Joseph A. Rosenthal, and Herbert W. Mondros, Rosenthal, Monhait, Gross & Goddess, P.A., Wilmington, DE; Arthur N. Abby (argued), of Abbey Gardy, LLP, New York City; Schiffrin & Barroway, LLP, Bala Cynwyd, PA, of counsel, for Appellants.

Robert K. Payson, and Donald J. Wolfe, Jr., of Potter Anderson & Corroon, Wilmington, DE; David C. McBride (argued), and John J. Paschetto, of Young Conaway Stargatt & Taylor, LLP, Wilmington, DE; Paul K. Rowe, of Wachtell, Lipton, Rosen & Katz, New York City; Alan S. Goudiss, of Sherman & Sterling, New York City, of counsel, for Appellees.

[1033] Before VEASEY, Chief Justice, HOLLAND, BERGER, STEELE and JACOBS, Justices, constituting the Court en Banc.

[1032] VEASEY, Chief Justice:

Plaintiff-stockholders brought a purported class action in the Court of Chancery, alleging that the members of the board of directors of their corporation breached their fiduciary duties by agreeing to a 22-day delay in closing a proposed merger. Plaintiffs contend that the delay harmed them due to the lost time-value of the cash paid for their shares. The Court of Chancery granted the defendants' motion to dismiss on the sole ground that the claims were, "at most," claims of the corporation being asserted derivatively. They were, thus, held not to be direct claims of the stockholders, individually. Thereupon, the Court held that the plaintiffs lost their standing to bring this action when they tendered their shares in connection with the merger.

Although the trial court's legal analysis of whether the complaint alleges a direct or derivative claim reflects some concepts in our prior jurisprudence, we believe those concepts are not helpful and should be regarded as erroneous. We set forth in this Opinion the law to be applied henceforth in determining whether a stockholder's claim is derivative or direct. That issue must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stock-holders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stock-holders, individually)?

To the extent we have concluded that the trial court's analysis of the direct vs. derivative dichotomy should be regarded as erroneous, we view the error as harmless in this case because the complaint does not set forth any claim upon which relief can be granted. In its opinion, the Court of Chancery properly found on the facts pleaded that the plaintiffs have no separate contractual right to the alleged lost time-value of money arising out of extensions in the closing of a tender offer. These extensions were made in connection with a merger where the plaintiffs' right to any payment of the merger consideration had not ripened at the time the extensions were granted. No other individual right of these stockholders having been asserted in the complaint, it was correctly dismissed.

In affirming the judgment of the trial court as having correctly dismissed the complaint, we reverse only its dismissal with prejudice.^[1] We remand this action to the Court of Chancery with directions to amend its order of dismissal to provide that: (a) the action is dismissed for failure to state a claim upon which relief can be granted; and (b) that the dismissal is without prejudice. Thus, plaintiffs will have an opportunity to replead, if warranted under Court of Chancery Rule 11.

Facts

Patrick Tooley and Kevin Lewis are former minority stockholders of Donaldson, Lufkin & Jenrette, Inc. (DLJ), a Delaware corporation engaged in investment banking. DLJ was acquired by Credit Suisse Group (Credit Suisse) in the Fall of 2000. Before that acquisition, AXA Financial, Inc.(AXA), which owned 71% of DLJ stock, controlled DLJ. Pursuant to a stockholder agreement between AXA and Credit Suisse, AXA agreed to exchange with Credit Suisse its DLJ stockholdings for a mix of stock and cash. The consideration [1034] received by AXA consisted primarily of stock. Cash made up one-third of the purchase price. Credit Suisse intended to acquire the remaining minority interests of publicly-held DLJ stock through a cash tender offer, followed by a merger of DLJ into a Credit Suisse subsidiary.

The tender offer price was set at $90 per share in cash. The tender offer was to expire 20 days after its commencement. The merger agreement, however, authorized two types of extensions. First, Credit Suisse could unilaterally extend the tender offer if certain conditions were not met, such as SEC regulatory approvals or certain payment obligations. Alternatively, DLJ and Credit Suisse could agree to postpone acceptance by Credit Suisse of DLJ stock tendered by the minority stockholders.

Credit Suisse availed itself of both types of extensions to postpone the closing of the tender offer. The tender offer was initially set to expire on October 5, 2000, but Credit Suisse invoked the five-day unilateral extension provided in the agreement. Later, by agreement between DLJ and Credit Suisse, it postponed the merger a second time so that it was then set to close on November 2, 2000.

Plaintiffs challenge the second extension that resulted in a 22-day delay. They contend that this delay was not properly authorized and harmed minority stockholders while improperly benefitting AXA. They claim damages representing the time-value of money lost through the delay.

The Decision of the Court of Chancery

The order of the Court of Chancery dismissing the complaint, and the Memorandum Opinion upon which it is based,^[2] state that the dismissal is based on the plaintiffs' lack of standing to bring the claims asserted therein. Thus, when plaintiffs tendered their shares, they lost standing under Court of Chancery Rule 23.1, the contemporaneous holding rule. The ruling before us on appeal is that the plaintiffs' claim is derivative, purportedly brought on behalf of DLJ. The Court of Chancery, relying upon our confusing jurisprudence on the direct/derivative dichotomy, based its dismissal on the following ground: "Because this delay affected all DLJ shareholders equally, plaintiffs' injury was not a special injury, and this action is, thus, a derivative action, at most."^[3]

Plaintiffs argue that they have suffered a "special injury" because they had an alleged contractual right to receive the merger consideration of $90 per share without suffering the 22-day delay arising out of the extensions under the merger agreement. But the trial court's opinion convincingly demonstrates that plaintiffs had no such contractual right that had ripened at the time the extensions were entered into:

Here, it is clear that plaintiffs have no separate contractual right to bring a direct claim, and they do not assert contractual rights under the merger agreement. First, the merger agreement specifically disclaims any persons as being third party beneficiaries to the contract. Second, any contractual shareholder right to payment of the merger consideration did not ripen until the conditions of the agreement were met. The agreement stated that Credit Suisse Group was not required to accept any shares for tender, or could extend the offer, under certain conditions — one condition of which included an extension or termination by agreement between [1035] Credit Suisse Group and DLJ. Because Credit Suisse Group and DLJ did in fact agree to extend the tender offer period, any right to payment plaintiffs could have did not ripen until this newly negotiated period was over. The merger agreement only became binding and mutually enforceable at the time the tendered shares ultimately were accepted for payment by Credit Suisse Group. It is at that moment in time, November 3, 2000, that the company became bound to purchase the tendered shares, making the contract mutually enforceable. DLJ stockholders had no individual contractual right to payment until November 3, 2000, when their tendered shares were accepted for payment. Thus, they have no contractual basis to challenge a delay in the closing of the tender offer up until November 3. Because this is the date the tendered shares were accepted for payment, the contract was not breached and plaintiffs do not have a contractual basis to bring a direct suit.^[4]

Moreover, no other individual right of these stockholder-plaintiffs was alleged to have been violated by the extensions.

That conclusion could have ended the case because it portended a definitive ruling that plaintiffs have no claim whatsoever on the facts alleged. But the defendants chose to argue, and the trial court chose to decide, the standing issue, which is predicated on an assertion that this claim is a derivative one asserted on behalf of the corporation, DLJ.

The Court of Chancery correctly noted that "[t]he Court will independently examine the nature of the wrong alleged and any potential relief to make its own determination of the suit's classification.... Plaintiffs' classification of the suit is not binding."^[5] The trial court's analysis was hindered, however, because it focused on the confusing concept of "special injury" as the test for determining whether a claim is derivative or direct. The trial court's premise was as follows:

In order to bring a direct claim, a plaintiff must have experienced some "special injury." [citing Lipton v. News Int'l, 514 A.2d 1075, 1079 (Del.1986)]. A special injury is a wrong that "is separate and distinct from that suffered by other shareholders, ... or a wrong involving a contractual right of a shareholder, such as the right to vote, or to assert majority control, which exists independently of any right of the corporation." [citing Moran v. Household Int'l. Inc., 490 A.2d 1059, 1070 (Del.Ch.1985), aff'd 500 A.2d 1346 (Del.1986 [1985])].^[6]

In our view, the concept of "special injury" that appears in some Supreme Court and Court of Chancery cases is not helpful to a proper analytical distinction between direct and derivative actions. We now disapprove the use of the concept of "special injury" as a tool in that analysis.

The Proper Analysis to Distinguish Between Direct and Derivative Actions

The analysis must be based solely on the following questions: Who suffered the alleged harm — the corporation or the suing stockholder individually — and who would receive the benefit of the recovery or other remedy? This simple analysis is well imbedded in our jurisprudence,^[7] but some cases have complicated it by injection of the amorphous and confusing concept of "special injury."

[1036] The Chancellor, in the very recent Agostino case,^[8] correctly points this out and strongly suggests that we should disavow the concept of "special injury." In a scholarly analysis of this area of the law, he also suggests that the inquiry should be whether the stockholder has demonstrated that he or she has suffered an injury that is not dependent on an injury to the corporation. In the context of a claim for breach of fiduciary duty, the Chancellor articulated the inquiry as follows: "Looking at the body of the complaint and considering the nature of the wrong alleged and the relief requested, has the plaintiff demonstrated that he or she can prevail without showing an injury to the corporation?"^[9] We believe that this approach is helpful in analyzing the first prong of the analysis: what person or entity has suffered the alleged harm? The second prong of the analysis should logically follow.

A Brief History of Our Jurisprudence

The derivative suit has been generally described as "one of the most interesting and ingenious of accountability mechanisms for large formal organizations."^[10] It enables a stockholder to bring suit on behalf of the corporation for harm done to the corporation.^[11] Because a derivative suit is being brought on behalf of the corporation, the recovery, if any, must go to the corporation. A stockholder who is directly injured, however, does retain the right to bring an individual action for injuries affecting his or her legal rights as a stockholder. Such a claim is distinct from an injury caused to the corporation alone. In such individual suits, the recovery or other relief flows directly to the stockholders, not to the corporation.

Determining whether an action is derivative or direct is sometimes difficult and has many legal consequences, some of which may have an expensive impact on the parties to the action.^[12] For example, if an action is derivative, the plaintiffs are then required to comply with the requirements of Court of Chancery Rule 23.1, that the stockholder: (a) retain ownership of the shares throughout the litigation; (b) make presuit demand on the board; and (c) obtain court approval of any settlement. Further, the recovery, if any, flows only to the corporation. The decision whether a suit is direct or derivative may be out-come-determinative. Therefore, it is necessary that a standard to distinguish such actions be clear, simple and consistently articulated and applied by our courts.

In Elster v. American Airlines, Inc.,^[13] the stockholder sought to enjoin the grant and exercise of stock options because they [1037] would result in a dilution of her stock personally. In Elster, the alleged injury was found to be derivative, not direct, because it was essentially a claim of mismanagement of corporate assets. Then came the complication in the analysis: The Court held that where the alleged injury is to both the corporation and to the stockholder, the stockholder must allege a "special injury" to maintain a direct action. The Court did not define "special injury," however. By implication, decisions in later cases have interpreted Elster to mean that a "special injury" is alleged where the wrong is inflicted upon the stockholder alone or where the stockholder complains of a wrong affecting a particular right. Examples would be a preemptive right as a stockholder, rights involving control of the corporation or a wrong affecting the stockholder, qua individual holder, and not the corporation.^[14]

In Bokat v. Getty Oil Co.,^[15] a stockholder of a subsidiary brought suit against the director of the parent corporation for causing the subsidiary to invest its resources wastefully, resulting in a loss to the subsidiary.^[16] The claim in Bokat was essentially for mismanagement of corporate assets. Therefore, the Court held that any recovery must be sought on behalf of the corporation, and the claim was, thus, found to be derivative.

In describing how a court may distinguish direct and derivative actions, the Bokat Court stated that a suit must be maintained derivatively if the injury falls equally upon all stockholders. Experience has shown this concept to be confusing and inaccurate. It is confusing because it appears to have been intended to address the fact that an injury to the corporation tends to diminish each share of stock equally because corporate assets or their value are diminished. In that sense, the indirect injury to the stockholders arising out of the harm to the corporation comes about solely by virtue of their stockholdings. It does not arise out of any independent or direct harm to the stockholders, individually. That concept is also inaccurate because a direct, individual claim of stockholders that does not depend on harm to the corporation can also fall on all stockholders equally, without the claim thereby becoming a derivative claim.

In Lipton v. News International, Plc.,^[17] this Court applied the "special injury" test. There, a stockholder began acquiring shares in the defendant corporation presumably to gain control of the corporation. In response, the defendant corporation agreed to an exchange of its shares with a friendly buyer. Due to the exchange and a supermajority voting requirement on certain stockholder actions, the management of the defendant corporation acquired a veto power over any change in management.

The Lipton Court concluded that the critical analytical issue in distinguishing direct and derivative actions is whether a "special injury" has been alleged. There, the Court found a "special injury" because the board's manipulation worked an injury upon the plaintiff-stockholder unlike the injury suffered by other stockholders. That was because the plaintiff-stockholder was actively seeking to gain control of the [1038] defendant corporation.^[18] Therefore, the Court found that the claim was direct. Ironically, the Court could have reached the same correct result by simply concluding that the manipulation directly and individually harmed the stockholders, without injuring the corporation.

In Kramer v. Western Pacific Industries, Inc.,^[19] this Court found to be derivative a stockholder's challenge to corporate transactions that occurred six months immediately preceding a buy-out merger. The stockholders challenged the decision by the board of directors to grant stock options and golden parachutes to management. The stockholders argued that the claim was direct because their share of the proceeds from the buy-out sale was reduced by the resources used to pay for the options and golden parachutes. Once again, our analysis was that to bring a direct action, the stockholder must allege something other than an injury resulting from a wrong to the corporation. We interpreted Elster to require the court to determine the nature of the action based on the "nature of the wrong alleged" and the relief that could result.^[20] That was, and is, the correct test. The claim in Kramer was essentially for mismanagement of corporate assets. Therefore, we found the claims to be derivative. That was the correct outcome.^[21]

In Grimes v. Donald,^[22] we sought to distinguish between direct and derivative actions in the context of employment agreements granted to certain officers that allegedly caused the board to abdicate its authority. Relying on the Elster and Kramer precedents that the court must look to the nature of the wrong and to whom the relief will go,^[23] we concluded that the plaintiff was not seeking to recover any damages for injury to the corporation. Rather, the plaintiff was seeking a declaration of the invalidity of the agreements on the ground that the board had abdicated its responsibility to the stockholders.^[24] Thus, based on the relief requested, we affirmed the judgment of the Court of Chancery that the plaintiff was entitled to pursue a direct action.

Grimes was followed by Parnes v. Bally Entertainment Corp., which held, among other things, that the injury to the stockholders must be "independent of any injury to the corporation."^[25] As the Chancellor correctly noted in Agostino, neither Grimes nor Parnes applies the purported "special injury" test.^[26]

Thus, two confusing propositions have encumbered our caselaw governing the direct/derivative distinction. The "special injury" concept, applied in cases such as Lipton, can be confusing in identifying the nature of the action. The same is true of the proposition that stems from Bokat — that an action cannot be direct if all stockholders are equally affected or unless the [1039] stockholder's injury is separate and distinct from that suffered by other stockholders. The proper analysis has been and should remain that stated in Grimes; Kramer and Parnes. That is, a court should look to the nature of the wrong and to whom the relief should go. The stockholder's claimed direct injury must be independent of any alleged injury to the corporation. The stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.

Standard to Be Applied in This Case

In this case it cannot be concluded that the complaint alleges a derivative claim. There is no derivative claim asserting injury to the corporate entity. There is no relief that would go the corporation. Accordingly, there is no basis to hold that the complaint states a derivative claim.

But, it does not necessarily follow that the complaint states a direct, individual claim. While the complaint purports to set forth a direct claim, in reality, it states no claim at all. The trial court analyzed the complaint and correctly concluded that it does not claim that the plaintiffs have any rights that have been injured.^[27] Their rights have not yet ripened. The contractual claim is nonexistent until it is ripe, and that claim will not be ripe until the terms of the merger are fulfilled, including the extensions of the closing at issue here. Therefore, there is no direct claim stated in the complaint before us.

Accordingly, the complaint was properly dismissed. But, due to the reliance on the concept of "special injury" by the Court of Chancery, the ground set forth for the dismissal is erroneous, there being no derivative claim. That error is harmless, however, because, in our view, there is no direct claim either.

Conclusion

For purposes of distinguishing between derivative and direct claims, we expressly disapprove both the concept of "special injury" and the concept that a claim is necessarily derivative if it affects all stockholders equally. In our view, the tests going forward should rest on those set forth in this opinion.

We affirm the judgment of the Court of Chancery dismissing the complaint, although on a different ground from that decided by the Court of Chancery. We reverse the dismissal with prejudice and remand this matter to the Court of Chancery to amend the order of dismissal: (a) to state that the complaint is dismissed on the ground that it does not state a claim upon which relief can be granted; and (b) that the dismissal is without prejudice.

Because our determination that there is no valid claim whatsoever in the complaint before us was not argued^[28] by the defendants and was not the basis of the ruling of the Court of Chancery,^[29] the interests of justice will be best served if the dismissal is without prejudice, and plaintiffs have an opportunity to replead if they have a basis [1040] for doing so under Court of Chancery Rule 11. This result — permitting plaintiffs to replead — is unusual, but not unprecedented.^[30]

It is ordered that the time within which a motion for reargument may be timely filed under Supreme Court Rule 18 is shortened to five days from the date of this opinion. This is due to the impending change in the composition of the Supreme Court, arising from the retirement of the Chief Justice in April 2004.

[1] Since the order of dismissal here did not state that it was without prejudice, it is deemed to operate as an adjudication upon the merits. See Court of Chancery Rule 41(b)(2).

[2] Tooley v. Donaldson Lufkin and Jenrette, No. Civ. A. 18414-NC, 2003 WL 203060 (Del.Ch. Jan. 21, 2003).

[3] Id. at *4.

[4] Id. at *3 (footnotes omitted (emphasis added)).

[5] Id.

[6] Id.

[7] See, e.g., Kramer v. Western Pacific Industries, Inc., 546 A.2d 348 (Del.1988).

[8] Agostino v. Hicks, No. Civ. A. 20020-NC, 2004 WL 443987 (Del.Ch. March 11, 2004).

[9] Agostino, 2004 WL 443987, at * 7. The Chancellor further explains that the focus should be on the person or entity to whom the relevant duty is owed. Id. at *7 n. 54. As noted in Agostino, id., this test is similar to that articulated by the American Law Institute (ALI), a test that we cited with approval in Grimes v. Donald, 673 A.2d 1207 (Del. 1996). The ALI test is as follows:

A direct action may be brought in the name and right of a holder to redress an injury sustained by, or enforce a duty owed to, the holder. An action in which the holder can prevail without showing an injury or breach of duty to the corporation should be treated as a direct action that may be maintained by the holder in an individual capacity.

2 American Law Institute, PRINCIPLES OF CORPORATE GOVERNANCE ANALYSIS AND RECOMMENDATIONS § 7.01(b) at 17.

[10] Kramer v. Western Pacific Industries, Inc., 546 A.2d at 351 (quoting R. Clark, Corporate Law 639-40 (1986)).

[11] Id.

[12] Grimes v. Donald, 673 A.2d at 1213 (Del. 1996).

[13] 100 A.2d 219, 222 (Del.Ch.1953).

[14] See Lipton v. News International, Plc., 514 A.2d 1075, 1078 (Del.1986); Moran v. Household International Inc., 490 A.2d 1059, 1069-70 (Del.Ch.1985) (to distinguish a direct and derivative action, injury must be separate and distinct from that suffered by other stockholders or involve a contractual right independent of the corporation).

[15] 262 A.2d 246 (Del.1970).

[16] Id. at 249.

[17] Lipton, 514 A.2d at 1078.

[18] Id.

[19] 546 A.2d 348, 352 (Del.1988).

[20] Id.

[21] In the Tri-Star case, however, this Court lapsed back into the "special injury" concept, which we now discard. In re Tri-Star Pictures, Inc. Litigation, 634 A.2d 319, 330 (1993).

[22] 673 A.2d 1207, 1213 (Del.1996).

[23] Elster, 100 A.2d at 221-23; Kramer, 546 A.2d at 351. See also John W. Welch, Shareholder Individual and Derivative Actions: Underlying Rationales and the Closely Held Corporation, 9 J. Corp. L. 147, 160 (1984) (stating that courts should analyze the rights involved to determine whether the action is direct or derivative).

[24] Grimes, 673 A.2d at 1213.

[25] 722 A.2d 1243, 1245 (Del.1999).

[26] Agostino, 2004 WL 443987, at *6 n. 49.

[27] Tooley, 2003 WL 203060, at *3.

[28] As we have noted, the opinion of the trial court clearly stated that plaintiffs did not have a contractual right that had ripened. Tooley, 2003 WL 203060, at *3. On appeal, appellees cited twice to the trial court's conclusion that there was no contractual right, but it was in the context of the derivative/direct claim issue. (Appellees' Answering Brief at pp. 3, 17-18). On appeal, plaintiffs-appellants do not challenge the trial court's finding. Moreover, inexplicably, plaintiffs-appellants filed no reply brief in this Court.

[29] See, Unitrin, Inc. v. American General Corp., 651 A.2d 1361, 1390 (Del.1995) (decision of Supreme Court reversing trial court based on different grounds than that argued on appeal).

[30] Compare Brehm v. Eisner, 746 A.2d 244, 267 (Del.1999) (permitting plaintiffs to proceed because of the unique circumstances noted there), with White v. Panic, 783 A.2d 543, 556 (Del.2001) (declining to permit plaintiffs to replead, there being no circumstances justifying such action).

906 A.2d 91 (2006)

John A. GENTILE, Victoria S. Cashman, Bradley T. Martin, John Knight, and Dyad Partners, LLC, Plaintiffs Below, Appellants,
v.
Pasquale David ROSSETTE, Douglas W. Bachelor, and LeaseNet Group, Inc., an Ohio Corporation, as by merger to LeaseNet Group, Inc., a Delaware corporation, Defendants Below, Appellees.

No. 573, 2005.
Supreme Court of Delaware.
Submitted: April 26, 2006.
Decided: August 17, 2006.

David A. Jenkins (argued), Joelle E. Polesky, Robert K. Beste, III, and Michele C. Gott, Esquires, of Smith, Katzenstein & Furlow LLP, Wilmington, Delaware; John L. Reed, Esquire, of Edwards & Angell Palmer & Dodge, LLP, Wilmington, Delaware; for Appellants.

Jesse A. Finkelstein, Raymond J. DiCamillo and Michael R. Robinson, Esquires, of Richards, Layton & Finger, P.A., Wilmington, Delaware; Of Counsel: Sean T. Carnathan (argued) and Alan J. Langton II, Esquires, of O'Connor, Carnathan and Mack LLC, Burlington, Massachusetts; for Appellees.

Before HOLLAND, BERGER and JACOBS, Justices.

[93] JACOBS, Justice.

The plaintiffs, who are former minority shareholders of SinglePoint Financial, Inc. ("SinglePoint" or "the company"), appeal from a grant of summary judgment by the Court of Chancery dismissing their claim for breach of fiduciary duty against SinglePoint's former directors and its CEO/controlling stockholder. The claim arises from a self-dealing transaction in which the CEO/controlling stockholder forgave the corporation's debt to him, in exchange for being issued stock whose value allegedly exceeded the value of the forgiven debt. The transaction, it is claimed, wrongfully reduced the cash-value and the voting power of the public stockholders' minority interest, and increased correspondingly the value and voting power of the controller's majority interest. After the debt conversion, SinglePoint was later acquired by another company ("Cofiniti") in a merger. Shortly thereafter, the acquirer, Cofiniti, filed for bankruptcy and was liquidated. The plaintiffs then brought this action in the Court of Chancery, seeking to recover the value of which they claimed to have been wrongfully deprived in the debt conversion. The Court of Chancery dismissed the action on the ground that the claim was exclusively derivative, and that as a result of the Cofiniti merger the plaintiffs had lost standing to assert the claim on behalf of SinglePoint.

The issue presented on this appeal is one purely of law: can SinglePoint's former minority stockholders bring a direct claim against the fiduciaries responsible for the debt conversion transaction complained of, or is such a claim exclusively derivative? We hold, for the reasons discussed herein, that the claim is not exclusively derivative and can be brought by the (former) minority shareholders directly. We must, therefore, reverse the contrary ruling of the Court of Chancery.

[94] I. FACTS^[1]

In 1995, plaintiff John A. Gentile and defendant Douglas W. Bachelor, who were acquaintances and co-workers, discussed creating a new software company. Late that year, Gentile and Bachelor presented the idea to Pasquale David Rossette, a childhood friend of Gentile, who agreed to provide the initial investment. Ultimately, Gentile, Rossette, and Bachelor formed the company that came to be known as SinglePoint—a high technology financial services company that supported financial advisors and their clients with the ability to manage assets online. During its relatively short existence, SinglePoint was unable to develop a commercially viable product or produce significant revenues. Faced with significant financial difficulties throughout its existence, SinglePoint turned to Rossette, who was the company's sole source of additional capital, for financial assistance on several occasions.

Gentile, Rossette and Bachelor served as SinglePoint's initial directors. Gentile was SinglePoint's first President and Chief Executive Officer, and Bachelor was its Chief Technology Officer. When SinglePoint encountered difficulties, it relied on Rossette for more funding. In 1998, after providing several cash infusions for the company, Rossette insisted that Gentile be replaced as President before he (Rossette) would supply any more funding. Gentile's replacement, Christopher McGrath, resigned less than one year later, and Bachelor became the new CEO. SinglePoint's financial woes continued, however, and in April 1999, Rossette decided to take over as CEO, a position he held for the remainder of SinglePoint's existence.

By March 2000, Rossette had advanced over $3 million to SinglePoint. As consideration for those loans, Rossette received promissory notes that were convertible into shares of SinglePoint common stock. As provided in the governing Stock Purchase Agreement, the original conversion rate was $1.33 of debt per share. On November 1, 1999, the conversion rate was reduced to $0.75 of debt per share, and on October 23, 1999, the conversion rate was reduced to $0.50 of debt per share.

