Companies are facing a growing number of derivative and securities class actions in the wake of the #MeToo movement. Having strong protocols to address allegations of harassment and sexual misconduct, thoroughly and promptly investigating such allegations, and carefully weighing the risks in severance payments to accused harassers are some of the steps companies can take to protect against such actions.
The increasing number of sexual harassment claims in the corporate world as part of the #MeToo movement has led to a number of high-profile employment-related claims. On the heels of those claims are a growing number of shareholder derivative and securities class actions.
The derivative lawsuits are brought by plaintiff-shareholders purportedly acting on behalf of the company asserting claims for breaches of fiduciary duty and waste of corporate assets against board members and corporate executives. These complaints generally allege that the defendants had actual knowledge of or were willfully blind to the sexual misconduct and that, once aware, they adopted a “circle the wagons” mentality designed to conceal the misconduct from shareholders and other stakeholders in the company. Derivative plaintiffs may also allege the misuse of corporate assets and legal resources for settlements and other payments to alleged harassers.
These derivative actions raise significant issues concerning the legal duties of corporations and their boards to police for potential sexual misconduct by senior executives and other employees. While a corporate board generally has no duty to monitor a corporate officer’s personal affairs, sexual misconduct by an executive in the workplace may trigger liability if the directors consciously allowed the unlawful conduct to occur or failed to establish a compliance system to facilitate employee reporting of sexual harassment and to ensure that the company appropriately investigates and addresses any such allegations. Rules governing derivative claims generally require that a derivative plaintiff request that the board initiate action against the alleged wrongdoers or state with particularity why such a demand would have been futile. Many of the incidents reported in the news have involved conduct alleged to have occurred at much earlier dates. In these instances, it should be difficult for shareholders to allege that the current board is conflicted because of the director’s own potential exposure. Regardless of timing, however, boards can enhance their ability to defend against such claims by conducting investigations that are both thorough and independent, and by establishing controls to detect and remediate sexual misconduct and harassment.
The securities lawsuits are brought by investors who typically allege that the company and its executives lied affirmatively or by omission regarding the company’s and executives’ adherence to ethical standards and corporate values surrounding integrity. In bringing securities claims as federal class actions, plaintiffs will face the pleading hurdles established by Congress through the Private Securities Litigation Reform Act of 1995, which require, among other things, that the complaint identify with particularity the allegedly false and misleading statements and explain why they are misleading, and allege facts supporting a strong inference of scienter.
In fulfilling these requirements, plaintiffs must identify statements the company or executives made that explicitly or implicitly suggested the executives were behaving ethically. To the extent the plaintiffs are able to identify these types of statements, they must also plead facts supporting a strong inference that the defendants acted with the intent to mislead investors. Experience shows that the single most important predictor of whether plaintiffs will bring securities fraud suits based on workplace sexual harassment issues or executive termination is whether the company’s stock price dropped following the revelation of the underlying facts or allegations.
Recent Shareholder Litigation Arising from Alleged Sexual Misconduct or Harassment
The cases highlighted below provide insight into potential theories of liability that derivative and securities plaintiffs may pursue.
- Wynn Resorts Ltd. Four derivative suits have been filed against the board and general counsel of Wynn Resorts Ltd., and the company and four of its executives face a federal securities fraud class action as well. The complaints followed a January 26, 2018, Wall Street Journal report that multiple women had accused the company’s founder, Steve Wynn, of sexually harassing or assaulting them. The derivative complaints generally allege that the defendants turned a blind eye and continued to endorse and pay excessive compensation to Mr. Wynn, all while assuring shareholders that the company’s controls were effective to prevent such misconduct; and that in doing so, the defendants put the company’s gaming license in jeopardy because the gaming industry subjects company executives to certain “suitability” requirements. The derivative complaints further allege that some of the defendants engaged in insider trading by selling stock when they knew about Mr. Wynn’s alleged misconduct. The securities class action, on the other hand, is filed on behalf of a purported class of investors in Wynn Resorts between February 28, 2014, and the publication of the Wall Street Journal article, which allegedly resulted in a 10% drop in share price. That complaint alleges that the company made misleading statements and/or failed to disclose Mr. Wynn’s misconduct.
- Twenty-First Century Fox, Inc. Twenty-First Century Fox, Inc. recently reached a $90 million settlement in a shareholder derivative action against the company’s officers and directors arising from the sexual harassment scandal involving founder and former CEO Roger Ailes and anchor Bill O’Reilly. The complaint alleged that senior executives created a “systemic, decades-long culture of sexual harassment, racial discrimination, and retaliation that led to a hostile work environment at Fox News Channel.” The complaint further alleged that the board breached its fiduciary duties to shareholders by failing to address these issues or implement controls sufficient to prevent them. In addition to the $90 million monetary payment, the settlement includes nonmonetary relief in the form of governance and compliance enhancements, including a team to monitor and investigate allegations of harassment.
- Liberty Tax, Inc. Shareholders of tax preparer Liberty Tax, Inc. filed a derivative suit against the company’s former CEO in Delaware Chancery Court alleging that he refused to give up control of the board after being terminated as CEO in September 2017 following credible evidence of wrongdoing, including sexual misconduct. Liberty Tax and the former CEO have answered the complaint, and litigation is ongoing.
- Signet Jewelers Limited. Signet Jewelers has been sued in a federal securities fraud class action based on the company’s alleged failure to disclose sexual harassment allegations against executives in an ongoing arbitration. A shareholder has also filed a derivative action against certain officers and directors of the company, alleging breach of fiduciary duty, abuse of control, and gross mismanagement related to the sexual harassment allegations. The complaints allege that a culture of sexual harassment posed a severe risk to Signet’s business because Signet’s key product—diamond bridal jewelry—was an “emotional” one meant for women.
