The Booth Family Trust v. Jeffries, 09-3443
| Decision Date | 05 April 2011 |
| Docket Number | No. 09-3443,09-3443 |
| Parties | The Booth Family Trust, Charles Federman, Trustee, Derivatively on Behalf of Nominal Defendant, Abercrombie & Fitch; Alfred Freed, Plaintiffs-Appellants, v. Michael S. Jeffries; Robert S. Singer; Russell M. Gertmenian; Archie M. Griffin; James B. Bachmann; Lauren J. Brisky; John W. Kessler; John A. Golden; Edward F. Limato; Samuel N. Shahid, Jr.; Allan A. Tuttle, and Abercrombie & Fitch Co., Defendants - Appellees. |
| Court | U.S. Court of Appeals — Sixth Circuit |
OPINION TEXT STARTS HERE
Appeal from the United States District Court for the Southern District of Ohio at Columbus. Nos. 05-01084; 05-00998; 05-00964; 05-00819; 05-00860—Edmund A. Sargus, Jr., District Judge.
Before: MARTIN and GRIFFIN, Circuit Judges; DUGGAN, District Judge.*
ARGUED: Beth A. Keller, New York, New York, for Appellants.
Philip A. Brown, VORYS, SATER, SEYMOUR AND PEASE LLP, Columbus, Ohio, for Appellees.
ON BRIEF: Beth A. Keller, Jamie R. Mogil, New York, New York, Jacob A. Goldberg, FARUQI & FARUQI, LLP, Huntington Valley, Pennsylvania, for Appellants.
Philip A. Brown, Alycia N. Broz, VORYS, SATER, SEYMOUR AND PEASE LLP, Columbus, Ohio, for Appellees.
MARTIN, J., delivered the opinion of the court, in which DUGGAN, D. J., joined. GRIFFIN, J. (pp. 19-23), delivered a separate dissenting opinion.
Plaintiffs-appellants are shareholders of Abercrombie & Fitch Co. The Shareholders filed a derivative suit on behalf of Abercrombie against several officers and directors alleging that defendants caused Abercrombie to make misleading public statements between June 2 and August 18, 2005, which caused the stock price to rise and then fall once the falsity of these statements was revealed.1 An investigation by the Securities Exchange Commission and securities fraud lawsuits followed, which the Shareholders allege damaged Abercrombie.
Upon the filing of the lawsuit, Abercrombie invoked a procedural option available under Delaware law by forming a special litigation committee to investigate the claims made by the Shareholders. The special litigation committee subsequently recommended that Abercrombie seek dismissal of the lawsuit, which Abercrombie did by filing a motion to dismiss. The district court granted the motion, holding that Abercrombie's special litigation committee was independent under Delaware law, it conducted its investigation in good faith, and its decision not to pursue the derivative suit was reasonable. However, we hold that there are serious questions as to Abercrombie's special litigation committee's independence, and therefore REVERSE the district court's decision, DENY the motion to dismiss, and REMAND for further proceedings.
The Shareholders generally allege that certain officers and directors caused Abercrombie to issue misleading public statements regarding the success of its business model in early 2005, which resulted in the stock price rising and then falling after the falsity of these statements was revealed later that year. Essentially, according to the complaint, Abercrombie adopted a business model of selling products with a low manufacturing cost at high retail prices, resulting in a high per-unit margin. The company sought to create such a desired brand that it could "train" its customers to not expect a sale or markdowns and instead just pay the high price. This approach manifested itself most particularly in Abercrombie's denim products, which were apparently made cheaply but sold expensively.
Beginning in early 2005 and continuing through the summer, Abercrombie issued reports indicating that its denim sales were strong and that its high gross margin business strategy was working. The Shareholders allege that these statements were misleading because company insiders knew that Abercrombie was amassing a large surplus of inventory such that there would have to be dramatic markdowns to clear out the inventory. The Shareholders further allege that the officers and directors knew that this corrective action would result in a decrease in per-unit profit and cast doubt on the viability of Abercrombie's business model, causing a negative correction in the company's stock price. The stock price eventually did fall, which kicked off a spate of lawsuits and regulatory investigations.