Before March 2000, SinglePoint's capital structure consisted principally of almost 6 million outstanding shares of common stock, plus over $3 million of debt owed to Rossette. By March 2000, Rossette concluded that the level of the company's debt to him was deterring third party investment in SinglePoint. Accordingly, Rossette decided to convert all but $1 million (about 2/3) of his SinglePoint debt into equity. The resulting debt conversion transaction is what gave rise to the plaintiffs' claim for breach of fiduciary duty.

At the time of the debt conversion, Rossette and Bachelor were SinglePoint's only two directors. Bachelor and Rossette negotiated the terms of the conversion, with Rossette purporting to represent himself individually, and Bachelor purporting to represent the company. Disregarding the contractual conversion rate of $0.50 of debt per share then in effect, Rossette and Bachelor agreed to a significantly lower conversion rate—$0.05 of debt per share. They next convened a board meeting (as the company's sole directors), and in that capacity they agreed that $2,220,951 of Rossette's debt would be converted into SinglePoint equity at the $0.05 per share rate. On that basis, Rossette would receive over 44 million shares of SinglePoint common stock—40 million shares more than he would have received under the [95] contractual conversion rate of $0.50 per share.

Because the proposed debt conversion required issuing more shares of common stock than were currently authorized, a special shareholders meeting was held to amend SinglePoint's certificate of incorporation. The shareholders were informed of the proposal to authorize additional shares, but were not informed of the underlying purpose—to convert over $2.2 million of the Rossette debt to equity. At the March 27, 2000 special shareholders meeting, the shareholders approved an increase of authorized shares of SinglePoint common stock from 10 million to 60 million shares, thereby enabling the conversion to occur. Before the conversion, Rossette held approximately 61.19% of the company's equity; after the conversion, he held 93.49%.^[2] As a result, the minority shareholders' interest was reduced correspondingly, from 38.81% to 6.51%.

After the debt conversion, SinglePoint began searching for an acquirer. In May 2000, only two months later, Rossette negotiated a merger with Cofiniti (SinglePoint's only direct competitor) in which Cofiniti would acquire SinglePoint. Under the agreed-upon merger terms, SinglePoint shareholders would receive approximately 0.49 shares of Cofiniti common stock for each share of SinglePoint common stock, and SinglePoint would become a wholly-owned subsidiary of Cofiniti.

To secure Rossette's approval of the merger, Cofiniti offered Rossette unique benefits. That did not occur fortuitously. Rossette made it clear that "for me to accept the terms and conditions of the Merger as set forth they [Cofiniti] would have to provide me the proper inducement to do so." The side benefits offered to Rossette included a put agreement requiring Cofiniti, after one year, to repurchase 360,000 shares of Cofiniti stock that Rossette had received in the merger, at $5 a share, for a total of $1.8 million. That put agreement had significant value, because Cofiniti's stock had no public market and, therefore, could not easily be sold. No other stockholder of SinglePoint was afforded similar "side benefit" treatment.

On October 13, 2000, SinglePoint issued an Information Statement informing shareholders of the upcoming merger with Cofiniti. The shareholders were told that "approval of the merger is assured because several of our large stockholders, representing in the aggregate approximately 96.8% of our outstanding common stock, have agreed to vote their shares in favor of the merger." The Information Statement further disclosed that Rossette had converted over $1 million of the debt the company owed him into SinglePoint stock. The Information Statement did not disclose that the actual amount of the converted debt was over $2.2 million, or the number of shares that were issued to Rossette in the debt conversion, or at what price. Nor did the Information Statement disclose the put agreement that Rossette had received from Cofiniti, or that the put agreement was what induced his approval of the merger, or that one year after the merger Rossette would receive $1.8 million. The merger was approved by a majority of the minority shareholders. The plaintiffs did not consent to, nor did they vote for, the merger, which closed on October 23, 2000.

Within 18 months of the merger, Cofiniti was fatally undone by many of the same [96] problems that had afflicted SinglePoint. On March 11, 2002, Cofiniti was forced to file for bankruptcy and, ultimately, to liquidate.^[3]

Almost one year earlier, on February 15, 2001, the plaintiffs brought an appraisal action in the Court of Chancery, seeking a determination of the fair value of their SinglePoint stock at the time of the Cofiniti merger. The Court of Chancery determined that the fair value of SinglePoint's common stock was $5.51 a share—110 times the per-share value ascribed to those SinglePoint shares in the debt conversion. The Court of Chancery refused, however, to entertain the minority stockholders' claims that their shares had been improperly diluted by the issuance of excessive shares to Rossette in the debt conversion. That dilution claim, the Court held, was not cognizable in an appraisal proceeding, because the claim was not one for waste that belonged to (and thus would be treated as an asset of) the corporation:

I also reject the Petitioners' arguments to the extent that they attempt to recharacterize the Share Dilution Claim as a claim for corporate waste, and thereby have the value of such a derivative claim added into the total enterprise value of SinglePoint as an asset of the Company. . . . The Petitioners cannot escape the rule and policy concerns set forth by the Supreme Court in Cavalier Oil by merely switching the label on what, in essence, is a claim for share dilution.^[4]

On March 27, 2003, the plaintiffs commenced this breach of fiduciary duty action in the Court of Chancery challenging (in Count I) the debt conversion as an improper extraction of the economic value and voting power from their minority interest, and (in Count II) the unique "put" benefits Rossette had received to induce his approval of the Cofiniti merger. The defendants moved for summary judgment on the ground that the plaintiffs' claims were derivative in nature, and that as a result of the Cofiniti merger the plaintiffs had lost standing to bring those claims. The defendants also argued that they were entitled to judgment as a matter of law on the substantive merits of the plaintiffs' claims. In a decision handed down on October 20, 2005, the Court of Chancery dismissed the plaintiffs' debt conversion claim (Count I). The Court held (somewhat inconsistently with its ruling in the appraisal action) that the claim was derivative and that the plaintiffs had lost standing to raise it.^[5] Thereafter, the Court of Chancery granted the plaintiffs' motion to certify an interlocutory appeal from its order dismissing the debt conversion claim. This Court accepted that interlocutory appeal.

II. THE COURT OF CHANCERY DECISION

In its October 20, 2005 opinion,^[6] the Court of Chancery held that the debt conversion claim was derivative, and that as a result of the 2000 merger with Cofiniti, the plaintiffs were no longer SinglePoint shareholders with standing to assert the corporation's claim. The Court held that the dilution claim was derivative, because "when a `board of directors authorizes the issuance of stock for no or grossly inadequate [97] consideration, the corporation is directly injured and shareholders are injured derivatively . . . [and that] mere claims of dilution, without more, cannot convert a claim traditionally understood as derivative, into a direct one.'"^[7] Although the Court of Chancery acknowledged that a share dilution claim may be brought as a direct claim where voting rights are harmed because of the dilution,^[8] it held that, to give rise to a direct claim, the dilution must result in a "material decrease" in voting power. Here, the Vice Chancellor held, there was no "material" decrease in voting power, because the plaintiffs were minority shareholders of SinglePoint both before and after the debt conversion.

The trial court reasoned that the gist of the plaintiffs' debt conversion claim was that SinglePoint was caused to sell its shares too cheaply, and as a result was deprived of the opportunity to sell those shares for a better price.^[9] Because that loss of opportunity was suffered only by the company, and because any remedy— either to cancel the "excess" shares issued to Rossette or to require Rossette to restore their fair value—would benefit only the company, the claim was derivative under the analysis mandated by Tooley v. Donaldson, Lufkin & Jenrette, Inc. ("Tooley").^[10]Accordingly, the Court of Chancery granted summary judgment dismissing the plaintiffs' debt conversion claim. On appeal from a grant of summary judgment, our review is de novo.^[11]

III. THE PARTIES' CONTENTIONS

This appeal concerns only the grant of summary judgment dismissing the claim for breach of fiduciary duty arising out of the debt conversion.^[12] The issue that we must decide is whether that claim was exclusively derivative in character. If it was, then the summary judgment grant must be affirmed; if not, then the summary judgment must be reversed.

The defendant-appellees argue that the plaintiffs' debt conversion fiduciary duty claim is exclusively derivative, and that the Vice Chancellor correctly so held. UnderTooley,^[13] whether a claim is derivative or direct depends solely upon two questions: "(1) who suffered the alleged harm (the corporation or the suing stockholders individually); and (2) who would receive the benefit of the recovery or other remedy (the corporation or the stockholders, individually)?"^[14]

Here, the defendants maintain, the only harm arguably resulting from the debt conversion was to the corporation, because in essence, the debt conversion claim is that SinglePoint was caused to overpay for the debt forgiveness. More specifically, the claim is that the debt conversion rate [98] ($.05 per share) was unfair and resulted in SinglePoint issuing "vastly more stock [to Rossette] than it should have."^[15] No harm from that overpayment resulted to any stockholder individually (defendants argue), because to the extent the overpayment invalidly increased the number of outstanding shares, the resulting dilution affected each and all of the pre-debt conversion shares identically—including the shares owned by Rossette. Moreover, defendants assert, whatever form any damages recovery or other remedy might take—whether it be to cancel the "excess" shares or to require the acquirer to pay their fair value—the only beneficiary of that remedy would be the company. Lastly, defendants contend that to the extent the plaintiffs' claim is for wrongful dilution of their voting power, restoration of that voting power is no longer possible because, as a result of the Cofiniti merger and the Cofiniti bankruptcy, for all practical purposes SinglePoint and Cofiniti no longer exist.

The defendants concede that a "stock dilution" claim may be brought as a direct claim if voting rights are harmed. They insist, however, that that can only occur where the loss of voting power is "material." The defendants conclude that the Court of Chancery correctly found that the plaintiffs never had any material voting power to lose, because both before and after the debt conversion, the public shareholders of SinglePoint held only a minority interest.

The plaintiffs vigorously contest these arguments. They claim that under Tooley their claim is direct, for two alternative reasons. First, their debt conversion claim cannot be derivative because only the shareholder minority—but not the corporation—was injured. The reason (plaintiffs say) is that the company was insolvent, and therefore suffered no harm by issuing its valueless stock to expunge a sizeable portion of its debt to Rossette.^[16] But, even if economically worthless, the SinglePoint stock did have voting power, and the debt conversion reduced the minority shareholders' ownership percentage, and voting power, from about 39% to 7%. Moreover, because of the significant (over 80%) reduction in their share ownership percentage, the minority stockholders also suffered a corresponding reduction of the proceeds they would have otherwise received in the Cofiniti merger. The plaintiffs contend that because SinglePoint no longer exists, only the former minority stockholders can benefit from a judicial remedy. The only remedy now available would be a recovery of the fair value of the Cofiniti merger proceeds the plaintiffs would have received but for the extraction of value resulting from the debt conversion. Any such recovery would benefit only the (former) SinglePoint minority.

[99] Second, and alternatively, the plaintiffs contend that their claim is direct under In re Tri-Star Pictures, Inc. Litigation.^[17] Their argument runs as follows: even if the SinglePoint shares had value, the debt conversion was a self-dealing corporate transaction with a significant stockholder, that increased the voting power and economic value of that significant stockholder's interest in SinglePoint, at the expense and to the corresponding detriment of the minority shareholders. The plaintiffs claim that the Court of Chancery erred by reading into Tri-Star a requirement that for such a transaction to give rise to a direct claim, the loss of voting power must be "material," i.e., that it must reduce the public stockholders' voting power from majority to minority status. We conclude that the plaintiffs are correct and that Tooleyand Tri-Star, properly applied, compel the conclusion that the debt conversion claim was both derivative and direct. It therefore was error to dismiss the claim on the basis that it was exclusively derivative.

IV. ANALYSIS

A. The Applicable Principles of Law

To analyze the character of the claim at issue, it is critical to recognize that it has two aspects. The first aspect is that the corporation (SinglePoint) was caused to overpay for an asset or other benefit that it received in exchange (here, a forgiveness of debt). The second aspect is that the minority stockholders lost a significant portion of the cash value and the voting power of their minority stock interest. Those separate harms resulted from the same transaction, yet they are independent of each other.

Normally, claims of corporate overpayment are treated as causing harm solely to the corporation and, thus, are regarded as derivative. The reason (expressed in Tooleyterms) is that the corporation is both the party that suffers the injury (a reduction in its assets or their value) as well as the party to whom the remedy (a restoration of the improperly reduced value) would flow. In the typical corporate overpayment case, a claim against the corporation's fiduciaries for redress is regarded as exclusively derivative, irrespective of whether the currency or form of overpayment is cash or the corporation's stock.^[18] Such claims are not normally regarded as direct, because any dilution in value of the corporation's stock is merely the unavoidable result (from an accounting standpoint) of the reduction in the value of the entire corporate entity, of which each share of equity represents an equal fraction. In the eyes of the law, such equal "injury" to the shares resulting from a corporate overpayment is not viewed as, or equated with, harm to specific shareholders individually.

There is, however, at least one transactional paradigm—a species of corporate overpayment claim—that Delaware case law recognizes as being both derivative and direct in character.^[19] A breach of [100] fiduciary duty claim having this dual character arises where: (1) a stockholder having majority or effective control causes the corporation to issue "excessive" shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2) the exchange causes an increase in the percentage of the outstanding shares owned by the controlling stockholder, and a corresponding decrease in the share percentage owned by the public (minority) shareholders.^[20] Because the means used to achieve that result is an overpayment (or "over-issuance") of shares to the controlling stockholder, the corporation is harmed and has a claim to compel the restoration of the value of the overpayment. That claim, by definition, is derivative.

But, the public (or minority) stockholders also have a separate, and direct, claim arising out of that same transaction. Because the shares representing the "overpayment" embody both economic value and voting power, the end result of this type of transaction is an improper transfer—or expropriation—of economic value and voting power from the public shareholders to the majority or controlling stockholder. For that reason, the harm resulting from the overpayment is not confined to an equal dilution of the economic value and voting power of each of the corporation's outstanding shares. A separate harm also results: an extraction from the public shareholders, and a redistribution to the controlling shareholder, of a portion of the economic value and voting power embodied in the minority interest. As a consequence, the public shareholders are harmed, uniquely and individually, to the same extent that the controlling shareholder is (correspondingly) benefited.^[21] In such circumstances, the public shareholders are entitled to recover the value represented by that overpayment—an entitlement that may be claimed by the public shareholders directly and without regard to any claim the corporation may have.

The above-described type of transaction was held to give rise to a direct claim in In re Tri-Star Pictures, Inc.^[22] In that case, the plaintiffs, who were a class of former minority stockholders of Tri-Star Pictures, challenged an assets-for-stock transaction between Tri-Star and its largest stockholder, the Coca-Cola Company. Before the transaction, Coca-Cola (voting in concert with other significant stockholders aligned with it) held 56.6% of Tri-Star's common stock; the minority stockholders (the plaintiff shareholder class) held 43.4%. The plaintiffs alleged that Coca-Cola had wrongfully caused Tri-Star to issue an excessive number of Tri-Star shares to Coca-Cola in exchange for Coca-Cola assets having less value. As a result, Coca-Cola increased its stock interest in Tri-Star to about 80%, which in turn reduced the public shareholders' interest to approximately [101] 20%. This Court held that because Coca-Cola, as Tri-Star's largest stockholder, did not suffer a dilution of cash value, of voting power, or of ownership percentage to the same extent and in the same proportion as the minority shareholders, the plaintiffs had suffered an injury that was unique to them individually and that could be remedied in a direct claim against the controlling stockholder and any other fiduciary responsible for the harm.^[23]

B. Analysis of the Debt Conversion Claim

The plaintiffs contend that this case is functionally indistinguishable from, and thus is controlled by, Tri-Star. The defendants respond (and the Court of Chancery agreed) that Tri-Star does not control, because for a loss of voting power to give rise to a direct claim, the loss must be "material," meaning that the challenged transaction must reduce the holdings of the plaintiff class from majority to minority stockholder status^[24]—a reduction that did not occur here.

Because the defendants do not claim that this case is distinguishable from Tri-Star in any other respect, the issue is a narrow one that may be stated thusly: where a Tri-Star type transaction reduces the voting power of the corporation's public shareholders, must the reduction be from majority to minority stockholder status, for the public shareholders to have standing to assert a direct claim against the fiduciaries responsible? We hold that the answer is no. We so conclude for three separate reasons.

First, a requirement of a reduction from majority to minority status finds no support in our case law. The Court of Chancery cited no authority supporting that conclusion,^[25] and nothing in Tri-Star, which created the analytical framework for this issue, compels it. In Tri-Star, Coca-Cola and the group of other stockholders with which Coca-Cola customarily voted as a bloc, were the corporation's majority stockholders. In Tri-Star, as here, the public stockholders held a minority interest, both before and after the challenged transaction. In both cases what was reduced was a significant portion of the economic value and voting power of that minority interest. In Tri-Star the minority interest was reduced from 43.4% to approximately 20%; here, the minority interest was reduced from approximately 39% to approximately 7%. None of the analysis in Tri-Star relating to whether the claim was direct or derivative turned on the extent or degree of the reduction of the minority interest. This case is, therefore, functionally indistinguishable from Tri-Star, and Tri-Star's governing rule should control.

[102] Second, the requirement of a "material" reduction in voting power should play no part in any analysis of whether a claim is direct, derivative, or both. Such a requirement distracts from—and obscures— the nature of the harm inflicted upon the minority in a Tri-Star transaction, and denigrates the seriousness of the breach of fiduciary duty causing that harm. The Tri-Star type of transaction was found to be wrongful because it resulted in an improper extraction or expropriation, by the controlling shareholder, of economic value and voting power that belonged to the minority stockholders. The specific manner in which this was accomplished was causing the corporation to issue, to the controlling stockholder, shares having more value than the value of what the corporation received in exchange. The consequence was to increase the controlling stockholder's percentage of stock ownership at the expense of the minority.^[26] The resulting reduction in economic value and voting power affected the minority stockholders uniquely, and the corresponding benefit to the controlling stockholder was the product of a breach of the duty of loyalty well recognized in other forms of self-dealing transactions.^[27] A rule that focuses on the degree or extent of the expropriation, and requires that the expropriation attain a certain level before the minority stockholders may seek a judicial remedy directly, denigrates the gravity of the fiduciary breach and condones overreaching by fiduciaries—at least in cases where the resulting harm to the minority falls below the prescribed threshold for "materiality." No principle of fiduciary law or policy justifies any condonation of fiduciary misconduct, even where the resulting harm is not "material" in the sense used by the trial court.

Third, the result reached here fits comfortably within the analytical framework mandated by Tooley.^[28] Although the corporation [103] suffered harm (in the form of a diminution of its net worth), the minority shareholders also suffered a harm that was unique to them and independent of any injury to the corporation.^[29] The harm to the minority shareholder plaintiffs resulted from a breach of a fiduciary duty owed to them by the controlling shareholder, namely, not to cause the corporation to effect a transaction that would benefit the fiduciary at the expense of the minority stockholders.^[30] Finally, in this specific case the sole relief that is presently available would benefit only the minority stockholders. Because SinglePoint no longer exists, there are no "overpayment" shares that a court of equity could cancel, and there is no corporate entity to which a recovery of the fair value of those shares could be paid. The only available remedy would be damages, equal to the fair value of the shares representing the overpayment by Single Point in the debt conversion. The only parties to whom that recovery could be paid are the plaintiffs. Hence, although under Tooleythe claim could be brought derivatively or directly, as a practical matter, the only claim available after Cofiniti was liquidated is a direct action by the plaintiffs.

For these reasons, we conclude that the Court of Chancery committed reversible error in granting summary judgment dismissing the plaintiffs' debt conversion claim.

V. CONCLUSION

The judgment of the Court of Chancery granting summary judgment dismissing Count I of the Complaint (the debt conversion claim) is reversed, and the case is remanded for proceedings consistent with this Opinion.

[1] The facts recited here, all supported by the record, are adopted primarily from the Court of Chancery's opinions in this action and an earlier statutory appraisal action.

[2] In their briefing, the defendants note that the 93.49% figure is erroneous, and point out that Rossette actually held 95.45% of SinglePoint after the debt conversion. Because the error does not affect the analysis employed here and for consistency, we adopt the 93.49% figure used by the Court of Chancery.

[3] Rossette's put agreement was also canceled.

[4] Gentile v. SinglePoint Fin., Inc., 2003 WL 1240504, *5 n. 35 (Del.Ch.) (referring to Cavalier Oil Corp. v. Harnett, 1988 WL 15816 (Del. Ch.), aff'd, 564 A.2d 1137 (Del.1989)).

[5] The Court did not address the merits of the Count I claims. It did, however, address the merits of the claims alleged in Count II, and denied summary judgment on those claims.

[6] Gentile v. Rossette, 2005 WL 2810683 (Del. Ch.).

[7] Id. (quoting In re J.P. Morgan Chase & Co. S'holders Litig., 2005 WL 1076069, at *6 (Del. Ch.)).

[8] Id. (citing Oliver v. Boston Univ., 2000 WL 1091480 (Del.Ch.)).

[9] Id. at *5.

[10] 845 A.2d 1031 (Del.2004).

[11] Emerald Partners v. Berlin, 726 A.2d 1215, 1219 (Del.1999); Stroud v. Grace, 606 A.2d 75, 81 (Del.1992).

[12] The Court of Chancery held that the Count II claims alleging breach of fiduciary duty in connection with the Cofiniti merger were direct claims, but denied summary judgment, because the Court was unable to conclude that on the undisputed facts the defendants were entitled to judgment as a matter of law. No party has appealed from the Count II determinations.

[13] 845 A.2d 1031 (Del.2004).

[14] Id. at 1033.

[15] Gentile v. Rossette, 2005 WL 2810683, at *4 (Del.Ch.) (quoting Pls.' Opening Br. at 12).

[16] To the extent the plaintiffs argue that SinglePoint was not harmed by the debt conversion, their position is at war with itself and fatally flawed. The plaintiffs cannot argue, for purposes of demonstrating a lack of harm to the corporation, that the SinglePoint stock was worthless, yet simultaneously contend that that same stock had value for purposes of establishing that the debt conversion at the $0.05 rate was unfair to the corporation. Indeed, the Court of Chancery's $5.50 per share appraisal award would appear to defeat that argument. Accordingly, we reject the plaintiffs' "no value" contention, and proceed from the premise that the SinglePoint stock had value. From that premise it follows that, to the extent SinglePoint was caused to issue an excessive amount of shares, the corporation was harmed by the debt conversion. Even so, we conclude, for the reasons set forth in Part IV, infra, of this Opinion, that the debt conversion claim is not exclusively derivative, and could have been brought either directly or derivatively.

[17] 634 A.2d 319 (Del.1993) ("Tri-Star").

[18] See In re J.P. Morgan Chase & Co. S'holders Litig., 2005 WL 1076069, at *7 (Del.Ch.), aff'd, 2006 WL 585606, (Del.Supr.); Avacus Partners, L.P. v. Brian, 1990 WL 161909, at *6 (Del.Ch.) (excessive exchange of stock); Kramer v. W. Pac. Indus., 546 A.2d 348 (Del. 1988) (excessive issuance of stock options and payment of fees to executives).

[19] It is legally possible for a claim to have such a dual character. As this Court has held, "Courts have long recognized that the same set of facts can give rise to both a direct claim and a derivative claim." Grimes v. Donald, 673 A.2d 1207, 1212 (Del.1996).

[20] See Turner v. Bernstein, 1999 WL 66532, at *11 (Del.Ch.) (a direct cash value dilution claim "arises only in transactions where a significant stockholder sells its assets to the corporation in exchange for the corporation's stock, and influences the transaction terms so that the result is (i) a decrease (or `dilution') of the asset value and voting power of the stock held by the public stockholders and (ii) a corresponding increase (or benefit) to the shares held by the significant stockholder."); see also In re Paxson Commc'n Corp. S'holders Litig., 2001 WL 812028, at *5 (Del.Ch.); Oliver v. Boston University, 2000 WL 1091480 (Del.Ch.).

[21] Unlike the typical "overpayment" transaction, where the form of overpayment (cash or stock) does not matter, in this atypical type of transaction, the dual character of the harm, and of the claims resulting from that harm, arise where the overpayment takes the form of issued corporate stock.

[22] 634 A.2d 319 (Del.1993).

[23] Id., at 332-333.

[24] Gentile v. Rossette, 2005 WL 2810683, at *5 ("As minority shareholders to begin with, Plaintiffs' voting power was not materially changed.").

[25] The Court of Chancery cites only to Oliver v. Boston Univ., 2000 WL 1091480 (Del.Ch.) for the proposition that "dilution claims emphasizing the diminishment of voting power have been categorized as direct claims;" and to Agostino v. Hicks, 845 A.2d 1110, 1124 (Del.Ch.2004),summarizing its relevance as "finding no cognizable loss of voting power where the plaintiffs held only a minority interest before the challenged transaction." Neither authority supports the "materiality" rule advanced by the Court of Chancery. The Agostino Court explicitly noted that the claim presented in that case was not a Tri-Star claim. And in Oliver, as here, the plaintiffs were minority stockholders before and after the challenged transaction. But see infra note 28 (discussing and overruling Behrens v. Aerial Commc'ns, Inc., 2001 WL 599870 (Del. Ch.)).

[26] Our characterization of the harm giving rise to a direct claim in a Tri-Star type transaction is somewhat different from the articulation used by the Tri-Star Court itself. In Tri-Star, this Court articulated the harm to the minority in terms of a "dilution" of the economic value and voting power of the stock held by the minority. In this case, we adopt a more blunt characterization—extraction or expropriation—because that terminology describes more accurately the real-world impact of the transaction upon the shareholder value and voting power embedded in the (pre-transaction) minority interest, and the uniqueness of the resulting harm to the minority shareholders individually, than does a description framed in terms of "dilution."

[27] See Weinberger v. UOP, Inc., 457 A.2d 701 (Del.1983) (discussing majority stockholder's duty of loyalty to minority in a going-private merger).

