Kamen v. Kemper Financial Services, Inc.

• Decision Date: 07 August 1991
• Docket Number: No. 89-2967,89-2967
• Parties: , Fed. Sec. L. Rep. P 96,183 Jill S. KAMEN, Plaintiff-Appellant, v. KEMPER FINANCIAL SERVICES, INC., and Cash Equivalent Fund, Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 458

939 F.2d 458

60 USLW 2176, Fed. Sec. L. Rep. P 96,183

Jill S. KAMEN, Plaintiff-Appellant, v. KEMPER FINANCIAL SERVICES, INC., and Cash Equivalent Fund,

Defendants-Appellees.

No. 89-2967.

United States Court of Appeals, Seventh Circuit.

Submitted July 3, 1991.

Decided Aug. 7, 1991.

Richard M. Meyer, Milberg, Weiss, Bershad, Specthrie & Lerach, New York City, Joel Sprayregen, Clifford E. Yuknis, Shefsky & Froelich, Chicago, Ill., for plaintiff-appellant.

Joan M. Hall, Joel T. Pelz, Ellen R. Kordik, Jenner & Block, Martin M. Ruken, Arthur J. McGivern, Charles F. Custer, Stuart D. Kenney, Vedder, Price, Kaufman & Kammholz, Chicago, Ill., Gwenda M. Burkhardt, Deerfield, Ill., for defendants-appellees.

Before CUMMINGS, EASTERBROOK and RIPPLE, Circuit Judges.

EASTERBROOK, Circuit Judge.

The Supreme Court remanded this case with instructions to decide whether, under federal law reflecting the law of Maryland, Kamen has established adequate reason for not making a demand on the directors of the Cash Equivalent Fund. --- U.S. ----, 111 S.Ct. 1711, 1722-23 & n. 10, 114 L.Ed.2d 152 (1991). Kamen's request that we allow the district court to resolve that question in the first instance is inconsistent with both the Supreme Court's instructions and her argument to the Supreme Court that we erred in declining to apply Maryland law. (We had declined, 908 F.2d 1338, 1342 (1990), because Kamen did not raise any question of Maryland law in the district court, or in this court until her reply brief--the very circumstance that Kamen now asserts makes a remand appropriate.) Moreover, the question is one of law, and little would be served by increasing the number of layers in this case, which has aged considerably without drawing close to trial.

Kamen maintains that the Fund violated her rights under federal law by circulating a proxy statement containing a misleading comparison between the investment fees charged to the Fund and the fees charged to other members of Kemper's group of funds. Rule 23.1 requires the plaintiff in a derivative suit to allege "with particularity ... the reasons for the plaintiff's ... not making the effort" to demand action from the directors. Kamen's complaint, as amended after the close of discovery, alleges six reasons for failure to make demand:

1. The seven independent directors on the ten-person board received "aggregate remuneration of approximately $300,000 a year" for their role as directors of the Cash Equivalent Fund and other members of the Kemper Group.

2. The directors voted to circulate the proxy statement containing the statement to which Kamen objects.

3. A demand would have been tantamount to a request that the directors sue themselves.

4. The directors were "under the control" of Kemper.

5. The Fund sought to dismiss her complaint on substantive as well as procedural grounds.

6. Federal "policy" established by the Investment Company Act of 1940 augurs against demand.

We dismiss reason six immediately in light of the Supreme Court's holding that no federal rule prevents the application of Maryland law. 111 S.Ct. at 1722. What remains for decision is whether Maryland treats any of the other five reasons as enough to allow derivative litigation without a demand on directors.

Like most states, Maryland both requires demand as a norm and excuses demand when the request would be futile. Waller v. Waller, 187 Md. 185, 191-92, 49 A.2d 449, 453 (1946); Eisler v. Eastern States Corp., 182 Md. 329, 333, 35 A.2d 118, 119-20 (1943). Maryland has done little to develop the scope of its futility exception. Only one case in the state's history discusses that doctrine. Parish v. Maryland & Virginia Milk Producers Association, 250 Md. 24, 81-84, 242 A.2d 512, 544-45 (1968).

