J&J Wins Shareholder Suit Over Board Misconduct

J&J Wins Shareholder Suit Over Board Misconduct

October 5th, 2011 // 12:23 pm @ jmpickett

A federal court judge has tossed a so-called derivate lawsuit in which a group of Johnson & Johnson shareholders charged that the health care giant’s board of directors breached their fiduciary duty, despite a series of red flags in the form of FDA warning letters; government subpoenas; a criminal plea to kickback charges; whistleblower lawsuits; product recalls and off-label marketing.

In arguing their case, the shareholders alleged that J&J directors “had substantial knowledge relating to the allegations…and knowingly permitted the company to continue to pursue its unlawful and unethical business practices and strategies” (look here for the back story, where you can read the original lawsuit, as well).

The lawsuit attempted to string together a series of gaffes, blunders and bad behavior that have kept J&J in the headlines for the past couple of years and eroded its venerable image among consumers, doctors and investors. Amid the chaos, jobs were eliminated; sales were lost; a plant is being retooled, and ceo Bill Weldon (see photo) was often urged to resign.

A derivative suit, by the way, is brought on behalf of a corporation against an insider – in this case, the J&J directors – and the shareholders argued that liability prevented a majority of board members from being disinterested and complying with their demand to pursue litigation. In other words, they were unable or unwilling to exercise independent judgment.

A J&J special committee last July had already concluded that there were no red flags or indications of systemic failure that were overlooked by the board or executive team and, for that reason, declined to proceed with the litigation. The lawyers for the shareholders seized on this rejection as yet another reason why the J&J board was not independent (back story).

However, US District Court Judge Freda Wolfson picked apart the “troubling and pervasive” charges and determined that the plaintiffs “failed to allege that the directors acted in bad faith to violate their fiduciary duties.” She also ruled the lawsuit did not include enough specific information to meet a higher standard of scrutiny required, because concerns were not first brought to the J&J board.

And in response to charges that too many J&J directors were conflicted by liability, Wolfson wrote that she “does not find a sufficient basis for inferring that a majority of the directors faced a substantial likelihood of personal liability in connection with what appears to be serious corporate misconduct on J&J’s part.” She also chastised the shareholders for confusing directors with officers, which she called a “grave error.”

She then took 67 pages to pick apart the arguments made by the shareholders (here is the opinion). As one example, Wolfson pointed to subpoenas issued in 2005 in connection with a government investigation into alleged kickbacks involving the Omnicare nursing home operator. The shareholders claim the board knew about the subpoenas because two directors also sat on a policy committee. But she maintained the entire board would not have necessarily known about alleged misconduct.

“…there are no allegations regarding meeting dates, who was actually present at the meetings, or what subjects were discussed. Without this sort of factual detail, the court cannot infer that a majority of the board knew about the substance of the 2005 subpoenas, or any other subpoenas or government investigations disclosed in the 10-Ks, for that matter.”

She goes on to write that “as to this red flag, the pertinent question is not whether the board knew about the subpoena, but whether the subpoena is a determination of wrongdoing. At least one court has suggested that subpoenas, and other forms of preliminary matters in an investigation of corporate misconduct, do not shed light on whether the corporation actually engaged in misconduct.

“I find this reasoning persuasive because such red flags do not suggest that a board was aware of corporate misconduct – they suggest only that the board was aware that the company was under investigation.” She acknowledged that a director’s knowledge of a subpoena may be considered, but “…it is insufficient on its own to demonstrate that the directors were not independent and disinterested.”

Source: Pharmalot