[28] Although not cited by the trial court, the appellees draw our attention to a pre-Tooley decision by the Court of Chancery, Behrens v. Aerial Communications, Inc., 2001 WL 599870 (Del.Ch.) which involved a transaction virtually identical to the one complained of here. In Behrens, a majority (80%) stockholder caused the corporation to exchange $420 million of debt that the corporation owed the majority stockholder, for newly issued common shares in an allegedly unfair and self-dealing debt exchange transaction. The claim was that the newly issued stock constituted an overpayment for the debt forgiveness. The debt exchange was followed by a merger in which the corporation was acquired. The minority shareholders sued the majority stockholder and the corporation's former directors both directly and derivatively, claiming that the debt replacement transaction constituted a breach of fiduciary duty to the minority. The defendants moved to dismiss on the ground that that claim was derivative, and that its extinguishment by the merger deprived the (former) minority stockholders of standing to assert the claim. The Court of Chancery agreed, and dismissed the claim, ruling that (i) the claim was derivative, because any dilution resulting from the debt conversion overpayment affected all outstanding shares equally, and (ii) for that same reason the claim was not direct, because the plaintiffs did not plead any "special injury" to the minority shareholders distinct from any injury to the corporation or majority shareholder—a showing that under pre-Tooley case law was required to establish a direct claim.

Because the Court of Chancery's analysis of the debt reduction transaction focused solely upon its dilutive effect on the shares, rather than upon the quite separate injury to the minority stockholders(resulting from the increase in the majority stockholder's ownership interest at the minority's expense), that approach is inconsistent with the analysis we hold is required here. To the extentBehrens failed to take cognizance of the separate harm to the minority stockholders, it is overruled.

[29] Tooley, 845 A.2d at 1039.

[30] Id.; Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993) ("the duty of loyalty mandates that the best interest of the corporation and its shareholders takes precedence over any interest possessed by a . . . controlling shareholder and not shared by the stockholders generally.");Weinberger v. UOP, 457 A.2d at 711 ("one may not mislead any stockholder by use of corporate information to which the latter is not privy.").

Joseph A. Rosenthal (argued), and Kevin Gross of Morris, Rosenthal, Monhait & Gross, P.A., Wilmington, and Mordecai Rosenfeld, New York City, on behalf of appellant.

Clark W. Furlow (argued), of Lassen, Smith, Katzenstein & Furlow, Wilmington, Wallace L. Timmeny (argued), James E. Ballowe, Jr. of McGuire, Woods, Battle & Booth, Washington, D.C., and F.L. Peter Stone of Connolly, Bove, Lodge & Hutz, Wilmington, on behalf of appellees.

Before HORSEY, WALSH and HOLLAND, Justices.

[769] HOLLAND, Justice:

This is an appeal from an order of the Court of Chancery dismissing a derivative action filed by the plaintiff-appellant, Ted Spiegel ("Spiegel"), a shareholder of Waste Management, Inc. ("Waste Management"). In his complaint, Spiegel alleged that Dean L. Buntrock ("Buntrock"), Chairman of the Board of Directors and Chief Executive Officer of Waste Management; Jerry E. Dempsey ("Dempsey"), Vice Chairman; Peter H. Huizenga ("Huizenga"), Vice President and Secretary; and James E. Koenig ("Koenig"), Staff Vice President^[1] (collectively "management defendants"), improperly acquired stock in ChemLawn Corporation ("ChemLawn"), based upon inside information, during the two years immediately preceding Waste Management's tender [770] offer for ChemLawn. Spiegel sought to compel the management defendants to account to Waste Management for the personal profits they made upon the sale of their ChemLawn stock.

The underlying issue in this controversy is the often debated subject of when the requirement that a stockholder make demand on a board of directors, prior to filing a derivative lawsuit for the benefit of a corporation, is excused and when a demand, which has been made, is properly refused. Superimposed upon the "demand excused/demand refused" debate^[2] are additional issues relating to the use of a special litigation committee by the Board of Waste Management, and the propriety of continuing to argue that demand was excused, after a demand has been made. All of the issues raised implicate the proper standard of judicial review.

This case presented the Court of Chancery with a procedural paradox in that each party's argument was the antithesis of their action. Spiegel contended that demand was excused. However, when his failure to make a pre-suit demand was raised by the Board of Waste Management ("Board") as a defense, Spiegel responded by filing a demand. The Board contended that demand was required, because it was disinterested and capable of responding to Spiegel's request for legal action. However, when a demand for such action was made by Spiegel, the Board responded by appointing a special litigation committee with complete authority to review and act upon Spiegel's request. Ultimately, each party used their opponent's legal sword as their own legal shield. Spiegel argued that by appointing a special litigation committee, the Board conceded that demand was excused and the Board argued that by filing a demand Spiegel had admitted that one was required.

The Court of Chancery carefully reviewed the allegations in Spiegel's complaint and found that demand was not excused. Thereafter, the Court of Chancery proceeded to examine the post-suit demand for legal action, which was sent to the Board by Spiegel, and the decision to refuse that demand. The Court of Chancery held that the decision to refuse Spiegel's demand was subject to review according to the traditional business judgment rule, notwithstanding the fact that the Board had delegated its authority to act on Spiegel's demand to a special litigation committee. Applying the traditional business judgment rule, the Court of Chancery held that Spiegel's demand, for the Board to take legal action on behalf of Waste Management, was properly refused.

On appeal, Spiegel contends that, even though he made a demand, given the facts of this case, demand was excused nevertheless. Therefore, Spiegel argues that the Court of Chancery should have reviewed the Board's motion to dismiss his complaint according to the procedures established in Zapata Corp. v. Maldonado, Del.Supr., 430 A.2d 779 (1981), rather than the traditional business judgment rule. Alternatively, Spiegel contends that even if the Zapata procedures are not applicable in this case, the Court of Chancery erred in dismissing his derivative complaint because Waste Management failed to meet its burden under Chancery Court Rule 56 of showing that there were no genuine issues of material fact.

We find that the record supports both of the Court of Chancery's rulings. Consequently, it is not necessary to address the other issues raised by Spiegel. We find that the Court of Chancery's decision to dismiss Spiegel's complaint should be affirmed.

Facts

Waste Management is a Delaware corporation headquartered in Oak Brook, Illinois. It provides domestic and international waste removal and disposal services. In the spring of 1984, Waste Management decided to diversify its operations by expanding into new service areas.

[771] In an effort to accomplish its goal, Waste Management hired Dempsey, who had led the successful diversification of Borg Warner Corporation.^[3] Buntrock requested Dempsey to perform a study of service industries which might be of interest to Waste Management. Dempsey retained the consulting division of Arthur Andersen & Co. to assist him with the study.

Dempsey prepared two reports, dated February 8, 1985 and March 13, 1985. The reports were titled "Waste Management, Inc. Acquisition Project Meeting." Both reports were presented to the Board by Dempsey. ChemLawn, a leader in the lawn care industry, was among eight companies included in each initial analysis. During the next two years, several additional reports were prepared to assist the Board in evaluating companies for potential acquisition.

Waste Management's interest in Chem-Lawn gradually intensified until on February 26, 1987, it launched a cash tender offer for ChemLawn at $27.00 per share.^[4] The tender offer included a disclosure that the management defendants owned shares of ChemLawn stock, which they had acquired during the prior two years.^[5] Waste Management's tender offer proved to be unsuccessful.

ChemLawn was purchased by EcoLab, Inc. for $36.50 per share. On March 30, 1987, the Wall Street Journal carried an article entitled "ChemLawn's Sale Could Yield $1 Million In Profit for Officials of Thwarted Suitor."^[6] That same day, Spiegel filed the action against Waste Management, and its directors, that is the subject of this appeal.

On April 30, 1987, the Board filed a motion to dismiss Spiegel's complaint pursuant to Court of Chancery Rule 23.1. The basis for that motion was that Spiegel had failed to make a demand upon the Board prior to instituting his derivative suit and had failed to allege with particularity facts demonstrating that such a demand would have been futile. See Ch.Ct.R. 23.1.^[7] The Board's motion also sought dismissal of the action against the seven disinterested directors because Spiegel's complaint alleged no wrongdoing by them.

Spiegel did not immediately contest the Board's motion to dismiss in the Court of Chancery.^[8] Instead, Spiegel responded by making a demand to the Board in a letter which stated:

[772] On behalf of Ted Spiegel, a shareholder of Waste Management, Inc., we hereby formally demand that the Board of Directors take all appropriate action to redress the wrongs as alleged in the enclosed complaint.

In response to Spiegel's demand letter, the Board established a special litigation committee of outside directors (the "Committee") "for the purpose of conducting an independent review of the transactions in the common stock of ChemLawn Corporation by officers of the Company."^[9] "Pursuant to Section 141(c) of the Delaware General Corporation Law and [Waste Management's] by-laws," the Board delegated authority to the Committee "to determine, as a result of its independent review, whatever action may be appropriate in the interest of the Company...."

The Committee conducted an investigation into Spiegel's allegations that spanned over five months. The Committee was represented by its own independent counsel, a Washington, D.C., attorney who was the former Deputy Director of Enforcement at the Securities and Exchange Commission, and who now specializes in securities law in private practice. The Committee interviewed a great many people, both within and without Waste Management.^[10] It also reviewed volumes of documents.

The Committee's report found that Waste Management had a continuing low level interest in ChemLawn, as one of many possible acquisition targets, throughout the two-year period in question, but that there was never any "serious interest" until January and February of 1987. On the basis of its investigation, and its analysis of the applicable law, the Committee concluded that it would not be in the best interests of Waste Management and its stockholders to pursue Spiegel's derivative action. The Committee's report stated, in part:

The Committee has determined to seek dismissal of the complaints in the pending derivative litigation. The Committee believes that the best interests of the Company would be furthered by terminating rather than pursuing the derivative litigation.... There is no question that ... discovery would be disruptive and burdensome in the extreme to the Company, its employees, and its directors. In addition, the publicity which would accompany the continuation of the lawsuit would result in immediate damage to the Company's goodwill and reputation with its shareholders, its customers, and the investment community, even though the allegations in the complaint ultimately proved meritless.

Against these burdens, the Committee has weighed the potential for success by the plaintiffs on their claim of insider trading and has concluded that the plaintiffs have proffered no evidence, and the Committee in its investigation has uncovered no evidence, that would support this serious charge of unlawful conduct.

Consequently, the Committee, acting for the Board, filed a motion on behalf of Waste Management, in the Court of Chancery to dismiss or, alternatively, for summary judgment, along with the affidavits of the Committee members and the entire report which summarized its findings and analysis.

Derivative Action/Demand Requirement

A basic principle of the General Corporation Law of the State of Delaware is that directors, rather than shareholders, [773] manage the business and affairs of the corporation. Paramount v. Time, Del. Supr., 571 A.2d 735, 738, 751 (1990); Mills Acquisition Co. v. Macmillan, Inc., Del. Supr., 559 A.2d 1261, 1280 (1989); Kaplan v. Peat, Marwick, Mitchell & Co., Del. Supr., 540 A.2d 726, 729 (1988); Pogostin v. Rice, Del.Supr., 480 A.2d 619, 624 (1984); Aronson v. Lewis, Del.Supr., 473 A.2d 805, 811-12 (1984). "The exercise of this managerial power is tempered by fundamental fiduciary obligations owed by the directors to the corporation and its shareholders." Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d at 729. The decision to bring a law suit or to refrain from litigating a claim on behalf of a corporation is a decision concerning the management of the corporation. Zapata Corp. v. Maldonado, 430 A.2d at 782. Consequently, such decisions are part of the responsibility of the board of directors. 8 Del.C. § 141(a).^[11]

Nevertheless, a shareholder may file a derivative action to redress an alleged harm to the corporation. The nature of the derivative action is two-fold.

First, it is the equivalent of a suit by the shareholders to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it.

Aronson v. Lewis, 473 A.2d at 811. In essence, it is a challenge to a board of directors' managerial power. Pogostin v. Rice, 480 A.2d at 624. Thus, by its very nature, "the derivative action impinges on the managerial freedom of directors." Id. In fact, the United States Supreme Court has noted that the shareholder derivative action "could, if unrestrained, undermine the basic principle of corporate governance that the decisions of a corporation — including the decision to initiate litigation — should be made by the board of directors or the majority of shareholders." Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 531, 104 S.Ct. 831, 836, 78 L.Ed.2d 645 (1984) (citing Hawes v. Oakland, 104 U.S. 450, 26 L.Ed. 827 (1882)). See Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d at 730.

"Because the shareholders' ability to institute an action on behalf of the corporation inherently impinges upon the directors' power to manage the affairs of the corporation the law imposes certain prerequisites on a stockholder's right to sue derivatively." Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d at 730 (citing Pogostin v. Rice, 480 A.2d at 624); Aronson v. Lewis, 473 A.2d at 811. Chancery Court Rule 23.1 requires that shareholders seeking to assert a claim on behalf of the corporation must first exhaust intracorporate remedies by making a demand on the directors to obtain the action desired, or to plead with particularity why demand is excused. Ch. Ct.R. 23.1; Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d at 730. See also Aronson v. Lewis, 473 A.2d at 811-812; Zapata Corp. v. Maldonado, 430 A.2d at 783.^[12]

The purpose of pre-suit demand is to assure that the stockholder affords the corporation the opportunity to address an alleged wrong without litigation, to decide whether to invest the resources of the corporation in litigation, and to control any litigation which does occur. Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d at 730.^[13] "[B]y promoting this form of alternate dispute resolution, rather than immediate recourse to litigation, the demand requirement is a recognition of the fundamental precept that directors manage the business and affairs of corporations." Aronson v. Lewis, 473 A.2d at 812.

Standard Of Review Demand Excused/Demand Refused

Since a conscious decision by a board of directors to refrain from acting [774] may be a valid exercise of business judgment, "where demand on a board has been made and refused, [courts] apply the business judgment rule in reviewing the board's refusal to act pursuant to a stockholder's demand" to file a lawsuit. Id. at 813 (citing Zapata Corp. v. Maldonado, 430 A.2d at 784 & n. 10). The business judgment rule is a presumption that in making a business decision, not involving self-interest, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Grobow v. Perot, Del.Supr., 539 A.2d 180, 187 (1988); Aronson v. Lewis, 473 A.2d at 812.^[14] "The burden is on the party challenging the decision to establish facts rebutting th[is] presumption." Aronson v. Lewis, 473 A.2d at 812. Thus, the business judgment rule operates as a judicial acknowledgement of a board of directors' managerial prerogatives. Id.

Spiegel submits that judicial review according to the traditional business judgment rule was inappropriate in his case. Spiegel sets forth two separate arguments in support of his position. First, that the allegations set forth in his complaint support a finding that demand was excused, according to this Court's holding in Aronson, notwithstanding the fact that he made a demand upon the Board. Second, and alternatively, that by appointing a special litigation committee with full authority to respond to his demand, the Board waived its right to challenge his allegation that demand was excused, and thereby invoked the special procedures for judicial review established in Zapata Corp. v. Maldonado, Del.Supr., 430 A.2d 779 (1981). We shall examine each of Spiegel's contentions.

Demand Made/Futility Waived

Spiegel filed a derivative action on behalf of Waste Management, alleging that a presuit demand on the Board was excused, i.e., would have been a futile gesture. However, Spiegel then filed a demand with the Board to take legal action and "redress the wrongs" set forth in his complaint. Spiegel alleges that he was entitled to simultaneously argue these inconsistent arguments. The Board argues that when Spiegel filed his demand, he waived his right to continue asserting that demand was excused. The Court of Chancery gave implicit recognition to the validity of Spiegel's position by examining the merits of both of his arguments.^[15]

"When deciding a motion to dismiss for failure to make a demand under Chancery Rule 23.1 the record before the court must be restricted to the allegations of the complaint." Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d at 727-28. See also Grobow v. Perot, 539 A.2d at 187; Pogostin v. Rice, 480 A.2d at 622-24; Aronson v. Lewis, 473 A.2d at 809. In determining demand futility, the Court of Chancery must decide whether, under the particularized facts alleged in the complaint:

[A] reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.

Aronson v. Lewis, 473 A.2d at 814. In this case, the Court of Chancery concluded that the facts alleged in Spiegel's complaint did not raise a reasonable doubt that the Board was disabled from responding to Spiegel's demand and passing upon whether it was in Waste Management's interest to pursue Spiegel's claims.

Spiegel argues that, even though he made a demand, the Court of Chancery properly reviewed the merits of his complaint, which alleged that demand was excused. Spiegel submits that demand [775] should be encouraged by permitting a demand to be made, while at the same time permitting the argument, that demand was excused, to be preserved. Spiegel finds some support for his position in other jurisdictions. See Bach v. National W. Life Ins. Co., 810 F.2d 509, 513 (5th Cir.1987); Joy v. North, 692 F.2d 880, 888 n. 7 (2d Cir.1982), cert. denied, 460 U.S. 1051, 103 S.Ct. 1498, 75 L.Ed.2d 930 (1983); Alford v. Shaw, 72 N.C.App. 537, 324 S.E.2d 878, 883 n. 2 (1985), aff'd and modified on other grounds, 320 N.C. 465, 358 S.E.2d 323 (1987). However, this Court has held that by making a demand, a shareholder thereby makes his original contention, that demand was excused, moot. Stotland v. GAF Corp., Del.Supr., 469 A.2d 421 (1983).

In Stotland, the shareholders' original derivative complaint did not allege that a demand had been made on the corporation's board of directors. The Court of Chancery denied the shareholders' motion to amend their complaint, and ordered the action dismissed due to the shareholders' failure either to make a demand or properly demonstrate its futility. Id. at 422. Following the dismissal, the shareholders made a demand on the board, and then filed an appeal from the dismissal, on grounds that a demand would have been futile. The board of directors appointed a special litigation committee to review the demand. That process was still in progress at the time when the shareholders' appeal was heard by this Court. We concluded that, by making the demand, the shareholder mooted his appeal, which was based on the issue of demand futility. We held that "once a demand has been made, absent a wrongful refusal, the stockholders' ability to initiate a derivative suit is terminated." Id. at 422 (citing Zapata Corp. v. Maldonado, 430 A.2d at 784-86).

This Court has recently held that when a board of directors is confronted with a derivative action asserted on its behalf, it cannot stand neutral. Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d at 731. The Board "must affirmatively object to or support the continuation of the [derivative] litigation." Id. Similarly, a stockholder who asserts a derivative claim cannot stand neutral, in effect, with respect to the board of directors' ability to respond to a request to take legal action, by simultaneously making a demand for such action and continuing to argue that demand is excused.

By making a demand, a stockholder tacitly acknowledges the absence of facts to support a finding of futility. Cf. Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d at 731. Thus, when a demand is made, the question of whether demand was excused is moot. Stotland v. GAF Corp., 469 A.2d at 422-23. Our decision in Stotland is applicable to Spiegel's case. Therefore, we hold once Spiegel made a demand, it was unnecessary for the Court of Chancery to consider the merits of Spiegel's argument that demand was excused. Id. at 423.

A shareholder who makes a demand can no longer argue that demand is excused. Id.^[16] The effect of a demand is to place control of the derivative litigation in the hands of the board of directors. Zapata Corp. v. Maldonado, 430 A.2d at 784-86.^[17] Consequently, stockholders who, [776] like Spiegel, make a demand which is refused, subject the board's decision to judicial review according to the traditional business judgment rule. Aronson v. Lewis, 473 A.2d at 813; Zapata Corp. v. Maldonado, 430 A.2d at 784 n. 10.

Special Litigation Committee

Alternatively, Spiegel argues that even though demand was made, the Board admitted that demand was excused by referring his demand to a special litigation committee, and by delegating to that committee the complete power to determine the Board's litigation posture.^[18] Therefore, Spiegel argues that the Board's rejection of his demand was subject to judicial review according to the special procedures set forth in Zapata, and not the traditional business judgment rule.^[19] In support of that position, Spiegel cites Abbey v. Computer & Comm. Tech. Corp., Del.Ch., 457 A.2d 368 (1983). The Court of Chancery found Abbey to be distinguishable and rejected Spiegel's argument. We agree with the Court of Chancery.

The facts upon which the Abbey decision was based are different from the facts of this case. In Abbey, the plaintiff made demand on the corporation's board of directors and then filed suit alleging that demand was excused. The board responded to the complaint in Abbey by appointing a new board member to serve as a one-man special litigation committee, and delegated full authority to him to handle the derivative action. The board in Abbey never made any attempt to address the derivative litigation itself. The Court of Chancery concluded, in Abbey, that the board had, "in effect, conceded its disqualification, and... thereby conceded [that demand was excused and that] the plaintiff [was entitled] to bring the [derivative] suit without awaiting word from it...." 457 A.2d at 374.

This case is the procedural reverse of Abbey. Spiegel filed his derivative suit without first making demand. The Board immediately took charge of the litigation and filed a motion to dismiss Spiegel's complaint for his failure to make a demand in accordance with Rule 23.1. Spiegel responded to the Board's motion by making a demand. In response to Spiegel's demand, the Board created a special litigation committee.

The significance of this procedural distinction was recognized by the Court of Chancery in Richardson v. Graves, Del. Ch., C.A. No. 6617, Longobardi, V.C. (June [777] 17, 1983). The plaintiff in Richardson, like Spiegel, relying on Abbey, argued that the board of directors had conceded that demand was excused as futile by the appointment of a special litigation committee. In Richardson, the Court of Chancery distinguished Abbey on the grounds that the board in Abbey did not file a motion to dismiss pursuant to Rule 23.1 until after it had surrendered exclusive control of the derivative action to a special litigation committee. Richardson v. Graves, slip op. at 10-11. By contrast, the Richardson board, like the Waste Management board, first filed a motion to dismiss Spiegel's complaint due to his failure to make a demand and later, after Spiegel did make a demand, appointed a special litigation committee to respond to that demand. In Richardson, the court held:

[T]he facts here do not support a finding of concession on the part of the Defendants [, the board of directors,] or divestment of their power at the time they moved to dismiss. The Defendants here filed a proper motion to dismiss and consistent with the policy of [Rule] 23.1 must in the first instance be afforded the opportunity to control the litigation.

Richardson v. Graves, slip op. at 11.

In this case, we find that the Court of Chancery properly rejected Spiegel's argument that Abbey stands for the proposition that a board of directors, ipso facto, waives its right to challenge a shareholder plaintiff's allegation that demand is excused by the act of appointing a special litigation committee and delegating to that committee the authority to act on the demand. Not only are the facts in Abbey procedurally different from those of the present case, but Abbey itself specifically recognizes the right of a board of directors to appoint committees to address derivative litigation, without automatically subjecting the committee's decision to the two-tier level of judicial scrutiny established in Zapata. In Abbey, the Court of Chancery properly concluded that the special review procedure which this Court set up in Zapata applies:

only in a situation where, because of some alleged self-interest, the board of directors is disqualified from acting itself. Otherwise, but for the disqualifying self-interest factor, the board could make its decision for itself, whether it chose to do so through a committee or not, and cause an appropriate motion to be made on behalf of the corporation just as in any normal suit in which the corporation was named as a party defendant.

Abbey v. Computer & Comm. Tech. Corp., 457 A.2d at 373. In this case, the Court of Chancery held that the decision of a board of directors to appoint a special litigation committee, with a delegation of complete authority to act on a demand, is not, in all instances, an acknowledgement that demand was excused and ergo that a shareholder's lawsuit was properly initiated as a derivative action. We affirm that holding.

Standard Of Review Demand Refused/Motion To Dismiss

Whenever any action or inaction by a board of directors is subject to review according to the traditional business judgment rule, the issues before the Court are independence, the reasonableness of its investigation and good faith. By electing to make a demand, a shareholder plaintiff tacitly concedes the independence of a majority of the board to respond. Therefore, when a board refuses a demand, the only issues to be examined are the good faith and reasonableness of its investigation.

Absent an abuse of discretion, if the requirements of the traditional business judgment rule are met, the board of directors' decision not to pursue the derivative claim will be respected by the courts. Aronson v. Lewis, 473 A.2d at 812; Zapata Corp. v. Maldonado, 430 A.2d at 784-85. In such cases, a board of directors' motion to dismiss an action filed by a shareholder, whose demand has been rejected, must be granted.^[20] "If Courts would not respect [778] the directors' decision not to file suit, then demand would be an empty formality." Starrels v. First Nat. Bank of Chicago, 870 F.2d 1168, 1174 (7th Cir.1989) (Easterbrook, J., concurring).

The same standard of judicial review is applicable when a board delegates authority to respond to a demand to a special litigation committee. The issues are solely the good faith and the reasonableness of the committee's investigation. Zapata Corp. v. Maldonado, 430 A.2d at 787. "The ultimate conclusion of the [special litigation] committee ... is not subject to judicial review." Id. (emphasis added). Judicial review of the merits of a special litigation committee's decision to refuse a demand is limited to those cases where demand upon the board of directors is excused and the board has decided to regain control of litigation through the use of an independent special litigation committee. Aronson v. Lewis, 473 A.2d at 813-14; Zapata Corp. v. Maldonado, 430 A.2d at 787. Cf. Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323, 327 (1987).

The Court of Chancery specifically recognized this important distinction. In this case, the Court of Chancery found there was no material dispute that the Board, through its Committee, had "function[ed] effectively ... in a way that fully satisfies the prerequisites for the application of the business judgment rule."^[21] Consequently, the Court of Chancery concluded that, in accordance with the business judgment expressed by the Board, through its Committee, Spiegel's derivative action had to be dismissed. Grobow v. Perot, Del.Supr., 539 A.2d 180 (1988); Aronson v. Lewis, Del.Supr., 473 A.2d 805 (1984). We agree.

Conclusion

For the reasons stated in this opinion, the ultimate decision of the Court of Chancery, dismissing Spiegel's complaint is AFFIRMED.

[1] All of the management defendants, except Koenig, are also directors of Waste Management.

[2] See Dooley & Veasey, The Role of the Board in Derivative Litigation: Delaware Law and the Current ALI Proposals Compared, 44 Bus.Law. 503 (1989). See also Bach v. National W. Life Ins. Co., 810 F.2d 509, 513-14 (5th Cir.1987).

[3] With Dempsey's leadership, Borg Warner Corporation evolved from a primarily manufacturing enterprise, to the point where service industries comprised the majority of its overall operations.

