Judge tosses suit against J&J board: law blocks accountability

October 5, 2011

In August, when Johnson & Johnson disclosed its deal to resolve criminal allegations that it falsely marketed the potent schizophrenic drug Risperdal, I said that if ever a board was ripe for a big, fat shareholder derivative suit, it was J&J’s. The Risperdal settlement was the company’s third criminal plea in a little more than a year, on top of a Justice Department and Food and Drug Administration investigation of its over-the-counter children’s drugs, state attorneys general subpoenas, whistleblower suits, and product recalls. The 111-page consolidated complaint that Bernstein Litowitz Berger & Grossmann and Robbins Geller Rudman & Dowd filed against J&J’s board members last December offered more red flags than a training school for toreadors.

Judge Freda Wolfson of New Jersey federal court agreed in a Sept. 30 opinion that the allegations the plaintiffs firms had raised were “troubling and pervasive,” noting in particular that claims the board ignored systemic illegal conduct were “disconcerting to the court.” Near the end of the ruling, after analyzing all of the shareholders’ assertions, the judge cited “what appears to be serious corporate misconduct on J&J’s part.”

And then she threw out the case.

Judge Wolfson found that the shareholders’ complaint didn’t offer sufficiently specific evidence that individual board members were aware of problems at the company and nevertheless failed to do anything. “None of the various types of red flags suggest that the board acted in bad faith,” the judge wrote. “Adding all of those allegations together does not lead me to a different conclusion in this case. While plaintiffs’ allegations are disconcerting, they do not contain the [requisite] detail.”

I could retread the judge’s examination of each and every one of the assertions Bernstein Litowitz and Robbins Geller raised, explaining why the judge found their evidence insufficient. I could point out Judge Wolfson’s apparent irritation with the plaintiffs firms for failing to quote specifics from the J&J regulatory filings they cite. (“It is not the court’s obligation to wade through pages of documents to locate the language plaintiffs seek to invoke,” she wrote.) Or I could explain the debate over whether the allegations against J&J should be weighed in the aggregate or one at a time.

But I think it’s more valuable to consider the big picture. Judge Wolfson’s dismissal of the J&J case before shareholders even had a chance to conduct discovery suit proves exactly what I argued in a recent column: the law makes it virtually impossible to hold corporate board members accountable through shareholder litigation.

Start with the choice Bernstein Litowitz and Robbins Geller made at the very beginning of this suit. Shareholders can take two paths in derivative cases. They can either serve a demand for action on the board or they can proceed with their claims on the theory that it would be futile to make such a demand. Bernstein and Robbins chose the latter course. They were right, of course, that the J&J board would never have decided to sue its own members. In fact, a different set of plaintiffs lawyers did serve a demand on the J&J board, which formed a special litigation committee, conducted a year-long investigation, and concluded — quel surprise! — that no litigation was warranted.

But you can’t simply cite common sense in derivative litigation. If you file a demand futility suit, you have to be able to show that a majority of board members were incapable of independence. In most derivative suits, including the J&J case, shareholders argue that board members won’t take action because they’re worried about their own liability. And to show that, as Judge Wolfson explains in her J&J ruling, plaintiffs lawyers have to meet what is often described as “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”

Under the Delaware Chancery Court’s 1996 Caremark precedent, as restated in the 2009 In re Citigroup case, shareholders have to show that corporate directors acted in bad faith, offering specific evidence that “[the board’s] indolence was so persistent that it could not be ascribed to anything other than a knowing decision not to even try to make sure the corporation’s officers had developed and were implementing a prudent approach to ensuring law compliance.” Only an “utter failure to attempt to assure a reasonable information and reporting system exists” leads to board liability under the laws that govern Delaware-chartered corporations, which means most U.S. business.

So even a board like J&J’s, which presided over a company rife with problems so severe that it reached three criminal plea deals in a single year, is off the hook unless its shareholders can show individual directors had actual knowledge of corporate failures and deliberately chose to ignore them. That’s the near-insurmountable standard Judge Wolfson found the plaintiffs failed to meet.

The judge did leave a tiny bit of opportunity for plaintiffs lawyers to revive their case. She suggested they could file a suit seeking J&J’s board records, then amend their derivative complaint to add specific allegations about which board members knew about J&J problems and when those problems were addressed at board meetings. But Judge Wolfson didn’t hold out much hope that shareholders would be able to muster the necessary evidence. Moreover, she added an oblique warning. Shareholders chose to litigate without corporate records the first time around, she said. So if they file an amended complaint, they may be stuck paying J&J’s legal bills for any “additional burden” imposed on the company by the second round of litigation.

That would be quite a message to send to shareholders. Try to hold your board responsible for corporate failures that have cost the company tens of millions of dollars, and you just might end up paying the lawyers who stood in the way.

J&J’s counsel, Walter Carlson of Sidley Austin, declined comment. Mark Lebovitch of Bernstein Litowitz was unavailable, and Darren Robbins of Robbins Geller didn’t respond to my e-mail.

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