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Safari File Edit View History Bookmarks Window Help 7 ) 67% Tue 4:02 PM Q O ly On th O Search .. . platform.virdocs.com icld N X V Busines . .. E b S DIR G it; therefore, they are individually liable to the corporation. corporate America. graph to nate th In re Caremark Int'l Inc. Derivative Litig. 698 A.2d 959 (Del. Ch. 1996) Caremark International was a health care company specializing in alternative-site care. After a lengthy investigation by the Department of Justice, the company and two of its executives-but none of its board members-were indicted for paying illegal kickbacks to doctors for patient referrals. Numerous shareholder derivative suits were filed alleging that Caremark's directors breached their duty of care by failing to supervise the offending executives, thereby exposing the company to criminal and civil liability. The suits sought to recover damages from the individual board members. Caremark eventually reached a settlement with the DOJ and a host of federal agencies; the company would plead guilty and pay approximately $250 million in civil penalties but would be allowed to continue participating in federal programs. An announcement of the settlement of the derivative claims followed, but it required court approval before it could be finalized. Legendary Delaware Chancery Court judge William T. Allen had the task of approving or disapproving the settlement. In doing so, he effectively overruled the law in Delaware at the time, holding that directors had no affirmative duty to oversee legal compli- ance at the corporation absent clear signs of employee wrongdoing, as established in Graham v. Allis-Chalmers Manufacturing Co., 188 A.2d 125 (Del. 1963), discussed below within the case decision. ALLEN, Chancellor or sale of control contexts. The theory here advanced is possibly B. Directors' Duties to Monitor Corporate Operations the most difficult theory in corporation law upon which a plain- The complaint charges the director defendants_with breach of tiff might hope to win a judgment. * * * their_duty of attention or care in connection with the on-going 2. Liability for failure to monitor: The second class of cases operation of the corporation's business. The claim is that the in which director liability for inattention is theoretically possible directors, allowed a situation to develop and continue which entail circumstances in which a loss eventuates not from a deci- exposed the corporation to enormous legal liability and that in sion but, from unconsidered inaction. Most of the decisions that so doing they violated a duty to be active monitors of corporate a corporation, acting through its human agents, makes are, of performance. The complaint thus does not charge either direc- course, not the subject of director attention. Legally, the board tor self-dealing or the more difficult loyalty-type problems arising itself will be required only to authorize the most significant cor- from cases of suspect director motivation, such as entrenchment porate acts or transactions: mergers, changes in capital structure, 047 75,589 APR 26Safari File Edit View History Bookmarks Window Help - ) 66% Tue 4:03 PM Q DE . . . A platform.virdocs.com icl N V Busines... E E b * S D DIR G from Smith v. Van Gorkom through Paramount Communications-the 71 graph to fundamental changes in business, appointment and compensation nate th of the CEO, etc. As the facts of this case graphically demonstrate, seriousness with which the corporation law views the role of the ordinary business decisions that are made by officers and employ- corporate board. Secondly, I note the elementary fact that relevant ees deeper in the interior of the organization can, however, vitally and timely information is an essential predicate for satisfaction of affect the welfare of the corporation and its ability to achieve its the board's supervisory and monitoring role under Section 141 of various strategic and financial goals. * * * Financial and organi- the Delaware General Corporation Law. Thirdly, I note the poten- zational disasters such as [in this case] raise the question, what tial impact of the federal organizational sentencing guidelines on is the board's responsibility with respect to the organization and any business organization. [The guidelines set forth a uniform sen- monitoring of the enterprise to assure that the corporation func- tencing structure for organizations to be sentenced for violation of tions within the law to achieve its purposes? * * * federal criminal statutes and offer powerful incentives for corpora- In 1963, the Delaware Supreme Court in [Graham] addressed tions to put in place compliance programs to detect violations of law, the question of potential liability of board members for losses expe promptly to report violations to appropriate public officials when rienced by the corporation as a result of the corporation having vio- discovered, and to take prompt, voluntary remedial efforts.] Any lated the anti-trust laws of the United States. There was no claim rational person attempting in good faith to meet an organizational in that case that the directors knew about the behavior of subordi governance responsibility would be bound to take into account this nate employees of the corporation that had resulted in the liability. development and the enhanced penalties and the opportunities for Rather, as in this case, the claim asserted was that the directors ought reduced sanctions that it offers. to have known of it and if they had known they would have been In light of these developments, it would, in my opinion, be under a duty to bring the corporation into compliance with the law a mistake to conclude that our Supreme Court . . . means that and thus save the corporation from the loss. The Delaware Supreme corporate boards may satisfy their obligation to be reason- Court concluded that, under the facts as they