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January 7, 2013


FRAUD AND MANIPULATION-1stCir: Failure to Plead Demand Futility Insufficient Ground for Dismissal of Derivative Action

By Anne Sherry, J.D.

The Court of Appeals for the First Circuit vacated a district court decision dismissing a derivative action for failure to state demand futility with particularity. Under Delaware law, which instructed the court's application of Puerto Rico law, the complaint established a reasonable doubt as to the interestedness or lack of independence of a majority of the board members sufficient to excuse demand (Uni—n de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan v. UBS Financial Services Inc. of Puerto Rico, January 4, 2013, Lipez, K.).

The plaintiffs, pension funds that own shares in closed-end investment funds advised by UBS Trust Company of Puerto Rico, alleged that UBS Trust caused the investment funds to become heavily weighted in bonds that soon lost 10 percent of their value, causing significant losses to the investment funds and thus to the plaintiffs. Another UBS affiliate, UBS Financial, shared in underwriters' fees of $27 million for its role in bringing the bonds to market. The plaintiffs brought a shareholder derivative action against the funds' directors, UBS Trust, and UBS Financial, and the district court dismissed the action without prejudice, finding that no presuit demand was made and that plaintiffs failed to state demand futility with particularity.

Because Puerto Rico law does not elaborate the requirements of demand or when it is excused, the appellate court looked to Delaware corporate law, on which Puerto Rico corporate law is modeled. The Delaware Rales v. Blasband decision applies where a plaintiff challenges a board's failure to discharge its oversight duties, the court concluded, and Rales excuses demand only if a majority of the board members are interested or lack independence.

The appellate court found that the district court focused too narrowly on whether the plaintiffs alleged that individual directors received a financial benefit from the bonds transaction. "Alleging the receipt of a personal financial benefit is not the sine qua non of demand futility," said the court; rather, the trial court should analyze the facts more broadly to determine whether the plaintiff has created a reasonable doubt that the directors could objectively evaluate demand. Furthermore, the appellate court found that the district court misconstrued the plaintiffs' burden of demonstrating that the benefits directors received were of "subjective material significance." Plaintiffs need not offer conclusive evidence of materiality, the court held, but must offer particulars from which the court can reasonably infer impaired judgment. The district court "repeatedly declined to make such reasonable inferences of materiality from the facts alleged by plaintiffs," the appellate court noted.

Reviewing the decision de novo, the appellate court evaluated the complaint's allegations as to six of the eleven directors and found that the plaintiff alleged with sufficient particularity a reasonable doubt regarding the ability of the six directors to evaluate the plaintiffs' demand with the disinterest and independence required under Puerto Rico law. Because that reasonable doubt existed as to a majority of board members, the plaintiffs adequately established under Rales that a presuit demand would have been futile. The appellate court vacated the district court's decision and remanded for further proceedings.

Cynthia A. Calder, Jay W. Eisenhofer, Mary S. Thomas of Grant & Eisenhofer PA; Charles Dufresne, Douglas R. Hirsch, Christiaan D. Johnson-Green of Sadis & Goldberg LLP; Mark C. Gardy, James S. Notis, Kelly Ann Noto of Gardy & Notis LLP; Harold D. Vicente-Colon, Harold D. Vicente-Gonzalez of Vicente & Cuebas for plaintiffs Union De Empleados De Muelles De Puerto Rico PRSSA Welfare Plan and Union De Empleados De Muelles De Puerto Rico AP Welfare Plan. Salvador J. Antonetti-Stutts, Ubaldo M. Fernandez, Mauricio Oscar Muniz-Luciano of O'Neill & Borges LLC; Nicole A. DiSalvo, Paul J. Lockwood of Skadden Arps Slate Meagher & Flom LLP for defendant UBS Financial Services Incorporated of Puerto Rico. Salvador J. Antonetti-Stutts, Ubaldo M. Fernandez, Mauricio Oscar Muniz-Luciano of O'Neill & Borges LLC; Nicole A. DiSalvo, Paul J. Lockwood of Skadden Arps Slate Meagher & Flom LLP for defendants UBS Trust Company of Puerto Rico, Miguel A. Ferrer Rivera, Carlos V. Ubinas, Stephen C. Roussin, Leslie Highley, Jr. Rafael Escalera-Rodriguez, Pedro Santiago-Rivera of Reichard & Escalera for defendants Mario S. Belaval and Agustin Cabrer-Roig.

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