During this time, when the insiders are alleged to have known that the price would soon fall, five of the defendants—Singer, Jeffries, Bachmann, Kessler, and Griffin—sold a large number of their personally owned shares of Abercrombie stock. The Shareholders claim that this amounts to insider trading, and they level additional allegations against this group of defendants.
In response to this lawsuit, in October 2005, Abercrombie's Board of Directors formed a special litigation committee. The board resolution creating the special litigation committee called for it to have two members. Initially, Abercrombie's special litigation committee was comprised of Daniel Brestle and Allan Tuttle, both members of Abercrombie's Board. Although Tuttle is now a defendant, he was not named when Abercrombie formed the special litigation committee. Brestle later resigned, but did so before the special litigation committee issued its report, and was replaced by Lauren Brisky. Brisky is also a Board member, and was a named defendant at the time of her appointment to the special litigation committee. The Board gave the special litigation committee complete authority to investigate the Shareholders' claims and to direct the company on whether to proceed with the lawsuit on its own behalf or to seek its dismissal as being against the interests of the company.
Abercrombie's special litigation committee retained the law firm of Cahill Gordon & Reindell LLP, a national law firm that had no prior relationship with Abercrombie. Cahill Gordon did the bulk of the work in interviewing witnesses and reviewing documents and records, advised the two special litigation committee members on the progress and results of the investigation, and made recommendations on how to proceed. Because of their prior relationship, Tuttle abstained from considering the claims against Singer. The record indicates that Tuttle did not attend the interview with Singer but does not otherwise explain how he was screened from considering the claims against Singer.
Approximately sixteen months after its formation, the special litigation committee produced a 144-page report detailing its investigation and concluding that there was no evidence to support the Shareholders' claims. The special litigation committee therefore directed Abercrombie to seek dismissal of the case. Abercrombie filed its motion to dismiss pursuant to Federal Rule of Civil Procedure 41(a)(2) on September 10, 2007 under the framework set out by the Delaware Supreme Court in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981). Under Zapata, as explained more fully below, a corporation may appoint a special litigation committee to investigate claims presented in a derivative action. If a court finds that a corporation's special litigation committee was independent, conducted its investigation in good faith, had reasonable bases for its conclusion and the decision to dismiss the lawsuit is not inconsistent with business judgment, the court will dismiss the derivative action. Id. at 788-89.
The Shareholders proceeded to take rather extensive discovery of Abercrombie's special litigation committee. On November 12, 2008, the Shareholders filed their opposition to the motion to dismiss, challenging the special litigation committee's conclusion that the suit should be dismissed. On March 12, 2009, the district court issued an opinion finding that Abercrombie's special litigation committee was independent, proceeded in good faith, and had reasonable bases for its conclusions. The district court declined to exercise its independent business judgment regarding the special litigation committee's recommendation, and therefore granted Abercrombie's motion to dismiss.
Neither the Delaware courts nor our sister circuits in cases applying Delaware law have clearly articulated the standard of review to be applied to a lower court's decision granting a motion to dismiss a derivative action based on the recommendation of a special litigation committee. This motion is a hybrid that does not have a clear analogue under the Federal Rules of Civil Procedure, but shares some characteristics of a motion to dismiss pursuant to Rule 12, and some characteristics of a motion for summary judgment under Rule 56. See Zapata, 430 A.2d at 787 (). When considering a motion to dismiss under Rule 12, we review the district court's decision de novo. In re NM Holdings Co., LLC, 622 F.3d 613, 618 (6th Cir. 2010). Similarly, we review de novo a grant of summary judgment pursuant to Rule 56. Profit Pet v. Arthur Dogswell, LLC, 603 F.3d 308, 311 (6th Cir. 2010).
For the purpose of determining the appropriate level of appellate scrutiny, the nature of a corporation's motion to dismiss pursuant to the recommendation of its special litigation committee is most similar to a summary judgment motion. As discussed below, the focus of the Zapata inquiry is not on the merits of the plaintiffs' claims, but on whether maintenance of the suit would be in the company's best interest. This inquiry is one step removed from the actual merits and allows a special litigation committee to recommend dismissal, consistent with its business judgment, even if a derivative suit may ultimately be successful. See Zapata, 430 A.2d at 788 (...
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