appeared, there was no ably informed concerning the corporation, without assuring basis to find that the directors had breached a duty to be informed themselves that information and reporting systems exist in the of the ongoing operations of the firm. In notably colorful terms, the organization that are reasonably designed to provide to senior court stated that "absent cause for suspicion there is no duty upon management and to the board itself timely, accurate information the directors to install and operate a corporate system of espionage sufficient to allow management and the board, each within its to ferret out wrongdoing which they have no reason to suspect scope, to reach informed judgments concerning both the corpora- exists." The Court found that there were no grounds for suspicion tion's compliance with law and its business performance. in that case and, thus, concluded that the directors were blamelessly Obviously the level of detail that is appropriate for such an unaware of the conduct leading to the corporate liability. information system is a question of business judgment. And obvi- How does one generalize this holding today? Can it be said ously too, no rationally designed information and reporting sys- today that, absent some ground giving rise to suspicion of viola- tem will remove the possibility that the corporation will violate tion of law, that corporate directors have no duty to assure that laws or regulations, or that senior officers or directors may never- 047 a corporate information gathering and reporting systems [sic] theless sometimes be misled or otherwise fail reasonably to detect exists which represents a good faith attempt to provide senior acts material to the corporation's compliance with the law. But it 75,589 26Safari File Edit View History Bookmarks Window Help )) 65% Tue 4:07 PM Q DE . . . A platform.virdocs.com C icl N Busines.. E E b S D DIR G and thus save the corporation from the loss. The Delaware Supreme corporate boards may satisfy their obligation to be reason- Court concluded that, under the facts as they appeared, there was no ably informed concerning the corporation, without assuring graph to basis to find that the directors had breached a duty to be informed themselves that information and reporting systems exist in the mate th of the ongoing operations of the firm. In notably colorful terms, the organization that are reasonably designed to provide to senior court stated that "absent cause for suspicion there is no duty upon management and to the board itself timely, accurate information the directors to install and operate a corporate system of espionage sufficient to allow management and the board, each within its to ferret out wrongdoing which they have no reason to suspect scope, to reach informed judgments concerning both the corpora- exists." The Court found that there were no grounds for suspicion tion's compliance with law and its business performance. in that case and, thus, concluded that the directors were blamelessly Obviously the level of detail that is appropriate for such an unaware of the conduct leading to the corporate liability. information system is a question of business judgment. And obvi- How does one generalize this holding today? Can it be said ously too, no rationally designed information and reporting sys- today that, absent some ground giving rise to suspicion of viola- tem will remove the possibility that the corporation will violate tion of law, that corporate directors have no duty to assure that laws or regulations, or that senior officers or directors may never- a corporate information gathering and reporting systems [sic] theless sometimes be misled or otherwise fail reasonably to detect exists which represents a good faith attempt to provide senior acts material to the corporation's compliance with the law. But it management and the Board with information respecting mate- is important that the board exercise a good faith judgment that rial acts, events or conditions within the corporation, including the corporation's information and reporting system is in concept compliance with applicable statutes and regulations? I certainly and design adequate to assure the board that appropriate informa- do not believe so. I doubt that such a broad generalization of the tion will come to its attention in a timely manner as a matter of Graham holding would have been accepted by the Supreme Court ordinary operations, so that it may satisfy its responsibility. in 1963. The case can be more narrowly interpreted as standing Thus, I am of the view that a director's obligation includes for the proposition that, absent grounds to suspect deception, nei- a duty to attempt in good faith to assure that a corporate infor- ther corporate boards nor senior officers can be charged with mation and reporting system, which the board concludes is ade- wrongdoing simply for assuming the integrity of employees and quate, exists, and that failure to do so under some circumstances the honesty of their dealings on the company's behalf. may, in theory at least, render a director liable for losses caused by A broader interpretation of Graham-that it means that a corpo- non-compliance with applicable legal standards. * * * rate board has no responsibility to assure that appropriate informa- The record at this stage does not support the conclusion that tion and reporting systems are established by management-would the defendants either lacked good faith in the exercise of their not, in any event, be accepted by the Delaware Supreme Court monitoring responsibilities or conscientiously permitted a known [today], in my opinion. In stating the basis for this view, I start with violation of law by the corporation to occur. the recognition that in recent years the Delaware Supreme Court has made it clear-especially in its jurisprudence concerning takeovers, Thus, the proposed settlement will be APPROVED. 047 75,589 APR 26