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In re JPMorgan Chase Derivative Litigation

United States District Court, E.D. California

June 30, 2017



         Shareholders have brought a derivative suit against a corporation's directors for their allegedly deceitful and financially-destructive role in the 2008 housing collapse. Defendants are current and former JPMorgan Chase & Co. (“JPMorgan”) directors. Plaintiffs are California-based shareholders. Plaintiffs argue defendants breached their fiduciary duties, committed securities violations, and unjustly enriched themselves through defendants' creation and sale of subprime residential mortgage-backed securities (“RMBS”). The court granted defendants' first motion to dismiss. Order Oct. 23, 2014, ECF No. 69 (“Prior Order”). Defendants have moved to dismiss plaintiffs' amended complaint, or alternatively, to transfer the case to New York. Id. Mot., ECF No. 123.

         The court heard the motion on December 15, 2016. Alexandra Summer, Francis Bottini, Jr., Mark Molumphy and Kelsey Fischer appeared for plaintiffs. Mins., ECF No. 139. Stuart Baskin, Alethea Sargent and Emily Griffen appeared for defendants Bell, Bowles, Burke, Crown, Flynn, Futter, Jackson, Novak, Raymond and Weldon. Id. Gary Kubek and Christopher Banks appeared for nominal defendant JPMorgan and defendants Dimon, Harrison and Lipp. Id. As explained below, the court GRANTS defendants' motion to dismiss in part and TRANSFERS the remaining claims to the Southern District of New York.

         I. BACKGROUND

         Plaintiffs complain that defendants fraudulently and carelessly mishandled JPMorgan's residential mortgage-backed securities business. First Am. Compl. ¶¶ 1, 2, ECF No. 122 (“FAC”). Understanding plaintiffs' claims in full at this point requires a brief review of the mortgage industry in which JPMorgan operates.

         A. Residential Mortgage-Backed Securities and the 2008 Financial Crisis

         Residential mortgage-backed securities or RMBS are bonds backed by payments homeowners make on their mortgage loans. See Id. ¶ 10. JPMorgan uses a process known as “securitization” to bundle hundreds of mortgage loans into RMBS, which they then market and sell to investors. Id. JPMorgan groups or tiers their RMBS based on a risk rating. Risky or subprime RMBS form the lower, cheaper tiers, while safer RMBS form the more expensive tiers. Id. ¶¶ 44-45. RMBS are considered subprime or risky when they are backed by mortgagers with impaired credit records, while safer RMBS are backed by more reliable mortgagers. Id. Investors choose a tier in which to invest and then their profits mirror the payments mortgagers make. The values of the RMBS fluctuate depending on whether homeowners pay down their mortgage principal early, refinance their mortgages or default.

         After the housing market collapsed in 2008, RMBS investors experienced significant fluctuation in returns on investment because foreclosures increased and home prices and interest rates plummeted. Id. ¶ 10. The downturn exposed flaws in JPMorgan's RMBS protocol and enflamed investors who felt defrauded and misled. Plaintiffs here contend the named directors played a key role in JPMorgan's misconduct in issuing RMBS. Id. ¶¶ 3, 9, 188, 291, 315, 388-89.

         B. Criminal Investigation into JPMorgan's RMBS Activity

         Investors' fraud allegations prompted the United States Department of Justice (“DOJ”) and various federal and state agencies to investigate whether JPMorgan's RMBS practices violated criminal laws. Id. ¶ 17. On November 15, 2013, JPMorgan announced a $4.5 billion settlement with 21 major institutional investors, and four days later announced a $13 billion settlement with the Department of Justice and other government agencies. Id. ¶ 5. Approximately $300 million of the settlement funds were allocated to investors from California. Id.. This settlement hinged on JPMorgan's RMBS conduct between 2005 and 2007: JPMorgan admitted it falsely marketed and sold compromised RMBS to investors without warning them the RMBS did not meet the corporation's internal securitization standards. Id. ¶¶ 6, 238, 300, 331. The settlement did not resolve an ongoing criminal investigation against JPMorgan originating in this district, the Eastern District of California. FAC ¶¶ 5, 49, 189, 366.