[4] On February 25, 1987, Waste Management sued ChemLawn to invalidate the anti-takeover laws of Ohio, ChemLawn's state of incorporation. ChemLawn counterclaimed, seeking to enjoin Waste Management's takeover bid. Among the allegations in ChemLawn's counterclaim was the charge that Buntrock, Huizenga, Dempsey and Koenig had acquired ChemLawn shares in violation of federal and state prohibitions against trading on inside information. After EcoLab, Inc. acquired ChemLawn, the Ohio litigation was voluntarily dismissed.

[5] The purchases of ChemLawn stock occurred between May 8, 1985, and February 5, 1987. They may be summarized as follows:

Purchaser                    # of Shares
---------                    -----------

Mr. Buntrock*                   35,000
Huizenga                         8,000
Dempsey                          4,000
Koenig                             400

* Mr. Buntrock's total purchases include not only his
personal purchases, but also those made by his wife and
by trust funds established for the Buntrocks' children.

[6] In March and April, 1987, the management defendants tendered all of their 47,400 shares of ChemLawn stock to EcoLab, Inc. during its successful tender offer, at prices ranging from $36.25 to $36.50 per share.

[7] Chancery Court Rule 23.1 states, in part:

The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he [or she] desires from the directors or comparable authority and the reasons for his [or her] failure to obtain the action or for not making the effort.

[8] The Court of Chancery set a brief schedule in order to properly act upon the Board's motion. That brief schedule was apparently abandoned by the parties after Spiegel filed his demand. The Court of Chancery's docket sheet indicates the next action taken with respect to this case was the filing of a motion to dismiss or, alternatively, for summary judgment by a special litigation committee appointed by the Board to investigate and respond to Spiegel's claims.

[9] The Committee's chairman was Lee L. Morgan, the most recent appointee to the Board and the retired chairman of Caterpillar, Inc. The other two members of the Committee were Olin Neill Emmons, a financial analyst and vice-president of Oberweis Securities, Inc., and James R. Peterson, a former officer and director of the Pillsbury Company, R.J. Reynolds Industries, Inc., and the Parker Pen Company.

[10] The Committee interviewed Spiegel's attorney. Spiegel's counsel advised the Committee that the allegations in the complaint were based solely on the article reported on March 30, 1987, in the Wall Street Journal.

[11] 8 Del.C. § 141(a) provides, in pertinent part:

The business and affairs of every corporation organized under this chapter shall be managed by a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.

[12] The United States Supreme Court recognized the demand requirement, as an embodiment of the director's prerogative to control a corporation's business and affairs, over a century ago in Hawes v. Oakland, 104 U.S. 450, 26 L.Ed. 827 (1882).

[13] See DeMott, Demand in Derivative Actions: Problems of Interpretation and Function, 19 U.C. Davis L.Rev. 461, 484-94 (1986).

[14] The protections of the business judgment rule can only be invoked by disinterested directors. Aronson v. Lewis, 473 A.2d at 812, 815 n. 8. However, the fact that all directors are named as defendants in a derivative complaint is not determinative of their lack of independence. Id. at 817-18; Pogostin v. Rice, 480 A.2d at 625.

[15] The federal district court in Delaware has also reviewed a futility of demand argument subsequent to the filing of a demand. Allison on Behalf of G.M.C. v. General Motors Corp., 604 F.Supp. 1106 (D.Del.), aff'd, 782 F.2d 1026 (3d Cir.1985).

[16] The federal district court in Delaware recognized the potential for the establishment of a rule in Delaware that a derivative plaintiff's assertion that demand is excused is mooted once demand is made. Allison on Behalf of G.M.C. v. General Motors Corp., 604 F.Supp. at 1119 n. 12.

[17] "[Stotland] thus treats the demand requirement as an aspect of the allocation of managerial powers within the corporation. The case also creates a substantial practical dilemma for the plaintiff: if no demand is made, the suit may and probably will be dismissed, but once the demand is made, the plaintiff can no longer maintain that demand should be excused." D. DeMott, Shareholder Derivative Actions: Law and Practice, § 5:03 (1987). We recognize this reaffirmation of our decision in Stotland requires a shareholder to make an election between filing a demand and filing a derivative action without a demand. We also recognize that "the entire question of demand futility is inextricably bound to issues of business judgment and the standards of that doctrine's applicability." Aronson v. Lewis, 473 A.2d at 812. However, this shareholder "dilemma" is not a Hobson's choice. "[U]nder Zapata and its progeny, a plaintiff who can establish demand futility not only avoids the need to make a demand which the corporation may refuse, but, at least in Delaware, also may be able to obtain judicial review of the merits of the case as part of the court's evaluation of any motion to terminate made by a special litigation committee acting on behalf of the corporation." D. Block, N. Barton & S. Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Directors, 484 (3d Ed. 1989).

[18] A board of directors may delegate its managerial authority to a committee of directors. 8 Del.C. § 141(c). Even when a majority of a board of directors is independent, one advantage of establishing a special litigation committee is to isolate the interested directors from material information during either the investigative or decisional process. Cf. Mills Acquisition Co. v. Macmillan, Inc., Del.Supr., 559 A.2d 1261 (1988). In this case, Spiegel emphasizes the difference between a Board's "delegation of its decision-making authority — as opposed to its investigative authority —" to a committee. See D. Block, N. Barton & S. Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Directors, 476-77 n. 180, 485-88 (3d Ed.1989). See also, D. Drexler, L. Black, and G. Sparks, Delaware Corporate Law & Practice, § 42.03[2][c] (1990).

[19] As this Court noted in Aronson:

The thrust of Zapata is that in either the demand-refused or the demand-excused case, the board still retains its Section 141(a) managerial authority to make decisions regarding corporate litigation.... Thus, even in a demand-excused case, a board has the power to appoint a committee of one or more independent disinterested directors to determine whether the derivative action should be pursued or dismissal sought. Under Zapata, the Court of Chancery, in passing on a committee's motion to dismiss a derivative action in a demand excused case, must apply a two-step test. First, the court must inquire into the independence and good faith of the committee and review the reasonableness and good faith of the committee's investigation. Second, the court must apply its own independent business judgment to decide whether the motion to dismiss should be granted.

Aronson v. Lewis, 473 A.2d at 813 (citations omitted).

[20] "The function of the business judgment rule is of paramount significance in the context of a derivative action. It comes into play in several ways — in addressing a demand, in the determination of demand futility, in efforts by independent disinterested directors to dismiss the action as inimical to the corporation's best interests, and generally, as a defense to the merits of the suit." Aronson v. Lewis, 473 A.2d at 812. "When used in this manner, the rule is said to be applied `offensively' — it is used not to defend the propriety of the underlying action but rather to secure dismissal of the suit without reaching the merits of the claim." D. Block, N. Barton & S. Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Directors, 492 (3d Ed. 1989) (citing D. DeMott, Shareholder Derivative Actions: Law and Practice § 5:04 (1987)); Block & Prussin, Termination of Derivative Suits Against Directors on Business Judgment Grounds: From Zapata to Aronson, 39 Bus.Law. 1503 (1984); Block, Prussin & Wachtel, Dismissal of Derivative Actions Under the Business Judgment Rule: Zapata One Year Later, 38 Bus. Law. 401 (1983); Sparks & Conan, Litigation Committees, 16 Rev.Sec.Reg. 817 (1983); Cox, Searching for the Corporation's Voice in Derivative Suit Litigation: A Critique of Zapata and the ALI Project, 1982 Duke L.J. 959 (1982); Payson, Goldman & Inskip, After Maldonado — The Role of the Special Litigation Committee in the Investigation and Dismissal of Derivative Suits, 37 Bus.Law. 1199 (1982); Veasey, Seeking a Safe Harbor from Judicial Scrutiny of Directors' Business Decisions — An Analytical Framework for Litigation Strategy and Counselling Directors, 37 Bus.Law. 1247 (1982); Block & Prussin, The Business Judgment Rule and Shareholder Derivative Actions: Viva Zapata?, 37 Bus.Law. 27 (1981).

[21] Although the Court of Chancery held that a pre-suit demand was required and not made, it did not dismiss Spiegel's complaint on that basis alone. Thereafter, it re-examined Spiegel's complaint, following the rejection of his post-suit demand, based upon the Committee's motion to dismiss. Cf. Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 943 (3d Cir.1982), aff'g 520 F.Supp. 1098, 1100 (D.Del.1981), vacated and remanded on other grounds, 465 U.S. 1001, 104 S.Ct. 989, 79 L.Ed.2d 224 (1984); Grossman v. Johnson, 674 F.2d 115, 125-26 (1st Cir.), cert. denied, 459 U.S. 838, 103 S.Ct. 85, 74 L.Ed.2d 80 (1982).

William T. Quillen (argued), Robert K. Payson, Peter M. Sieglaff, Potter, Anderson & Corroon, Wilmington; and Allan M. Pepper, Michael D. Braff, Kaye, Scholer, Fierman, Hays & Handler, New York City, for appellants.

Joseph A. Rosenthal (argued), Morris & Rosenthal, P.A., Wilmington; and Irving Bizar, Pincus, Ohrenstein, Bizar, D'Alessandro & Solomon, New York City, for appellee.

Before McNEILLY, MOORE and CHRISTIE, JJ.

[807] MOORE, Justice:

In the wake of Zapata Corp. v. Maldonado, Del.Supr., 430 A.2d 779 (1981), this Court left a crucial issue unanswered: when is a stockholder's demand upon a board of directors, to redress an alleged wrong to the corporation, excused as futile prior to the filing of a derivative suit? We granted this interlocutory appeal to the defendants, Meyers Parking System, Inc. (Meyers), a Delaware corporation, and its directors, to review the Court of Chancery's denial of their motion to dismiss this action, pursuant to Chancery Rule 23.1, for the [808] plaintiff's failure to make such a demand or otherwise demonstrate its futility.^[1] The Vice Chancellor ruled that plaintiff's allegations raised a "reasonable inference" that the directors' action was unprotected by the business judgment rule. Thus, the board could not have impartially considered and acted upon the demand. See Lewis v. Aronson, Del.Ch., 466 A.2d 375, 381 (1983).

We cannot agree with this formulation of the concept of demand futility. In our view demand can only be excused where facts are alleged with particularity which create a reasonable doubt that the directors' action was entitled to the protections of the business judgment rule. Because the plaintiff failed to make a demand, and to allege facts with particularity indicating that such demand would be futile, we reverse the Court of Chancery and remand with instructions that plaintiff be granted leave to amend the complaint.

I.

The issues of demand futility rest upon the allegations of the complaint. The plaintiff, Harry Lewis, is a stockholder of Meyers. The defendants are Meyers and its ten directors, some of whom are also company officers.

In 1979, Prudential Building Maintenance Corp. (Prudential) spun off its shares of Meyers to Prudential's stockholders. Prior thereto Meyers was a wholly owned subsidiary of Prudential. Meyers provides parking lot facilities and related services throughout the country. Its stock is actively traded over-the-counter.

This suit challenges certain transactions between Meyers and one of its directors, Leo Fink, who owns 47% of its outstanding stock. Plaintiff claims that these transactions were approved only because Fink personally selected each director and officer of Meyers.^[2]

Prior to January 1, 1981, Fink had an employment agreement with Prudential which provided that upon retirement he was to become a consultant to that company for ten years. This provision became operable when Fink retired in April 1980.^[3] Thereafter, Meyers agreed with Prudential to share Fink's consulting services and reimburse Prudential for 25% of the fees paid Fink. Under this arrangement Meyers paid Prudential $48,332 in 1980 and $45,832 in 1981.

On January 1, 1981, the defendants approved an employment agreement between Meyers and Fink for a five year term with provision for automatic renewal each year thereafter, indefinitely. Meyers agreed to pay Fink $150,000 per year, plus a bonus of 5% of its pre-tax profits over $2,400,000. Fink could terminate the contract at any time, but Meyers could do so only upon six months' notice. At termination, Fink was to become a consultant to Meyers and be paid $150,000 per year for the first three years, $125,000 for the next three years, and $100,000 thereafter for life. Death benefits were also included. Fink agreed to devote his best efforts and substantially his entire business time to advancing Meyers' interests. The agreement also provided [809] that Fink's compensation was not to be affected by any inability to perform services on Meyers' behalf. Fink was 75 years old when his employment agreement with Meyers was approved by the directors. There is no claim that he was, or is, in poor health.

Additionally, the Meyers board approved and made interest-free loans to Fink totalling $225,000. These loans were unpaid and outstanding as of August 1982 when the complaint was filed. At oral argument defendants' counsel represented that these loans had been repaid in full.

The complaint charges that these transactions had "no valid business purpose", and were a "waste of corporate assets" because the amounts to be paid are "grossly excessive", that Fink performs "no or little services", and because of his "advanced age" cannot be "expected to perform any such services". The plaintiff also charges that the existence of the Prudential consulting agreement with Fink prevents him from providing his "best efforts" on Meyers' behalf. Finally, it is alleged that the loans to Fink were in reality "additional compensation" without any "consideration" or "benefit" to Meyers.

The complaint alleged that no demand had been made on the Meyers board because:

13. ... such attempt would be futile for the following reasons:

(a) All of the directors in office are named as defendants herein and they have participated in, expressly approved and/or acquiesced in, and are personally liable for, the wrongs complained of herein.

(b) Defendant Fink, having selected each director, controls and dominates every member of the Board and every officer of Meyers.

(c) Institution of this action by present directors would require the defendant-directors to sue themselves, thereby placing the conduct of this action in hostile hands and preventing its effective prosecution.

Complaint, at ¶ 13.

The relief sought included the cancellation of the Meyers-Fink employment contract and an accounting by the directors, including Fink, for all damage sustained by Meyers and for all profits derived by the directors and Fink.

II.

Defendants moved to dismiss for plaintiff's failure to make demand on the Meyers board prior to suit, or to allege with factual particularity why demand is excused. See Del.Ch.Ct.R. 23.1, supra.

After recounting the allegations, the trial judge noted that the demand requirement of Rule 23.1 is a rule of substantive right designed to give a corporation the opportunity to rectify an alleged wrong without litigation, and to control any litigation which does arise. Lewis, 466 A.2d at 380. According to the Vice Chancellor, the test of futility is "whether the Board, at the time of the filing of the suit, could have impartially considered and acted upon the demand". Id. at 381.

As part of this formulation, the trial judge stated that interestedness is one factor affecting impartiality, and indicated that the business judgment rule is a potential defense to allegations of director interest, and hence, demand futility. Id. However, the court observed that to establish demand futility, a plaintiff need not allege that the challenged transaction could never be deemed a product of business judgment. Id. Rather, the Vice Chancellor maintained that a plaintiff "must only allege facts which, if true, show that there is a reasonable inference that the business judgment rule is not applicable for purposes of considering a pre-suit demand pursuant to Rule 23.1". Id. The court concluded that this transaction permitted such an inference. Id. at 384-86.

Upon these formulations, the Court of Chancery addressed the plaintiff's arguments [810] as to the futility of demand. Id. at 381-84. The trial judge correctly noted that futility is gauged by the circumstances existing at the commencement of a derivative suit. This disposed of plaintiff's argument that defendants' motion to dismiss established board hostility and the futility of demand. Id. at 381.

The Vice Chancellor then dealt with plaintiff's contention that Fink, as a 47% shareholder of Meyers, dominated and controlled each director, thereby making demand futile. Id. at 381-83. Plaintiff also argued that Fink's interest, when combined with the shareholdings of four other defendants, amounted to 57.5% of Meyers' outstanding shares. Id. at 381. After noting the presumptions under the business judgment rule that a board's actions are taken in good faith and in the best interests of the corporation, the Court of Chancery ruled that mere board approval of a transaction benefiting a substantial, but non-majority, shareholder will not overcome the presumption of propriety. Id. at 382. Specifically, the court observed that:

A plaintiff, to properly allege domination of the Board, particularly domination based on ownership of less than a majority of the corporation's stock, in order to excuse a pre-suit demand, must allege ownership plus other facts evidencing control to demonstrate that the Board could not have exercised its independent business judgment.

Id.

As to the combined 57.5% control claim, the court stated that there were no factual allegations regarding the alignment of the four directors with Fink, such as a claim that they were beneficiaries of the Meyers-Fink agreement. Id. at 382, 383. Because it was not alleged in the complaint, the court rejected plaintiff's argument that, as evidence of alignment with Fink, two of the directors have "similar" compensation agreements with Meyers. Id. at 383.

Turning to plaintiff's allegations of board approval, participation in, and/or acquiescence in the wrong, the trial court focused on the underlying transaction to determine whether the board's action was wrongful and not protected by the business judgment rule. Id. [citing Dann v. Chrysler, Del.Ch., 174 A.2d 696 (1961)]. The Vice Chancellor indicated that if the underlying transaction supported a reasonable inference that the business judgment rule did not apply, then the directors who approved the transaction were potentially liable for a breach of their fiduciary duty, and thus, could not impartially consider a stockholder's demand. Id.

The trial court then stated that board approval of the Meyers-Fink agreement, allowing Fink's consultant compensation to remain unaffected by his ability to perform any services, may have been a transaction wasteful on its face. Id. [citing Fidanque v. American Maracaibo Co., Del.Ch., 92 A.2d 311 (1952)]. Consequently, demand was excused as futile, because the Meyers' directors faced potential liability for waste and could not have impartially considered the demand. Id. at 384.

III.

The defendants make two arguments, one policy-oriented and the other, factual. First, they assert that the demand requirement embraces the policy that directors, rather than stockholders, manage the affairs of the corporation. They contend that this fundamental principle requires the strict construction and enforcement of Chancery Rule 23.1. Second, the defendants point to four of plaintiff's basic allegations and argue that they lack the factual particularity necessary to excuse demand. Concerning the allegation that Fink dominated and controlled the Meyers board, the defendants point to the absence of any facts explaining how he "selected each director". With respect to Fink's 47% stock interest, the defendants say that absent other facts this is insufficient to indicate domination and control. Regarding the claim of hostility to the plaintiff's suit, because defendants would have to sue themselves, the latter assert that this bootstrap argument ignores the possibility that the directors have other [811] alternatives, such as cancelling the challenged agreement. As for the allegation that directorial approval of the agreement excused demand, the defendants reply that such a claim is insufficient, because it would obviate the demand requirement in almost every case. The effect would be to subvert the managerial power of a board of directors. Finally, as to the provision guaranteeing Fink's compensation, even if he is unable to perform any services, the defendants contend that the trial court read this out of context. Based upon the foregoing, the defendants conclude that the plaintiff's allegations fall far short of the factual particularity required by Rule 23.1.

IV.

A.

A cardinal precept of the General Corporation Law of the State of Delaware is that directors, rather than shareholders, manage the business and affairs of the corporation. 8 Del.C. § 141(a). Section 141(a) states in pertinent part:

"The business and affairs of a corporation organized under this chapter shall be managed by or under the direction of a board of directors except as may be otherwise provided in this chapter or in its certificate of incorporation."

8 Del.C. § 141(a) (Emphasis added). The existence and exercise of this power carries with it certain fundamental fiduciary obligations to the corporation and its shareholders.^[4]Loft, Inc. v. Guth, Del.Ch., 2 A.2d 225 (1938), aff'd, Del.Supr., 5 A.2d 503 (1939). Moreover, a stockholder is not powerless to challenge director action which results in harm to the corporation. The machinery of corporate democracy and the derivative suit are potent tools to redress the conduct of a torpid or unfaithful management. The derivative action developed in equity to enable shareholders to sue in the corporation's name where those in control of the company refused to assert a claim belonging to it. The nature of the action is two-fold. First, it is the equivalent of a suit by the shareholders to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it.

By its very nature the derivative action impinges on the managerial freedom of directors.^[5] Hence, the demand requirement of Chancery Rule 23.1 exists at the threshold, first to insure that a stockholder exhausts his intracorporate remedies, and [812] then to provide a safeguard against strike suits. Thus, by promoting this form of alternate dispute resolution, rather than immediate recourse to litigation, the demand requirement is a recognition of the fundamental precept that directors manage the business and affairs of corporations.

In our view the entire question of demand futility is inextricably bound to issues of business judgment and the standards of that doctrine's applicability. The business judgment rule is an acknowledgment of the managerial prerogatives of Delaware directors under Section 141(a). See Zapata Corp. v. Maldonado, 430 A.2d at 782. It is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Kaplan v. Centex Corp., Del.Ch., 284 A.2d 119, 124 (1971); Robinson v. Pittsburgh Oil Refinery Corp., Del.Ch., 126 A. 46 (1924). Absent an abuse of discretion, that judgment will be respected by the courts. The burden is on the party challenging the decision to establish facts rebutting the presumption. See Puma v. Marriott, Del.Ch., 283 A.2d 693, 695 (1971).

The function of the business judgment rule is of paramount significance in the context of a derivative action. It comes into play in several ways — in addressing a demand, in the determination of demand futility, in efforts by independent disinterested directors to dismiss the action as inimical to the corporation's best interests, and generally, as a defense to the merits of the suit. However, in each of these circumstances there are certain common principles governing the application and operation of the rule.

First, its protections can only be claimed by disinterested directors whose conduct otherwise meets the tests of business judgment. From the standpoint of interest, this means that directors can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing, as opposed to a benefit which devolves upon the corporation or all stockholders generally. Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717, 720 (1971); Cheff v. Mathes, Del.Supr., 199 A.2d 548, 554 (1964); David J. Greene & Co. v. Dunhill International, Inc., Del.Ch., 249 A.2d 427, 430 (1968). See also 8 Del.C. § 144. Thus, if such director interest is present, and the transaction is not approved by a majority consisting of the disinterested directors, then the business judgment rule has no application whatever in determining demand futility. See 8 Del.C. § 144(a)(1).

Second, to invoke the rule's protection directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. Having become so informed, they must then act with requisite care in the discharge of their duties. While the Delaware cases use a variety of terms to describe the applicable standard of care, our analysis satisfies us that under the business judgment rule director liability is predicated upon concepts of gross negligence.^[6] See Veasey & Manning, Codified Standard [813] — Safe Harbor or Uncharted Reef? 35 Bus.Law. 919, 928 (1980).

However, it should be noted that the business judgment rule operates only in the context of director action. Technically speaking, it has no role where directors have either abdicated their functions, or absent a conscious decision, failed to act.^[7] But it also follows that under applicable principles, a conscious decision to refrain from acting may nonetheless be a valid exercise of business judgment and enjoy the protections of the rule.

The gap in our law, which we address today, arises from this Court's decision in Zapata Corp. v. Maldonado. There, the Court defined the limits of a board's managerial power granted by Section 141(a) and restricted application of the business judgment rule in a factual context similar to this action. Zapata Corp. v. Maldonado, 430 A.2d at 782-86, rev'g, Maldonado v. Flynn, Del.Ch., 413 A.2d 1251 (1980).

By way of background, this Court's review in Zapata was limited to whether an independent investigation committee of disinterested directors had the power to cause the derivative action to be dismissed. Preliminarily, it was noted in Zapata that "[d]irectors of Delaware corporations derive their managerial decision making power, which encompasses decisions whether to initiate, or refrain from entering, litigation, from 8 Del.C. § 141(a)". Zapata, 430 A.2d at 782 (footnotes omitted). In that context, this Court observed that the business judgment rule has no relevance to corporate decision making until after a decision has been made. Id. In Zapata, we stated that a shareholder does not possess an independent individual right to continue a derivative action. Moreover, where demand on a board has been made and refused, we apply the business judgment rule in reviewing the board's refusal to act pursuant to a stockholder's demand. Id. at 784 & n. 10. Unless the business judgment rule does not protect the refusal to sue, the shareholder lacks the legal managerial power to continue the derivative action, since that power is terminated by the refusal. Id. at 784. We also concluded that where demand is excused a shareholder possesses the ability to initiate a derivative action, but the right to prosecute it may be terminated upon the exercise of applicable standards of business judgment. Id. The thrust of Zapata is that in either the demand-refused or the demand-excused case, the board still retains its Section 141(a) managerial authority to make decisions regarding corporate litigation. Moreover, the board may delegate its managerial authority to a committee of independent disinterested directors. Id. at 786. See 8 Del.C. § 141(c). Thus, even in a demand-excused case, a board has the power to appoint a committee of one or more independent disinterested directors to determine whether the derivative action should be pursued or dismissal sought. Zapata, 430 A.2d at 786. Under Zapata, the Court of Chancery, in passing on a committee's motion to dismiss a derivative action in a demand excused case, must apply a two-step test. First, the court must inquire into the independence and good faith of the committee and review the reasonableness and good faith of the committee's investigation. Id. at 788. Second, the court must apply its own independent business judgment to decide whether the motion to dismiss should be granted. Id. at 789.

After Zapata numerous derivative suits were filed without prior demand upon boards of directors. The complaints in such actions all alleged that demand was excused because of board interest, approval or acquiescence in the wrongdoing. In any event, the Zapata demand-excused/demand-refused [814] bifurcation, has left a crucial issue unanswered: when is demand futile and, therefore, excused?

Delaware courts have addressed the issue of demand futility on several earlier occasions. See Sohland v. Baker, Del. Supr., 141 A. 277, 281-82 (1927); McKee v. Rogers, Del.Ch., 156 A. 191, 193 (1931); Miller v. Loft, Del.Ch., 153 A. 861, 862 (1931); Fleer v. Frank H. Fleer Corp., Del.Ch., 125 A. 411, 414 (1924); Harden v. Eastern States Public Service Co., Del.Ch., 122 A. 705, 707 (1923); Ellis v. Penn Beef Co., Del.Ch., 80 A. 666, 668 (1911). Cf. Mayer v. Adams, Del.Supr., 141 A.2d 458, 461 (1958) (minority demand on majority shareholders). The rule emerging from these decisions is that where officers and directors are under an influence which sterilizes their discretion, they cannot be considered proper persons to conduct litigation on behalf of the corporation. Thus, demand would be futile. See, e.g., McKee v. Rogers, Del.Ch., 156 A. 191, 192 (1931) (holding that where a defendant controlled the board of directors, "[i]t is manifest then that there can be no expectation that the corporation would sue him, and if it did, it can hardly be said that the prosecution of the suit would be entrusted to proper hands"). But see, e.g., Fleer v. Frank H. Fleer Corp., Del.Ch., 125 A. 411, 415 (1924) ("[w]here the demand if made would be directed to the particular individuals who themselves are the alleged wrongdoers and who therefore would be invited to sue themselves, the rule is settled that a demand and refusal is not requisite"); Miller v. Loft, Inc., Del.Ch., 153 A. 861, 862 (1931) ("if by reason of hostile interest or guilty participation in the wrongs complained of, the directors cannot be expected to institute suit, ... no demand upon them to institute suit is requisite").

