Corporate Governance

Delaware Courts and Exonerating the Board from Supervising Risk: In re Citigroup Derivative Litigation (The Weakness of the Caremark Standard)

By J. Robert Brown

We are discussing In re Citigroup Derivative Litigation.

As we have noted, the Chancellor in this case took an almost derisive approach towards plaintiffs' allegations that the board potentially should have played a larger role in the oversight of the risk undertaken by Citigroup that ultimately resulted in "staggering" losses and near nationalization of the financial institution. 

The court refused to let the case go forward because of the lack of evidence that the directors actually failed in their duty to oversee the company.  "The Complaint and plaintiffs' answering brief repeatedly make the conclusory allegation that the defendants have breached their duty of oversight, but nowhere do plaintiffs adequately explain what the director defendants actually did or failed to do that would constitute such a violation."

The failing of the court was to recognize that with a risk assessment process in place, the system was either a Potemkin village, that did not require officers to report changes in risk taking that threatened the entire existence of the company, or adequate to put the board on notice of the shift in risk but the board did nothing in response.  If the former, the court had an opportunity to define in a more meantinful way what it means for companies to put in place reporting systems that funnel information to the board.  The court could have found that it was not enough to have a system but that the system also had to alert the board to material changes in the company's financial condition.

With respect to the latter, the court could have used the case as a vehicle to help define the role of directors when they are aware of serious problems and shifts in risk within a company.

Of course, the court did neither, dismissing the plaintiffs' case.  In other words, the court refused to require that reporting systems be meaningful.  The case reiterates that in Delaware process (the existence of a reporting system) is enough and that the Delaware courts resolutely will not ensure that the process in fact performs the required functions.

The case further stands for the proposition that boards are better off not knowing what goes on inside the company.  Rather than require that such serious problems be reported to the board, the court allowed it to be a defense that the board did not know about them (or at least that plaintiffs had not alleged sufficient facts to show that the board knew). 

As usual, we have posted primary materials on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on March 13, 2009 (boomark / email).