         C. Shareholder Derivative Suits

         In this case, three JPMorgan shareholders sue JPMorgan's directors for their alleged involvement in RMBS activity from 2005 to 2007, focusing particularly on this activity's impact in California. Id. at 65-88. This suit is one of many derivative suits attacking JPMorgan's mishandling of RMBS during the financial crisis, which point to the resulting billion dollar settlements as proof of damages. Courts uniformly have dismissed these derivative suits at the outset, at least in part, for not meeting Federal Rule of Civil Procedure 23.1(b)'s pleading requirements.[1]

         Rule 23.1(b)(3) requires that shareholders bringing derivative suits specifically plead what efforts they undertook to have a corporation's board of directors file the suit on the corporation's behalf; in other words, did shareholders make a pre-suit demand on the board that was rejected? Alternatively, the Rule requires that shareholders plead the specific reasons they have not asked the board to bring their claims; to show why a demand on the board would have been futile. Fed.R.Civ.P. 23.1(b)(3)(A), (B) (providing that the complaint must “(3) state with particularity-(A) any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members; and (B) the reasons for not obtaining the action or not making the effort.”); Potter v. Hughes, 546 F.3d 1051, 1062 (9th Cir. 2008). A derivative suit cannot proceed without showing either demand refusal or excusal. Fed.R.Civ.P. 23.1(b)(3).

         A separate derivative suit brought in the Southern District of New York, and dismissed there, is particularly relevant here. See Steinberg v. Dimon, 2014 WL 3512848 (S.D.N.Y. July 16, 2014). Defendants argue Steinberg's judgment precludes plaintiffs from re-litigating similar claims and issues here. Mot. at 4-8. In Steinberg, a shareholder derivatively sued fifteen JPMorgan directors in New York for breaching their fiduciary duties, wasting corporate assets, unjustly enriching themselves, and violating section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a) (“Securities Act”). See Baskin Decl., Ex. D (Steinberg Compl.), ECF No. 124-4. The New York district court dismissed the complaint for insufficiently pleading demand futility under Rule 23.1. Steinberg, 2014 WL 3512848 at *5.

         D. This Case

         Plaintiffs contend defendants exposed JPMorgan to financial risk and ruin through the corporation's subprime mortgage business by destabilizing internal standards and controls, fraudulently marketing RMBS, and concealing material information from investors. FAC 10. Plaintiffs bring three California state claims and one federal claim. They made no pre-suit demand on JPMorgan's board and allege doing so would have been futile. Id. ¶ 296 (“making a demand would be a futile and useless act as the majority of JPMorgan's directors are not able to conduct an independent and objective investigation of the alleged wrongdoing”).

         Plaintiffs' state law claims allege: (1) Defendants breached their fiduciary duties by putting their own pecuniary interests above the company's; (2) defendants wasted corporate assets by compensating executives and directors for illegal conduct; and (3) defendants unjustly enriched themselves. Id. ¶¶ 357, 370, 373. Plaintiffs' fourth federal claim alleges certain named defendants violated section 14(a) of the Securities Act by issuing false and misleading 2011 and 2012 proxy statements that lured shareholders into blindly reinstating leadership incumbents and approving risky proposals. Id. ¶¶ 377-95. Plaintiffs name defendants Bowles, Burke, Cote, Crown, Dimon, Futter, Jackson, Raymond and Weldon in connection with both proxy statements, defendants Gray and Novak regarding only the 2011 proxy statement, and defendant Bell regarding only the 2012 proxy statement. Id. ¶¶ 378-79.

