[UPDATED 05.13.08 PM: Newly-amended complaint, as filed, and summarized, here.]
Grab your favorite “cuppa“, and take your time, here — I know I intend to(!) — for on this relatively-quiet Saturday morning, I am going to try and explain, in (mostly) plain-English, what is going on with the putative shareholders’ derivative suit, now pending against Schering-Plough’s Board of Directors, and several of its officers (and nominally, the company itself — but more on that, later).
The name of the case is Cain (ex rel. Schering-Plough) v. Hassan, et al., Case No. 2:08-cv-01022-DMC-MF (U.S. Dist. Ct., N.J., Complaint filed February 25, 2008). Catchy, no? No. I know. It is — like almost all the other Schering ENHANCE related matters, now pending before the very-able Judge Dennis M. Cavanaugh — in the federal district courthouse in New Jersey.
Ahhh, yes — if I haven’t already lost you, to the New York Times crossword puzzle, then please read on. . . . I really do intend to add to this — and hopefully, refine it — on and off, over the weekend.
To explain what a shareholder derivative suit is all about, to someone who is not a corporate lawyer, is more than a notion — and takes more than a moment — so let’s first talk generally, then specifically, about Schering’s pending version, okay?
Okay. Here we go:
Corporate directors and officers owe “fiduciary duties” of care, and loyalty to the corporations they serve (not vice-versa, Mr. Hassan!). Now, in some narrowly-curtailed areas, the directors and officers are said to owe these duties directly to the shareholders of the corporation — so directly, that the shareholders are granted the right, under Delaware law, to sue these directors and officers, personally (and to ultimately attach, and then sell-off, these peoples’ cars, estates, summer-houses, cottages, jets and yatchs, to repay the damages), for these sorts of alleged violations, if proved.
These special duties are the heart and soul of corporate law. So, because the duties are seen as so fundamental to the fair and balanced functioning of any corporate entity, the shareholders themselves — if their claims fall into one of these narrow categories (disloyalty; or lack of care) — may seek relief on behalf of the corporation in a “derivative suit” (the shareholders sue in the name of the corporation, derivatively). These sorts of suits are allowed for special breaches of corporate fiduciary duties. With me so far? Good.
The reason the law allows this, is that — as is likely the case at Schering-Plough, at least lately — the officers and directors are thought to be just a little too self-interested in preserving their cushy positions — as high officers, and $200,000-plus a year retainer-paid directors (for about 12 serious days of work, as a director, generally, speaking, in any given year — nice gig, eh?), to act proactively, and aggressively — even if it means firing close, dear friends and colleagues, of long-standing (always awkward, that) — to prevent abuse of the shareholders. Contrast this with those officers’ and directors’ desires to keep the gravy train rolling — and now you see what these suits are usually all about. To be clear, the sorts of violations we are talking about here must strike at the core of the functions of corporate governance to qualify for these sorts of special remedies/special treatments. Still here? Good [Wake your partner up!].
So, this is not the simple desire to receive a fair day’s pay for a day’s work, here. No, to be considered “materially self-interested“, as opposed to “genuinely disinterested“, a director, or officer will be scrutinized to determine whether the officer or director. . . had a material financial interest in the complained-of transaction — which interest differed from the shareholders, generally. “Material” in this setting refers to a financial interest of such a magnitude that the judgment of a reasonable person, in the same position, could be affected, to the detriment of the shareholders, generally. The most important question, then, is which community of reasonable people do we ask? Do we ask in downtown Newark, or on skid-row, in Patterson, New Jersey? Probably not.
No, probably the courts will ask this question of “reasonable people“, sitting under their original Calder or Picasso, 19th century Persian rug underfoot, sipping some nice Earl Grey, in their Ames chairs, ensconced in the Hamptons, for the weekend. . . .
Now, perhaps $200,000-plus per year, for 12 or so full-days of work, does not meet that test, you might opine, through clenched-teeth, or as you clutch your pearls. And, perhaps, if I lived high enough on that particular hill, I too might be inclined to agree with you, through my clenched teeth.
