Pirelli Armstrong Tire Corp. Retir. Med. v. Raines

• Decision Date: 08 August 2008
• Docket Number: No. 07-7108.,07-7108.
• Citation: 534 F.3d 779
• Parties: PIRELLI ARMSTRONG TIRE CORPORATION RETIREE MEDICAL BENEFITS TRUST, Derivatively on Behalf of FEDERAL NATIONAL MORTGAGE ASSOCIATION and Wayne County Employees' Retirement System, Derivatively on Behalf of Federal National Mortgage Association, Appellants v. Franklin D. RAINES, et al., Appellees.
• Court: U.S. Court of Appeals — District of Columbia Circuit

534 F.3d 779

PIRELLI ARMSTRONG TIRE CORPORATION RETIREE MEDICAL BENEFITS TRUST, Derivatively on Behalf of FEDERAL NATIONAL MORTGAGE ASSOCIATION and Wayne County Employees' Retirement System, Derivatively on Behalf of Federal National Mortgage Association, Appellants v. Franklin D. RAINES, et al., Appellees.

No. 07-7108.

United States Court of Appeals, District of Columbia Circuit.

Argued April 23, 2008.

Decided August 8, 2008.

Appeal from the United States District Court for the District of Columbia (No. 04cv01783).

Randall J. Baron argued the cause for appellants. With him on the briefs were Eric A. Isaacson and Benny C. Goodman III.

Maureen E. Mahoney argued the cause for appellees. With her on the briefs were Everett C. Johnson, Jr., J. Scott Ballenger, Jeffrey W. Kilduff, Michael J. Walsh, Jr., Barbara Van Gelder, James D. Wareham, James E. Anklam, John J. Clarke, Jr., Earl J. Silbert, James Hamilton, Rhonda D. Orin, Daniel J. Healy, William K. Dodds, Stephanie A. Joyce, Glenn B. Manishin, David E. Barry, William A. Krohley, Christopher C. Palermo, Steven M. Salky, Eric Delinsky, Holly A. Pal, Kevin M. Downey, and Paul Mogin. Barbara A. Miller entered an appearance.

Before: TATEL, BROWN, and KAVANAUGH, Circuit Judges.

Opinion for the Court filed by Circuit Judge KAVANAUGH, in which Circuit Judge TATEL joins.

Opinion concurring in the judgment filed by Circuit Judge BROWN.

KAVANAUGH, Circuit Judge:

In 2004, Fannie Mae announced one of the largest corporate earnings restatements in U.S. history. Numerous investigations and official reports followed. The story of Fannie Mae told by these reports is disturbing. It thus comes as no surprise that the Fannie Mae accounting debacle has generated a wave of lawsuits. In this case, certain Fannie Mae shareholders filed a derivative suit on behalf of Fannie Mae against the Company's directors. The complaint targets the directors' failure to prevent the accounting irregularities. The complaint also challenges the directors' decision to approve severance arrangements for two Fannie Mae officers, Franklin D. Raines and J. Timothy Howard.

The parties agree that Delaware law provides the substantive standards for evaluating plaintiffs' complaint. Shareholders ordinarily must make a demand on the company's board of directors in order to bring a derivative suit. Although these shareholders did not make such a demand, the law does not require demand when it would be futile. But consistent with the long-standing principle that directors and not shareholders manage a corporation, the Delaware precedents on demand futility make clear that the bar is high, the standards are stringent, and the situations where demand will be excused are rare.

Carefully applying the Delaware precedents, the District Court found that plaintiffs' complaint failed to meet the test for demand futility and dismissed the case. We affirm.

I

Fannie Mae is a federally chartered corporation authorized by Congress in 1934 and created in 1938. Initially established as a public entity, Fannie Mae was privatized in 1968. Fannie Mae thus has shareholders, directors, and officers like other non-governmental corporations.

Fannie Mae's mission is to increase affordable housing for moderate- and low-income families. It purchases mortgages originated by other lenders and helps lenders convert their home loans into mortgage-backed securities. The goal is to provide stability and liquidity to the mortgage market. This allows mortgage lenders to provide more loans, thereby increasing the rate of homeownership in America.

During the summer of 2003, Fannie Mae's sister organization Freddie Mac disclosed accounting irregularities. Shortly thereafter, the Office of Federal Housing Enterprise Oversight, an Executive Branch agency, reviewed Fannie Mae's accounting. In September 2004, OFHEO released an interim report that highlighted deficiencies in Fannie Mae's accounting policies, internal controls, and financial reporting. OFHEO's interim report led to an investigation by the Securities and Exchange Commission. On December 15, 2004, the SEC announced that it would require a $9 billion earnings restatement by Fannie Mae.

Six days after the SEC's announcement, two Fannie Mae officers (CEO Franklin D. Raines and CFO J. Timothy Howard) resigned. The Board did not fire Raines or Howard for cause; as a result, they were able to leave the company with approximately $31 million in severance benefits.

In late 2004, shareholders filed multiple derivative suits on behalf of Fannie Mae against Fannie Mae's directors. See In re Fed. Nat'l Mortgage Ass'n Litig., 503 F.Supp.2d 9, 13 (D.D.C.2007). As relevant here, plaintiffs allege that Fannie Mae's Board of Directors failed to exercise sufficient oversight to prevent the accounting violations. Plaintiffs also contend that the outside directors on the Board should have (i) terminated Raines and Howard for cause, thereby denying them severance benefits, and (ii) sued to obtain disgorgement of previous compensation Raines and Howard received.

