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In re BofI Holding, Inc. Shareholder Litigation

United States District Court, S.D. California

March 1, 2017




         Before the Court is Defendants'[1] motion to dismiss the Consolidated Verified Shareholder Derivative Complaint[2] (the “CSC”), Dkt. Nos. 36 & 38, filed by Bof I shareholders Andrew Calcaterra, Robylee Doherty, and Zhang Yong. Dkt. No. 41. The motion has been fully briefed. See Dkt. Nos. 43 & 47. The parties' various motions to file documents, submitted with their briefs, under seal are also before the Court. See Dkt. Nos. 42, 48, & 50.

         The facts of this case are familiar to the Court. The events and allegations that precipitated this shareholder litigation dispute are similar in kind and in substance to those that underlay In re: Bof I Holding, Inc. Sec. Litig., No. 3:15-cv-02324-GPC-KSC (S.D. Cal.) (filed Oct. 10, 2015), a related class action securities fraud suit.[3]Notwithstanding these parallels, however, the nature of this suit is distinct. The instant matter is a shareholder derivative suit, brought by stockholders of Bof I Holding, Inc., on behalf of the company, against all nine members of Bof I's Board of Directors[4] and various other company officers. Through this suit, Plaintiffs seek to protect Bof I and to recover against the directors and officers who have allegedly caused damage to the company. See Response, Dkt. No. 43 at 11. Defendants, in response, argue that Plaintiffs lack standing to bring this shareholder derivative suit because they have failed to plead demand futility as to a majority of Bof I's Board of Directors. See MTD, Dkt. No. 41-1 at 6-7.

         There is no dispute that Plaintiffs did not make a demand upon the Board, requesting that the Board respond to the misconduct alleged herein, before filing the present suit. CSC ¶ 142. Thus, the key issue for this Court is whether or not Plaintiffs' failure to make a demand on the Board is rightfully excused under the Federal Rules of Civil Procedure. See Fed. R. Civ. P. 23.1(b)(3).


         Nominal Defendant Bof I Holding, Inc. (“Bof I”), through Bof I Federal Bank, provides online consumer and business banking products. CSC ¶¶ 2, 14. Its deposit products include consumer and business checking, demand, savings and time deposit accounts, and its loan portfolio primarily consists of residential single family and multifamily mortgage loans, commercial real estate secures and commercial lending products, finance factoring products, and other consumer lending products. Id. ¶ 2. Of chief importance to Bof I Federal Bank is its practice of providing mortgages to high-net-worth individuals for the purchase of high-end properties. Id. ¶ 3.

         A nine-member Board of Directors (“the Board”) manages Bof I. See Id. ¶ 29. Those individuals include: Theodore C. Allrich, Chairman of the Board and a member of the Board's Compensation Committee; James S. Argalas, member of the Board's Audit Committee and member of the Company's Internal Asset Review Committee; John Gary Burke, member of the Board's Compensation Committee and Chairman of the Internal Assets Review Committee of the Board; James J. Court; Uzair Dada; Gregory Garrabrants, Bof I's CEO, President, and Director; Paul J. Grinberg, member of the Board's Compensation Committee and member of the Board's Audit Committee; Nicholas A. Mosich, Vice President of the Board and member of the Board's Audit Committee; and Edward J. Ratinoff, member of the Nominating Committee. Id. ¶¶ 15, 17, 18, 19, 20, 21, 22, 23, 26. Every member of the Board is named as a Defendant (hereafter referred to as the “Director Defendants”). Id. ¶ 29. The other named Defendants are Eshel Bar-Adon, Executive Vice President and Chief Legal Officer of Bof I; Andrew J. Micheletti, Executive Vice President and Chief Financial Officer, John C. Tolla, Chief Governance and Compliance Officer; and Derrick K. Walsh, Chief Accounting Officer and Senior Vice President. Id. ¶¶ 16, 24, 25, 27.