Even so (even if the courts are likely to look at other directors and officers of multi-billion-dollar public companies as the “reasonable person peer group“), here, it seems — to me, at least — a very fair question, to ask whether some $37 million in 2008, alone — a year of eroding sales, and steeply falling profits on the franchise/flagship product of the corporation, paid to a CEO — IF he is simply able to limp along, and retain his seat as CEO — whether it looks like the interests of that CEO are at-least starting to very-significantly diverge from those of all the Schering shareholders, generally? Yes, I do think that’s a fair question. Okay. Now to the caveats, qualifiers, and miscellania.
However — as ever — there is a “catch“: the catch, here, is that generally, any recovery will be in favor of the corporation, and not directly returned to individual, suing, shareholders. That is, any money won from the directors and officers personally is returned to the company’s coffers. So why bring these suits, at all? Well, mostly, to be sure the corporate form of doing business does not get corrupted into a simple license to fleece the public, and not have any real person held accountable for it. But, to be honest, in my opinion, another large component of the motivation behind such suits, very-generally speaking, is that such cases allow the plaintiffs’ attorneys (lawyers for the suing shareholders) to recover their fees from the corporation, itself. [But that rather oddly-conflicted set of interests is a topic for another day.]
I will have more of the specific factual backround from the case here, after this Monday night, May 12, 2008 — as that is the newest court-imposed deadline for Ms. Cain to file her amended complaint, here, but below is the way the Cain v. Hassan, et al. complaint sets all of this out, for the moment [emphasis supplied]:
. . . .72. The Board cannot be relied upon to reach a truly independent decision as to whether to consider a demand for action against themselves and the officers responsible for the misconduct alleged in this Complaint, in that, inter alia, the Board is dominated by Defendants who were personally and directly involved in the misconduct alleged and/or who each approved the actions complained of here. This domination of the Board has impaired the Board’s ability to validly exercise its business judgment and rendered it incapable of reaching an independent decision as to whether to accept Plaintiff’s demands.
73. In order to bring this action for breaching their fiduciary duties, each of the Defendants would have to sue himself/herself and/or his/her fellow Directors and allies in the top ranks of the Company, who are his/her good friends and with whom he/she has entangling financial alliances, interests and dependencies, which each Director of the Board would not do. Therefore, the Board would not be able to vigorously prosecute any such action and cannot in good faith exercise independent business judgment to determine whether to bring this action against themselves and one another.
74. The Defendants named herein, receive payments, benefits, stock options and other emoluments by virtue of their membership on the Board and their control of Schering. They have thus benefited from the wrongdoing herein alleged and have engaged in such conduct to preserve their positions of control and the perquisites thereof, and are incapable of exercising independent objective judgment in deciding whether to bring this action.
75. Reasonable doubt exists as to whether the Board can be relied upon to independently consider a pre-suit demand to bring the claims alleged herein. According to the Company’s 2007 Proxy, the Company readily acknowledges that defendants Hassan and Leder are not independent Directors under the NYSE standards, because of their personal, professional, and financial entanglements with each other and the Company.
76. Reasonable doubt exists as to whether defendant Hassan can be relied upon to independently consider a pre-suit demand to bring the claims alleged herein. As the CEO and President of the Company, Defendant Hassan is responsible for directing the Company’s day-to-day operations and for overseeing its corporate development and strategic planning. Hassan was therefore an integral cog in Defendants’ plan to suppress the findings of the ENHANCE study for nearly two years. Moreover, Hassan is financially beholden to the Company. For example, the Company paid Hassan over $$29,657,926 in total compensation for his service as CEO and President in 2006. As a result, in accordance with the New York Stock Exchange listing standards, Defendant Hassan is not independent.
77. Reasonable doubt exists whether Defendant Leder can be relied upon to independently consider a pre-suit demand to bring the claims alleged herein. Defendant Leder has personal and professional entanglements with the Company. Leder’s son, Ethan Leder, is chief executive officer of United BioSource Corporation [UBC], which provides specialized pharmaceutical services, including pharmacoeconomic information and analysis. Schering-Plough, for many years, has obtained services from companies that are part of the United BioSource family of companies. During 2006, Schering-Plough business with these companies totaled approximately $1.6 million. During 2005, Schering-Plough business with these companies totaled approximately $2.3 million, which was between 3% and 4% of UBC’s annual gross revenues for fiscal year 2005. As a result of these transactions, Defendant Leder is not independent. . . .