Shareholders bringing a derivative suit first must make a demand on the Board, in effect asking the Board to have the corporation pursue the claims itself. The shareholders here did not do so. They assert that demand is excused in this case because a majority of the directors could not render a disinterested and independent decision whether to pursue those claims.¹ The District Court found that demand was not excused and dismissed the suit.²

II

Before turning to the merits of this appeal, we address jurisdiction. The parties all agree there is federal subject-matter jurisdiction based on 12 U.S.C. § 1723a(a), which authorizes Fannie Mae to "sue and to be sued, and to complain and to defend, in any court of competent jurisdiction, State or Federal." Based on an independent assessment, we also conclude that this provision establishes federal subject-matter jurisdiction.

In American National Red Cross v. S.G., the Supreme Court considered a statute providing that the Red Cross could "`sue and be sued in courts of law and equity, State or Federal, within the jurisdiction of the United States.'" 505 U.S. 247, 248, 112 S.Ct. 2465, 120 L.Ed.2d 201 (1992) (quoting 36 U.S.C. § 2 (now codified as amended at 36 U.S.C. § 300105(a)(5))). The Court held that this sue-and-be-sued clause conferred federal subject-matter jurisdiction over cases in which the Red Cross was a party. Red Cross, 505 U.S. at 257, 112 S.Ct. 2465. In so ruling, the Court articulated the general principle that "a congressional charter's `sue and be sued' provision may be read to confer federal court jurisdiction if, but only if, it specifically mentions the federal courts." Id. at 255, 112 S.Ct. 2465 (emphasis added). The Red Cross Court stated that express reference to federal courts in a federally chartered entity's sue-and-be-sued clause was "necessary and sufficient to confer jurisdiction." Id. at 252, 112 S.Ct. 2465 (emphasis added).

The Red Cross majority repeatedly characterized this principle as a "rule," see id. at 255-57, 112 S.Ct. 2465, noting that it had been "established" in the early 19th Century by Osborn v. Bank of United States, 22 U.S. (9 Wheat.) 738, 818, 6 L.Ed. 204 (1824), and subsequently confirmed in Bankers Trust Co. v. Texas & Pacific Railway Co., 241 U.S. 295, 304, 36 S.Ct. 569, 60 L.Ed. 1010 (1916), and D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 455-56, 62 S.Ct. 676, 86 L.Ed. 956 (1942). And the Red Cross dissenters similarly understood the rule's clarity, although they disagreed with the rule's content: "The Court today concludes that whenever a statute granting a federally chartered corporation the `power to sue and be sued' specifically mentions the federal courts (as opposed to merely embracing them within general language), the law will be deemed ... to confer on federal district courts jurisdiction over any and all controversies to which that corporation is a party." 505 U.S. at 265, 112 S.Ct. 2465 (Scalia, J., dissenting) (emphasis omitted).

Applying the Red Cross rule to the present case, we find that there is federal jurisdiction because the Fannie Mae "sue and be sued" provision expressly refers to the federal courts in a manner similar to the Red Cross statute. To be sure, the Fannie Mae sue-and-be-sued clause differs from the Red Cross statute in one respect: It refers to "any court of competent jurisdiction, State or Federal," whereas the Red Cross statute refers to "courts of law and equity, State or Federal." Compare 12 U.S.C. § 1723a(a), with 36 U.S.C. § 300105(a)(5). We agree, however, with the majority of district courts that have confronted the question since Red Cross: Section 1723a(a) provides federal subject-matter jurisdiction in Fannie Mae cases. See, e.g., Grun v. Countrywide Home Loans, Inc., 2004 WL 1509088, at *2 (W.D.Tex. July 1, 2004); Connelly v. Fed. Nat'l Mortgage Ass'n, 251 F.Supp.2d 1071, 1073 (D.Conn.2003); C.C. Port, Ltd. v. Davis-Penn Mortgage Co., 891 F.Supp. 371, 372 (N.D.Tex.1994), aff'd, 58 F.3d 636 (5th Cir.1995); Peoples Mortgage Co. v. Fed. Nat'l Mortgage Ass'n, 856 F.Supp. 910, 917 (E.D.Pa.1994).

It is true that two district courts have reached the contrary conclusion, reasoning that applying the Red Cross rule to Fannie Mae is problematic because doing so, in their view, renders superfluous the words "of competent jurisdiction" in the Fannie Mae statute. See Knuckles v. RBMG, Inc., 481 F.Supp.2d 559, 563 (S.D.W.Va.2007); Fed. Nat'l Mortgage Ass'n v. Sealed, 457 F.Supp.2d 41, 44-46 (D.D.C.2006). We disagree with the Knuckles and Sealed district court opinions. Applying the Red Cross rule to the Fannie Mae statute does not render the words "of competent jurisdiction" superfluous. The words "of competent jurisdiction" help clarify that: (i) litigants in state courts of limited jurisdiction must satisfy the appropriate jurisdictional requirements, see Osborn, 22 U.S. (9 Wheat.) at 817-18 (finding...