         E. Prior Dismissal and Amended Complaint

         The court dismissed plaintiffs' prior complaint in 2014, with leave to amend. See Prior Order; First Consolidated Compl., ECF No. 29; Defs.' First Mot. Dismiss, ECF No. 48. The court found defendants lacked sufficient ties to California to sustain personal jurisdiction as to plaintiffs' state claims and that plaintiffs' federal claim failed under Rule 12(b)(6). Prior Order at 24. After two years of jurisdictional discovery, plaintiffs filed the operative first amended complaint. See Order Granting Discovery, ECF No. 92; FAC (filed April 28, 2016). Although the amended complaint raises the same four claims as stated in the original complaint, it offers more detail about JPMorgan's California-specific RMBS business, FAC at 65-88, bolsters plaintiffs' theories and explanation as to why JPMorgan's proxy statements were misleading, and changes the relief sought under its federal claim, compare Compl. ¶¶ 304-08, with FAC ¶¶ 377- 95. Defendants now revive their initial jurisdictional arguments in seeking to dismiss the amended complaint. Plaintiffs oppose, Opp'n, ECF No. 132, and defendants reply, ECF No. 133.


         Defendants raise multiple jurisdictional inquiries and so the court must first consider the proper order of analysis. Potter, 546 F.3d at 1055; see also Ruhrgas AG v. Marathon Oil Co., 526 U.S. 574, 584 (1999) (explaining although “subject-matter jurisdiction necessarily precedes a ruling on the merits, the same principle does not dictate a sequencing of jurisdictional issues”) (citation omitted). A federal court must independently ensure it has subject matter jurisdiction over every claim and personal jurisdiction over every party. The parties do not dispute the court's subject matter jurisdiction here: The federal claim presents a federal question and the state law claims satisfy diversity jurisdiction. FAC ¶ 18.

         The parties do dispute the court's personal jurisdiction over defendants with respect to the state law claims. Mot. at 14-19; Opp'n at 22-24. Because JPMorgan is neither incorporated in California nor principally located here, FAC ¶ 23, defendants argue plaintiffs have not shown each defendant has sufficient contacts with California to trigger this court's personal jurisdiction over them. California's personal jurisdiction standard requires that each defendant have at least some minimum contacts with California to warrant haling them into court here. Schwarzenegger v. Fred Martin Motor Co., 374 F.3d 797, 800 (9th Cir. 2004) (citing Fed.R.Civ.P. 4(k)(1)(A)). Defendants' argument based on absence of contacts is warranted as to the state claims, as discussed below.

         Plaintiffs' federal claim, however, derives from the federal Securities Act, which confers “personal jurisdiction over the defendant in any federal court” provided “[the] defendant has minimum contacts with the United States . . . .” Sec. Investor Prot. Corp. v. Vigman, 764 F.2d 1309, 1316 (9th Cir. 1985) (citing 15 U.S.C. § 78(a)(a)); Touche Ross & Co. v. Redington, 442 U.S. 560, 577 (1979). JPMorgan is a Delaware corporation with its principal place of business in New York, and the individual defendants are citizens of the United States, FAC ¶¶ 23, 27-40; Vigman, 764 F.2d at 1316. Personal jurisdiction adheres as to the federal claim.

         If plaintiffs' federal claim withstands dismissal, and if plaintiffs' state claims factually relate to their federal claim, the court has discretion to exercise pendent personal jurisdiction over the defendants as to all claims in this suit without separately analyzing defendants' relationships with California. See Action Embroidery Corp. v. Atl. Embroidery, Inc., 368 F.3d 1174, 1181 (9th Cir. 2004).


         If plaintiffs' state claims “arise[] out of the same nucleus of operative facts” as the federal claim that granted the court personal jurisdiction, the court may exercise personal jurisdiction over defendants with respect to the entire case. This discretionary pendent personal jurisdiction doctrine derives from “considerations of judicial economy, convenience and fairness to litigants.” Id. (internal citation and quotation marks omitted). Claims are sufficiently factually related to trigger the doctrine when a plaintiff “‘would ordinarily be expected to try them all in one judicial proceeding.'” Rep. of the Phil. v. Marcos, 862 F.2d 1355, 1359 (9th Cir. 1988) (quoting United Mine Workers v. Gibbs, 383 U.S. 715, 725 (1966)). That claims advance different theories of liability does not diminish their factual relatedness. See, e.g., CollegeSource, Inc. v. AcademyOne, Inc., 653 F.3d 1066, 1070-73 (9th Cir. 2011) (finding pendent personal jurisdiction where federal and state claims all based on corporation's misappropriating college catalogs).

