At oral argument Thursday in the Delaware Supreme Court, where Walmart is appealing a lower court order to produce internal FCPA investigation files to shareholders, one remarkable exchange indicated that the idea of revising the Caremark standards, which I talked about in my prior post, was squarely on the minds of the justices.
Walmart is arguing in the appeal that it should be required to produce only board agendas and minutes or formal reports because all other documents are not relevant or are protected by privilege. Having produced them, the case should be dismissed.
Stuart Grant, the shareholders counsel, explained to the five justices that he cannot allege in blanket terms that the “board” acted wrongly. He must specify a named officer or director who did (or didn’t do) something specific.
The only way to establish liability for fraud, self-dealing or failure to investigate red flags, he said, is to make an allegation supported by some specific preliminary piece of evidence like emails or file notes.
At a later stage, Grant said, the plaintiffs may be entitled to take depositions and to do more extensive discovery. But without preliminary evidence of specified individual misconduct, Grant suggested his shareholder clients are vulnerable to a motion to dismiss the entire case.
That, he said, is why the plaintiffs have requested the files of Maritza Munich, a former Walmart lawyer and compliance officer who worked on the early investigation, as well as files of the investigation team, and the board audit committee.
Justice Holland: “Mr. Grant, one way I understand your theory is that directors don’t put cover up in minutes. If you look at Stone v Ritter that discusses their duty of oversight, they not only have to put a system in place but they have to respond to red flags. The purpose of your 220 [discovery] demand is to try to ascertain whether there were red flags and that the directors were aware of and thus breached their fiduciary duties so demand would be excused.”
Grant: “Correct. That’s exactly right.”
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My take as an outsider watching the case and wondering how it might impact the compliance profession?
Red flags aren’t likely to be found in standard board documents like formal reports or agendas and minutes, which are the only documents Walmart has been willing to give the plaintiffs. If you re-read the New York Times reports, they’re packed with references to red flags discovered and documented by Munich and the investigation team and circulated to top executives and some directors.
For me, three of those red flags stand out.
First, after Munich’s investigation was terminated, the top executives and the board’s audit committee accepted the conclusion that the whole thing was a ruse by the whistleblower to defraud the company. In other words, no bribes were paid because the money was stolen first. Despite a thorough refutation by the investigators — why, for example, were the payments allegedly authorized in the first place and hidden in fraudulent accounting — the board closed the file based on that “ruse” theory.
Second, apparently the directors did not question why Munich, who abruptly submitted her resignation when the investigation was shut down, urged the company to reject the “ruse” argument and to finish her investigation, and if she was forced to resign.
Third, based on extensive records of payments in the millions, the investigators suspected that a top executive ran the bribery scheme but they were never allowed to question him.
The rules of the Delaware court that are intended to prevent fishing expeditions and strike suits need to be flexible enough to accommodate this extraordinary case and reasonably push it forward after two years.
If a case like this one dies in an early stage due to documents and files being held secret, no one wins.
The reputation of the Delaware Supreme Court would be damaged. Shareholders would be left without a potential remedy for directors’ alleged misconduct. The public would be left in the dark. And the compliance profession would stay on the run from retribution by senior executives and directors who are shielded by the antiquated Caremark guidelines.
Michael Scher is a contributing editor of the FCPA Blog. He has over three decades of experience as a senior compliance officer and attorney for international transactions. He can be contacted here.