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In re Maxwell Technologies, Inc. Derivative Litigation

United States District Court, S.D. California

May 27, 2014



ROGER T. BENITEZ, District Judge.

Before this Court is the Motion to Dismiss filed by Nominal Defendant Maxwell Technologies, Inc. (Maxwell). (Docket No. 39). For the reasons stated below, the Motion is GRANTED.


Maxwell is a Delaware corporation with a principal place of business in San Diego, CA. (Verified Consol. S'holder Derivative Compl. [Compl.] ¶¶ 29, 81). Maxwell develops, manufactures, and markets energy storage and power delivery products, as well as microelectronics. ( Id. ¶ 81).

On March 7, 2013, Maxwell announced that it was restating its financial statements for 2011 and the first three quarters of 2012. Maxwell's sales organization made arrangements with distributors for special payment terms. Under Maxwell's revenue recognition policy and GAAP principles, revenue is only to be recognized where certain conditions are met. As a result of the arrangements, the revenue from such sales should not have been recognized at the time of shipment. However, the arrangements were not communicated to the finance and accounting department. Maxwell recognized the revenue from these sales too early, causing the financial statements to overstate revenue. The inaccurate revenue numbers were included in a number of SEC filings.[1] These filings assert that GAAP principles are used and that the financial statements "present fairly the financial position, results of operations, and cash flows" of Maxwell. ( Id. ¶ 59). The financial data was also discussed in conference calls with investors.

On April 26, 2012, Maxwell announced disappointing financial results for the first quarter of 2012. ( Id. ¶ 127). A one-day drop of $6.20 per share, from $15.80 per share to $9.60 per share, followed. ( Id. ¶ 128).

On March 7, 2013, Maxwell made the announcement that there had been errors in past financial statements and it would be required to restate results for 2011 and the first three quarters of 2012. ( Id. ¶ 8). Maxwell's press release disclosed the fact that this was due to premature revenue recognition. ( Id. ) Maxwell stated in its press release that it had preliminarily concluded that there were "material weaknesses" in its internal controls over financial reporting related to the identification and evaluation of revenue transactions which deviate from contractually established payment terms, and that therefore its internal controls over financial reporting and disclosure "are not effective." ( Id. ) Maxwell also announced that certain employees had been terminated, and that the Senior Vice President of Sales and Marketing had resigned. ( Id. ) The next day, shares fell $1.01. ( Id. ¶ 152)

On March 19, 2013, Maxwell announced that McGladrey LLP had resigned as the independent accounting firm. ( Id. ¶ 153). McGladrey stated that it could not rely on management's representations, that there were material weaknesses in internal controls, and that it could not rely on information obtained directly from third parties. ( Id. ) On April 30, 2013, Maxwell disclosed that the DOJ and SEC had begun investigations. ( Id. ¶ 191).

Maxwell published the restated financial statements on August 1, 2013. In total, Maxwell admitted that it overstated $10.1 million in revenue in 2011, and $9.2 million in 2012. ( Id. ¶¶ 12, 155, 156).

In October 2013, Maxwell announced that Maxwell's President and CEO, David Schramm, would leave his position at the end of the year. ( Id. ¶ 227). Maxwell reached an agreement with Schramm whereby Schramm would serve as an advisor to Maxwell for two years. ( Id. ) The agreement also contained restrictive covenants, provided compensation, and addressed legal claims. ( Id. )

Separate shareholder derivative actions were filed in the Southern District of California by Plaintiffs Walter Kienzle and Sameer Agrawal. The actions were consolidated on October 30, 2013. (Docket No. 28). A Verified Consolidated Shareholder Derivative Complaint was filed on January 30, 2014. (Docket No. 38).

In addition to nominal defendant Maxwell Technologies, the Amended Complaint names as "Individual Defendants" members of Maxwell's board of directors and certain Maxwell officers. The "Director Defendants" are Jose L. Cortes, Roger Howsmon, Burkhard Goeschel, Jean Lavigne, Mark Rossi, Robert Guyett, Yon Yoon Jorden, and David Schramm. (Compl. ¶¶ 30-38). Three of the eight directors; Guyett, Jorden, and Rossi; are members of the Audit Committee. ( Id. ¶¶ 34-36). Schramm also served as President and Chief Executive Officer of Maxwell from 2007 to 2013. ( Id. ¶ 37). The three other "Officer Defendants" are Kevin S. Royal (Chief Financial Officer), George Kriegler III (Senior Vice President and Chief Operating Officer from August 2009-April 2012), and Van M. Andrews (Senior Vice President, Sales and Marketing until his resignation on March 1, 2013). ( Id. ¶¶ 40-42).

