Records Requests and the Caremark Standard At Issue in Delaware
Flying somewhat below the radar, the on-going case of Indiana Electrical Workers Pension Trust Fund IBEW v. Wal-Mart Stores Inc. may prove to be one worthy of closer consideration. The case stems from the alleged involvement of Wal-Mart in a Mexico bribery scheme which was the subject of an extensive expose in a New York Times article.
As distilled by Ben W. Heineman, Jr. a former GE senior vice president for law and public affairs and a senior fellow at Harvard University’s schools of law and government, the essential allegations in the Times story are as follows:
- For a substantial period before 2005, the CEO of Wal-Mart in Mexico and his chief lieutenants, including the Mexican general counsel and chief auditor, knowingly orchestrated bribes of Mexican officials to obtain building permits, zoning variances and environmental clearances, and also falsified records to hide these payments. When the lawyer in Mexico directly responsible for bribery payments had a change of heart and reported the scheme to Wal-Mart lawyers in the United States, those lawyers hired an independent firm which, after an initial look, recommended a major inquiry.
This was rejected by senior Wal-Mart management, which instead told an internal Wal-Mart investigative unit to look into it. That unit, too, said, in early 2006, that a substantial inquiry was warranted. But top Wal-Mart leaders in the U.S., including the company’s general counsel, referred the matter back to the Wal-Mart general counsel in Mexico – the very lawyer who was allegedly at the center of the bribery scheme. Unsurprisingly, the Mexican general counsel promptly closed the matter, finding no problems and suggesting no disciplinary measures for senior Wal-Mart leaders in Mexico. He remained in his position until relieved of his duties just before the Times story appeared.
After publication of the article, the Indiana Electrical Workers Pension Trust Fund IBEW, who had received copies of the same files leaked by a whistleblower to The New York Times filed suit in August of 2012 seeking information to enable it to proceed with a derivative action against Walmart alleging that Walmart’s board had failed in its oversight responsibilities and engaged in a cover-up of the alleged scheme. The gist of the case involved a claim brought under Delaware General Corporation Law §220. In the initial action, then-Chancellor Strine, now chief justice of the Supreme Court, ordered Wal-Mart to hand over certain internal files (but not all the fund sought) concerning what its directors knew about certain bribery claims, including allegations that certain executives paid bribes to facilitate Mexican real estate deals, in violation of the Foreign Corrupt Practices Act. (Ind. Elec. Workers Pension Trust Fund IBEW v. Wal-Mart Stores, Inc., Del. Ch, No. 7779-CS, 5/20/2013).
Walmart appealed and the Indiana Electrical Workers Pension Trust fund cross-appealed the decision. Oral arguments on the appeal were heard on July 10th before the Delaware Supreme Court. The Court will decide, among other issues, if Wal-Mart should release the files of the senior executives who briefed the directors, the Board’s Audit committee, and Maritza Munich, Walmart’s in-house counsel who resigned after the investigation was closed.
While this may not seem worth of note—Section 220 cases are common and their impact is typically limited to the parties involved in the action there has been much speculation in certain circles that the Delaware Supreme Court could use it as an opportunity to revisit and clarify the Caremark standard.
Under Caremark, “a director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standards.” The case did not articulate any specific requirements as to the nature and quality of the oversight process. It simply required that one be in place.
According to some commentators, including Michael Volkov, CEO of The Volkov Law Group LLC and a regular speaker on compliance, internal investigations and enforcement matters, “[t]he Wal-Mart case presents a set of circumstances where the court could find that Wal-Mart failed to meet the threshold standard or, more importantly, failed to exercise proper oversight and monitoring of the compliance program in accordance with a more stringent standard reflecting an up-to-date recognition of the change in corporate governance requirements and expectations since the Caremark decision.
At oral argument, the Justices seemed unsure how far to extend the reach of a Section 220 books and records request and it is unclear whether the case will work any changes in the Caremark standards or not.
Justice Randy J. Holland asked Mr. Grant, counsel for the Indiana Electrical Workers about the about the purpose of its § 220 complaint. “You are trying to ascertain if there are red flags that they board should have known” or did know about “but did nothing about?” Holland said.
Grant agreed, adding that communications and documents relating to internal auditors, audit committee member, internal investigators and former Wal-Mart compliance officer Maritza Munich are also needed to make that determination.
Justice Carolyn Berger emphasized that IBEW should be only entitled to documents that meet the “necessary and essential” standard. Berger expressed concern that what the IBEW wanted goes too far for the § 220 stage. “The description of what you would get sounds a lot like what you would get in normal discovery,” she said.
Stuart H. Deming, founder of Deming PLLC, suggests that the case could have sweeping ramifications for corporate compliance programs.
“A decision enforcing the rights of shareholders in this context should certainly heighten the sensitivity of boards of directors to their obligations under Caremark,” Deming, who represents foreign and domestic companies in a range of compliance matters.
Even if the case does not fundamentally change the Caremark analysis, some believe it will have important implications for boards of directors.
According to Mr. Deming, “even if an opinion is issued that does not enforce the rights of shareholders in the context of the circumstance associated with Wal-Mart, the mere fact that the issue has been raised is likely, at least in the short run, to have an impact in heightening the sensitivity of boards of directors to compliance obligations.”
It is beyond doubt that the Caremark decision could use amplification. As corporate compliance becomes the focus of increased attention, guidance as to what constitutes adequate oversight could help both boards and shareholders.