However, those cases cannot be taken to mean that any board approval of a challenged transaction automatically connotes "hostile interest" and "guilty participation" by directors, or some other form of sterilizing influence upon them. Were that so, the demand requirements of our law would be meaningless, leaving the clear mandate of Chancery Rule 23.1 devoid of its purpose and substance.

The trial court correctly recognized that demand futility is inextricably bound to issues of business judgment, but stated the test to be based on allegations of fact, which, if true, "show that there is a reasonable inference" the business judgment rule is not applicable for purposes of a pre-suit demand. Lewis, 466 A.2d at 381.

The problem with this formulation is the concept of reasonable inferences to be drawn against a board of directors based on allegations in a complaint. As is clear from this case, and the conclusory allegations upon which the Vice Chancellor relied, demand futility becomes virtually automatic under such a test. Bearing in mind the presumptions with which director action is cloaked, we believe that the matter must be approached in a more balanced way.

Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. Hence, the Court of Chancery must make two inquiries, one into the independence and disinterestedness of the directors and the other into the substantive nature of the challenged transaction and the board's approval thereof. As to the latter inquiry the court does not assume that the transaction is a wrong to the corporation requiring corrective steps by the board. Rather, the alleged wrong is substantively reviewed against the factual background alleged in the complaint. As to the former inquiry, directorial independence and disinterestedness, the court reviews the factual allegations to decide whether they raise a reasonable doubt, as a threshold matter, that the protections of the business judgment rule are available to the board. [815] Certainly, if this is an "interested" director transaction, such that the business judgment rule is inapplicable to the board majority approving the transaction, then the inquiry ceases. In that event futility of demand has been established by any objective or subjective standard.^[8]See, e.g., Bergstein v. Texas Internat'l Co., Del.Ch., 453 A.2d 467, 471 (1982) (because five of nine directors approved stock appreciation rights plan likely to benefit them, board was interested for demand purposes and demand held futile). This includes situations involving self-dealing directors. See Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717 (1971); Sterling v. Mayflower, Del.Supr., 93 A.2d 107 (1952); Trans World Airlines, Inc. v. Summa Corp., Del.Ch., 374 A.2d 5 (1977); David J. Greene & Co. v. Dunhill International, Inc., Del.Ch., 249 A.2d 427 (1968).

However, the mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterestedness of directors, although in rare cases a transaction may be so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability therefore exists. See Gimbel v. Signal Cos., Inc., Del.Ch., 316 A.2d 599, aff'd, Del.Supr., 316 A.2d 619 (1974); Cottrell v. Pawcatuck Co., Del.Supr., 128 A.2d 225 (1956). In sum the entire review is factual in nature. The Court of Chancery in the exercise of its sound discretion must be satisfied that a plaintiff has alleged facts with particularity which, taken as true, support a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment. Only in that context is demand excused.

B.

Having outlined the legal framework within which these issues are to be determined, we consider plaintiff's claims of futility here: Fink's domination and control of the directors, board approval of the Fink-Meyers employment agreement, and board hostility to the plaintiff's derivative action due to the directors' status as defendants.

Plaintiff's claim that Fink dominates and controls the Meyers' board is based on: (1) Fink's 47% ownership of Meyers' outstanding stock, and (2) that he "personally selected" each Meyers director. Plaintiff also alleges that mere approval of the employment agreement illustrates Fink's domination and control of the board. In addition, plaintiff argued on appeal that 47% stock ownership, though less than a majority, constituted control given the large number of shares outstanding, 1,245,745.

Such contentions do not support any claim under Delaware law that these directors lack independence. In Kaplan v. Centex Corp., Del.Ch., 284 A.2d 119 (1971), the Court of Chancery stated that "[s]tock ownership alone, at least when it amounts to less than a majority, is not sufficient proof of domination or control". Id. at 123. Moreover, in the demand context even proof of majority ownership of a company does not strip the directors of the presumptions of independence, and that their acts have been taken in good faith and in the best interests of the corporation. There must be coupled with the allegation of control such facts as would demonstrate that through personal or other relationships the directors are beholden to the controlling person. See Mayer v. Adams, Del.Ch., 167 A.2d 729, 732, aff'd, Del.Supr., 174 A.2d 313 (1961). To date the principal decisions dealing [816] with the issue of control or domination arose only after a full trial on the merits. Thus, they are distinguishable in the demand context unless similar particularized facts are alleged to meet the test of Chancery Rule 23.1. See e.g., Kaplan, 284 A.2d at 123; Chasin v. Gluck, Del.Ch., 282 A.2d 188 (1971); Greene v. Allen, Del.Ch., 114 A.2d 916 (1955); Loft, Inc. v. Guth, Del.Ch., 2 A.2d 225, 237 (1938), aff'd, Del.Supr., 5 A.2d 503 (1939).

The requirement of director independence inhers in the conception and rationale of the business judgment rule. The presumption of propriety that flows from an exercise of business judgment is based in part on this unyielding precept. Independence means that a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences. While directors may confer, debate, and resolve their differences through compromise, or by reasonable reliance upon the expertise of their colleagues and other qualified persons, the end result, nonetheless, must be that each director has brought his or her own informed business judgment to bear with specificity upon the corporate merits of the issues without regard for or succumbing to influences which convert an otherwise valid business decision into a faithless act.

Thus, it is not enough to charge that a director was nominated by or elected at the behest of those controlling the outcome of a corporate election. That is the usual way a person becomes a corporate director. It is the care, attention and sense of individual responsibility to the performance of one's duties, not the method of election, that generally touches on independence.

We conclude that in the demand-futile context a plaintiff charging domination and control of one or more directors must allege particularized facts manifesting "a direction of corporate conduct in such a way as to comport with the wishes or interests of the corporation (or persons) doing the controlling". Kaplan, 284 A.2d at 123. The shorthand shibboleth of "dominated and controlled directors" is insufficient. In recognizing that Kaplan was decided after trial and full discovery, we stress that the plaintiff need only allege specific facts; he need not plead evidence. Otherwise, he would be forced to make allegations which may not comport with his duties under Chancery Rule 11.^[9]

Here, plaintiff has not alleged any facts sufficient to support a claim of control. The personal-selection-of-directors allegation stands alone, unsupported. At best it is a conclusion devoid of factual support. The causal link between Fink's control and approval of the employment agreement is alluded to, but nowhere specified. The director's approval, alone, does not establish control, even in the face of Fink's 47% stock ownership. See Kaplan v. Centex Corp., 284 A.2d at 122, 123. The claim that Fink is unlikely to perform any services under the agreement, because of his age, and his conflicting consultant work with Prudential, adds nothing to the control claim.^[10] Therefore, we cannot conclude that the [817] complaint factually particularizes any circumstances of control and domination to overcome the presumption of board independence, and thus render the demand futile.

C.

Turning to the board's approval of the Meyers-Fink employment agreement, plaintiff's argument is simple: all of the Meyers directors are named defendants, because they approved the wasteful agreement; if plaintiff prevails on the merits all the directors will be jointly and severally liable; therefore, the directors' interest in avoiding personal liability automatically and absolutely disqualifies them from passing on a shareholder's demand.

Such allegations are conclusory at best. In Delaware mere directorial approval of a transaction, absent particularized facts supporting a breach of fiduciary duty claim, or otherwise establishing the lack of independence or disinterestedness of a majority of the directors, is insufficient to excuse demand.^[11] Here, plaintiff's suit is premised on the notion that the Meyers-Fink employment agreement was a waste of corporate assets. So, the argument goes, by approving such waste the directors now face potential personal liability, thereby rendering futile any demand on them to bring suit. Unfortunately, plaintiff's claim falls in its initial premise. The complaint does not allege particularized facts indicating that the agreement is a waste of corporate assets. Indeed, the complaint as now drafted may not even state a cause of action, given the directors' broad corporate power to fix the compensation of officers.^[12]

In essence, the plaintiff alleged a lack of consideration flowing from Fink to Meyers, since the employment agreement provided that compensation was not contingent on Fink's ability to perform any services. The bare assertion that Fink performed "little or no services" was plaintiff's conclusion based solely on Fink's age and the existence of the Fink-Prudential employment agreement. As for Meyers' loans to Fink, beyond the bare allegation that they were made, the complaint does not allege facts indicating the wastefulness of such arrangements. Again, the mere existence of such loans, given the broad corporate powers conferred by Delaware law, does not even state a claim.^[13]

In sustaining plaintiff's claim of demand futility the trial court relied on Fidanque v. American Maracaibo Co., Del. Ch., 92 A.2d 311, 321 (1952), which held that a contract providing for payment of consulting fees to a retired president/director was a waste of corporate assets. Id. In Fidanque, the court found after trial that the contract and payments were in reality compensation for past services. Id. at 320. This was based upon facts not present here: the former president/director was a 70 year old stroke victim, neither the agreement nor the record spelled out his consulting duties at all, the consulting salary equalled the individual's salary when he was president and general manager of the corporation, and the contract was silent as to continued employment in the event that the retired president/director again became incapacitated and unable to perform his duties. Id. at 320-21. Contrasting the facts of Fidanque with the complaint here, it is apparent that plaintiff has not alleged [818] facts sufficient to render demand futile on a charge of corporate waste, and thus create a reasonable doubt that the board's action is protected by the business judgment rule. Cf. Beard v. Elster, Del.Supr., 160 A.2d 731 (1960); Lieberman v. Koppers Company Line, Inc., Del.Ch., 149 A.2d 756, aff'd, Lieberman v. Becker, Del.Supr., 155 A.2d 596 (1959).

D.

Plaintiff's final argument is the incantation that demand is excused because the directors otherwise would have to sue themselves, thereby placing the conduct of the litigation in hostile hands and preventing its effective prosecution. This bootstrap argument has been made to and dismissed by other courts. See, e.g., Lewis v. Graves, 701 F.2d 245, 248-49 (2d Cir.1983); Heit v. Baird, 567 F.2d 1157, 1162 (1st Cir. 1977); Lewis v. Anselmi, 564 F.Supp., 768, 772 (S.D.N.Y.1983). Its acceptance would effectively abrogate Rule 23.1 and weaken the managerial power of directors. Unless facts are alleged with particularity to overcome the presumptions of independence and a proper exercise of business judgment, in which case the directors could not be expected to sue themselves, a bare claim of this sort raises no legally cognizable issue under Delaware corporate law.

V.

In sum, we conclude that the plaintiff has failed to allege facts with particularity indicating that the Meyers directors were tainted by interest, lacked independence, or took action contrary to Meyers' best interests in order to create a reasonable doubt as to the applicability of the business judgment rule. Only in the presence of such a reasonable doubt may a demand be deemed futile. Hence, we reverse the Court of Chancery's denial of the motion to dismiss, and remand with instructions that plaintiff be granted leave to amend his complaint to bring it into compliance with Rule 23.1 based on the principles we have announced today.

* * *

REVERSED AND REMANDED.

[1] Chancery Rule 23.1, similar to Fed.R.Civ.P. 23.1, provides in pertinent part:

In a derivative action brought by 1 or more shareholders or members to enforce a right of a corporation or of an unincorporated association, the corporation or association having failed to enforce a right which may properly be asserted by it, the complaint shall allege that the plaintiff was a shareholder or member at the time of the transaction of which he complains or that his share of membership thereafter devolved on him by operation of law. The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and the reasons for his failure to obtain the action or for not making the effort. Del.Ch.Ct.R. 23.1 (Emphasis added).

[2] The Court of Chancery stated that Fink had been chief executive officer of Prudential prior to the spin-off and thereafter became chairman of Meyers' board. This was not alleged in the complaint. Lewis, 466 A.2d at 379.

[3] The trial court stated that Fink "changed his status with Prudential building from employee to consultant". Lewis, 466 A.2d at 379.

[4] The broad question of structuring the modern corporation in order to satisfy the twin objectives of managerial freedom of action and responsibility to shareholders has been extensively debated by commentators. See, e.g., Fischel, The Corporate Governance Movement, 35 Vand.L.Rev. 1259 (1982); Dickstein, Corporate Governance and the Shareholders' Derivative Action: Rules and Remedies for Implementing the Monitoring Model, 3 Cardozo L.Rev. 627 (1982); Haft, Business Decisions by the New Board: Behavioral Science and Corporate Law, 80 Mich.L.Rev. 1 (1981); Dent, The Revolution in Corporate Governance, The Monitoring Board, and The Director's Duty of Care, 61 B.U.L.Rev. 623 (1981); Moore, Corporate Officer & Director Liability: Is Corporate Behavior Beyond the Control of Our Legal System? 16 Capital U.L.Rev. 69 (1980); Jones, Corporate Governance: Who Controls the Large Corporation? 30 Hastings L.J. 1261 (1979); Small, The Evolving Role of the Director in Corporate Governance, 30 Hastings L.J. 1353 (1979).

[5] Like the broader question of corporate governance, the derivative suit, its value, and the methods employed by corporate boards to deal with it have received much attention by commentators. See, e.g., Brown, Shareholder Derivative Litigation and the Special Litigation Committee, 43 U.Pitt.L.Rev. 601 (1982); Coffee and Schwartz, The Survival of the Derivative Suit: An Evaluation and a Proposal for Legislative Reform, 81 Colum.L.Rev. 261 (1981); Shnell, A Procedural Treatment of Derivative Suit Dismissals by Minority Directors, 609 Calif.L.Rev. 885 (1981); Dent, The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit? 75 N.W.U.L. Rev. 96 (1980); Jones, An Empirical Examination of the Incidence of Shareholder Derivative and Class Action Lawsuits, 1971-1978, 60 B.U. L.Rev. 306 (1980); Comment, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U.Chi.L.Rev. 168 (1976); Dykstra, The Revival of the Derivative Suit, 116 U.Pa.L.Rev. 74 (1967); Note, Demand on Directors and Shareholders as a Prerequisite to a Derivative Suit, 73 Harv.L.Rev. 729 (1960).

[6] While the Delaware cases have not been precise in articulating the standard by which the exercise of business judgment is governed, a long line of Delaware cases holds that director liability is predicated on a standard which is less exacting than simple negligence. Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717, 722 (1971), rev'g, Del.Ch., 261 A.2d 911 (1969) ("fraud or gross overreaching"); Getty Oil Co. v. Skelly Oil Co., Del.Supr., 267 A.2d 883, 887 (1970), rev'g, Del.Ch., 255 A.2d 717 (1969) ("gross and palpable overreaching"); Warshaw v. Calhoun, Del.Supr., 221 A.2d 487, 492-93 (1966) ("bad faith ... or a gross abuse of discretion"); Moskowitz v. Bantrell, Del.Supr., 190 A.2d 749, 750 (1963) ("fraud or gross abuse of discretion"); Penn Mart Realty Co. v. Becker, Del.Ch., 298 A.2d 349, 351 (1972) ("directors may breach their fiduciary duty ... by being grossly negligent"); Kors v. Carey, Del.Ch., 158 A.2d 136, 140 (1960) ("fraud, misconduct or abuse of discretion"); Allaun v. Consolidated Oil Co., Del.Ch., 147 A. 257, 261 (1929) ("reckless indifference to or a deliberate disregard of the stockholders").

[7] Although questions of director liability in such cases have been adjudicated upon concepts of business judgment, they do not in actuality present issues of business judgment. See Graham v. Allis-Chalmers Manufacturing Co., Del.Supr., 188 A.2d 125 (1963); Kelly v. Bell, Del.Ch., 254 A.2d 62 (1969), aff'd, Del. Supr., 266 A.2d 878 (1970); Lutz v. Boas, Del. Ch., 171 A.2d 381 (1961). See also Arsht, Fiduciary Responsibilities of Directors, Officers & Key Employees, 4 Del.J.Corp.L. 652, 659 (1979).

[8] We recognize that drawing the line at a majority of the board may be an arguably arbitrary dividing point. Critics will charge that we are ignoring the structural bias common to corporate boards throughout America, as well as the other unseen socialization processes cutting against independent discussion and decisionmaking in the boardroom. The difficulty with structural bias in a demand futile case is simply one of establishing it in the complaint for purposes of Rule 23.1. We are satisfied that discretionary review by the Court of Chancery of complaints alleging specific facts pointing to bias on a particular board will be sufficient for determining demand futility.

[9] Chancery Rule 11 provides:

Every pleading of a party represented by an attorney shall be signed by at least 1 attorney of record in his individual name, whose address shall be stated. A party who is not represented by an attorney shall sign his pleading and state his address. Except when otherwise specifically provided by statute or rule, pleadings need not be verified or accompanied by affidavit. The signature of an attorney constitutes a certificate by him that he has read the pleading; that to the best of his knowledge, information, and belief there is good ground to support it; and that it is not interposed for delay. If a pleading is not signed or is signed with intent to defeat the purpose of this rule, it may be stricken as sham and false and the action may proceed as though the pleading had not been served. For a willful violation of this rule an attorney may be subjected to appropriate disciplinary action. Similar action may be taken if scandalous or indecent matter is inserted.

Del.Ch.Ct.R. 11.

[10] Plaintiff made no legal argument that the "best efforts" provision of the agreement prohibited dual consultant duties, thereby demonstrating that the contract's approval evidenced control or was otherwise wrongful.

[11] See also In re Kauffman Mutual Fund Actions, 479 F.2d 257, 265 (1st Cir.1973); Greenspun v. Del E. Webb, 634 F.2d 1204, 1210 (9th Cir.1980); Grossman v. Johnson, 674 F.2d 115, 124 (1st Cir.1982); Lewis v. Curtis, 671 F.2d 779, 785 (3d Cir.1982); Lewis v. Graves, 701 F.2d 245, 248 (2d Cir.1983).

[12] 8 Del.C. § 122(5) provides that "[e]very corporation created under this chapter shall have the power to appoint such officers and agents as the business of the corporation requires and to pay or otherwise provide for them suitable compensation". 8 Del.C. § 122(5).

[13] Plaintiff's allegation ignores 8 Del.C. § 143 which expressly authorizes interest-free loans to "any officer or employee of the corporation... whenever, in the judgment of the directors, such loan ... may reasonably be expected to benefit the corporation." 8 Del.C. § 143.

Stephen P. Lamb (argued), Robert A. Glen, Cathy L. Reese and Jaya B. Gokhale of Skadden, Arps, Slate, Meagher & Flom, Wilmington, for appellants Steven M. Rales and Mitchell P. Rales.

David C. McBride of Young, Conaway, Stargatt & Taylor, Wilmington, for appellants Danaher Corp. and Easco Hand Tools, Inc.

Mark Minuti of Saul, Ewing, Remick & Saul, Wilmington, Stephen A. Whinston (argued), and Arthur Stock of Berger & Montague, P.C., Philadelphia, PA, for appellee Alfred Blasband.

Before VEASEY, C.J., MOORE and HOLLAND, JJ.

[929] VEASEY, Chief Justice:

This certified question of law comes before the Court pursuant to Article IV, Section 11(9) of the Delaware Constitution and Supreme Court Rule 41. The question of law was certified by the United States District Court for the District of Delaware (the "District Court"), and was accepted by this Court on June 16, 1993. See Rales v. Blasband, Del.Supr., 626 A.2d 1364 (1993). Briefing and oral argument in this Court followed. This is the decision of the Court on the certified question.

The underlying action pending in the District Court is a stockholder derivative action [930] filed on March 25, 1991, by Alfred Blasband ("Blasband") on behalf of Danaher Corporation, a Delaware corporation ("Danaher"). Blasband's original complaint was dismissed by the District Court on August 15, 1992, based on Blasband's lack of standing, but the United States Court of Appeals for the Third Circuit (the "Third Circuit") vacated the District Court's order and permitted Blasband to amend his complaint. Blasband v. Rales, 971 F.2d 1034 (3d Cir.1992) ("Blasband I"). Following Blasband's filing of an amended complaint (the "amended complaint"), the defendants filed a motion to dismiss and moved to certify the following question of law to this Court:

In the context of this novel action, which is neither a simple derivative suit nor a double derivative suit, but which the United States Court of Appeals for the Third Circuit describes as a "first cousin to a double derivative suit," has plaintiff Alfred Blasband, in accordance with the substantive law of the State of Delaware, alleged facts to show that demand is excused on the board of directors of Danaher Corporation, a Delaware corporation?

After consideration of the allegations of the amended complaint, the briefs, and the oral argument of the parties in this Court, it is our conclusion that the certified question must be answered in the affirmative. Because the amended complaint does not challenge a decision of the board of directors of Danaher (the "Board"), the test enunciated in Aronson v. Lewis, Del.Supr., 473 A.2d 805 (1984) is not implicated. In the unusual context of this case, demand on the Board is excused because the amended complaint alleges particularized facts creating a reasonable doubt that a majority of the Board would be disinterested or independent in making a decision on a demand.

I. FACTS^[1]

Blasband is currently a stockholder of Danaher. Prior to 1990 Blasband owned 1100 shares of Easco Hand Tools, Inc., a Delaware corporation ("Easco"). Easco entered into a merger agreement with Danaher in February 1990 whereby Easco became a wholly-owned subsidiary of Danaher (the "Merger").

Steven M. Rales and Mitchell P. Rales (the "Rales brothers") have been directors, officers, or stockholders of Easco and Danaher at relevant times. Prior to the Merger, the Rales brothers were directors of Easco, and together owned approximately 52 percent of Easco's common stock. They continued to serve as directors of Easco after the Merger.

The Rales brothers also own approximately 44 percent of Danaher's common stock. Prior to the Merger, Mitchell Rales was President and Steven Rales was Chief Executive Officer of Danaher. The Rales brothers resigned their positions as officers of Danaher in early 1990, but continued to serve as members of the Board.^[2] The Board consists of eight members. The other six members are Danaher's President and Chief Executive Officer, George Sherman ("Sherman"), Donald E. Ehrlich ("Ehrlich"), Mortimer Caplin ("Caplin"), George D. Kellner ("Kellner"), A. Emmett Stephenson, Jr. ("Stephenson"), and Walter Lohr ("Lohr"). A number of these directors have business relationships with the Rales brothers or with entities controlled by them.^[3]

The central focus of the amended complaint is the alleged misuse by the Easco board of the proceeds of a sale of that company's 12.875% Senior Subordinated Notes due 1998 (the "Notes"). On or about September 1, 1988, Easco sold $100 million of the Notes in a public offering (the "Offering"). The prospectus for the Offering stated that the proceeds from the sale of the Notes would be used for (1) repaying outstanding [931] indebtedness, (2) funding corporate expansion, and (3) general corporate purposes. The prospectus further stated that "[p]ending such uses, the Company will invest the balance of the net proceeds from this offering in government and other marketable securities which are expected to yield a lower rate of return than the rate of interest borne by the Notes."

Blasband alleges that the defendants did not invest in "government and other marketable securities," but instead used over $61.9 million of the proceeds to buy highly speculative "junk bonds" offered through Drexel Burnham Lambert Inc. ("Drexel"). Blasband alleges that these junk bonds were bought by Easco because of the Rales brothers' desire to help Drexel at a time when it was under investigation and having trouble selling such bonds. The amended complaint describes the prior business relationship between the Rales brothers and Drexel in the mid-1980s, including Drexel's assistance in the Rales brothers' expansion of Danaher through corporate acquisitions and the role played by Drexel in the Rales brothers' attempt to acquire Interco, Inc. Moreover, Drexel was the underwriter of the Offering of Easco's Notes.

The amended complaint alleges that these investments have declined substantially in value, resulting in a loss to Easco of at least $14 million. Finally, Blasband complains that the Easco and Danaher boards of directors refused to comply with his request for information regarding the investments.^[4]

II. SCOPE AND STANDARD OF REVIEW

Because we are addressing a certified question of law, as distinct from a review of a lower court decision, the normal standards of review do not apply. This matter is presented in the context of a motion to dismiss Blasband's amended complaint filed in the District Court pursuant to Federal Rule of Civil Procedure ("Fed.R.Civ.P.") 23.1 for failure to demonstrate that demand on the Board is excused. The well-pleaded factual allegations of the derivative complaint are accepted as true on such a motion. E.g., In re General Motors Class E Stock Buyout Sec. Litig., 790 F.Supp. 77, 81 (D.Del.1992). See also Grobow v. Perot, Del.Supr., 539 A.2d 180, 186 (1988). Conclusory allegations, however, are not accepted as true. In re General Motors, 790 F.Supp. at 81. See also Allison v. General Motors Corp., 604 F.Supp. 1106 (D.Del.1985), aff'd, 782 F.2d 1026 (3d Cir.1986).

The scope of the issues that may be considered in addressing a certified question is limited by the procedural posture of the case. Supreme Court Rule 41(a) provides that this Court may not accept a certified question of law unless "the certifying court has not decided the question in the case." The question of Blasband's standing to pursue the derivative claims in the amended complaint has already been decided by the Third Circuit. Blasband I, 971 F.2d at 1046. That ruling therefore is the law of the case, and cannot be reconsidered by this Court in the present proceeding. See Blasband v. Rales, 979 F.2d 324 (3d Cir.1992) ("Blasband II") (holding in mandamus action that the District Court was precluded from certifying essentially the same standing question when the Court of Appeals had already decided the issue). The same principle applies to other determinations made by the Third Circuit in its decision.^[5]

[932] The parties have raised a threshold issue regarding this Court's ability to consider the legal standards which are applicable to the certified question. Blasband contends that the role of this Court in responding to the certified question is limited to a mechanical application of the two-part test^[6] set forth in Aronson v. Lewis, Del.Supr., 473 A.2d 805, 814 (1984). The defendants disagree, and argue that the Court should apply a test more stringent than the Aronson test to protect corporations against strike suits.

