special litigation committee

In October 1977 Dr. Athalie Doris Joy filed a shareholder derivative suit in the United States District Court for the District of Connecticut on behalf of Connecticut Financial Services Corporation, later Citytrust Bancorp, Inc., against its wholly owned banking subsidiary Citytrust and its officers and directors. The complaint asserted common-law claims for breach of fiduciary duty and violations of the National Bank Act arising from a series of loans made by Citytrust to the Katz Corporation to finance construction of an office building in Norwalk, Connecticut, and sought recovery of approximately six million dollars. The underlying transactions began in 1967 when Citytrust entered a twenty-year lease for space in the planned building. In January 1971 Katz obtained a four-million-dollar construction mortgage in which Citytrust participated for five hundred thousand dollars while Chase Manhattan Bank supplied the remainder. Unsecured advances from Citytrust to Katz grew steadily, reaching nine hundred thousand dollars by December 1972 and one million eight hundred forty thousand dollars by June 1973. In November 1973 Citytrust obtained a blanket second mortgage on the building and other Katz properties. By April 1975 Citytrust had extended more than two million six hundred thousand dollars in loans and, as a condition of refinancing arranged with Lincoln National Life Insurance Company, assumed a thirty-year master lease guaranteeing the six-million-dollar Lincoln loan. National Bank Examiners classified portions of the Katz debt as doubtful in 1975 and substandard earlier. On August 18, 1976 the Citytrust board authorized additional loans that caused the total indebtedness to exceed the ten-percent statutory limit, after which Citytrust charged off two million dollars. In June 1977 the Katz partnership conveyed title to the building to Citytrust in exchange for releases, and Citytrust assumed the six-million-dollar Lincoln mortgage. Second Nutmeg Financial later purchased the building but subsequently defaulted, returning ownership to Citytrust. After the Supreme Court decided Burks v. Lasker, the boards of Citytrust and its parent created a Special Litigation Committee consisting of two newly elected outside directors, Marion S. Kellogg and Ernest C. Trefz. The Committee retained independent counsel, investigated for nine months, and issued a report recommending dismissal as to twenty-three outside defendants and possible settlement with seven inside defendants. The district court permitted limited discovery on the Committee's bona fides, placed the report under seal, granted summary judgment for the twenty-three outside defendants, and Joy appealed both the judgment and the sealing order to the Second Circuit.

Harry Lewis, a stockholder of Meyers Parking System, Inc., brought this derivative action against Meyers and its ten directors, including Leo Fink who owned 47% of the outstanding stock. In 1979 Prudential Building Maintenance Corp. spun off its shares of Meyers to Prudential’s stockholders, after which Meyers provided parking lot facilities and related services throughout the country with its stock actively traded over-the-counter. Prior to January 1, 1981, Fink had an employment agreement with Prudential that became operable upon his retirement in April 1980, and Meyers agreed to share Fink’s consulting services while reimbursing Prudential for 25% of the fees paid to him, resulting in payments of $48,332 in 1980 and $45,832 in 1981. On January 1, 1981, the Meyers board approved a five-year employment agreement with Fink that included an annual salary of $150,000 plus a bonus of 5% of pre-tax profits over $2,400,000, automatic renewal, differing termination rights, post-termination consulting compensation scaling down to $100,000 per year for life, and death benefits. The board also approved interest-free loans to Fink totaling $225,000 that remained unpaid as of August 1982 when the complaint was filed. Fink was 75 years old when the agreement was approved, and there was no claim that he was in poor health. The complaint alleged that the transactions had no valid business purpose and constituted waste of corporate assets because the amounts were grossly excessive, Fink performed little or no services, and the Prudential agreement prevented him from providing his best efforts. It further alleged that no demand had been made on the board because all directors participated in and were liable for the wrongs, Fink controlled and dominated every board member by personally selecting each director, and the directors would have to sue themselves. Defendants moved to dismiss the action pursuant to Chancery Rule 23.1 for failure to make a demand or demonstrate its futility. The Court of Chancery denied the motion. The Supreme Court of Delaware granted the defendants’ application for an interlocutory appeal to review the denial of the motion to dismiss.

Petitioner brought this suit to enforce § 20(a) of the Act, 15 U. S. C. § 80a-20(a), which prohibits materially misleading proxy statements. The complaint was styled as a shareholder derivative action brought on behalf of respondent Cash Equivalent Fund, Inc. (Fund), a registered investment company, against Kemper Financial Services, Inc. (KFS), the Fund’s investment adviser. Petitioner alleged that KFS obtained shareholder approval of the investment-adviser contract by causing the Fund to issue a proxy statement that materially misrepresented the character of KFS’ fees. Petitioner also averred that she made no precomplaint demand on the Fund’s board of directors because doing so would have been futile. In support of this allegation, the complaint stated that all of the directors were under the control of KFS, that the board had voted unanimously to approve the offending proxy statement, and that the board had subsequently evidenced its hostility to petitioner’s claim by moving to dismiss. The District Court granted KFS’ motion to dismiss on the ground that petitioner had failed to plead the facts excusing demand with sufficient particularity for purposes of Federal Rule of Civil Procedure 23.1. The Court of Appeals affirmed the dismissal of petitioner’s § 20(a) claim. Drawing heavily on the American Law Institute’s Principles of Corporate Governance, the Court of Appeals adopted as a rule of federal common law the ALI’s so-called “universal demand” rule, under which the futility exception is abolished. The court noted that the Fund is incorporated in Maryland. It held that petitioner’s challenge to the court’s power to adopt the ALI’s universal-demand rule came too late to be considered. We granted certiorari, 498 U. S. 997 (1990), and now reverse.