Who needs en banc? Not 2nd Circ. panel in London Whale derivative case

August 14, 2015

(Reuters) – The 2nd U.S. Circuit Court of Appeals really, really doesn’t like to hear cases en banc, so shareholders’ lawyers at Robbins Arroyo knew the odds were against them when they asked the entire court to take up the dismissal of a derivative suit accusing JPMorgan Chase directors of botching the company’s investigation of the London Whale trading debacle.

The 2nd Circuit didn’t take the case en banc – but Robbins Arroyo got part of what it wanted anyway. On Wednesday, the three 2nd Circuit judges who originally decided the case in June – Chief Judge Robert Katzmann and Judges Rosemary Pooler and Susan Carney – vacated their previous decision and issued a new one that changes the 2nd Circuit’s standard of review for appeals of dismissal decisions in derivative cases. The new decision does away with decades-old 2nd Circuit precedent that required the appellate court to defer to the discretion of trial judges, replacing it with the more objective de novo standard the 2nd Circuit uses in reviewing just about every other kind of case dismissal.

In effect, the London Whale panel took a shortcut from the usually time-consuming en banc process. As Chief Judge Katzmann mentioned in two footnotes in Wednesday’s opinion, the panel judges circulated a draft of their precedent-changing decision among all of their 2nd Circuit colleagues. Presumably, though the opinion does not say so, the other judges agreed with the panel’s determination that the court should review derivative dismissals de novo and not under the old abuse-of-discretion standard.

It was obvious from the panel’s first decision in June that Judges Katzmann, Pooler and Carney chafed at the abuse-of-discretion standard, though they nevertheless said they were bound to use it by 2nd Circuit precedent. Even in June, the panel said deference shouldn’t apply because trial judges in the dismissal stage of derivative litigation don’t make evidentiary decisions, weigh the credibility of witnesses or otherwise evaluate facts the appeals court doesn’t have access to. Dismissal decisions are based only on the complaint in the case and the law, the 2nd Circuit said in June, so there is no reason to use an abuse-of-discretion standard to review those decisions.

That was especially true, the London Whale panel said in its first opinion, because several federal circuits and the Delaware Supreme Court have all revised their appellate standards to review derivative dismissals de novo. The circuit split led previous appellate panels in the 2nd Circuit, as well as panels in the 9th and District of Columbia Circuits, to question the abuse-of-discretion standard, the June opinion said. The U.S. Supreme Court was set to resolve the split in 2013 but had to dismiss the case that presented the question when it settled.

So the 2nd Circuit’s willingness to abandon the abuse-of-discretion standard didn’t come as a surprise to shareholder lawyer George Aguilar of Robbins Arroyo. But the procedure of the decision, without an en banc hearing, was unexpected. Aguilar told me the panel judges asked him at oral argument in April for his view of whether they could depart from 2nd Circuit precedent without the entire circuit reversing the old standard. He said no, a position he maintained in the petition for en banc review. Robbins Geller Rudman & Dowd, which is appealing the dismissal of a different London Whale derivative suit and sought to file an amicus brief in the Robbins Arroyo case, also said in its filing that the 2nd Circuit couldn’t change the standard without an en banc hearing.

The timing of the decision – which came only six weeks after Robbins Arroyo petitioned for an en banc hearing and without opposition briefing from defense lawyers at Sullivan & Cromwell and Gibson Dunn & Crutcher – was also a happy surprise for the plaintiffs’ lawyers. Both Aguilar and Darren Robbins of Robbins Geller said the 2nd Circuit’s de novo standard will bring more certainty to shareholder derivative litigation by assuring that appellate courts are able to analyze demand compliance and demand futility without deferring to trial judges’ determinations. Aguilar said the 2nd Circuit opinion may also inspire the 9th and D.C. Circuits to revise their standards of review without en banc hearings.

The second part of the London Whale decision Wednesday wasn’t such good news for shareholders. Using its new de novo standard, the panel looked at the complaint’s allegations that the JPMorgan board didn’t adequately address a shareholder demand for investigation because it only examined trading losses by the bank’s chief investment office, not JPMorgan executives’ statements about the brewing scandal. (The bank, of course, has said its board oversaw a deep and broad internal investigation that far surpassed ordinary corporate probes.)

The panel concluded that there is so little precedent on so-called demand-refused derivative suits, as opposed to more run-of-the-mill demand-futility, that it needed guidance from Delaware’s Supreme Court. It certified to that court the question: “If a shareholder demands that a board of directors investigate both an underlying wrongdoing and subsequent misstatements by corporate officers about that wrongdoing, what factors should a court consider in deciding whether the board acted in a grossly negligent fashion by focusing its investigation solely on the underlying wrongdoing?”

Assuming the Delaware Supreme Court agrees to take the question, which certainly seems likely, the London Whale case will return to the 2nd Circuit panel once that court has provided guidance. So shareholders still have a number of obstacles to surmount before their derivative case can be revived, especially considering Delaware’s typical deference to the business judgment of a well-functioning board.

But Robbins Arroyo’s clients are in much better position than they were at the beginning of the summer, and a lot more quickly than they had any reason to expect.

JPMorgan counsel Richard Pepperman of Sullivan & Cromwell declined to provide a statement in response to a request for comment. Jonathan Dickey of Gibson Dunn, who represents the outside directors, did not respond to my phone message.

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