Consideration of this issue must begin with the language of the certified question itself:

In the context of this novel action, which is neither a simple derivative suit nor a double derivative suit, but which the United States Court of Appeals for the Third Circuit describes as a "first cousin to a double derivative suit," has plaintiff Alfred Blasband, in accordance with the substantive law of the State of Delaware, alleged facts to show that demand is excused on the board of directors of Danaher Corporation, a Delaware corporation?

(Emphasis added). The certified question does not limit the issue presented to the mere application of the Aronson test, but instead calls upon this Court to decide whether Blasband's amended complaint establishes that demand is excused under the "substantive law of the State of Delaware." It is therefore necessary for this Court to determine what the applicable "substantive law" is before we can decide whether demand on the Board should be excused. Accordingly, the language of the question certified to this Court requires a consideration of the appropriate legal principles, including the applicability of the Aronson test in this unusual context, so that we may properly decide the issue presented to us.

III. THE STANDARDS FOR DETERMINING WHETHER DEMAND IS EXCUSED IN THIS DERIVATIVE SUIT

The stockholder derivative suit is an important and unique feature of corporate governance. In such a suit, a stockholder asserts a cause of action belonging to the corporation. Aronson, 473 A.2d at 811; Levine v. Smith, Del.Supr., 591 A.2d 194, 200 (1991). In a double derivative suit, such as the present case, a stockholder of a parent corporation seeks recovery for a cause of action belonging to a subsidiary corporation. See Sternberg v. O'Neil, Del.Supr., 550 A.2d 1105, 1123-24 (1988). Because directors are empowered to manage, or direct the management of, the business and affairs of the corporation, 8 Del.C. § 141(a), the right of a stockholder to prosecute a derivative suit is limited to situations where the stockholder has demanded that the directors pursue the corporate claim and they have wrongfully refused to do so or where demand is excused because the directors are incapable of making an impartial decision regarding such litigation. Levine, 591 A.2d at 200. Fed. R.Civ.P. 23.1, like Chancery Court Rule 23.1, constitutes the procedural embodiment of this substantive principle of corporation law.^[7]

[933] Derivative suits have been used most frequently as a means of redressing harm to a corporation allegedly resulting from misconduct by its directors. As we observed in Aronson:

[A] stockholder is not powerless to challenge director action which results in harm to the corporation. The machinery of corporate democracy and the derivative suit are potent tools to redress the conduct of a torpid and unfaithful management.

473 A.2d at 811. In such instances, stockholders often do not make a demand on the board of directors, and instead file suit claiming that demand is excused.

Because such derivative suits challenge the propriety of decisions made by directors pursuant to their managerial authority, we have repeatedly held that the stockholder plaintiffs must overcome the powerful presumptions of the business judgment rule before they will be permitted to pursue the derivative claim. Aronson, 473 A.2d at 814; Grobow, 539 A.2d at 186; Levine, 591 A.2d at 200, 205-6; Pogostin v. Rice, Del.Supr., 480 A.2d 619, 624 (1984). Our decision in Aronson enunciated the test for determining a derivative plaintiff's compliance with this fundamental threshold obligation: "whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." 473 A.2d at 814.

Although these standards are well-established, they cannot be applied in a vacuum. Not all derivative suits fall into the paradigm addressed by Aronson and its progeny. The essential predicate for the Aronson test is the fact that a decision of the board of directors is being challenged in the derivative suit. Our discussion of the Aronson test in Pogostin v. Rice makes this clear:

Directorial interest exists whenever divided loyalties are present, or a director has received, or is entitled to receive, a personal financial benefit from the challenged transaction which is not equally shared by the stockholders. The question of independence flows from an analysis of the factual allegations pertaining to the influences upon the directors' performance of their duties generally, and more specifically in respect to the challenged transaction.

The second, or business judgment inquiry of Aronson, focuses on the substantive nature of the challenged transaction and the board's approval thereof.

480 A.2d at 624 (emphasis added) (citations omitted). See also III Ernest L. Folk, III, Rodman Ward, Jr., and Edward P. Welch, Folk on the Delaware General Corporation Law § 327.4.1.1 (1992) ("Demand is excused under this step only if a reasonable doubt is raised concerning the disinterestedness or independence of the board majority approving the challenged transaction." (Emphasis added)).

Under the unique circumstances of this case, an analysis of the Board's ability to consider a demand requires a departure here from the standards set forth in Aronson. The Board did not approve the transaction which is being challenged by Blasband in this action. In fact, the Danaher directors have made no decision relating to the subject of this derivative suit. Where there is no conscious decision by directors to act or refrain from acting, the business judgment rule has no application. Aronson, 473 A.2d at 813. The absence of board action, therefore, makes it impossible to perform the essential inquiry contemplated by Aronson — whether the directors have acted in conformity with the business judgment rule in approving the challenged transaction. See Pogostin, 480 A.2d at 624.

Consistent with the context and rationale of the Aronson decision, a court should not apply the Aronson test for demand futility where the board that would be considering the demand did not make a business decision which is being challenged in the [934] derivative suit. This situation would arise in three principal scenarios: (1) where a business decision was made by the board of a company, but a majority of the directors making the decision have been replaced;^[8] (2) where the subject of the derivative suit is not a business decision of the board;^[9] and (3) where, as here, the decision being challenged was made by the board of a different corporation.

Instead, it is appropriate in these situations to examine whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations. Thus, a court must determine whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand. If the derivative plaintiff satisfies this burden, then demand will be excused as futile.

In so holding, we reject the defendants' proposal that, for purposes of this derivative suit and future similar suits, we adopt either a universal demand requirement or a requirement that a plaintiff must demonstrate a reasonable probability of success on the merits. The defendants seek to justify these stringent tests on the need to discourage "strike suits" in situations like the present one. This concern is unfounded.

A plaintiff in a double derivative suit is still required to satisfy the Aronson test in order to establish that demand on the subsidiary's board is futile. The Aronson test was designed, in part, with the objective of preventing strike suits by requiring derivative plaintiffs to make a threshold showing, through the allegation of particularized facts, that their claims have some merit. Aronson, 473 A.2d at 811-12. Moreover, defendants' proposal of requiring demand on the parent board in all double derivative cases, even where a board of directors is interested, is not the appropriate protection against strike suits. While defendants' alternative suggestion of requiring a plaintiff to demonstrate a reasonable probability of success is more closely related to the prevention of strike suits, it is an extremely onerous burden to meet at the pleading stage without the benefit of discovery.^[10] Because a plaintiff must [935] satisfy the Aronson test in order to show that demand is excused on the subsidiary board, there is no need to create an unduly onerous test for determining demand futility on the parent board simply to protect against strike suits.

IV. WHETHER THE BOARD IS INTERESTED OR LACKS INDEPENDENCE

In order to determine whether the Board could have impartially considered a demand at the time Blasband's original complaint was filed, it is appropriate to examine the nature of the decision confronting it. A stockholder demand letter would, at a minimum, notify the directors of the nature of the alleged wrongdoing and the identities of the alleged wrongdoers. The subject of the demand in this case would be the alleged breaches of fiduciary duty by the Easco board of directors in connection with Easco's investment in Drexel "junk bonds." The allegations of the amended complaint, which must be accepted as true in this procedural context, claim that the investment was made solely for the benefit of the Rales brothers, who were acting in furtherance of their business relationship with Drexel and not with regard to Easco's best interests. Such conduct, if proven, would constitute a breach of the Easco directors' duty of loyalty. See Heineman v. Datapoint Corp., Del.Supr., 611 A.2d 950, 954 (1992) ("These allegations paint a picture of directors funneling corporate assets to their private use, a practice at clear variance with the directors' fiduciary obligation.")

The task of a board of directors in responding to a stockholder demand letter is a two-step process. First, the directors must determine the best method to inform themselves of the facts relating to the alleged wrongdoing and the considerations, both legal and financial, bearing on a response to the demand. If a factual investigation is required,^[11] it must be conducted reasonably and in good faith. Levine, 591 A.2d at 213; Spiegel v. Buntrock, Del.Supr., 571 A.2d 767, 777 (1990). Second, the board must weigh the alternatives available to it, including the advisability of implementing internal corrective action and commencing legal proceedings. See Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 941 (3d Cir.1982) (observing that directors, when faced with a stockholder demand, "can exercise their discretion to accept the demand and prosecute the action, to resolve the grievance internally without resort to litigation, or to refuse the demand"), judgment vacated on other grounds, 465 U.S. 1001, 104 S.Ct. 989, 79 L.Ed.2d 224 (1984). See also Aronson, 473 A.2d at 811-12 (discussing the role of the demand requirement as a "form of alternate dispute resolution" that requires the stockholder to exhaust "his intracorporate remedies"). In carrying out these tasks, the board must be able to act free of personal financial interest and improper extraneous influences.^[12] We [936] now consider whether the members of the Board could have met these standards.

A. Interest

The members of the Board at the time Blasband filed his original complaint were Steven Rales, Mitchell Rales, Sherman, Ehrlich, Caplin, Kellner, Stephenson, and Lohr. The Rales brothers and Caplin were also members of the Easco board of directors at the time of the alleged wrongdoing. Blasband's amended complaint specifically accuses the Rales brothers of being the motivating force behind the investment in Drexel "junk bonds." The Board would be obligated to determine whether these charges of wrongdoing should be investigated and, if substantiated, become the subject of legal action.

A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders. Aronson, 473 A.2d at 812; Pogostin, 480 A.2d at 624. Directorial interest also exists where a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders. In such circumstances, a director cannot be expected to exercise his or her independent business judgment without being influenced by the adverse personal consequences resulting from the decision.

We conclude that the Rales brothers and Caplin must be considered interested in a decision of the Board in response to a demand addressing the alleged wrongdoing described in Blasband's amended complaint. Normally, "the mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterestedness of directors...." Aronson, 473 A.2d at 815. Nevertheless, the Third Circuit has already concluded that "Blasband has pleaded facts raising at least a reasonable doubt that the [Easco board's] use of proceeds from the Note Offering was a valid exercise of business judgment." Blasband I, 971 F.2d at 1052. This determination is part of the law of the case, Blasband II, 979 F.2d at 328, and is therefore binding on this Court. Such determination indicates that the potential for liability is not "a mere threat" but instead may rise to "a substantial likelihood."^[13] See Aronson, 473 A.2d at 815.

Therefore, a decision by the Board to bring suit against the Easco directors, including the Rales brothers and Caplin, could have potentially significant financial consequences for those directors. Common sense dictates that, in light of these consequences, the Rales brothers and Caplin have a disqualifying financial interest that disables them from impartially considering a response to a demand by Blasband.

B. Independence

Having determined that the Rales brothers and Caplin would be interested in a decision on Blasband's demand, we must now examine whether the remaining Danaher directors are sufficiently independent to make an impartial decision despite the fact that they are presumptively disinterested. As explained in Aronson, "[i]ndependence means that a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences." 473 A.2d at 816. To establish lack of independence, Blasband must show that the directors are "beholden" to the Rales brothers or so under their influence that their discretion would be sterilized. Id. at 815; Levine, 591 A.2d at 205; Kaplan v. Centex Corp., Del.Ch., 284 A.2d 119, 123 (1971); Lewis v. Aronson, Del.Ch., C.A. No. 6919, Hartnett, V.C. (May 1, 1985) (on remand) (holding that demand was excused because the plaintiff's amended complaint alleged sufficient specific facts to create a reasonable doubt regarding the board's independence because it was beholden to a 47 percent [937] stockholder). We conclude that the amended complaint alleges particularized facts sufficient to create a reasonable doubt that Sherman and Ehrlich, as members of the Board, are capable of acting independently of the Rales brothers.

Sherman is the President and Chief Executive Officer of Danaher. His salary is approximately $1 million per year. Although Sherman's continued employment and substantial remuneration may not hinge solely on his relationship with the Rales brothers, there is little doubt that Steven Rales' position as Chairman of the Board of Danaher and Mitchell Rales' position as Chairman of its Executive Committee place them in a position to exert considerable influence over Sherman. In light of these circumstances, there is a reasonable doubt that Sherman can be expected to act independently considering his substantial financial stake in maintaining his current offices.

Ehrlich is the President of Wabash National Corp. ("Wabash"). His annual compensation is approximately $300,000 per year. Ehrlich also has two brothers who are vice presidents of Wabash. The Rales brothers are directors of Wabash and own a majority of its stock through an investment partnership they control. As a result, there is a reasonable doubt regarding Ehrlich's ability to act independently since it can be inferred that he is beholden to the Rales brothers in light of his employment.

Therefore, the amended complaint pleads particularized facts raising a reasonable doubt as to the independence of Sherman and Ehrlich. Because of their alleged substantial financial interest in maintaining their employment positions, there is a reasonable doubt that these two directors are able to consider impartially an action that is contrary to the interests of the Rales brothers.

V. CONCLUSION

We conclude that, under the "substantive law" of the State of Delaware, the Aronson test does not apply in the context of this double derivative suit because the Board was not involved in the challenged transaction. Nevertheless, we do not agree with the defendants' argument that a more stringent test should be applied to deter strike suits. Instead, the appropriate inquiry is whether Blasband's amended complaint raises a reasonable doubt regarding the ability of a majority of the Board to exercise properly its business judgment in a decision on a demand had one been made at the time this action was filed. Based on the existence of a reasonable doubt that the Rales brothers and Caplin would be free of a financial interest in such a decision, and that Sherman and Ehrlich could act independently in light of their employment with entities affiliated with the Rales brothers, we conclude that the allegations of Blasband's amended complaint establish that DEMAND IS EXCUSED on the Board. The certified question is therefore answered in the AFFIRMATIVE.

[1] The District Court's Order Certifying Question of Law to the Delaware Supreme Court, dated June 9, 1993, states that "the allegations of the verified amended complaint ... set forth the undisputed facts." Therefore, the facts set forth herein are taken from the amended complaint.

[2] Steven Rales is the Chairman of the Board and Mitchell Rales is Chairman of the Executive Committee of the Board.

[3] The Rales brothers' business relationships with Sherman and Ehrlich are detailed in the section of this opinion addressing the independence of the Board.

[4] There is no indication that Blasband availed himself of 8 Del.C. § 220, which permits a stockholder, upon complying with the procedural requirements of the statute and upon showing a specific proper purpose, to obtain in a summary proceeding an order permitting inspection of specific books and records.

[5] Our recognition of the limited scope of the present proceeding should not be interpreted as either an acceptance or a rejection of the Third Circuit's conclusions on matters of the substantive Delaware corporation law relating to the standing issue decided in Blasband I. At the time the Third Circuit considered the standing issue, it was not able to certify that issue to this Court. As a result of a recent amendment (adopted in January 1993) to Article IV, Section 11(9) of the Delaware Constitution, any Article III federal court, or the highest appellate court of any other state, may now certify a question of law to this Court as long as the criteria in Supreme Court Rule 41(b) are met. See Draper v. Gardner Defined Plan Trust, Del.Supr., 625 A.2d 859, 868 n. 12 (1993).

[6] In Aronson, this Court held that demand is excused if the derivative complaint pleads particularized facts creating a reasonable doubt that "(1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." 473 A.2d at 814.

[7] The United States Supreme Court has recognized that the demand requirements for a derivative suit are determined by the law of the state of incorporation. In Kamen v. Kemper Fin. Serv., Inc., 500 U.S. 90, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991), the Court held:

In our view, the function of the demand doctrine in delimiting the respective powers of the individual shareholder and of the directors to control corporate litigation clearly is a matter of "substance" not "procedure."

. . . .

The presumption that state law should be incorporated into federal common law is particularly strong in areas in which private parties have entered legal relationships with the expectation that their rights and obligations would be governed by state-law standards.

Corporation law is one such area.

. . . .

... The scope of the demand requirement under state law clearly regulates the allocation of corporate governing powers between the directors and individual shareholders. Because a futility exception to demand does not impede the regulatory objectives of the [Investment Company Act of 1940, 15 U.S.C. § 80a-1a et seq], a court that is entertaining a derivative action under that statute must apply the demand futility exception as it is defined by the law of the State of incorporation.

500 U.S. at ___-___, ___-___, 111 S.Ct. at 1716-17, 1722-23 (citations omitted). Because both Danaher and Easco are Delaware corporations, the substantive corporation law of Delaware determines whether or not the demand requirements of Fed.R.Civ.P. 23.1 have been satisfied. See also Allison, 604 F.Supp. at 1115-16.

[8] This first scenario was addressed by the Court of Chancery in Harris v. Carter, Del.Ch., 582 A.2d 222 (1990):

In the special case, however, where there is a change in board control between the date of the challenged transaction and the date of suit, it might open the way to error to focus on the board existing at the time of the challenged transaction. What, in the end, is relevant is not whether the board that approved the challenged transaction was or was not interested in that transaction but whether the present board is or is not disabled from exercising its right and duty to control corporate litigation.

I do not consider that Aronson intended to determine that demand under Rule 23.1 upon an independent board that has come into existence after the time of the "challenged transaction" would be excused if the board that approved the challenged transaction did not qualify for business judgment protection.

Id. at 230 (emphasis added). Because the new board in Harris was not yet in place at the time of the original complaint in that case, the Court of Chancery did not need to determine how, or if, Aronson would apply where there was a change in the board prior to the derivative suit being filed.

[9] For example, if a stockholder brings a derivative suit alleging that a third party breached a contract with the corporation, demand should not be excused simply because the subject matter of the suit — the third party's breach of contract — does not implicate the business judgment rule. Similarly, where directors are sued derivatively because they have failed to do something (such as a failure to oversee subordinates), demand should not be excused automatically in the absence of allegations demonstrating why the board is incapable of considering a demand. Indeed, requiring demand in such circumstances is consistent with the board's managerial prerogatives because it permits the board to have the opportunity to take action where it has not previously considered doing so.

[10] Although derivative plaintiffs may believe it is difficult to meet the particularization requirement of Aronson because they are not entitled to discovery to assist their compliance with Rule 23.1, see Levine, 591 A.2d at 208-10, they have many avenues available to obtain information bearing on the subject of their claims. For example, there is a variety of public sources from which the details of a corporate act may be discovered, including the media and governmental agencies such as the Securities and Exchange Commission. In addition, a stockholder who has met the procedural requirements and has shown a specific proper purpose may use the summary procedure embodied in 8 Del.C. § 220 to investigate the possibility of corporate wrongdoing. Compaq Computer Corp. v. Horton, Del.Supr., 631 A.2d 1 (1993). See n. 4, supra. Surprisingly, little use has been made of section 220 as an information-gathering tool in the derivative context. Perhaps the problem arises in some cases out of an unseemly race to the court house, chiefly generated by the "first to file" custom seemingly permitting the winner of the race to be named lead counsel. The result has been a plethora of superficial complaints that could not be sustained. Nothing requires the Court of Chancery, or any other court having appropriate jurisdiction, to countenance this process by penalizing diligent counsel who has employed these methods, including section 220, in a deliberate and thorough manner in preparing a complaint that meets the demand excused test of Aronson.

[11] In most instances, a factual investigation is appropriate so that the board can be fully informed about the validity, if any, of the claims of wrongdoing contained in the demand letter. Nevertheless, a formal investigation will not always be necessary because the directors may already have sufficient information regarding the subject of the demand to make a decision in response to it. See Levine, 591 A.2d at 214. In such a case, the minutes or other writing of the Board may properly reference that information in a summary manner.

[12] Where a demand has actually been made, the stockholder making the demand concedes the independence and disinterestedness of a majority of the board to respond. Spiegel, 571 A.2d at 777; Levine, 591 A.2d at 212-13. In the present context, however, no demand has been made and the Court must determine whether the Board could have considered a demand without being affected by improper influences. See Aronson, 473 A.2d at 816.

[13] We emphasize that this assessment of potential liability is based solely on the presumed truthfulness of the allegations of Blasband's amended complaint and the Third Circuit's conclusions thereon, all of which must be accepted by this Court in the present procedural posture. No portion of our decision should be interpreted as a prediction regarding the outcome of this litigation since the Easco defendants have not had the opportunity to rebut Blasband's allegations of wrongdoing.

[493] Joseph A. Rosenthal, Herbert W. Mondros, Rosenthal Monhait Gross & Goddess, P.A., Wilmington, Delaware; Peter Bull, Bull & Lifshitz, LLP, New York, New York, for Plaintiff.

Gregory V. Varallo, Kelly A. Green, Richards, Layton & Finger, P.A., Wilmington, Delaware; Michael D. Torpey, James N. Kramer, Penelope A. Graboys, Jonathan Gaskin, Christopher A. Garcia, Clifford Chance U.S. LLP, San Francisco, California; David M. Shannon, Stephen Pettigrew, Nvidia Corporation, Santa Carla, California, for Defendants.

OPINION

STRINE, Vice Chancellor.

In this case, the plaintiffs bring a derivative action on behalf of NVIDIA Corporation, a technology firm. They allege that the defendants — all NVIDIA directors and/or officers — either sold stock at a time when they knew material, non-public information about the company and/or are culpable for failing to prevent accounting irregularities that caused the company to restate its financial statements for the period during which the stock sales took place. The plaintiffs seek relief for NVIDIA for harm relating to this supposed malfeasance and nonfeasance.

The defendants have moved for dismissal for failure to make a demand under Court of Chancery Rule 23.1. In support of that contention, they point to the conclusory allegations of the amended complaint^[1] as being insufficient to cast a doubt on the impartiality of NVIDIA's majority independent board.

In this opinion, I conclude that the defendants' motion must be granted. Having failed to heed the numerous admonitions by our judiciary for derivative plaintiffs to obtain books and records before filing a complaint, the plaintiffs have unsurprisingly submitted an amended complaint that lacks particularized facts compromising the impartiality of the NVIDIA board that would have acted on a demand. When the case most cries out for the pleading of real facts — e.g., about the board's knowledge of the accounting [494] problems at the company or the company's audit committee process — the complaint is at its most cursory, substituting conclusory allegations for concrete assertions of fact.

I. Facts

The following recitation of facts is drawn entirely from the amended complaint filed by the plaintiffs. That complaint is quite lengthy and contains substantial excerpts from NVIDIA financial statements and press releases. The bulk of the complaint, however, is misleading because in many materially consequential ways the complaint is wholly conclusory, if not entirely silent.

A. The Company

NVIDIA makes and markets three-dimensional ("3D") graphics processors and related software. Its customers are other technology companies that incorporate NVIDIA products and software into their own computer products — e.g., "mother-boards" — which are, in turn, sold to other downstream industry members — e.g., personal computer manufacturers.

NVIDIA went public in January 1999 and its stock is listed on the NASDAQ. As of the time it went public, the company had not achieved profitability. In 2000, NVIDIA raised $400 million in additional capital by way of a secondary offering of debt and common stock.

B. The Essence of the Plaintiffs' Claims

The plaintiffs allege that the defendants engaged in a variety of misconduct related to NVIDIA's failure to accurately account for and disclose its financial results for the period from February 15, 2000 to July 30, 2002 — what I shall call the "Contested Period." During the Contested Period, NVIDIA allegedly released bullish disclosures regarding its results and future prospects.

These optimistic statements were, the plaintiffs contend, materially misleading because they were premised on improper accounting. According to them, NVIDIA "used `cookie jar' reserves (bad debt, sales returns, and account[s] payable) to even out earnings in bad times, used `back-in' accounting to ensure that forecasted margins were achieved and managed profit margins by manipulating shipments at the end of quarters."^[2] The plaintiffs contend that this conduct was intended to inflate NVIDIA's stock price.

Also during the Contested Period, the defendants as a class sold $194.6 million in company stock at diverse times. Four of the defendants were responsible for over $157 million of this sum:

• Defendant Jen-Hsun Huang sold almost 1.2 million shares, reaping proceeds of over $50 million. Huang is a co-founder of NVIDIA, and has been the company's President, Chief Executive Officer and a director at all relevant times.

• Defendant Christine B. Hoberg was NVIDIA's Chief Financial Officer from December 1998 until April 29, 2002. She sold $22.3 million worth of stock during the Contested Period.

• Defendant Jeffrey Fisher has been, at all relevant times, NVIDIA's Vice President of Worldwide Sales. During the Contested Period, Fisher sold $36.3 million worth of NVIDIA stock.

• Defendant Chris A. Malachowsky, at all relevant times, has been NVIDIA's Vice President of Hardware Engineering. Malachowsky co-founded the company with Huang. During the Contested Period, he sold $48.6 million in company shares.

[495] Although the bulk of the disputed sales resulted from these sales by NVIDIA managers — only one of whom, defendant Huang, was on the NVIDIA board — the plaintiffs have also pointed to large sales during the Contested Period by the following defendants, all of whom are members of the NVIDIA board:

• Defendant Tench Coxe sold 160,000 shares of NVIDIA stock on November 27, 2001, yielding proceeds of over $8.6 million. Coxe is a managing director of Sutter Hill Ventures, a venture capital firm.

• Defendant James C. Gaither sold 19,804 NVIDIA shares on November 14, 2001, reaping proceeds of over $472,000. Like Coxe, Gaither is a managing director of Sutter Hill. Gaither is also senior counsel and former partner of Cooley Godward LLP, a law firm that was brought in to help NVIDIA's audit committee address SEC concerns regarding its financial statements during the Contested Period.

• Defendant Harvey C. Jones sold 90,000 shares of NVIDIA stock on December 5, 2001 for over $5.5 million. Jones is Chairman of a privately held microprocessing design and licensing firm that he co-founded.

• Defendant William J. Miller sold a total of 150,000 shares in March and December of 2001, yielding proceeds of over $9.7 million. When the SEC began investigating NVIDIA's financial statements for the Contested Period, Miller allegedly became head of the internal audit committee NVIDIA formed to address those issues.

• Defendant A. Brooke Seawell engaged in sales of 105,000 shares of NVIDIA stock during three months of the Contested Period — September, November, and December of 2001 — yielding over $5.6 million. Aside from a brief tenure as NVIDIA's interim CFO during FY 1999, Seawell has primarily made his living outside NVIDIA. Since February 2000, Seawell has been a general partner of Technology Cross-over Ventures.

• Defendant Mark A. Stevens sold 112,500 NVIDIA shares during March 2001 in return for nearly $7.2 million. Stevens is a managing member of Sequoia Capital, a venture capital firm.