The plaintiff in Parish contended that a majority of the association's board had defrauded it. The suit named as defendants both the association and the members of its board. The court thought that it would be futile to ask the members of the board to sue themselves for wrongdoing and held that demand is excused when the alleged wrongdoers both are defendants and constitute a majority of the board. The Fund contends that Parish requires judgment in its favor because Kamen does not allege that the directors engaged in fraud and has not sued any of them; Kamen submits that Parish requires a decision in her favor because all of the members of the Fund's board approved the proxy statement and thus took part in what she characterizes as wrongdoing.

Parish does not dispose of these arguments one way or another. It is a single point, and you can draw a line any which way through one point on a plane. Parish does, however, enable us to resolve several of Kamen's arguments. By reiterating that demand is the norm in Maryland, Parish shows that Kamen's first and fourth allegations are insufficient. Kamen observes that the directors receive fees for their services and alleges generally that the directors are under Kemper's thumb. If allegations of this kind sufficed, the demand rule would be negated--for almost all directors receive fees, and independent directors come to a board after being slated by corporate insiders. There would have been no need in Parish to inquire into the directors' personal culpability if their status as directors (together with payment for their time) were enough to dispense with demand. The "control" allegation also flunks the "particularity" requirement of Rule 23.1, which governs how the plaintiff must allege matters substantively material under state law. The complaint alleges no facts pertinent to control and so does not satisfy the "particularity" requirement even if "control" could be a sufficient excuse under Maryland law.

Parish is inconsistent with Kamen's third allegation too: that demand would be equivalent to a request that the directors sue themselves. Kamen wants relief against Kemper, which collected the allegedly excessive fees, not against the directors personally. As Kamen does not believe that the facts justify action against the directors individually, demand would not have implied that the directors should go sue themselves. Maryland does not think it sufficient that something bad happened on a director's watch; it requires proof of wrongdoing. E.g., Waller, 187 Md. at 190-91, 49 A.2d at 452-53; Booth v. Robinson, 55 Md. 419 (1880). The business judgment rule protects the directors against personal liability for ordinary errors. So Kamen's reasons come down to two: that the directors approved the proxy statement, and that the directors have opposed her suit on the merits.

Whether the directors' involvement in the transaction complained of excuses demand depends on the function of the demand rule. If demand serves only to alert the directors to a grievance, then their involvement excuses demand because they already know what they have done. If however demand either recognizes the allocation of powers within the corporation (apportioning the initial decision to those the investors have handed the reins) or serves a screening role (a form of alternative dispute resolution helping to weed out weak cases), then the fact that the directors participated in the transaction is not enough. Maryland has not spoken clearly to the function demand serves; still, Waller treats demand as a useful screen for the courts, and Parish says that application must be made unless the directors are "wrongdoers". Participants who are not "wrongdoers" may evaluate their acts and change their minds.

Decisions in several states support Kamen's argument that the directors' participation in the questioned acts excuses demand. E.g., Barr v. Wackman, 36 N.Y.2d 371, 368 N.Y.S.2d 497, 329 N.E.2d 180 (1975); Valiquet v. First Federal Savings & Loan Association, 87 Ill.App.3d 195, 42 Ill.Dec. 212, 217, 408 N.E.2d 921, 926 (1st Dist.1979). The tide is running against this approach, however. See ALI, Principles of Corporate Governance: Analysis and Recommendations 76-81 (T.D. No. 8, 1988) (Reporter's note analyzing state cases). Delaware, today's dominant corporate jurisdiction, has emphatically rejected the proposition that an investor may forego demand whenever the directors participated in the transaction they challenge. E.g., Grobow v. Perot, 539 A.2d 180 (Del.1988); Aronson v. Lewis, 473 A.2d 805 (Del.1984). See also, e.g., Starrels v. First National Bank of Chicago, 870 F.2d 1168, 1170-71 (7th Cir.1989); Lewis v. Graves, 701 F.2d 245, 248-49 (2d Cir.1983), collecting authority to the same effect. The prevailing contemporary view is that...