Hack v. Wright, Civil Action No. 4:14-CV-3442

396 F.Supp.3d 720

Robert HACK, Plaintiff,

v.Theodore M. WRIGHT, et al, Defendants.

Civil Action No. 4:14-CV-3442

United States District Court, S.D. Texas, Houston Division.

Signed July 5, 2019

ORDER ADOPTING REPORT AND RECOMMENDATION

KEITH P. ELLISON, UNITED STATES DISTRICT JUDGE

Pending before the Court is Defendants' Motion to Dismiss (Doc. No. 29), which had been referred to Magistrate Judge Dena Hanovice Palermo for a report and recommendation. On May 29, 2019, Judge Palermo issued the Report and Recommendation on Plaintiffs Motion to Remand (Doc. No. 40), recommending that the Motion to Dismiss be granted. The time for filing objections has passed, and no objections were filed.

Pursuant to Federal Rule of Civil Procedure 72(b), the Court has reviewed the Report and Recommendation for clear error. Finding no clear error, the Court adopts the Report and Recommendation in its entirety. Accordingly, Defendants' Motion to Dismiss (Doc. No. 29) is hereby granted. Plaintiff is granted leave to amend by July 19, 2019. Plaintiff is ordered to notify the Court, no later than July 1, 2019:

a. Whether he will amend the complaint based on documents Defendants recently produced, or

b. Whether he intends to make a Section 220 demand, and

c. Whether he needs a stay for the company to respond to his demand.

IT IS SO ORDERED .

REPORT AND RECOMMENDATION ON DEFENDANTS' MOTION TO DISMISS

Dena Hanovice Palermo, United States Magistrate Judge

Plaintiff Robert Hack ("Plaintiff") filed this shareholder derivative action against Defendants Theodore Wright, Bob Martin, Jon Jacoby, Kelly Malson, Douglas Martin, David Schofman, Scott Thompson, Brian Taylor, and Michael Poppe (collectively "Defendants"), as well as against Conn's, Inc. as a nominal Defendant ("Conn's" or "Corporation").¹ Compl., ECF No. 1. Before the Court is Defendants' motion to dismiss for failure to plead demand futility under Rule 23.1 and failure to state a claim under Rule 12(b)(6).² ECF No. 29. Having considered the record and authorities, the Court recommends that Defendants' motion should be granted without prejudice and Plaintiff should be granted leave to amend.

I.BACKGROUND

A. The Parties.

Plaintiff—a shareholder of Conn's—filed this derivative action on behalf of Conn's.

ECF No. 1 at ¶¶ 1, 16. This case shares a common factual background with the securities class action against Conn's, which sells household appliances in retail stores across the country and also has a credit arm of its business, providing in-house credit options, third-party financing programs, and third-party rent-to-own payment plans to its customers. Id. at ¶¶ 29, 55; see In re Conn's, Inc. Sec. Litig. , No. 14-CV-548 (S.D. Tex.). Beginning in February 2014, Conn's made public announcements that its fourth quarter fiscal year 2014 bad debts in its credit segment exceeded its previously issued full-year fiscal 2014 guidance and it expected earnings per share dilution in the fourth quarter in 2014 and in 2015. ECF No. 1 at ¶¶ 118-23. Plaintiff alleges in his complaint that the Individual Defendants engaged in wrongdoing between April 3, 2013 through the date the complaint was filed, on December 1, 2014 (the "Relevant Period"). Id. at ¶ 1.

Plaintiff brings this claim against seven members of the Corporation's eight-member Board of Directors ("Board")—Theodore Wright,³ Douglas Martin, Bob Martin, Jon Jacoby, Kelly Malson, David Schofman, and Scott Thompson.⁴ Plaintiff also brings this suit against two executive officers who are not on the Board—Brian Taylor, the Corporation's Chief Financial Officer ("CFO"), and Michael Poppe, the Corporation's Chief Operating Officer ("COO"). Id. at ¶¶ 1, 6, 17-28. The complaint alleges they each held these positions during the Relevant Period.⁵ Id. at ¶¶ 17-28.

B. Plaintiff's Complaint.

In his 89-page complaint, Plaintiff alleges that, during the Relevant Period, "all members of the Board knew that Conn's lowered its underwriting standards and offered credit lines to customers who lacked creditworthiness, as a strategy to generate revenue." Id. at ¶ 2; see also id. at ¶¶ 7, 60-65. Plaintiff alleges this led to financial problems, of which the Defendants were aware. Id. at ¶¶ 2, 71, 83. Plaintiff alleges that the Board of Directors knowingly approved false and misleading public statements (including press releases, annual and quarterly reports, statements during conference calls and conferences, and statements to analysts) that misrepresented the underwriting policy changes, overstated the financial condition of the Corporation, and falsely attributed financial problems to reasons other than the lower underwriting standards, thereby violating their fiduciary duties and federal securities laws. Id. at ¶¶ 2, 7, 48, 50, 53, 58-123.