         In October 2015, Charles Matthew Erhart, a former Bof I internal auditor who allegedly raised compliance issues to senior management and federal regulators, id. ¶ 5, filed a whistleblower action against Bof I. See Erhart v. Bof I Holding, Inc., Case No. 15- cv-2287-BAS-NLS (S.D. Cal.) (filed Oct. 13, 2015). The whistleblower complaint alleged widespread wrongdoing at Bof I. For example, Erhart alleged that senior officers at the company had instructed him to “refrain from putting anything in writing regarding the Company's violations of laws” and to “label anything he did in his audit function which might be incriminating as “attorney work product/communication.” CSC ¶ 5. Other allegations faulted Bof I for borrowing to foreign nationals “who should have been off-limits under anti-money laundering laws, ” for keeping accounts without tax identification numbers “contrary to Bof I's representations to the Office of the Comptroller of the Currency (“OCC”), ” and for otherwise failing to provide “full and timely information to regulators.” Id.

         The revelation of these and other allegations included in Erhart's complaint caused Bof I's shares to fall by 30.2%, or by $42.87, to $99.13 by the close of business on October 14, 2015. Id. ¶ 6. As mentioned above, the accusations aired in the complaint have also led to a class action lawsuit for securities fraud. See In re Bof I Holding, Inc. Sec. Litig., 3:15-cv-02324-GPC-KSC (S.D. Cal.) (filed October 15, 2015).

         In response to these and other allegations, Plaintiffs, all of whom held Bof I stock during the relevant period, brought this derivative action.[5] They allege that from February 6, 2013 to the present, Bof I's officers engaged in misconduct by causing Bof I to issue false or misleading statements about the company's condition and/or by failing to disclose that: (1) Bof I's internal controls were inadequate and “frequently disregarded”; (2) that Bof I's portfolio contains loans to foreign nationals who are off-limits because of federal anti-money laundering laws; (3) that many of Bof I's accounts lacked tax identification numbers; and (4) that Defendants violated the anti-retaliation laws of the Sarbanes-Oxley Act of 2002 (“SOX”) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) by allegedly firing Erhart in retaliation for his whistleblowing. See CSC ¶¶ 1, 5, 11, 12, 13.

         Based on these representations of wrongdoing, Plaintiffs assert three claims against all the Defendants, namely, (1) breach of fiduciary duties, (2) abuse of control, (3) unjust enrichment, and one claim, (4) breach of duty of honest services, against Defendants Garrabrants, Micheletti, Bar-Adon, Tolla, and Walsh only. Id. ¶¶ 61-64.


         As stated previously, Plaintiffs did not make a demand on Bof I's Board of Directors before filing suit, urging them to institute this action against the individual Defendants. CSC ¶ 143. Plaintiffs allege that making such a demand would have been futile because a majority of the Board of Directors lacks independence or faces a substantial likelihood of liability for their misconduct, thus rendering them incapable of fairly considering a demand. See id.

         A. General Board Allegations

         The following are demand futility allegations lodged against the Board of Directors as a whole.

         1. Dismissal of Erhart

         The CSC avers that the entire Board is compromised, and therefore was unable to impartially consider a demand at the time of filing the complaint, because they all face a substantial likelihood of liability for retaliating against Erhart in violation of SOX. Id. ¶¶ 149-59. Plaintiffs contend that the entire Board is responsible for violating SOX because it authorized and approved the firing of Erhart on June 9, 2015 with full knowledge of Erhart's protected status as a whistleblower. Id. ¶ 157. “All Board members thus face a substantial likelihood of liability for breaching their fiduciary duties by causing the Company to violate the anti-retaliation provisions of Sarbanes-Oxley, Dodd-Frank, and other laws.” Id. ¶ 158. In addition, Plaintiffs argue, the Board also faces a substantial likelihood of liability for failing to act in the face of the unlawful activities alleged by Erhart. Id. ¶ 159.

         Paragraphs 149 through 158 of the CSC discuss the circumstances leading to the alleged termination of Erhart, and together they narrate the following sequence of events.