79. Reasonable doubt exists whether Defendant Kidder can be relied upon to independently consider a pre-suit demand to bring the claims alleged herein. Defendant Kidder holds close alliances with and allegiances to interested Director, Hassan and is beholden to him for his position on the Schering Board. Defendant Kidder served on the board of Electronic Data Systems Corporation (“EDS”) with Hassan. In October 2005, Kidder left the EDS board. On December 5, 2005, just two months later, Schering announced that the Company elected Kidder to its Board of Directors. In making the announcement Hassan stated, “Bob [Kidder] brings broad experience in the management of complex global organizations and sophisticated financial transactions. His experience and good judgment will be important as we move forward with new phases of our Action Agenda to transform Schering-Plough into a high-performance, global competitor.” Defendant Kidder’s relationship with Hassan enabled him to be nominated and elected to the Schering Board, where he now receives $200,000 a year in total compensation for his services.
80. Reasonable doubt exists whether Defendants Leder, McGrath, Thompson and Turner, as members of the Company’s Science & Technology Committee, can be relied upon to independently consider a pre-suit demand to bring the claims alleged herein. The Science & Technology Committee functions include assisting the Board of Directors in the general oversight of science and technology matters that impact Schering’s business and products. According to its charter, in carrying out its function, the Committee may undertake such activities as it deems useful, which may include providing input to the Board regarding the scientific aspects of the Company’s R&D portfolio and how developments in science and technology may impact the Company. Despite each member of the Science & Technology Committee being charged with overseeing and reporting on how scientific developments could impact the Company and its products, defendants Leder, McGrath, Thompson and Turner have failed to adopt an acceptable oversight and reporting process that is in the best interest of the Company, as evidenced by the fact that these Defendants allowed and/or caused the Company to suppress the unfavorable results of the ENHANCE study for nearly two years. By failing to perform their duties as prescribed by their charter and subjecting the Company to significant losses, Defendants Leder, McGrath, Thompson and Turner are personally implicated by the allegations contained herein and they would have been unable to comply with their fiduciary duties to disinterestedly consider pre-suit demand of the allegations contained here. . . .
82. The Defendants are fiduciaries of Schering and of all of its public shareholders and owe to them the duty to conduct the business of the Company loyally, with due care and in good faith. This cause of action is asserted based upon the Defendants’ intentional, reckless or grossly negligent acts, which constitute breaches of their fiduciary duties of loyalty, due care and good faith and waste of the Company’s corporate assets, in violation of state law.
83. The Defendants, in their roles as executives and/or Directors of the Company, participated in the acts of mismanagement alleged herein, or acted in reckless disregard of the facts known to them, and failed to exercise due care to prevent the violation of the federal securities and consumer protection laws. Specifically, the Defendants caused the Company to suppress the results of the ENHANCE study, which contradicted the Company’s public statements about Zetia and Vytorin. The Defendants became aware, or should have become aware through reasonable inquiry, of the facts alleged herein, but Defendants did nothing to correct these false statements and omissions and thereby breached their duty of care, loyalty, accountability and disclosure to the shareholders of the Company.
84. As a direct and proximate result of Defendants’ wrongful conduct, Schering has suffered considerable damage and a drastic diminution in value.
85. All Defendants, singly and in concert, engaged in the aforesaid conduct in intentional breach and/or reckless disregard of their fiduciary duties to the Company.
86. The Defendants conspired to abuse, and did abuse, the control vested in them by virtue of their high-level positions in the Company.
87. By reason of the foregoing, the Defendants have breached their fiduciary obligations to Schering and its shareholders.
88. Schering and its shareholders have been injured by reason of the Defendants’ intentional breach and/or reckless disregard of their fiduciary duties to the Company. Plaintiff, as a shareholder and representative of Schering, seeks damages and other relief for the Company as hereinafter set forth. . . .
90. Defendants have been responsible for the gross mismanagement of Schering. Defendants have also failed to exercise independent or good faith oversight of Schering or its executives, and thus have permitted that gross mismanagement.
