Derivative Actions — State Law Sets Demand Requirement in Diversity Action — Also in Federal Question Case If Federal Policies Not Frustrated — State-Law Demand Requirement Applies in RICO Action
Gomes v. Am. Century Cos., 2013 U.S. App. LEXIS 6184 (8th Cir. Mar. 28, 2013):
Nelson Gomes, an investor in the American Century International Discovery Fund ("the Fund"), brought Maryland common-law claims and federal racketeering claims for violations of 18 U.S.C. §§ 1962(c) and (d) against the appellees, who are the Fund's fiduciaries ("the fiduciaries"). Among other claims, the complaint alleged derivative claims on behalf of the Fund for breach of fiduciary duty, negligence, waste, and racketeering. The district court dismissed Gomes's complaint for failure to state a claim. Gomes appeals the dismissal of his derivative claims, and we affirm. ***
The complaint alleges that the fiduciaries knowingly caused the Fund to invest millions of dollars in two off-shore Internet gambling websites. The websites, Bwin Interactive Entertainment AG and NETeller Plc, illegally took wagers from gamblers in the United States. When the government began aggressively prosecuting off-shore gambling operations during the summer of 2006, both websites forfeited hundreds of millions of dollars and stopped operating in the United States. Their share values dropped precipitously. As the websites' share values plummeted, so too did the share values of the Fund, because the Fund's value was calculated on the basis of the net value of the Fund's portfolio. The Fund realized millions of dollars in losses when it sold its shares of Bwin and NETeller.
The Illegal Gambling Business Act of 1970 makes it a felony to "own all or part of an illegal gambling business." 18 U.S.C. § 1955(a). A violation of § 1955 is a predicate crime under the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961(1). Gomes claims that the fiduciaries knew that purchasing the shares was illegal, because before the purchases, the Justice Department had issued public warnings stating that Internet gambling websites which took bets from United States residents were criminal organizations. NETeller's prospectus from April 2004 also candidly acknowledged that it might be prosecuted, and the principals of similar off-shore websites already had been prosecuted.
The fiduciaries moved to dismiss Gomes's complaint for failure to make a presuit demand on the board of directors of the Fund. The district court granted the motion, and Gomes appeals. ***
We review de novo a district court's decision to grant a motion to dismiss, accepting the complaint's allegations as true. L.L. Nelson Enters., Inc. v. Cnty. of St. Louis, Mo., 673 F.3d 799, 804 (8th Cir. 2012). To survive a motion to dismiss, a complaint must plead "enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). Federal Rule of Civil Procedure 23.1 imposes a heightened pleading standard on complaints in derivative actions. It requires that the plaintiff "state with particularity . . . any effort by the plaintiff to obtain the desired action from the directors or comparable authority" and "the reasons for not obtaining the action or not making the effort." Fed. R. Civ. P. 23.1(b)(3).
Although Rule 23.1 "contemplates both the demand requirement and the possibility that demand may be excused, it does not create a demand requirement of any particular dimension." Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 96 (1991) (emphasis omitted). Rather, it is "a rule of pleading" that "requires that the complaint in such a case allege the facts that will enable a federal court to decide whether such a demand requirement has been satisfied." Halebian v. Berv, 590 F.3d 195, 211 (2d Cir. 2009) (internal quotations omitted).
When a plaintiff pursues derivative claims arising under state law without making a pre-suit demand, a federal court must apply state law to determine whether demand is excused. Id. at 204. When the derivative cause of action arises under federal law, federal courts should "incorporate state law as the federal rule of decision, unless application of the particular state law in question would frustrate specific objectives of the federal programs." Kamen, 500 U.S. at 98 (internal quotations and alterations omitted).
Gomes argues that applying Maryland's demand requirement to his racketeering claim would be inconsistent with RICO's broad remedial purpose. ***
Whether demand is required before the filing of a derivative RICO claim is a question of federal law. See Kamen, 500 U.S. at 97. But gaps in federal statutes bearing on the allocation of governing power within a corporation should be filled with state law, unless doing so would be "inconsistent with the policies underlying the federal statute." Id. at 99, 108. "The scope of the demand requirement under state law clearly regulates the allocation of corporate governing powers between the directors and individual shareholders." Id. at 108. Therefore, we must determine whether Maryland's demand requirement is inconsistent with "the policies underlying" RICO. Id.
Gomes argues that it would frustrate RICO's broad "remedial purposes" to apply Maryland's demand requirement to his racketeering claim. See Organized Crime Control Act of 1970, Pub. L. No. 91-452, § 904(a), 84 Stat. 922, 947. A broad remedial purpose, however, is not inconsistent with a demand requirement. The Supreme Court long has held that securities laws combating fraud, including the Investment Company Act of 1940 ("ICA"), 15 U.S.C. § 80a-1 et seq., should be construed flexibly to effectuate their remedial purposes. See Herman & MacLean v. Huddleston, 459 U.S. 375, 386-87 (1983); Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 151 & n.15 (1972). Nonetheless, in Burks v. Lasker, 441 U.S. 471 (1979), the Court held that the ICA did not prevent the directors of a New York corporation from terminating a derivative claim brought without a pre-suit demand. Id. at 484-85. Despite the ICA's remedial purposes, the Court explained, "[t]here may well be situations in which the independent directors could reasonably believe that the best interests of the shareholders call for a decision not to sue." Id. at 485. The Court held that "Congress did not require that States, or federal courts, absolutely forbid director termination of all nonfrivolous actions." Id. at 486.
Gomes relies on Daily Income Fund, Inc. v. Fox, 464 U.S. 523 (1984), where the Supreme Court allowed derivative claims under the ICA to proceed without a demand, but Fox held that demand was not required for a different reason: mutual funds were not authorized to pursue claims under § 36(b), so the requirements of Rule 23.1 simply did not apply. Id. at 542. It is undisputed that Gomes's claims are subject to Rule 23.1 and that the fiduciaries could legally choose to adopt his claims.
Under Kamen, the question is whether application of Maryland's demand requirement would frustrate the policies of RICO, and we think it would not. That a federal statute has a remedial purpose does not make all claims arising under it immune from state law demand requirements. See Burks, 441 U.S. at 485-86. Requiring an investor to offer the corporation an opportunity to pursue its own claim does not preclude the investor from suing if the directors refuse the demand. See Werbowsky v. Collomb, 766 A.2d 123, 144 (Md. 2001). Because Maryland's demand requirement does not frustrate the federal policies underlying RICO, we apply Maryland law to all of Gomes's claims to determine whether demand was excused.
Share this article: