Espinoza ex rel. JPMorgan Chase & Co. v. Dimon

• Citation: 797 F.3d 229
• Decision Date: 12 August 2015
• Docket Number: Docket No. 14–1754.
• Parties: Ernesto ESPINOZA, Derivatively on Behalf of JPMORGAN CHASE & CO., Plaintiff–Appellant, v. James DIMON, Douglas L. Braunstein, Michael J. Cavanagh, 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, Ina R. Drew, David C. Novak, Defendants–Appellees, JPMorgan Chase & Co., Nominal Defendant–Appellee, William H. Gray, III, Defendant.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

797 F.3d 229

Ernesto ESPINOZA, Derivatively on Behalf of JPMORGAN CHASE & CO., Plaintiff–Appellant

v.James DIMON, Douglas L. Braunstein, Michael J. Cavanagh, 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, Ina R. Drew, David C. Novak, Defendants–Appellees

JPMorgan Chase & Co., Nominal Defendant–Appellee

William H. Gray, III, Defendant.

Docket No. 14–1754.

United States Court of Appeals, Second Circuit.

Argued: April 1, 2015.

Decided: Aug. 12, 2015.

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, N.Y., for Plaintiff–Appellant.

Richard C. Pepperman, II, Sullivan & Cromwell LLP, New York, N.Y. (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, N.Y., 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.

Before: KATZMANN, Chief Judge, POOLER and CARNEY, Circuit Judges.

Opinion

KATZMANN, Chief Judge:

This derivative action is one of many to arise out of the “London Whale” trading debacle, which cost JPMorgan Chase billions. Plaintiff-appellant Ernesto Espinoza, a JPMorgan shareholder, believes that JPMorgan has not done enough to go after those he deems responsible. Through this lawsuit, he challenges the decision of the JPMorgan board to reject his demand that JPMorgan take action against the alleged wrongdoers. Although a board's rejection of a shareholder demand is normally conclusive so long as that rejection was based on a reasonable investigation, here Espinoza contends that the board's investigation was unreasonably narrow. Specifically, Espinoza alleges that the board's investigation only looked into the underlying trading losses, but did not explore certain alleged misstatements that JPMorgan executives made about those losses. Espinoza asserts that these misstatements exposed JPMorgan to significant liability, and should have led the board to take action against the executives involved. The district court (Daniels, J. ) dismissed Espinoza's complaint, finding that he had not pleaded facts showing that the JPMorgan Board of Directors had wrongfully refused the demand for action.

We write to address both the standard of review and the underlying merits of the case.¹ As to the standard of review, the law of our circuit has traditionally held that a district court's decision to dismiss a derivative action is reviewed only for abuse of discretion. But deferential review is not warranted: Reviewing the dismissal of a derivative action, as with the dismissal of any other sort of complaint, involves nothing more than reading the allegations in the complaint and deciding whether those allegations state a claim. Accordingly, we today revisit the standard of review and hold that dismissals of derivative actions are reviewed de novo.²

Reviewing this case under that de novo standard, we conclude that Delaware law is unclear on how to handle Espinoza's argument that the scope of the board's investigation was too narrow. Although several Delaware cases hold that a board has wide discretion about the procedures it uses when investigating a demand, no case addresses allegations that the substantive scope of an investigation was too narrow. We therefore certify the legal question necessary to decide the merits to the Delaware Supreme Court.

BACKGROUND

Because the district court disposed of this case on a motion to dismiss, we assume the truth of the allegations in the plaintiff's complaint for purposes of this appeal. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). The following recitation of facts is thus adopted from Espinoza's complaint.

A. The London Whale

The London Whale story begins in JPMorgan's Chief Investment Office (“CIO”), which manages and invests the excess cash from JPMorgan's other businesses. J.A. 10. Before 2009, the CIO invested primarily in conservative securities, with the goal of limiting JPMorgan's exposure to structural risks such as shifts in interest rates or foreign-exchange rates. J.A. 29. Beginning in 2008 and 2009, however, Defendant–Appellee Jamie Dimon, the Chief Executive Officer of JPMorgan, began transforming the CIO from a conservative risk-management unit into a more aggressive proprietary-trading desk, with the aim of generating additional profit. J.A. 30.