         Here, the court previously found plaintiffs' state and federal claims sufficiently factually related to trigger pendent personal jurisdiction. See Prior Order at 23. Plaintiffs' amended complaint maintains the same factual basis for their claims and defendants raise no new arguments to challenge their factual relatedness. Compare Compl. ¶¶ 191-212, with FAC ¶¶ 263-84. Plaintiffs' state law claims are rooted in allegations that defendants dragged JPMorgan into the risky RMBS business, manufactured a culture of security law violations, poorly managed JPMorgan's employees, and ultimately forced JPMorgan into a position of having to agree to multi-billion-dollar settlements. See FAC ¶¶ 356-76. Plaintiffs' federal claim is based in allegations that JPMorgan's proxy statements mischaracterized its leadership's risk management and internal controls. Id. ¶¶ 377-95. Plaintiffs say, in essence, the proxy statements were misleading because they did not disclose the wrongs plaintiffs allege in their state law claims. Id. Plaintiffs' state and federal claims derive from the same basic factual allegations.

         Even if the interest of judicial economy warrants exercising pendent personal jurisdiction over defendants as to plaintiffs' state law claims, jurisdiction fundamentally is not established. If plaintiffs' federal claim cannot proceed, any pendent personal jurisdictional hook vanishes.


         As noted, defendants move to dismiss plaintiff's federal claim, arguing that a New York district court's dismissal of a related shareholder derivative suit precludes the claim here as a matter of law. Mot. at 13 (citing Steinberg, 2014 WL 3512848, at *5).

         The doctrines of claim preclusion and issue preclusion define whether a prior judgment has a preclusive effect. Under claim preclusion, “[a] final judgment on the merits of an action precludes the parties or their privies from relitigating issues that were or could have been raised in that action.” Federated Dep't Stores, Inc. v. Moitie, 452 U.S. 394, 398 (1981) (internal citation omitted). Conversely, issue preclusion bars “successive litigation of an issue of fact or law actually litigated and resolved in a valid court determination essential to the prior judgment, ” even if the issue recurs by way of a different claim. New Hampshire v. Maine, 532 U.S. 742, 748-49 (2001). By “preclud[ing] parties from contesting matters that they have had a full and fair opportunity to litigate, ” these two doctrines protect against “the expense and vexation attending multiple lawsuits, conserve[] judicial resources, and foster[] reliance on judicial action by minimizing the possibility of inconsistent decisions.” Montana v. United States, 440 U.S. 147, 153-54 (1979).

         The Steinberg court dismissed the derivative suit before it, finding the plaintiff there inadequately pled demand futility. Before assessing whether claim or issue preclusion applies, this court thus examines the demand futility requirements in shareholder derivative suits as relevant here.

         A. Proving Demand Futility Under Delaware Law

         Under Federal Rule of Civil Procedure 23.1(b), a plaintiff may bring a shareholder derivative suit only if she “allege[s] with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors.” Potter, 546 F.3d at 1056. Failure to so allege is excusable only if demand would have been futile. Fed.R.Civ.P. 23.1.

         To assess whether demand is futile, the court applies the law of the state in which the corporation is incorporated. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 109 n.10 (1991). JPMorgan is incorporated in Delaware. FAC ¶ 23. Delaware law provides two different demand futility inquiries, depending on if the suit challenges board conduct and judgment in general, as compared to an affirmative board decision See Wood v. Baum, 953 A.2d 136, 140 (Del. 2008). If a derivative suit challenges a decision the corporate board made, the court evaluates demand futility under the two-pronged Aronson test. See Aronson v. Lewis, 473 A.2d 805, 815 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Under this test, the court first evaluates the directors' independence and disinterestedness and then focuses on the substance of the challenged transaction and the directors' approval of it. See Id. at 814.