Lessons from Prior Case Law
While the #MeToo movement is a recent phenomenon, there is limited case law addressing such claims in the shareholder derivative and securities litigation contexts that, if applicable and adhered to today, should guide the adjudication of such disputes.
- ICN Pharmaceuticals. Nearly two decades ago, in White v. Panic, 793 A.2d 356 (Del. Ch. 2000), affirmed 783 A.2d 543 (Del. 2001), the Delaware Supreme Court affirmed the dismissal of a derivative action surrounding the board’s treatment of sexual harassment suits filed against Milan Panic, the founder and CEO of ICN Pharmaceuticals, Inc. As alleged in the complaint, the CEO had “repeatedly propositioned or groped and rewarded or punished female employees based on whether they complied or complained.” ICN had paid, or loaned money to the CEO to pay, a total of $3.5 million to confidentially settle the harassment suits. The plaintiff sued derivatively, alleging that the board members breached their fiduciary duties by failing to curb the CEO’s alleged misconduct and by using corporate funds to resolve the lawsuits. The Delaware Chancery Court dismissed the claims, and the Delaware Supreme Court affirmed, finding that plaintiff failed to plead particularized facts sufficient to overcome the legal presumption that the directors’ decisions were a good-faith exercise of their business judgment. The court reasoned that the board’s decision to approve and pay the settlements were business decisions within the discretion of the board. The court also noted that the board had “broad discretion” to set executive compensation and sanction misconduct.
Notably, however, the chancery court did not hold that the plaintiff’s theories of liability failed as a matter of law. Rather, the plaintiff had failed to use the “tools at hand”—a Section 220 books and records inspection—to investigate the alleged fiduciary breaches before bringing suit, which might have provided the factual details necessary to survive a motion to dismiss. As the court noted, “[i]nformation gained by means of a request to inspect corporate books or records might have led to the facts justifying an inference that the Director Defendants reached their conclusions because of considerations other than stockholder interest.” Since White was decided, Section 220 pre-suit investigations are the norm rather than the exception. In other words, similar lawsuits brought today will more likely be predicated upon particularized facts with better prospects of survival.
- Hewlett-Packard Company. Derivative and securities litigation arose in the wake of the departure of Hewlett-Packard Company’s (HP’s) CEO Mark Hurd, following allegations of sexual harassment by an independent contractor and an internal investigation that revealed Mr. Hurd had misrepresented the relationship on expense reports and in conversations with the company’s investigators.
In Zucker v. Andreessen, No. 6014-VCP, 2012 WL 2366448 (Del. Ch. 2012), the Delaware Chancery Court dismissed the derivative action pursuant to Court of Chancery Rule 23.1. The plaintiff in that case alleged that HP’s directors committed waste and breached their duty of care in awarding Mr. Hurd’s severance package and in failing to have an effective CEO succession plan. The court dismissed the complaint for failure to plead that a demand on the board to initiate legal action would have been futile. In doing so, the court found the plaintiff failed to plead that the severance agreement was not the product of a valid exercise of business judgment or that it wasted assets, because the severance agreement was not egregious or irrational on its face, particularly in light of Mr. Hurd’s purportedly successful stewardship of the company.
Separately, in Retail Wholesale & Department Store Union Local 338 Retirement Fund v. Hewlett-Packard Co., No. 14-16433 (9th Cir. 2017), the US Court of Appeals for the Ninth Circuit affirmed the dismissal of a putative shareholder class action against HP and Mr. Hurd. Investors in that case brought a federal securities fraud claim based on allegations that statements in and surrounding the company’s ethics code—which was available to investors on HP’s website in accordance with US Securities and Exchange Commission (SEC) rules—were false and misleading for failing to disclose Mr. Hurd’s alleged misconduct. The Ninth Circuit affirmed dismissal of the complaint for failure to plead a misrepresentation or omission of material fact, finding that HP’s ethics code contained only aspirational statements that did not state or suggest that all executives were in compliance therewith. This case illustrates that the mere existence of an internal investigation does not trigger a duty to disclose the investigation or results thereof, nor do general statements regarding corporate culture or integrity. However, Retail Wholesale leaves open the possibility that if a company has made specific statements suggesting its executives are in compliance with internal or external ethical standards, this could trigger a duty to disclose any misconduct.
Takeaways
The recent cases and existing (albeit limited) precedent suggest a number of steps that companies and their boards can take to protect against potential derivative and securities class actions based on alleged sexual misconduct in the workplace.
- Have strong controls in place to identify, investigate, and address allegations of sexual misconduct and harassment in the workplace
- Take all allegations of sexual misconduct seriously and conduct a thorough, unbiased, and credible investigation, using independent outside investigators if necessary
- Consider obtaining legal advice on whether allegations of sexual misconduct or the findings of an internal investigation should be disclosed, particularly if they involve employees considered critical to the success of the company or systemic sexual misconduct
- Carefully weigh the litigation risks when considering severance payments to alleged harassers upon termination/departure, and when considering contributing to settlements with the victims
- Expect that when allegations of executive level misconduct become public, shareholders will seek books and records to investigate whether there was wrongdoing by the board
- Be aware of and sensitive to public statements (including, for example, risk factor disclosures) regarding the company’s compliance with applicable law and internal ethics standards to avoid triggering a potential duty to disclose senior executive or other serious sexual misconduct.
Contacts
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Boston
Michael Blanchard
Jason D. Frank
Jordan D. Hershman
New York
Bernard J. Garbutt III
Mary Gail Gearns
Brian A. Herman
Michael S. Kraut
Kenneth I. Schacter
Philadelphia
Laura Hughes McNally
Karen Pieslak Pohlmann
San Francisco
Joseph E. Floren
Charlene S. Shimada