Seeking to satisfy this new emphasis on profits, the CIO began taking riskier positions in synthetic credit derivatives. In particular, a group of London traders led by Bruno Iksil—later known by the nom de finance “the London Whale”—made larger and larger bets in these markets. J.A. 32–33. But when these bets began to sour, the CIO doubled down by investing even more money in risky derivatives in an attempt to shore up these investments. J.A. 33–34. To conceal the losses, JPMorgan modified its “Variance at Risk” (“VaR”) model in a way that gave the misleading impression that JPMorgan's overall risk had stayed constant; an unmodified VaR model would have shown that JPMorgan's risk had in fact doubled. J.A. 35. The model's modification was overseen and approved by Dimon.

As losses mounted, the markets and the press began to catch wind of JPMorgan's troubles. On April 6, 2012, Bloomberg reported that the CIO's positions in the credit derivative market had become so large that they were driving price moves in that market. J.A. 36. Shortly thereafter, Dimon, along with Defendant–Appellee Douglas Braunstein, JPMorgan's then-Chief Financial Officer, held a conference call with analysts and investors to discuss JPMorgan's earnings for the first quarter of 2012. During this conference call, Dimon and Braunstein repeatedly claimed that the CIO was conservatively investing in safe securities. J.A. 36–40. For example, Braunstein stated that “[w]e invest ... in high grade, low-risk securities” and “[a]ll of [the CIO's investment] decisions are made on a very long-term basis ... to keep the Company effectively balanced from a risk standpoint.” J.A. 37–38. Similarly, Dimon characterized the mounting publicity over the CIO's losses as “a complete tempest in a teapot.” J.A. 39.

But on May 10, 2012, JPMorgan was forced to reveal to investors the scale of the CIO's losses. J.A. 40. Dimon disclosed, for the first time, that JPMorgan had modified its VaR model to minimize the scale of the risks taken by the CIO. Id. Dimon acknowledged that the CIO's investments had been “flawed, complex, poorly reviewed, poorly executed, and poorly monitored.” J.A. 41. After all the dust settled, JPMorgan divulged that its total losses from the CIO exceeded $6.25 billion. J.A. 42. The debacle prompted a number of regulatory and Congressional investigations into JPMorgan's inadequate oversight of the CIO. J.A. 45–49.

B. Espinoza's Demand and the Board's Investigation

On May 23, 2012, Espinoza, a shareholder of JPMorgan, sent a letter to the JPMorgan Board of Directors demanding that the Board investigate the London Whale debacle. J.A. 51. This demand asked the Board to investigate (1) the failure of JPMorgan's risk-management policies, (2) the dissemination of false or misleading information about the scandal, and (3) the extent to which JPMorgan had repurchased stock at inflated prices due to the failure to disclose the losses. J.A. 69. Espinoza also demanded that, following the investigation, JPMorgan sue the responsible individuals and claw back previously-awarded salary and bonuses. J.A. 69–70. Espinoza also demanded that JPMorgan improve corporate governance and implement better risk controls. J.A. 70.

In response to Espinoza's demand, which was joined by similar demands from other JPMorgan shareholders, the JPMorgan Board established a “Review Committee” composed of Defendants–Appellees Laban Jackson, Jr., Lee Raymond, and William Weldon, all members of the Board. J.A. 52–53. This committee would oversee JPMorgan's internal “Management Task Force,” which had been assembled to investigate the London Whale debacle, and consider what actions, if any, JPMorgan should take in response. J.A. 53. The task force was led by Defendant–Appellee Michael Cavanagh. J.A. 54.

The Board rejected Espinoza's demand by letter dated February 5, 2013. J.A. 83–86. The letter outlined the Review Committee and task force's extensive investigation, which included (1) 22 interviews of current and former JPMorgan employees, (2) a review of roughly 300,000 documents, (3) meetings with regulators, (4) an analysis of relevant news reports, and (5) a survey of industry best practices. J.A. 83–84. The Board stated that, in its judgment, further litigation was not in the best interests of JPMorgan. J.A. 86. In support of this conclusion, the letter identified various remedial measures that had already been taken, including a revamp of the CIO leadership and mandate, improved risk controls, reduced salary for certain senior management and CIO personnel, clawbacks of previously awarded bonuses, and the departure or reassignment of certain individuals involved in the debacle. J.A. 85. The Board also cited various factors that it weighed in deciding to not pursue litigation, including the cost of litigation, the low likelihood of success, the cost of bogging employees down in lawsuits, and the effect on employee morale. J.A. 85–86.

Espinoza then filed this lawsuit, arguing that his demand had been wrongfully refused. On March 31, 2014, the district court dismissed the complaint for failure to state a claim because the complaint did not show that the...