 2009 until mid-January 2012. He announced his retirement in October 2012.
John Wilmot was the CFO of the CIO beginning in January 2011 and "resigned in connection with the CIO scandal."
Barry Zubrow was the Company's head of Corporate and Regulatory Affairs from January 2012 to February 2013. He previously served as the CRO from November 2007 to January 2012. He also served on the Company's Operating Committee from 2010 until October 2012, when he announced his retirement effective February 2013.
Zubrow, Wilmot, Weiland, Hogan, Goldman, Drew, Cavanagh, and Braunstein are referred to as the "Officer Defendants."
3. Risk Management and Relevant Committees
The Board's Audit Committee is charged with overseeing the Company's risk assessment and management process. Of the Director Defendants, Bell, Bowles, and Jackson serve on the Audit Committee. The Risk Policy Committee "oversees the CEO and management's responsibilities to assess and manage JPMorgan's various types of risk, " including credit, market, interest rate, investment, liquidity, and reputational risks. Crown is the Chairman of the Risk Policy Committee, and from 2008 to May 2012, former-directors Cote and Futter were members of the Committee. Flynn joined the Risk Policy Committee in August 2012.
The Company maintains a firm-wide operation run by the Company's CRO, independent of the Company's individual lines of business, referred to as "Risk Management."
The Plaintiff alleges breaches of the duty of loyalty, by way of a lack of good faith, in "remaining] willfully blind" "in the face of  red flags" which showed the CIO to be engaging in higher-risk activity than represented.The essence of the derivative action is that, despite the risky trading undertaken by the CIO, "the Board failed to ensure the implementation of a risk management structure commensurate" with that risk.
Prior to filing the Complaint, the Plaintiff undertook a § 220 demand (the "§ 220 Demand") and obtained and reviewed documents dating back to 2009 from which it alleges what the Board and relevant committees knew, and when. The Plaintiff asks me to draw negative inferences from what was not produced. What follows is an overview of the facts alleged in the Complaint; I do not aim to describe the Complaint and the documents it incorporates by reference in their entirety.
C. The CIO
JPMorgan's CIO, "formed in 2005 through a spin-off of the Company's internal treasury function, is part of the Corporate and Private Equity sector at JPMorgan and manages the Company's excess cash deposits." It was touted in the Company's annual reports, the Plaintiff notes, "as mitigating structural risks that arise out of the various business activities" of the Company. The Plaintiff alleges that the CIO "[traditionally . . . followed a typical conservative approach for large banks and invested the Company's excess deposits in very safe instruments, including U.S. treasury bonds, municipal bonds, corporate securities, high-grade corporate bonds, and high-grade mortgage-backed securities." Because the CIO was supposedly engaging in hedging, that is, "an investment position that is specifically made, documented and designed to reduce or offset the risk from a specific investment, " it was subject to regulations of the Office of the Comptroller of the Currency ("OCC"), which require, in essence, defined strategies that describe the investment instruments and acceptable levels of risk.
In 2005, Dimon appointed Drew to serve as the Company's Chief Investment Officer "as part of his plan to transform the CIO from a risk-mitigating operation to a profit center, " by which they, together with other senior executives, "aggressively transformed the CIO into a proprietary trading desk." In May 2006, the CIO authorized trading in credit derivative indices and credit default swaps not limited to a single corporation. This "New Business Initiative" "was presented as a risk reduction effort to protect JPMorgan against cyclical exposure to credit, " and was assigned an initial Value-at-Risk ("VaR") of $5 million. This credit-trading program came to be known as the Synthetic Credit Portfolio. The Plaintiff notes that trading in the CIO was more profitable than in other divisions because the CIO's cost of investment capital was lower than that of the investment bank division (the "Investment Bank") by virtue of using excess bank deposits and because CIO traders retained a smaller portion of the trading profits than Investment Bank traders.
Beginning in November 2007, "internal audits recognized there were problems with the CIO's methods of accounting and price testing of credit derivatives." In conducting an audit that was characterized as a "First Time Review of New Business, Product or Service, " the Company's internal auditors described the CIO's activities as "proprietary position strategies executed on credit and asset backed indices" and did not indicate that the credit trading activity was being conducted to lower the Company's risk. The internal audit group found the CIO's control environment satisfactory but noted "calculation errors" in the CIO Valuation Control Group's testing of prices of credit derivatives.
The Plaintiff alleges, "After changing the focus of the SCP from asset-liability management to generating revenue, JPMorgan failed to document this change in the SCP in accordance with its own internal policies and failed to disclose the portfolio's existence to regulators." In 2008, for example, Dimon, Drew, and "certain of the [other] Defendants" "violated OCC notification requirements by failing to inform the OCC that the SCP had added credit index tranche positions to the SCP even though this addition represented a 'substantial change in business strategy.'" Specifically, the SCP was not mentioned in written communication to regulators until January 2012, five years after its inception, and "the first time the OCC became aware of the SCP's true size and risk exposure was after the portfolio attracted media attention in April 2012."
D. Relevant Board and Committee Activity in 2009-2010
The Plaintiff alleges that "[beginning in 2009, the Board repeatedly knew of red flags and warnings regarding the substantially risky nature of the CIO's business, and the dramatically rising size and profitability of the CIO's business."Specifically, for example, the Audit Committee met on March 17, 2009, at which time Drew gave a presentation (the "March 2009 Audit Presentation") which included notification that the "[i]ncrease in size, complexity and range of product investments, as well as severe market conditions, have led to increased demands on CIO's risk management and control environment;" the portfolio had grown by $132 billion since the last time the Audit Committee reviewed it. In the March 2009 Audit Presentation, the Audit Committee was informed that "the operating model is clearly more complicated and more prone to error than in the past, " and that "FASB and other accounting rules continue to be more restrictive with enhanced documentation required and stricter interpretation of rules by auditors/regulators." Further, the March 2009 Audit Presentation showed that the CIO would be integrating a portion of the Investment Bank's "Proprietary Positions Book" ("PPB") technology platform into its existing infrastructure. The PPB technology "had the ability to handle complex derivative trades to address the fact that [the CIO's] prior infrastructure could not handle the new ...