According to the plaintiffs, at some point in 2001, the SEC commenced an investigation into NVIDIA's accounting practices during the Contested Period. In February 2002, the company announced that it was conducting an internal review of its financial statements for the Contested Period in response to the SEC inquiry. After this disclosure, NVIDIA's stock price dropped significantly.

On April 29, 2002, the internal review resulted in a restatement of the company's financial results for the first three quarters of fiscal year ("FY") 2002, and for FY 2001 and 2000. NVIDIA's CFO, defendant Hoberg, resigned that same day.

Unhelpfully, the complaint fails to detail specifically the net result of these restatements. Of course, the very fact that the financials were restated suggests that the original filings for those periods were materially deficient. Still, as we shall see later, the plaintiffs' omission was no doubt tactical, leaving the court without a way to assess the magnitude of the corrections.

Allegedly, during the same time frame the company was reacting to the SEC's inquiry, NVIDIA continued to provide bullish reports regarding its prospects for calendar year 2002 (i.e., NVIDIA's FY 2003), despite adverse news reports and the filing of a lawsuit against the company by a former accounting manager, claiming, [496] among other things, that NVIDIA's accounting practices were improper in the following respects:

A. [NVIDIA used its] returns reserve policy as a way of creating a "slush" fund to use to manage gross margin in times when actual revenues were too low or actual expenses were too high to meet targeted gross operating margin requirements. There was no consistent articulated returns reserve policy.

B. All accounting was done in a back-in fashion. Proper accounting procedures would have the compilation of revenue and expenses done first and have these actual figures be used in the computation of gross margin. NVIDIA used a targeted gross margin number and then worked backward to achieve that by creating revenue and expense calculations necessary to achieve the forecasted margin which were not reflective of the actual transactions or results that occurred. Examples would include stopping shipments before the end of a quarter to prevent revenue from being too high and using a nearly-fictional returns reserve to manage expenses as needed. The end result was that quarterly results of NVIDIA reported to the public and the Securities and Exchange Commission were false and misleading....^[3]

On July 30, 2002, NVIDIA announced that it expected revenues for the second quarter of FY 2003 to be 32% less than anticipated — contradicting the company's previous guidance. After this announcement, the trading price of NVIDIA shares dropped by 32%. The next month, NVIDIA announced that it had received comments from the SEC on its 10-K for FY 2002 and its 10-Q for the quarter ending April 28, 2002 (the first quarter of NVIDIA's FY 2003). According to that announcement, the SEC's Division of Enforcement was investigating the company.

In broad strokes, the plaintiffs paint a bleak picture of NVIDIA at the end of summer 2002. During the Contested Period, the company's market capitalization had exceeded $10 billion at times. By the second half of 2002, the company was worth only around $2 billion. Not only that, the company was under the cloud of an SEC investigation, as well as a slew of securities lawsuits brought against certain NVIDIA insiders who had traded during the Contested Period.

C. The Allegations of Wrongdoing in the Complaint

The complaint makes two alternative arguments about the various defendants. The first — and more aggressive — is that each of the defendants who sold during the Contested Period was in possession of material, non-public information and traded to his personal advantage using that information. Specifically, the defendants allegedly knew that NVIDIA's improper accounting practices were propping up its stock price artificially and they thus reaped unfair profits by selling to buyers who were in the dark about the reality of NVIDIA's (impliedly more troubled) financial status.

The plaintiffs buttress this argument by contending that:

• Each of the defendants was in a position to know of the improper accounting practices engaged in by NVIDIA [497] during the Contested Period. This allegation is made cursorily.

• Each of the defendants engaged in trades shortly after NVIDIA released a financial statement that was later restated.

• Aside from the sale by defendant Gaither, all of the defendants' sales resulted in proceeds of millions of dollars.

• The sales did not result from a regular, preplanned trading program and were not consistent with the defendants' trading patterns for the year immediately before the sales. This allegation is made cursorily.

In further support of their contention that the circumstances suggest an inference of intentional trading on material, inside information, the plaintiffs argue that many of the defendants engaged in sales that constituted a large percentage of their overall NVIDIA holdings, to wit:

The percentage of shares sold by each defendant is as follows:^[4]

NAME                     Shares Sold During        Shares          % of Shares Sold
                         Relevant Period         Beneficially       To Shares Held
                                                 Owned As Of             As Of
                                                March 31, 2002      March 31, 2002

Jen-Hsun Huang                1,190,000           9,058,322               12%

Jeffrey D. Fisher               954,300             308,717               76%

Christine B. Hoberg             575,715              26,796               96%

Chris A. Malachowsky          1,547,960           6,814,000               19%

Tench Coxe                      160,000             783,836               20%

James C. Gaither                 19,804              50,000               28%

Harvey C. Jones                  90,000             779,204               10%

William J. Miller               150,000             150,000               50%

A. Brooke Seawell               105,000               -0-                100%

Mark A. Stevens                 112,500             242,872               32%

The plaintiffs' alternative argument is that the defendants — primarily those who were non-management directors of NVIDIA — breached their fiduciary duty to NVIDIA by failing to ensure that there was an adequate system of financial controls in place at the company. Because the outside directors were allegedly indolent in the fulfillment of their duty to make sure that the company had in place a functioning system to guarantee compliance with legally mandated accounting standards, certain managers at NVIDIA caused the company to issue materially misleading financial statements. Advertently or not, the outside director-defendants benefited because of the failure of oversight, by being able to sell large amounts of stock into a market artificially inflated by the company's false financials.

[498] D. The Harm Suffered by NVIDIA and the Relief Sought by the Plaintiffs

The complaint alleges that the defendants' breaches of fiduciary duty caused NVIDIA injury in several related ways. First, their conduct has exposed NVIDIA itself to federal securities liability for misleading investors about its financial health, and has caused NVIDIA to incur substantial costs in responding to the suits and to the SEC's investigation. Second, NVIDIA's credibility as an entity has allegedly been damaged, leading investors to be skeptical of its statements about its performance.

To remedy this injury, the plaintiffs seek a judgment holding the defendants responsible to, among other things: (1) repay or otherwise indemnify NVIDIA for any damages it must pay or costs it must incur as a result of the federal securities suits and the SEC investigation; (2) repay all salaries and other remuneration they received from NVIDIA during the time they were committing breaches of fiduciary duty; and (3) disgorge all profits they made from trades in NVIDIA stock during the Contested Period.

E. What is Not in the Complaint

In the procedural context of this motion, what is not contained in the complaint is consequential. Among the other issues that the complaint does not address either at all or only in cursory terms are:

• The actual effect of the restatements on NVIDIA's bottom line;

• The reasons why particular defendants should have been on notice of the accounting irregularities that are alleged. In this regard, it is notable that the defendants range from purely outside directors to the CFO during the Contested Period. The complaint is entirely devoid of particularized allegations of fact demonstrating that the outside directors had actual or constructive notice of the accounting improprieties. Even as to defendant Huang, the only director-defendant who was a manager, the complaint lacks particularized allegations regarding his involvement in the process of preparing the company's financial statements.

• The status of the company's financial controls during the Contested Period, including whether the company had an audit committee during that period, how often and how long it met, who advised the committee, and whether the committee discussed and approved any of the allegedly improper accounting practices. Relatedly, the complaint is devoid of any pleading regarding the full board's involvement in the preparation and approval of the company's financial statements.

• The relationship of the defendants' trades — particularly those of the outside directors — to permitted trading periods. That is, although the complaint pleads that the defendants typically traded after a financial statement was released (e.g., a 10-Q), the complaint does not indicate whether this was company practice precisely because by requiring directors and other insiders to sell in periods after the company released a certified financial statement of updated material developments, the company could best ensure that company insiders were not advantaged in selling to outsiders.

• The actual trading patterns of the defendants — particularly the outside directors — during the periods preceding the Contested Period, or the relationship of their trades to options vesting periods, or to the end of restrictions on marketability that may have been imposed when NVIDIA first went public.

[499] • The reason why the defendants' trades are scattered so widely (and in a seemingly random way) throughout the Contested Period, albeit at times tending to follow the issuance of company financial statements.

II. Legal Analysis

This matter comes before me now on the defendants' motion to dismiss, which is primarily predicated on Court of Chancery Rule 23.1, because the claims asserted by the plaintiffs are derivative in nature and belong to NVIDIA itself.^[5] In their submissions, the defendants have pointed to a variety of facts outside the complaint. In particular, they argue that the entire premise of the plaintiffs' complaint is "ludicrous" because the restatements that NVIDIA filed for FY 2000 through 2002 had the ultimate effect of increasing the company's net income by $1.3 million, although they admit that this resulted from an increase in FY 2000 results and decreases in 2001 and 2002 results. They contend, however, that the stock market's reaction to the restatement is the most telling fact — and one that is also left out of the complaint — namely, that the market price of NVIDIA shares increased by nearly 17% the first trading day after the announcement.

I am obliged to turn down the defendants' invitation to use these allegations as a factor in my analysis of their motion to dismiss.^[6] Instead, I will consider their motion against a record confined to the well-pled allegations of the complaint. Likewise, I will draw all reasonable inferences from the non-conclusory factual allegations of the complaint in the plaintiffs' favor.^[7] But I cannot accept cursory contentions of wrongdoing as a substitute for the pleading of particularized facts.^[8] Mere notice pleading is insufficient to meet the plaintiffs' burden to show demand excusal in a derivative case.^[9]

Here, both the plaintiffs and the defendants agree that the standard set forth in Rales v. Blasband^[10] applies to the determination of whether demand on the NVIDIA board is excused and this action can proceed. The reason that they agree that Rales applies is that the plaintiffs do not challenge any particular business decision made by the NVIDIA board as a whole.

Instead, the plaintiffs allege that the defendant-directors individually breached their fiduciary duties by either purposely trading in their individual capacities while possessing material, non-public information about NVIDIA's improper accounting practices and financial results and/or by failing to ensure that NVIDIA had in place the financial control systems necessary to ensure compliance with applicable accounting standards. As this court held in In re Baxter Internatational, Inc. Shareholders Litigation — and both parties concur — these kinds of allegations do not attack a [500] specific business judgment of the board,^[11] and, therefore, the Rales test, and not the two-pronged demand excusal test of Aronson v. Lewis,^[12] is applied determine whether demand is excused.

As I will soon describe, the differences between the Rales and the Aronson tests in the circumstances of this case are only subtly different, because the policy justification for each test points the court toward a similar analysis. To show why, it is useful to remember that the second prong of Aronson permits a plaintiff suing a board that is structurally independent and presumptively capable of acting impartially on a demand to proceed with its lawsuit — i.e., a board that passes muster under Aronson's first prong, which focuses on board disinterest and independence — if it pleads a claim for breach of fiduciary duty with particularity.^[13]

In simple terms, the second prong of Aronson can be said to fulfill two important integrity-assuring functions in our law. First, but somewhat less relevant to this case, the second Aronson prong addresses concerns regarding the inherent "structural bias" of corporate boards, by allowing suits to go forward even over a putatively independent board's objection if the plaintiff can meet a heightened pleading standard that provides confidence that there is a substantial basis for the suit.^[14]

Second, and particularly pertinent here, the second Aronson prong responds to the related concern that a derivative suit demand asks directors to authorize a suit against themselves — i.e., asks them to take an act against their personal interests. The conundrum for the law in this area is well understood. If the legal rule was that demand was excused whenever, by mere notice pleading, the plaintiffs could state a breach of fiduciary duty claim against a majority of the board, the demand requirement of the law would be weakened and the settlement value of so-called "strike suits" would greatly increase, to the perceived detriment of the best interests of stockholders as investors. But, if the demand excusal test is too stringent, then stockholders may suffer as a class because the deterrence effects of meritorious derivative suits on faithless conduct may be too weak. The second prong of Aronson therefore balances the conflicting policy interests at stake by articulating a safety valve that releases a suit for prosecution when the complaint meets a heightened pleading standard of particularity, because in these circumstances the threat of liability to the directors required to act on the demand is sufficiently substantial to cast a reasonable doubt over their impartiality.^[15]

[501] At first blush, the Rales test looks somewhat different from Aronson, in that involves a singular inquiry into:

[W]hether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations. Thus, a court must determine whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand. If the derivative plaintiff satisfies this burden, then demand will be excused as futile.^[16]

Upon closer examination, however, that singular inquiry makes germane all of the concerns relevant to both the first and second prongs of Aronson. For example, in a situation when a breach of fiduciary duty suit targets acts of self-dealing committed, for example, by the two key managers of a company who are also on a nine-member board, and the other seven board members are not alleged to have directly participated or even approved the wrongdoing (i.e., it was not a board decision), the Rales inquiry will concentrate on whether five of the remaining board members can act independently of the two interested manager-directors. This looks like a first prong Aronson inquiry.

When, however, there are allegations that a majority of the board that must consider a demand acted wrongfully, the Rales test sensibly addresses concerns similar to the second prong of Aronson. To wit, if the directors face a "substantial likelihood" of personal liability, their ability to consider a demand impartially is compromised under Rales, excusing demand.^[17]

In the Baxter case, this court recognized that the threat of liability that directors face can be influenced in a substantial way if the corporate charter contains an exculpatory charter provision authorized by 8 Del. C. § 102(b)(7). Baxter held that in the event that the charter insulates the directors from liability for breaches of the duty of care, then a serious threat of liability may only be found to exist if the plaintiff pleads a non-exculpated claim against the directors based on particularized facts.^[18]Baxter has relevance here because the NVIDIA charter indisputably contains an exculpatory charter provision that immunizes the NVIDIA directors from liability for duty of care violations.

Taken together, the principles I have just discussed provide the framework for the proper disposition of this motion. In order to analyze the motion, I must consider whether the NVIDIA board in place at the time of this suit could impartially consider a demand. This requires me to analyze whether the underlying conduct complained of in the complaint (which can only awkwardly be called transactions in this case) renders any of the board members "interested," and, if so, whether any of the [502] other members of the board are compromised in their ability to act independently of the directors found to be interested. If a majority of the board is impartial under this initial analysis, I must next consider whether the complaint sets forth particularized facts that plead a non-exculpated claim of breach of fiduciary duty against a majority of the board, thereby stripping away their first-blush veneer of impartiality.

I turn to that analysis now.

A. Are Any of the Directors Interested?

The NVIDIA board is comprised of seven members. The plaintiffs allege that each of the seven is "interested" for purposes of considering a demand because each traded stock during the Contested Period. As such, each supposedly had a personal "interest" in a challenged transaction that is separate from NVIDIA's and therefore cannot be impartial.

I reject this attempt to extend concepts designed to fit classic self-dealing transactions into another context that is quite different. In a typical derivative suit involving a transaction between a director and her corporation, that director is interested because she is on the other side of the transaction from the corporation and faces liability if the entire fairness standard applies, regardless of her subjective good faith, so long as she cannot prove that the transaction was fair to the corporation. In those circumstances, the director has always been considered "interested"^[19] and it displays common sense for the law to consider that director unable to consider a demand to set aside the transaction between the corporation and herself.

In this case, the plaintiffs attack a myriad of stock sales, not between the defendant-directors and NVIDIA, but between the defendant-directors and market-place buyers. As a matter of course, corporate insiders sell company stock and such sales, in themselves, are not quite as suspect as a self-dealing transaction in which the buyer and seller can be viewed as sitting at both sides of the negotiating table. Although insider sales are (rightly) policed by powerful forces — including the criminal laws — to prevent insiders from unfairly defrauding outsiders by trading on non-public information, it is unwise to formulate a common law rule that makes a director "interested" whenever a derivative plaintiff cursorily alleges that he made sales of company stock in the market at a time when he possessed material, non-public information.

This would create the same hair-trigger demand excusal that Aronson and Rales eschewed. The balanced approach that is more in keeping with the spirit of those important cases is to focus the impartiality analysis on whether the plaintiffs have pled particularized facts regarding the directors that create a sufficient likelihood of personal liability because they have engaged in material trading activity at a time when (one can infer from particularized pled facts that) they knew material, non-public information about the company's financial condition.

With this concept in mind, a quick review of the composition of the NVIDIA board is in order. Of the seven members, only defendant Huang is a member of company management.^[20] Only one other board member is alleged to have any relationship [503] with the company other than as a director — i.e., director Gaither, a former partner and current senior counsel to Cooley Godward, a law firm that allegedly has represented the company for years and represented the company's audit committee in responding to the SEC investigation. The complaint fails to allege the amount of the fees that Cooley Godward received for that work, or that Gaither's compensation as senior counsel depends on the work he helps bring in. That is, the complaint fails to allege the materiality of these factors to Gaither.

In any event, even if one assumes that these allegations compromised Huang and Gaither,^[21] the plaintiffs have failed to mount any challenge to the other five directors' independence, other than that those directors traded in NVIDIA stock during the Contested Period. From the complaint, it appears that these five directors — defendants Coxe, Jones, Miller, Seawell, and Stevens — are not materially dependent on Huang's good graces to make a living or beholden to him for any other personal reason.

As a result, the key inquiry in the Rales analysis is whether the plaintiffs have pled facts that show that these five directors face a sufficiently substantial threat of personal liability to compromise their ability to act impartially on a demand. I turn to that question now.

B. Is the Board's Impartiality Compromised by the Threat of Personal Liability?

In order for the five directors — i.e., those other than Huang and Gaither^[22] — to have their impartiality compromised, they must face a substantial likelihood of liability for breach of fiduciary duty for one of two alternative reasons: (1) that they personally profited from stock sales while in knowing possession of material, non-public information or (2) that they committed a non-exculpated breach of fiduciary duty by failing to oversee the company's compliance with legally mandated accounting and disclosure standards.

1. The Plaintiffs' Insider Trading Claims

Although the plaintiffs allege that Coxe, Jones, Miller, Seawell and Stevens had reason to know that the company's financial statements were misstated, this allegation is wholly conclusory. Entirely absent from the complaint are well-pled, particularized allegations of fact detailing the precise roles that these directors played at the company,^[23] the information that would have come to their attention in those roles, and any indication as to why they would have perceived the accounting irregularities.

Likewise, while it is true that the dollar proceeds reaped by these directors from their sales was substantial, the complaint cannot be fairly said to contain particularized facts providing an inference of insider trading. For example, the timing of the defendants' trades is quite disparate, having only the common pattern of coming after the filing of a certified financial statement. No inference can be drawn from [504] that simple fact because it is more obviously consistent with the idea that NVIDIA permitted stock sales in such periods because it diminished the possibility that insiders could exploit outside market buyers. Similarly, the complaint alleges that the defendants' trades were inconsistent with their trading practices for the prior year. The prior year measure in itself is a weak one, covering as it does a temporally brief period. But, in any event, the complaint fails to specify what trades, if any, these directors made in that prior year. Not only that, the complaint fails to address whether the directors traded because options were expiring or because IPO-related restrictions on liquidity had recently ended.

It is no doubt true that some of the sales by certain of these five directors comprised a substantial portion of their NVIDIA holdings. For example, director Sea-well sold his entire position in NVIDIA and director Miller sold half of his holdings. But the others — directors Stevens (32%), Coxe (20%), and Jones (10%) — sold much smaller stakes. In the absence of any fact pleading that supports a rational inference that any of these directors had some basis to believe that NVIDIA's financial statements were materially misleading in a manner that inflated the company's stock price, the mere fact that two of the directors sold large portions of their stock does not, in my view, support the conclusion that those two directors face a real threat of liability.^[24]

In this respect, it is important to note that none of these five defendants is even named as a defendant in the pending federal securities suits. The complaints in those suits — which were recently dismissed without prejudice for failing to state a claim — were the primary source of information used by the plaintiffs in this action. The plaintiffs admitted as much at oral argument.

At oral argument, the plaintiffs also conceded that they had failed to seek NVIDIA's books and records under 8 Del. C. § 220. These books and records could have provided the basis for the pleading of particularized facts — i.e., for the filing of a complaint that meets the legally required standard. Rather than pursue that option, the plaintiffs, after confronting a motion to dismiss their original complaint, were content to simply amend their complaint in reliance upon the (now dismissed) federal complaints, which did not even name the NVIDIA outside directors as defendants. They have thus ignored the repeated admonitions of the Delaware Supreme Court and this court for derivative plaintiffs to proceed deliberately and to use the books and records device to gather the materials necessary to prepare a solid complaint.^[25]

The cursory allegations of the complaint in this action do not come close to meeting the plaintiffs' burden to show that these five defendants face a substantial threat of liability for insider trading-based fiduciary duty violations. Nothing in the complaint provides any particularized basis to infer that these outside directors had any idea about the questionable accounting practices. This is fatal to the plaintiffs' effort to show demand excusal.

[505] Delaware law has long held — see Brophy v. Cities Service, Inc.^[26] — that directors who misuse company information to profit at the expense of innocent buyers of their stock should disgorge their profits.^[27] This doctrine is not designed to punish inadvertence, but to police intentional misconduct.^[28] As then-Vice Chancellor Berger noted, Brophy is rooted in trust principles that provide "that, if a person in a confidential or fiduciary position, in breach of his duty, uses his knowledge to make a profit for himself, he is accountable for such profit."^[29] Or as then-Vice Chancellor Hartnett put it, "it must be shown that each sale by each individual defendant was entered into and completed on the basis of, and because of, adverse material non-public information."^[30] That is, Delaware case law makes the same policy judgment as federal law does, which is that insider trading claims depend importantly on proof that the selling defendants acted with scienter.^[31]

The complaint before me fails to allege particularized facts that support a rational inference that these five directors possessed information about NVIDIA's actual performance that was materially different than existed in the marketplace at the time they traded, much less that they consciously acted to exploit such superior knowledge.

2. The Plaintiffs' Caremark Claims

The other alternative attack on these five defendants is premised on what may be called, for short, a Caremark^[32] claim. The allegation is that these five defendants (and their other two board colleagues) failed to oversee the process by which NVIDIA prepared its financial statements so as to ensure that the resulting statements had integrity and met legal standards. A Caremark claim is a difficult [506] one to prove.^[33]

Although the Caremark decision is rightly seen as a prod towards the greater exercise of care by directors in monitoring their corporations' compliance with legal standards, by its plain and intentional terms, the opinion articulates a standard for liability for failures of oversight that requires a showing that the directors breached their duty of loyalty by failing to attend to their duties in good faith.^[34] Put otherwise, the decision premises liability on a showing that the directors were conscious of the fact that they were not doing their jobs. As Chancellor Allen put it,

Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation ... in my opinion only a sustained or systematic failure of the board to exercise oversight — such as an utter failure to attempt to assure a reasonable information and reporting system exists — will establish the lack of good faith that is a necessary condition to liability. Such a test of liability — lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight — is quite high. But, a demanding test of liability in the oversight context is probably beneficial to stockholders as a class, as it is in the board decision context, since it makes board service by qualified persons more likely, while continuing to act as a stimulus to good faith performance of duty by such directors.^[35]

Functionally, Caremark also matches the liability landscape for most corporate directors, who are insulated from monetary damage awards by exculpatory charter provisions.

In this case, the plaintiffs have not come close to pleading a Caremark claim. Their [507] conclusory complaint is empty of the kind of fact pleading that is critical to a Caremark claim, such as contentions that the company lacked an audit committee, that the company had an audit committee that met only sporadically and devoted patently inadequate time to its work, or that the audit committee had clear notice of serious accounting irregularities and simply chose to ignore them or, even worse, to encourage their continuation.^[36]

From the complaint, it is impossible to tell anything about the financial compliance systems in place at NVIDIA during the Contested Period. This is a void that could have been filled had the plaintiffs procured pertinent books and records. For all I know, the NVIDIA audit committee met six times a year for half-day sessions, was comprised entirely of independent directors, had retained a qualified and independent audit firm that performed no other services for the company, was given no notice of the alleged irregularities by either management or the audit firm, had paid its audit firm to perform professionally credible random tests of management's integrity in recording revenue and other important financial data, and could not have been expected to discover the accounting irregularities, even when exercising a good faith effort, because discovery required disclosure by management or uncovering by the auditors of conduct deep below the surface of the financial statements.

I am, of course, not opining that NVIDIA's directors actually implemented an adequate system of financial controls. What I am opining is that there are not well-pled factual allegations — as opposed to wholly conclusory statements — that the NVIDIA independent directors committed any culpable failure of oversight under the Caremark standard. Indeed, at oral argument, counsel for the plaintiffs candidly admitted that he did not know whether NVIDIA had an audit committee before the SEC inquiry in February 2002, and if it did, whether and how many times it met during the Contested Period. He also admitted that the complaint does not plead a single fact suggesting specific red — or even yellow — flags were waved at the outside directors.^[37] Stated bluntly, these concessions amount to an admission that the complaint is barren of the fact allegations necessary to warrant demand excusal.

For this reason, the complaint fails to plead facts suggesting that a majority of the NVIDIA board faces a sufficient threat of liability to compromise their ability to act impartially on a demand.^[38] Thus, under Rales, the complaint is dismissed.^[39] 

[508] III. Conclusion and Final Order

The defendants' motion to dismiss under Rule 23.1 is hereby GRANTED. IT IS SO ORDERED.

[1] Hereinafter primarily referred to as the complaint.

[2] Am. Compl. ¶ 4.

[3] Am. Compl. ¶ 8 (quoting Andren v. NVIDIA Corp., No. CV007900, Compl. ¶ 10 (Cal.Super.Ct. May 16, 2002)) (emphasis in original).

[4] This chart is taken directly from Am. Comp. ¶ 35. It does not include shares issuable pursuant to options exercisable within 60 days of March 31, 2002.

[5] As a secondary matter, the defendants also allege that the complaint should be dismissed under Rule 12(b)(6) for failure to state a claim upon which relief can be granted. In view of my disposition of the Rule 23.1 motion, I need not address this secondary argument.

[6] E.g., White v. Panic, 783 A.2d 543, 547 n. 5 (Del.2001); see also In re Santa Fe Pac. Corp. S'holder Litig., 669 A.2d 59, 68 (Del.1995) ("Generally, matters outside the pleadings should not be considered in ruling on a motion to dismiss.").

[7] See Grobow v. Perot, 539 A.2d 180, 187 (Del.1988).

[8] See id.

[9] See White, 783 A.2d at 552-53.