         Erhart, “in the course of performing his duties as Bof I's Staff Internal Auditor, ” realized and reported that certain Bof I senior officers, including Director Defendant Garrabrants, Defendant Bar-Adon, and Defendant Tolla, had violated securities and other laws.[6] CSC ¶¶ 77, 149. At some point, he informed those three officers of his “good-faith whistleblower complaint, ” but Garrabrants, Bar-Adon, and Tolla each “brushed aside” his concerns. Id. ¶¶ 149-50. As a result, Erhart “lodged his complaints with the OCC and SEC.” Id. ¶ 150. He also filed a complaint with OSHA recounting the unlawful activities he had witnessed and the retaliation he was facing for having spoken out. See Id. ¶ 151.

         Simultaneously, news of Erhart's allegations and audit findings were climbing through the company's chain of command. In mid-December 2014, Jonathan Ball, the Vice President of Internal Audit (id. ¶ 61), drafted an evaluation of Erhart's job performance. Id. ¶ 152. That performance was later revised by Tolla, who “downgraded Erhart's performance in retaliation for his whistleblowing activities.” Id. Ball, who was troubled by Tolla's actions, “directly advised the Audit Committee about Tolla's downgrading of Erhart's performance evaluation.” Id. Allegedly, however, the Audit Committee did not correct Tolla's conduct and, in fact, approved of it. Id. (“Upon information and belief, the Audit Committee ratified and approved the retaliation against Erhart by failing to instruct Tolla to restore Erhart's performance grade to the level determined by Ball.”)

         Months later, on March 12, 2015, Erhart was approached by Bar-Adon who said that he sought to speak with Erhart in his capacity as “General Counsel to the Audit Committee.” Id. ¶ 153. Based upon this encounter, Plaintiffs allege that the Audit Committee had “directed Bar-Adon to meet with Erhart regarding such activities” and, therefore, “had actual knowledge of Erhart's whistleblowing complaints.” Id.

         Thereafter, the Audit Committee met in San Diego for a formal meeting on April 27, 2015. Id. ¶ 155. Grinberg, Argalas, and Mosich, the three Audit Committee members, were all present at the meeting, along with Micheletti, Bar-Adon, Tolla, Tony de la Mora, Interim FVP of Internal Audit, and other company auditors. Id. At the meeting, Plaintiffs allege that Grinberg presented to the Audit Committee all complaints received by him as Chair of the Audit Committee. Id. They further allege that “[u]pon information and belief, Grinberg advised the other Audit Committee members about Erhart's complaints.” Id.

         A number of weeks later, on May 21, 2015, the entire Board of Directors convened, with all nine members present. Id. ¶ 156. According to Bof I's 2015 proxy statement, the Audit Committee “reports to the full Board at regular meetings concerning the activities of the committee and actions taken by the committee since the last regular meeting.” Id. ¶ 154. Plaintiffs allege that on May 21, 2015 Grinberg “presented a report to the full Board from the Audit Committee, which report upon information and belief included all details regarding Erhart's complaints and the fact that Erhart had claimed whistleblower protection. The Board also met in Executive Session to discuss Erhart's complaints and other matters.” Id. ¶ 156.

         Plaintiffs go on to state that three weeks after the May 21, 2015 Board meeting, and in spite of having “actual knowledge of Erhart's whistleblowing activity, and despite knowing that Dodd-Frank, Sarbanes-Oxley, and other laws prohibit retaliation against employees who report alleged wrongdoing, the Board authorized and approved the firing of Erhart on June 9, 2015.” Id. ¶ 157

         2. False and Misleading Statements

         Plaintiffs further argue that: (1) “no reasonable stockholder would reasonably believe that a majority of the members of the Board would be able to independently and properly consider a demand in good faith” because the Board violated their fiduciary obligations by approving and signing the company's SEC filings containing false and misleading statements. Id. ¶ 161. Specifically, the CSC avers that the entire Board wrongly approved and signed the Form 10-Ks dated September 4, 2013, August 28, 2014, and August 26, 2015, all of which contained false and misleading statements about Bof I's compliance with securities and other laws.[7] See id.

         3. Compensation & Participation in Mortgage-lending Program

         The CSC also alleges that the Director Defendants are interested for purposes of demand futility because they “are more interested in protecting themselves than they are in protecting the Company by bringing this action.” Id. ¶ 164.