Plaintiffs allege that the Individual Defendants breached their fiduciary duties by causing Maxwell to issue false and misleading statements about Maxwell's financial condition, and by falsely representing that Maxwell maintained adequate internal controls despite knowing that the controls were materially deficient. ( Id. ¶ 2). Plaintiffs allege that the Individual Defendants knew and concealed from the public the fact that Maxwell had overstated revenues and earnings, that revenue had been reported before the sales price was fixed and collectability was reasonably assured, and that the internal accounting controls were deficient. ( Id. ¶ 17). They claim that the breaches have led to multiple lawsuits, and will cost Maxwell millions of dollars. ( Id. ¶ 6). They state that Maxwell's market capitalization is severely diminished and its prospect of raising equity in the future is "questionable." ( Id. ¶ 18).

Plaintiffs also point out that the four officers received performance-based compensation. ( Id. ¶ 252). They allege that because the financial results were inflated by wrongdoing, the officers received more compensation that they would have otherwise. ( Id. )

The Consolidated Complaint states five claims: (1) breach of fiduciary duties; (2) abuse of control; (3) gross mismanagement; (4) unjust enrichment; and (5) waste. Claims one, two, three, and five are brought against all Individual Defendants. Claim four, unjust enrichment, is brought only against the four officers: Schramm, Royal, Kreigler, and Andrews. Motions to dismiss were filed by Maxwell (Docket No. 39), Van Andrews (Docket No. 43), and the other individual defendants. (Docket No. 40). Maxwell asks this Court to dismiss this case for failure to comply with Federal Rule of Civil Procedure 23.1, on the basis that Plaintiffs have not made a demand upon the directors, or demonstrated that such a demand would be futile and should be excused.


"The normal rule is that a company is run by its management, and the corporation itself has the right to make claims." Quinn v. Anvil Corp., 620 F.3d 1005, 1011 (9th Cir. 2010) (citation omitted). A derivative action is an "extraordinary process" in which the courts permit a shareholder to "step into the corporation's shoes and to seek in its right the restitution he could not demand in his own." Id. at 1012 (internal quotations and citations omitted). Accordingly, a shareholder is required to demonstrate "strict compliance" with both federal procedural requirements and the applicable substantive law before he is able "wrest control" from the board of directors. Potter v. Hughes, 546 F.3d 1051, 1058 (9th Cir. 2008).

Federal Rule of Civil Procedure 23.1 imposes special requirements when one or more shareholders of a corporation bring a derivative action to enforce a right that the corporation may properly assert, but has failed to enforce. FED. R. CIV. P. 23.1(a). The complaint is required to:

state with particularity:
(A) any effort by the plaintiff to obtain the desired action from the directors or comparable authority...; and
(B) the reasons for not obtaining the action or not making the effort.

FED. R. CIV. P. 23.1(b)(3). A shareholder who seeks to bring a derivative suit must either first demand action from the board, or "plead with particularity the reasons why such demand would have been futile." In re Silicon Graphics, Inc. Secur. Litig., 183 F.3d 970, 989 (9th Cir. 1999), abrogated on other grounds by Tellabs, Inc. v. Makor Issues & Rights Ltd., 551 U.S. 308, 322-24 (2007). In determining whether demand would be futile under the circumstances, courts apply the law of the state of incorporation. Id. at 990. As Maxwell is a Delaware corporation, this Court therefore applies Delaware law.

A stockholder may prosecute a derivative suit only in situations where the stockholder has demanded that the directors pursue the corporate claim and they have wrongfully refused to do so, or where demand is excused because the directors are "incapable of making an impartial decision regarding such litigation." Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993). Where plaintiffs seek to redress harm to the corporation based on misconduct by its directors, stockholders often do not make a demand. Id. at 933.

In determining whether demand is futile, a court determines whether "facts are alleged with particularity which create a reasonable doubt that the directors' action was entitled to the protections of the business judgment rule." Aronson v. Lewis, 473 A.2d 805, 808 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). The business judgment rule presumes that in making a business decision, the directors of a corporation "acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Id. at 812.

Where a shareholder plaintiff seeks to challenge a decision of the board, courts apply the Aronson test. Rales, 634 A.2d at 933. Under this test, a court must determine "whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." Id. (quoting Aronson, 473 A.2d at 814). The first prong of the test inquires into the directors, the second into the substantive nature of the transaction and the board's approval thereof. Aronson, 473 A.2d at 814.

However, "where the board that would be considering the demand did not make a business decision that is being challenged in the derivative suit, " the Aronson test does not apply. Rales, 634 A.2d at 933-34. This includes situations where "the subject of the derivative suit is not a business decision of the board." Id. at 934. Then, the appropriate inquiry is whether the particularized factual allegations in a complaint "create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand." Id.

Where, as here, the board contains an even number of members, the plaintiff must raise reasonable doubts as to half of the members. See Beam ex rel. Martha Stewart Lving Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1046 n. 8 (Del. 2004) (where half of even-numbered board is not independent, there is not a majority of independent directors and demand would be futile). In the instant case, Plaintiffs must therefore make sufficient ...

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