Plaintiff also alleges that the false and misleading information presented to the public artificially inflated Conn's stock prices during the Relevant Period. Id. at ¶¶ 3, 66, 81, 114. Plaintiff alleges that five of the Individual Defendants—Mr. Wright, Mr. Jacoby, Mr. D. Martin, Mr. Thompson, and Mr. Poppe—sold over 1.3 million Conn's shares for over $66 million on the basis of material non-public information about Conn's true financial condition. Id. at ¶¶ 4, 124-126. Plaintiff brings claims for breach of fiduciary duty, unjust enrichment, gross mismanagement, and insider trading. Id. at ¶¶ 168-190.

C. Defendants' Motion To Dismiss.

Defendants seek to dismiss Plaintiff's complaint on two grounds: (1) Plaintiff failed to adequately plead that demanding the Board to bring this suit would be futile under Federal Rule of Civil Procedure 23.1, and (2) Plaintiff failed to state a claim on which relief can be granted under Federal Rule of Civil Procedure 12(b)(6) for each of his four claims. ECF No. 29 at 6. Plaintiff concedes he did not demand the Board to bring this action but contends demand would be futile because the seven Director Defendants are interested, lack independence, and would face a substantial likelihood of personal liability. ECF No. 30 at 11.

II.RULE 23.1

A. Legal Standard For Demand Futility Under Rule 23.1.

Federal Rule of Civil Procedure 23.1 requires a shareholder derivative complaint to state with particularity "(A) any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members; and (B) the reasons for not obtaining the action or not making the effort." FED. R. CIV. P. 23.1(b)(3). Because Rule 23.1 does not identify substantive standards, "the particularity of a plaintiff's pleadings is governed by the standards of the state of incorporation." Freuler v. Parker , 803 F. Supp. 2d 630, 636 (S.D. Tex. 2011), aff'd , 517 F. App'x 227 (5th Cir. 2013) (applying Delaware law). The parties agree that since Conn's is incorporated in Delaware, Delaware law applies. ECF No. 29 at 8; ECF No. 30 at 12.

"When a corporation suffers harm, the board of directors is the institutional actor legally empowered under Delaware law to determine what, if any, remedial action the corporation should take, including pursuing litigation against the individuals involved." Van der Gracht de Rommerswael on Behalf of Rent-A-Center, Inc. v. Speese , No. 4:17-CV-227, 2017 WL 9280071, at *6 (E.D. Tex. Aug. 11, 2017) (quoting In re China Agritech, Inc. S'holder Deriv. Litig. , No. 7163-VCL, 2013 WL 2181514, at *13 (Del. Ch. May 21, 2013)) (applying Delaware law), report and recommendation adopted , 2017 WL 4545929 (E.D. Tex. Oct. 12, 2017). "Under Delaware law, directors are entitled to the presumption that they were faithful to their fiduciary duties." Freuler , 803 F. Supp. 2d at 637 (quoting Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart , 845 A.2d 1040, 1048 (Del. 2004) ).

"In a stockholder derivative suit, a stockholder pursues a cause of action that belongs to the corporation." Id. at 636 (citing Aronson v. Lewis , 473 A.2d 805, 811 (Del. 1984) ). "A stockholder may not pursue a derivative suit to assert a claim of the corporation unless the stockholder: (a) has first demanded that the directors pursue the corporate claim and the directors have wrongfully refused to do so; or (b) establishes that pre-suit demand is excused because the directors are deemed incapable of making an impartial decision regarding the pursuit of litigation." Van der Gracht , 2017 WL 9280071, at *7 (quoting Wood v. Baum , 953 A.2d 136, 140 (Del. 2008) ). "Where, as here, a plaintiff does not make a pre-suit demand on the board of directors, the complaint must plead ‘with particularity facts showing that a demand on the board would have been futile’ " in order to overcome the business judgment presumption. Id. (quoting In re Citigroup, Inc. S'holder Deriv. Litig. , 964 A.2d 106, 121 (Del. Ch. 2009) ).

Under Delaware law, just as under its federal counterparts, the standard for pleading demand futility is more stringent than on a 12(b)(6) motion to dismiss for failure to state a claim. See Grobow v. Perot , 526 A.2d 914, 920 (Del. Ch. 1987), aff'd , 539 A.2d 180 (Del. 1988). The plaintiff must plead "particularized factual statements that are essential to the claim...." Freuler , 803 F. Supp. 2d at 638 (quoting Brehm v. Eisner , 746 A.2d 244, 254 (Del. 2000) ). However, he "need not plead evidence." Van der Gracht , 2017 WL 9280071, at *7 (quoting Aronson , 473 A.2d at 816 ). "[T]he plaintiff is entitled to all ‘reasonable inferences [that] logically flow from particularized facts....’ " Id. (quoting Beam , 845 A.2d at 1048 ).

"Plaintiffs must show that a majority—or in a case where there are an even number of directors, exactly half—of the board was incapable of considering demand." In re INFOUSA, Inc. S'holder Litig. , 953 A.2d 963, 989-90 (Del. Ch. 2007) (citation omitted). "[D]emand futility must be determined on a claim-by-claim basis." Taylor v. Kissner , 893 F. Supp. 2d 659, 666 (D. Del. 2012) (citing MCG Capital Corp. v. Maginn , No. 4521-CC, 2010 WL 1782271, at *18 (Del....