         When a derivative claim does not challenge a particular decision the board made as a whole, Rales governs. See Rattner v. Bidzos, 2003 WL 22284323, at *8 (Del. Ch. 2003) (citing Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993)). Under Rales, a court must determine whether the plaintiffs' particularized factual allegations raise a reasonable doubt, at the time the plaintiffs filed suit, about the board's ability to properly exercise its independent and disinterested business judgment in responding to a demand. Id. (citing Rales, 634 A.2d at 934). If the derivative plaintiffs satisfy this burden, demand is excused as futile. Id. So, under Delaware law, when shareholders allege board misconduct but do not identify a specific board decision, the court considers the claim's merit to assess whether it raises a reasonable doubt that a majority of the board of directors were “incapable of making an impartial decision regarding the pursuit of the litigation.” Wood, 953 A.2d at 140. One way to raise reasonable doubt is to show a majority of the board faced a “substantial likelihood” of personal liability from the legal action that has been brought. Rales, 634 A.2d at 936 (citation omitted). In making this assessment, courts focus on strength of the underlying claim's merits: The higher the chance of success on the claim the more likely demand as to that claim is futile.

         To determine if the Steinberg court's Rule 23.1(b) dismissal precludes plaintiffs from litigating a claim or issue in this court, the court must decide initially whether federal or state preclusion rules govern.

         B. Choice of Law for Preclusion Analysis

         Determining which preclusion law governs depends on the nature of the potentially precluding judgment. If a federal court sitting in diversity jurisdiction issued the arguably precluding opinion, then the preclusion rules of the state in which that court sits would apply. Taylor v. Sturgell, 553 U.S. 880, 891 (2008) (citing Semtek Int'l Inc. v. Lockheed Martin Corp., 531 U.S. 497, 507-08 (2001)). But if the prior case rested on a federal question, then federal courts apply the “federal rule[s]” of res judicata, which the United States Supreme Court has ultimate authority to declare. Semtek, 531 U.S. at 508; Heiser v. Woodruff, 327 U.S. 726, 733 (1946) (“It has been held in non-diversity cases since Erie R. Co. v. Tompkins, that the federal courts will apply their own rule of res judicata.”); First Pacific Bancorp, Inc. v. Helfer, 224 F.3d 1117, 1128 (9th Cir. 2000) (“When considering the preclusive effect of a federal court judgment, we apply the federal [preclusion] law.”) (citation omitted).

         Here, federal common law determines Steinberg's preclusive effect because Steinberg addressed a federal question. That Steinberg also involved state law claims does not change this court's conclusion because the Steinberg court considered those claims on the basis of supplemental jurisdiction only. Steinberg Compl. ¶ 9.

         C. Federal Issue Preclusion

         Issue preclusion or collateral estoppel prevents parties from relitigating the same issues actually adjudicated in an earlier judgment. This narrow doctrine applies only “[w]hen an issue of fact or law is actually litigated and determined by a valid and final judgment, and the determination is essential to the judgment.” B & B Hardware, Inc. v. Hargis Indus., Inc., 135 S.Ct. 1293, 1303 (2015) (citation and quotations marks omitted).

         Defendants contend that because the members of the board of directors sued here are the same board members upon whom Steinberg attempted to show demand was futile, the Steinberg court's Rule 23.1(b) dismissal bars plaintiffs from re-litigating demand futility as to their federal claim. Because plaintiffs must prove demand futility before proceeding on their federal claim, concluding that issue preclusion applies would defeat their claim. The parties dispute only whether the demand futility question in Steinberg was “identical” to the demand futility question raised here.

         1. Federal Common Law on Identicality of ...

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