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JOHNSON v. HUI

November 21, 1990

JOHN C. JOHNSON, JR., on behalf of Himself and Derivatively on Behalf of Everex Systems, a Delaware Corporation, Plaintiff,
v.
STEVEN L. W. HUI, JOHN A. LEE, MICHAEL C. Y. WONG, MICHAEL G. EVERITT, GREGORY M. AVIS, RAYMOND YU, ROBERT G. TEAL, GABRIEL T. W. CHAN, GATCOMBE CORPORATION N.V., and ACIEST COMPANY, LTD., Defendants, and EVEREX SYSTEMS INC., a Nominal Defendant



The opinion of the court was delivered by: HENDERSON

 THELTON E. HENDERSON, UNITED STATES DISTRICT JUDGE

 A shareholder has brought a derivative suit against the directors of a corporation for allegedly trading on inside information. The corporation moves to dismiss the complaint for the shareholder's failure to make demand, which the shareholder argues would have been futile.

 For the reasons below, the motion to dismiss is denied.

 I. BACKGROUND

 The defendant, Everex Systems, Inc., is a Delaware corporation with principal offices in California. Everex designs, manufactures, and markets personal computer systems and peripheral equipment. Everex stock has been traded on the national over-the-counter market since 1987.

 The complaint alleges that on three occasions Everex directors, among others, have sold their shares in the corporation using inside information: twice in 1989, after the release of favorable quarterly financial results, and once in 1990, after the release of an unfavorable forecast of future results and the subsequent release of unfavorable results. These sales were illegal, avers the complaint, because the directors knew or should have known early in 1989 that Everex would have less favorable results toward the end of the year; thus, the directors allegedly used inside information to sell their shares at a temporarily inflated price, far above what the stock currently trades for. The complaint accuses the directors of underreporting their sales in an effort to maintain the facade of a financially healthy corporation.

 The complaint names eight individuals and two business associations as defendants. The business associations are shareholders in Everex and allegedly traded on inside information. The eight individuals are current or past directors of Everex; several are officers. Six current or past directors allegedly traded on inside information. Two current directors, Teal (director since 1987) and Chan (director since June 1989), allegedly aided and abetted the other defendants by not disclosing to the public the unfavorable inside information on which the others allegedly profited.

 Johnson, an Everex shareholder, brought this action, based on diversity, on behalf of Everex pursuant to Fed. R. Civ. P. 23.1. The complaint alleges (1) breach of fiduciary duty by engaging in insider trading and (2) insider trading under Cal. Corp. Code ยง 25402. Everex has moved to dismiss the derivative complaint on the grounds that Johnson should have made a demand on the corporation to bring the action in its own right because such a demand would not have been futile; further, this Court should in any event follow the Seventh Circuit in abolishing the futility exception to the demand requirement. Johnson argues that a demand would have been futile and should, therefore, be excused.

 II. DISCUSSION

 A. The Legal Standard

 Fed. R. Civ. P. 23.1 sets forth the requirements for derivative suits. The parties' dispute concerns only one requirement.

 
The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority . . . and the reasons for the plaintiff's failure to obtain the action or for not making the effort.

 Rule 23.1 thus codifies the long-standing requirement that a plaintiff who pursues the extraordinary remedy of a derivative suit make demand upon his corporation's directors. See, e.g., Lewis v. Graves, 701 F.2d 245, 247 (2d Cir. 1983). This requirement is not merely a technical pleading hurdle; it is based on a fundamental tenet of American corporate law that places the responsibility for making decisions in the hands of the board of directors. In re BankAmerica Securities Litigation, 636 F. Supp. 419, 420 (C.D. Cal. 1986). Only ...


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