         In support of this allegation, Plaintiffs offer each Board member's compensation for fiscal year 2015: Garrabrants, $6, 310, 485; Allrich, $514, 598; Argalas, $188, 210; Court, $188, 210; Dada, $85, 061; Grinberg, $281, 133; Mosich, $253, 970; and Ratinoff, $188, 210. Id. In further support of this position, the CSC contends that the independence of Allrich, Argalas, Burke, Garrabrants, Grinberg, and Mosich is further compromised by the fact that each obtained a mortgage on their primary residence at below market interest rates through participation in Bof I's mortgage-lending program, which is made available to Bof I's directors, officers, and employees. Id. ¶ 165. “As such, Allrich, Argalas, Burke, Garrabrants, Grinberg, and Mosich are more interested in maintaining their lucrative positions at Bof I than they are in protecting Bof I by bringing this action.” Id.

         B. Individual Board Member Allegations

         Also in furtherance of pleading demand futility, the CSC lodges a variety of individual demand futility allegations against specific Board members based upon their roles or conduct at Bof I.

         1. Garrabrants

         The CSC's demand futility allegations contend that Garrabrants, notwithstanding any allegations attributed to the Board, independently lacks independence. Id. ¶ 144.

         Garrabrants, Plaintiffs argue, lacks independence because he “prepared, signed, or caused the Company to issue many of the false and misleading statements” that Plaintiffs cite in the CSC. Id. In particular, Plaintiffs note that Garrabrants signed the company's SEC filings, all of which allegedly contained false and misleading statements, including: the Forms 10-K dated September 3, 2013, August 28, 2014, and August 26, 2015, and the Forms 10-Q dated November 5, 2013, February 5, 2014, May 6, 2014, November 4, 2014, January 29, 2015, and April 30, 2015. Id. ¶ 147.

         In addition, Plaintiffs allege that making demand upon Garrabrants would have been futile because he faces a substantial likelihood of liability for his misconduct. Garrabrants, they contend, is “a named defendant in the currently-pending federal class actions, alleging he violated § 10(b) of the Exchange Act and Rule 10b-5 when he disseminated or approved the false and misleading statements.” Id. ¶ 145. Thus, because “pursu[ing] these derivative claims . . . would expose his own misconduct in the class action for violations of the federal securities laws . . . Garrabrants is fatally conflicted and, therefore, unable to render a disinterested decision as to whether the Company should pursue these derivative claims.” Id. ¶ 146.

         Yet another fact demonstrating the likelihood that Garrabrants will face liability for his conduct, they argue, is the fact that “Garrabrants also participated in conference calls with analysts and investors during the Relevant Period . . . [and] therefore faces a substantial likelihood of liability for breaching his fiduciary duties.” Id. ¶ 148.

         2. Audit Committee Members (Argalas, Grinberg, Mosich)

         The CSC singles out Argalas, Grinberg, and Mosich as particularly lacking in independence or likely to face a substantial likelihood of liability because of their conduct and duties as Audit Committee members. Plaintiffs contend that the Audit Committee defendants “had a clear duty to be kept informed about the Company's accounting procedures, ” but failed to do so by reviewing and approving Bof I's SEC filings that contained false and misleading statements. Id. ¶ 163.

         3. Grinberg

         Plaintiffs argue that Grinberg additionally lacked independence to consider a shareholder demand because he “breached his fiduciary duty by failing to disclose a related party transaction between Bof I and his employer Encore Capital.” Id. ¶ 166.


         A. Rule 23.1

         A derivative shareholder's claim allows an individual stockholder to bring “suit to enforce a corporate cause of action against officers, directors, and third parties.” Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95 (1991) (quoting Ross v. Bernhard, 396 U.S. 531, 534 (1970)). “Devised as a suit in equity, the purpose of the derivative action was to place in the hands of the individual shareholder a means to protect the interests of the corporation from the misfeasance and malfeasance of faithless directors and managers.” Id. (quoting Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548 (1949)) (quotations omitted).

         This derivative right, however, is not absolute. Before a shareholder can act on behalf of the corporation in this manner, he or she must demonstrate “that the corporation itself had refused to proceed after suitable demand, unless excused by extraordinary conditions.” Id. at 95-96 (quoting Ross, 396 ...

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