91. Defendants abdicated their corporate responsibilities by mismanaging the Company in at least the following ways:
a. They caused Schering to violate the federal securities laws and state consumer protection statutes;
b. They concealed from the Company’s shareholders their plans to suppress the results of the ENHANCE study; and
c. They subjected Schering to adverse publicity, greatly increased its costs to raise capital, and impaired its earnings.
92. By their actions, Defendants breached their duties to oversee, direct and control Schering in a manner consistent with the legal duties of directors and officers of a publicly held company and under the applicable state laws.
93. As a direct and proximate result of Defendants’ gross mismanagement as alleged herein, Schering has sustained damages. . . .
95. As a direct result of wrongdoing alleged herein, Defendants have unreasonably and unnecessarily caused Schering to expend hundreds of millions of dollars of corporate assets to the extreme detriment of the Company. . . .
Okay — now who does Ms. Cain accuse of doing these things? Well, the suit names. individually, each of the directors during the complained-of period, as follows: FRED HASSAN, HANS W. BECHERER, THOMAS J. COLLIGAN, C. ROBERT KIDDER, PHILIP LEDER, M.D., EUGENE R. MCGRATH, CARL E. MUNDY, JR., ANTONIO M. PEREZ, PATRICIA F. RUSSO, JACK L. STAHL, DR. CRAIG B. THOMPSON, KATHRYN C. TURNER, ROBERT F.W. VAN OORDT and ARTHUR F. WEINBACH.
[More to come.]
So, all of the above resulted in only a phrase in one long sentence of Schering’s most recent periodic filing with the SEC. So, here is what Schering’s most-recent Form 10-Q disclosed about it [I’ve bolded my editorial comments, and the part related to the above-derivative suit]:
. . . .In addition, since mid-January 2008, Schering-Plough has become aware of or been served with litigation [over 120 separate pieces of it!], including civil class action lawsuits alleging common law and state consumer fraud claims in connection with Schering-Plough’s sale and promotion of the Merck/Schering-Plough joint-venture products’ VYTORIN and ZETIA; several putative shareholder securities class action lawsuits (where several officers are also named defendants) alleging false and misleading statements and omissions by Schering-Plough and its representatives related to the timing of disclosures concerning the ENHANCE results, allegedly in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934; a putative shareholder securities class action lawsuit (where several officers and directors are also named), alleging material misstatements and omissions related to the ENHANCE results in the offering documents in connection with Schering-Plough’s 2007 securities offerings, allegedly in violation of the Securities Act of 1933, including Section 11; a putative class action suit alleging that Schering-Plough and certain officers breached their fiduciary duties under ERISA and seeking damages in the amount of losses allegedly suffered by the Plans; a Shareholder Derivative Action alleging that the Board of Directors breached its fiduciary obligations relating to the timing of the release of the ENHANCE results; and a letter on behalf of a single shareholder requesting that the Board of Directors investigate the allegations in the litigation described above and, if warranted, bring any appropriate legal action on behalf of Schering-Plough. . . . .
Wow. That’s a stultifying morass of legalese, no?
Lets take it apart, then. Yes, let’s.
First — notice what is not there: Schering’s Form 10-Q does not mention any suits for “waste of corporate assets” in the delay of the release of the ENHANCE results.
Now, notice that Paragraph 95 of the Cain v. Hassan derivative suit specifically alleges a “wasting of corporte assets” claim. This could be a problem for Schering.
You see — Item 103 of SEC Regulation S-K requires that a materially-complete “description of the factual basis alleged to underlie the proceeding and the relief sought” be included in the Form 10-Q, as to all material litigation.
Where is that disclosure, above? No where, that’s where.
Now S-K, Item 103 also has special instructions for these sorts of derivative suits, because the interests of the directors and officers (as outlined above) may be adverse to those of the company:
“. . . .Any material proceedings to which any director, officer or affiliate of the registrant. . . is a party adverse to the registrant or any of its subsidiaries or has a material interest adverse to the registrant or any of its subsidiaries also shall be described. . . .“
[Back later, probably in the evening, on Monday, May 12, 2008 — after Ms. Cain’s lawyers have filed her Amended Shareholders’ Derivative Complaint — with news from that filing (outlining any important changes in theories, or new counts alleged), and to do some more of this analysis, here. It will depend on my other commitments, and the timing of that filing, on Monday.]