[10] 634 A.2d 927 (Del.1993).

[11] See 654 A.2d 1268, 1269-71 (Del.Ch.1995).

[12] 473 A.2d 805 (Del.1984).

[13] See Aronson, 473 A.2d at 815.

[14] See id. at 815 n. 8.

[15] Aronson, 473 A.2d at 815 ("[T]he mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterestedness of directors, although in rare cases a transaction may be so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability therefore exists."); Ash v. McCall, 2000 WL 1370341, at *10 (Del.Ch. Sept. 15, 2000) ("Directors who are sued for failure to oversee subordinates have a disabling interest for presuit demand purposes when the potential for liability is not a mere threat but instead may rise to a substantial likelihood." (internal quotation marks and footnote omitted)); Kohls v. Duthie, 791 A.2d 772, 782 (Del.Ch.2000) (suggesting that a "`substantial threat' of personal liability" can make a director interested with respect to whether litigation should be brought); see also 1 Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery § 9-2(b)(3)(iii) (2003) (stating that directors will be deemed interested for demand purposes when the complaint alleges specific facts that makes directorial liability "a substantial likelihood" and not just "a mere threat"); Leo E. Strine, Jr., The Inescapably Empirical Foundation of the Common Law of Corporations, 27 Del. J. Corp. L. 499, 508 (2002) (describing Aronson's second prong as "a safety valve permitting a derivative plaintiff to not make a demand if he can show with particularity that the board decision under attack ... is not entitled to business judgment rule protection").

[16] Rales, 634 A.2d at 934.

[17] See id. at 936; Ash, 2000 WL 1370341, at *10; Baxter, 654 A.2d at 1269-70.

[18] See Baxter, 654 A.2d at 1270.

[19] See, e.g., 8 Del. C. § 144(a).

[20] Although he is the company's CEO, Huang also sold only 12% of his shares, founded the company, and seems from the complaint to have as strong a stake in NVIDIA's long-term credibility and prospects as anyone. Solely, for purposes of analysis, however, I assume he cannot objectively consider a demand.

[21] My assumption here is merely that, an assumption, and not a legal conclusion.

[22] In this respect, it is useful to note that the fact that three non-director-defendants, who each engaged in very substantial trades during the Contested Period, are named in the case has little bearing on the demand excusal analysis for an obvious reason: they are not on the board.

[23] See supra pp. 498-99 (noting the absence of allegations regarding such basic facts as whether NVIDIA had a standing audit committee or whether it met).

[24] The complaint does not allege whether the directors received cash compensation or simply shares. If they received none of the latter and/or had previously been subject to restrictions on sales as a result of the IPO, the large sales become far less eye-brow raising. In any event, absent facts suggesting an inference that these five directors knew of the accounting irregularities, the plaintiff's complaint does not raise a sufficiently ominous picture of liability.

[25] E.g., Brehm v. Eisner, 746 A.2d 244, 266-67 (Del.2000); Rales, 634 A.2d at 934 n. 10; Ash, 2000 WL 1370341, at *15 n. 56.

[26] 70 A.2d 5 (1949).

[27] Id. at 8.

[28] This State's derivative remedy for insider trading by fiduciaries presents an obvious potential for regulatory conflict between state courts and the federal enforcement regime, which notably includes the potential for criminal penalties. Our courts have thus been sensitive to the need for effective — i.e., rigorous, but also efficient, in the sense of being proportionate and non-duplicative — enforcement of the important public policy that prevents corporate insiders from exploiting material, non-public information to make trading profits. Cf. Goldman v. Isaacs, 2001 WL 1671439, at *1 (Del.Ch. Dec.17, 2001) ("Developments in federal law have led to the creation of various federal remedies for market participants injured by insider trading.... What effect, if any, should changes in federal law and the risk of double liability have on the applicability of Brophy ...?").

[29] Rosenberg v. Oolie, 1989 WL 122084, at *3 (Del.Ch. Oct. 16, 1989) (internal quotation marks and citations omitted).

[30] Stepak v. Ross, 1985 WL 21137, at *5 (Del. Ch. Sept. 5, 1985).

[31] The federal courts have expended a great deal of energy in recent years debating the precise way to implement the mandate of 15 U.S.C. § 78u-4(b)(2) that plaintiffs accusing directors (or others) of insider trading file complaints that "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." I will not burden the reader with citations to this large body of judicial work; suffice it to say that the plaintiffs did not, under Delaware law, plead particularized facts supporting a Brophy claim against these five directors, because, no matter the test, the complaint does not support an inference that these NVIDIA directors had reason to know of the accounting irregularities, much less that NVIDIA's stock price was artificially inflated during the Contested Period.

[32] In re Caremark Int'l Derivative Litig., 698 A.2d 959 (Del.Ch.1996).

[33] See id. at 967 ("The theory here advanced is possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.").

[34] A director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest. For this reason, the same case that invented the so-called "triad[]" of fiduciary duty, see Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993) ("Cede II"), also defined good faith as loyalty. See In re Gaylord Container Corp. S'holders Litig., 753 A.2d 462, 475 n. 41 (Del.Ch.2000) (explaining the origins of this oddment of our law, i.e., the "triad[]").

It does no service to our law's clarity to continue to separate the duty of loyalty from its own essence; nor does the recognition that good faith is essential to loyalty demean or subordinate that essential requirement. There might be situations when a director acts in subjective good faith and is yet not loyal (e.g., if the director is interested in a transaction subject to the entire fairness standard and cannot prove financial fairness), but there is no case in which a director can act in subjective bad faith towards the corporation and act loyally. The reason for the disloyalty (the faithlessness) is irrelevant, the underlying motive (be it venal, familial, collegial, or nihilistic) for conscious action not in the corporation's best interest does not make it faithful, as opposed to faithless.

The General Assembly could contribute usefully to ending the balkanization of the duty of loyalty by rewriting § 102(b)(7) to make clear that its subparts all illustrate conduct that is disloyal. For example, one cannot act loyally as a corporate director by causing the corporation to violate the positive laws it is obliged to obey. See 8 Del. C. § 102(b)(7)(ii). Many recent events have only emphasized the importance of that obvious component of the duty of loyalty. But it would add no substance to our law to iterate a "quartet" of fiduciary duties, expanded to include the duty of "legal fidelity," because that requirement is already a subsidiary element of the fundamental duty of loyalty. The so-called expanded "triad[]" created by Cede II, I respectfully submit, is of no greater utility.

[35] Caremark, 698 A.2d at 971 (emphasis in original).

[36] In other words, the plaintiffs have failed to avail themselves of a route to demand excusal that Chancellor Chandler suggested might exist in an oversight case, namely the pleading of particularized facts that support an inference that the directors "did possess knowledge of facts suggesting potential accounting improprieties ... and took no action to respond to them." Ash, 2000 WL 1370341, at *15.

[37] The plaintiffs relied upon an employment complaint filed by a former executive, which they attached to their complaint. Notably, she did not allege in her employment complaint that members of the board knew of the accounting misconduct by certain managers, much less than they were complicit in it.

[38] The plaintiffs have pled other related claims involving disclosure and, oddly, corporate waste. The defendants have no more reason to fear liability for these claims (and perhaps much less) than the claims this opinion concentrates on, which are the ones emphasized by the plaintiffs themselves.

[39] Because of the inadequacy of the amended complaint, it can also be said confidently that there are no well-pled facts that support an inference that the independent directors failed to meet even the level of due care that is the litmus test for liability, absent an exculpatory charter provision — gross negligence. If gross negligence means something other than negligence, pleading it successfully in a case like this requires the articulation of facts that suggest a wide disparity between the process the directors used to ensure the integrity of the company's financial statements and that which would have been rational. No factual allegations of this kind are present in the complaint.

I raise the subject of gross negligence with hesitation, but with a case-specific justification. As an analytical matter, it is perhaps possible for the common law of Delaware corporations to consider the imposition of a disgorgement remedy on independent directors when it is proven that: (1) the corporation did not have in place a rational process to guarantee the integrity of its financial statements because the independent directors breached their fiduciary duty through a cognizable failure of due care (i.e., gross negligence in the words of the key precedents); (2) as a result of this gross failure in due care, company insiders caused the company to release materially misleading financial statements that led market participants to value the company's stock at an artificially high price; and (3) the independent directors, without knowledge of the actual status of the company's financial health and subjectively believing that the financial statements were materially complete and accurate, nonetheless sold shares and profited at the expense of public buyers, and caused the company to suffer injury. In those circumstances, would the provision of § 102(b)(7) barring exculpation for improper personal benefits potentially expose the independent directors to a remedy designed to strip them of benefits that would not have been achieved had they complied with their duty of care? Because the plaintiffs have not even pled a due care violation under a gross negligence standard, they have not shown that a majority of the NVIDIA board faces a real threat of liability even if a lesser standard applies and even if the logic of this example (which I raise but do not embrace or reject) has force.

Buried in this footnote is an alternative legal policy issue, which is whether the Caremark loyalty-based standard provides the only basis of liability for a lack of oversight claim, reducing a failure of care to a violation of expected director conduct subjecting the directors to social shame and potential unseating at the polls, but not to legal liability, irrespective of the existence of an exculpatory charter provision. That may be a debatable proposition, but, as I understand it, the well-thought out Caremark decision accurately reflects our law, strikes a sensible policy balance in this difficult area, and I adhere to it.

Pamela S. Tikellis, Esquire (argued), Robert J. Kriner, Jr., Esquire, and Brian D. Long, Esquire, of Chimicles & Tikellis LLP, Wilmington, Delaware; Of Counsel: Nicholas E. Chimicles, Esquire and James R. Malone, Jr., Esquire, of Chimicles & Tikellis LLP, Haverford, Pennsylvania; Lawrence A. Sucharow, Esquire and Joel Bernstein, Esquire of Goodkind, Labaton, Rudoff & Sucharow LLP, New York, New York; Reginald A. Krasney, Esquire of Wayne, Pennsylvania, for Appellant.

A. Gilchrist Sparks, III, Esquire, and S. Mark Hurd, Esquire, of Morris, Nichols, Arsht & Tunnell, Wilmington, Delaware; Of Counsel: Barry G. Sher, (argued), and Brett D. Jaffe, Esquire, of Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York, for Appellees Patrick, Martinez, Seligman, Moore, and Ubben and Nominal Appellee Martha Stewart Living Omnimedia, Inc.

[1044] Andre G. Bouchard, Esquire, of Bouchard, Margules & Friedlander, P.A., Wilmington, Delaware; Of Counsel: Barbara Moses, Esquire, of Morvillo, Abramowitz, Grand, Iason & Silberberg, P.C., New York, New York, for Appellee Stewart.

Before VEASEY, Chief Justice, HOLLAND, BERGER, STEELE and JACOBS, Justices, constituting the Court en Banc.

[1043] VEASEY, Chief Justice.

In this appeal we review and affirm the judgment of the Court of Chancery in dismissing under Rule 23.1 a claim in a derivative suit because the plaintiff failed to make presuit demand on the corporation's board of directors and failed to demonstrate demand futility. In his opinion,^[1] the Chancellor dealt with several issues and provided a detailed account of the facts of the case. We summarize only those facts most pertinent to this appeal. The single issue before us is that of demand futility, no appeal having been taken on the other issues.

The Chancellor analyzed in detail the plaintiff's demand futility allegations. We agree with the Chancellor's well-reasoned opinion. But, pursuant to our plenary appellate review, we undertake a further explication of certain points covered by the Chancellor, including the matter of director independence.

Facts

The plaintiff, Monica A. Beam, owns shares of Martha Stewart Living Omnimedia, Inc. (MSO). Beam filed a derivative action in the Court of Chancery against Martha Stewart, the five other members of MSO's board of directors, and former board member L. John Doerr.^[2] In four counts, Beam's amended complaint (the "complaint") challenged three types of activity by Stewart and the MSO board. The Court of Chancery dismissed three of the four claims under Court of Chancery Rule 12(b)(6). Those dismissals were not appealed and are not before us.

In the single claim at issue on appeal (Count 1), Beam alleged that Stewart breached her fiduciary duties of loyalty and care by illegally selling ImClone stock in December of 2001 and by mishandling the media attention that followed, thereby jeopardizing the financial future of MSO. The Court of Chancery dismissed Count 1 under Court of Chancery Rule 23.1 because Beam failed to plead particularized facts demonstrating presuit demand futility.

When Beam filed the complaint in the Court of Chancery, the MSO board of directors consisted of six members: Stewart, Sharon L. Patrick, Arthur C. Martinez, Darla D. Moore, Naomi O. Seligman, and Jeffrey W. Ubben. The Chancellor concluded that the complaint alleged sufficient facts to support the conclusion that two of the directors, Stewart and Patrick, were not disinterested or independent for purposes of considering a presuit demand.

The Court of Chancery found that Stewart's potential civil and criminal liability for the acts underlying Beam's claim rendered Stewart an interested party and therefore unable to consider demand.^[3] The Court also found that Patrick's position [1045] as an officer and inside director,^[4] together with the substantial compensation she receives from the company, raised a reasonable doubt as to her ability objectively to consider demand.^[5] The defendants do not challenge the Court's conclusions with respect to Patrick and Stewart.

We now address the plaintiff's allegations concerning the independence of the other board members. We must determine if the following allegations of the complaint, and the reasonable inferences that may flow from them, create a reasonable doubt of the independence of either Martinez, Moore or Seligman:^[6]

4. Defendant Arthur C. Martinez ("Martinez") is a director of the Company, a position that he has held since January 2001. Until December 2000, Martinez served as Chairman of the board of directors of Sears Roebuck and Co., and was its Chief Executive Officer from August 1995 until October 2000. Martinez joined Sears, Roebuck and Co. in September 1992 as the Chairman and Chief Executive Officer of Sears Merchandise Group, Sears's former retail arm. From 1990 to 1992, he was Vice Chairman of Saks Fifth Avenue and was a member of Saks Fifth Avenue's board of directors. Martinez is currently a member of the board of directors of PepsiCo, Inc., Liz Claiborne, Inc. and International Flavors & Fragrances, Inc., and is the Chairman of the Federal Reserve Bank of Chicago. Martinez is a longstanding personal friend of defendants Stewart and Patrick. While at Sears, Martinez established a relationship with the Company, which marketed a substantial volume of products through Sears. Martinez was recruited for the board by Stewart's longtime personal friend, Charlotte Beers. Defendant Patrick was quoted in an article dated March 22, 2001 appearing in Directors & Board as follows: "Arthur is an old friend to both me and Martha."

5. Defendant Darla D. Moore ("Moore") is a director of the Company, a position she has held since September 2001. Moore has been a partner of Rainwater, Inc., a private investment firm, since 1994. Before that, Moore was a Managing Director of Chase Bank. Moore is also a trustee of Magellan Health Services, Inc. Moore is a longstanding friend of defendant Stewart. In November 1995, she attended a wedding reception hosted by Stewart's personal lawyer, Allen Grubman, for his daughter. Also in attendance were Stewart and Stewart's friend, Samuel Waksal. In August 1996, Fortune carried an article highlighting Moore's close personal relationship with Charlotte Beers and defendant Stewart. When Beers, a longtime friend and confidante to Stewart, resigned from the Company's board in September 2001, Moore was nominated to replace her.

6. Defendant Naomi O. Seligman ("Seligman") is a director of the Company, a position that she has held since [1046] September 1999. Seligman was a co-founder of Cassius Advisers, an e-commerce consultancy, where she has served as a senior partner since 1999, and is a co-founder of the Research Board, Inc., an information technology research group, where she served as a senior partner from 1975 until 1999. Seligman currently serves as a director of Akamai Technologies, Inc., The Dun & Bradstreet Corporation, John Wiley & Sons and Sun Microsystems, Inc. According to a story appearing on July 2, 2002 in The Wall Street Journal, Seligman contacted the Chief Executive Officer of John Wiley & Sons (a publishing house) at defendant Stewart's behest last year to express concern over its planned publication of a biography that was critical of Stewart.

* * *

8. Martinez, Moore, Seligson [sic], and Ubben are hereinafter referred to collectively as the Director Defendants. By reason of Stewart's overwhelming voting control over the Company, each of the Director Defendants serves at her sufferance. Each of the Director Defendants receive [sic] valuable perquisites and benefits by reason of their service on the Company's Board....

* * *

DEMAND ALLEGATIONS

73..... No demand on the Board of Directors was made prior to institution of this action, as a majority of the Board of Directors is not independent or disinterested with respect to the claims asserted herein.

* * *

77. Defendant Martinez is not disinterested in view of his longstanding personal friendship with both Patrick and Stewart.

78. Defendant Moore is not disinterested in view of her longstanding personal relationship with defendant Stewart.

79. Defendant Seligman is not disinterested; she has already shown that she will use her position as a director at another corporation to act at the behest of defendant Stewart when she contacted the Chief Executive Officer of John Wiley & Sons in an effort to dissuade the publishing house from publishing a biography that was critical of Stewart.

80. The Director Defendants are not disinterested as they are jointly and severally liable with Stewart in view of their failure to monitor Stewart's actions. Moreover, pursuit of these claims would imperil the substantial benefits that accrue to them by reason of their service on the Board, given Stewart's voting control.^[7]

Decision of the Court of Chancery

The Chancellor found that Beam had not alleged sufficient facts to support the conclusion that demand was futile because he determined that the complaint failed to raise a reasonable doubt that these outside directors are independent of Stewart. Because Patrick and Stewart herself are not independent for demand purposes, all the plaintiff need show is that one of the remaining directors is not independent, there being only six board members.^[8] The allegations relating to Moore, Seligman and Martinez are set forth above.

[1047] It is appropriate here to quote the Chancellor's analysis of the allegations regarding these three directors:

The factual allegations regarding Stewart's friendship with Martinez are inadequate to raise a reasonable doubt of his independence. While employed by Sears, Martinez developed business ties to MSO due to Sears' marketing of a substantial quantity of MSO products. Martinez was recruited to serve on MSO's board of directors by Beers, who is described as Stewart's longtime personal friend and confidante and who was at that time an MSO director. Shortly after Martinez joined MSO's board, Patrick was quoted in a magazine article saying, "Arthur [Martinez] is an old friend to both me and Martha [Stewart]." Weighing against these factors, the amended complaint discloses that Martinez has been an executive and director for major corporations since at least 1990. At present he serves as a director for four prominent corporations, including MSO, and is the chairman of the Federal Reserve Bank of Chicago. One might say that Martinez's reputation for acting as a careful fiduciary is essential to his career — a matter in which he would surely have a material interest. Furthermore, the amended complaint does not give a single example of any action by Martinez that might be construed as evidence of even a slight inclination to disregard his duties as a fiduciary for any reason. In this context, I cannot reasonably infer, on the basis of several years of business interactions and a single affirmation of friendship by a third party, that the friendship between Stewart and Martinez raises a reasonable doubt of Martinez's ability to evaluate demand independently of Stewart's personal interests.

The allegations regarding the friendship between Moore and Stewart are somewhat more detailed, yet still fall short of raising a reasonable doubt about Moore's ability properly to consider demand on Count I. In 1995, Stewart's lawyer, Allen Grubman, hosted a wedding reception for his daughter. Among those in attendance at the reception were Moore, Stewart, and Waksal. In addition, Fortune magazine published an article in 1996 that focused on the close personal friendships among Moore, Stewart, and Beers. In September 2001, when Beers resigned from MSO's board of directors, Moore was selected to replace her. Although the amended complaint lists fewer positions of fiduciary responsibility for Moore than were listed for Martinez, it is clear that Moore's professional reputation similarly would be harmed if she failed to fulfill her fiduciary obligations. To my mind, this is quite a close call. Perhaps the balance could have been tipped by additional, more detailed allegations about the closeness or nature of the friendship, details of the business and social interactions between the two, or allegations raising additional considerations that might inappropriately affect Moore's ability to impartially consider pursuit of a lawsuit against Stewart. On the facts pled, however, I cannot say that I have a reasonable doubt of Moore's ability to properly consider demand.

No particular felicity is alleged to exist between Stewart and Seligman. The amended complaint reports in ominous tones, however, that Seligman, who is a director both for MSO and for JWS, contacted JWS' chief executive officer about an unflattering biography of Stewart slated for publication. From this, the Court is asked to infer that Seligman acted in a way that preferred the protection of Stewart over her fiduciary duties to one or both of these [1048] companies. Without details about the nature of the contact, other than Seligman's wish to "express concern," it is impossible reasonably to make this inference. Stewart's public image, as plaintiff persistently asserts, is critical to the fortunes of MSO and its shareholders. As a fiduciary of MSO, Seligman may have felt obligated to express concern and seek additional information about the publication before its release. As a fiduciary of JWS, she could well have anticipated some risk of liability if any of the unflattering characterizations of Stewart proved to be insufficiently researched or made carelessly. There is no allegation that Seligman made any inappropriate attempt to prevent the publication of the biography. Nor does the amended complaint indicate whether the biography was ultimately published and, if so, whether Seligman's inquiry is believed to have resulted in any changes to the content of the book. As alleged, this matter does not serve to raise a reasonable doubt of Seligman's independence or ability to consider demand on Count I.

In sum, plaintiff offers various theories to suggest reasons that the outside directors might be inappropriately swayed by Stewart's wishes or interests, but fails to plead sufficient facts that could permit the Court reasonably to infer that one or more of the theories could be accurate.^[9]

Demand Futility and Director Independence

This Court reviews de novo a decision of the Court of Chancery to dismiss a derivative suit under Rule 23.1.^[10] The scope of this Court's review is plenary.^[11] The Court should draw all reasonable inferences in the plaintiff's favor. Such reasonable inferences must logically flow from particularized facts alleged by the plaintiff.^[12] "[C]onclusory allegations are not considered as expressly pleaded facts or factual inferences."^[13] Likewise, inferences that are not objectively reasonable cannot be drawn in the plaintiff's favor.

Under the first prong of Aronson,^[14] a stockholder may not pursue a derivative suit to assert a claim of the corporation unless: (a) she has first demanded that the directors pursue the corporate claim and they have wrongfully refused to do so; or (b) such demand is excused because the directors are deemed incapable of making an impartial decision regarding the pursuit of the litigation.^[15] The issue in this case is the quantum of doubt about a director's independence that is "reasonable" in order to excuse a presuit demand. The parties argue opposite sides of that issue.

The key principle upon which this area of our jurisprudence is based is that the directors are entitled to a presumption that they were faithful to their fiduciary duties.^[16] In the context of presuit [1049] demand, the burden is upon the plaintiff in a derivative action to overcome that presumption.^[17] The Court must determine whether a plaintiff has alleged particularized facts creating a reasonable doubt of a director's independence to rebut the presumption at the pleading stage.^[18] If the Court determines that the pleaded facts create a reasonable doubt that a majority of the board could have acted independently in responding to the demand, the presumption is rebutted for pleading purposes and demand will be excused as futile.^[19]

A director will be considered unable to act objectively with respect to a presuit demand if he or she is interested in the outcome of the litigation or is otherwise not independent.^[20] A director's interest may be shown by demonstrating a potential personal benefit or detriment to the director as a result of the decision.^[21] "In such circumstances, a director cannot be expected to exercise his or her independent business judgment without being influenced by the ... personal consequences resulting from the decision."^[22] The primary basis upon which a director's independence must be measured is whether the director's decision is based on the corporate merits of the subject before the board, rather than extraneous considerations or influences.^[23] This broad statement of the law requires an analysis of whether the director is disinterested in the underlying transaction and, even if disinterested, whether the director is otherwise independent. More precisely in the context of the present case, the independence inquiry requires us to determine whether there is a reasonable doubt that any one of these three directors is capable of objectively making a business decision to assert or not assert a corporate claim against Stewart.

Independence Is a Contextual Inquiry

Independence is a fact-specific determination made in the context of a particular case. The court must make that determination by answering the inquiries: [1050] independent from whom and independent for what purpose? To excuse presuit demand in this case, the plaintiff has the burden to plead particularized facts that create a reasonable doubt sufficient to rebut the presumption that either Moore, Seligman or Martinez was independent of defendant Stewart.

In order to show lack of independence, the complaint of a stockholder-plaintiff must create a reasonable doubt that a director is not so "beholden" to an interested director (in this case Stewart) that his or her "discretion would be sterilized."^[24] Our jurisprudence explicating the demand requirement

is designed to create a balanced environment which will: (1) on the one hand, deter costly, baseless suits by creating a screening mechanism to eliminate claims where there is only a suspicion expressed solely in conclusory terms; and (2) on the other hand, permit suit by a stockholder who is able to articulate particularized facts showing that there is a reasonable doubt either that (a) a majority of the board is independent for purposes of responding to the demand, or (b) the underlying transaction is protected by the business judgment rule.^[25]

The "reasonable doubt" standard "is sufficiently flexible and workable to provide the stockholder with `the keys to the courthouse' in an appropriate case where the claim is not based on mere suspicions or stated solely in conclusory terms."^[26]

Personal Friendship

A variety of motivations, including friendship, may influence the demand futility inquiry. But, to render a director unable to consider demand, a relationship must be of a bias-producing nature. Allegations of mere personal friendship or a mere outside business relationship, standing alone, are insufficient to raise a reasonable doubt about a director's independence.^[27] In this connection, we adopt as our own the Chancellor's analysis in this case:

[S]ome professional or personal friendships, which may border on or even exceed familial loyalty and closeness, may raise a reasonable doubt whether a director can appropriately consider demand. This is particularly true when the allegations raise serious questions of either civil or criminal liability of such a close friend. Not all friendships, or even most of them, rise to this level and the Court cannot make a reasonable inference that a particular friendship does so without specific factual allegations to support such a conclusion.^[28]

The facts alleged by Beam regarding the relationships between Stewart and these other members of MSO's board of directors largely boil down to a "structural bias" argument, which presupposes that [1051] the professional and social relationships that naturally develop among members of a board impede independent decisionmaking.^[29] This Court addressed the structural bias argument in Aronson v. Lewis:

Critics will charge that [by requiring the independence of only a majority of the board] we are ignoring the structural bias common to corporate boards throughout America, as well as the other unseen socialization processes cutting against independent discussion and decisionmaking in the boardroom. The difficulty with structural bias in a demand futile case is simply one of establishing it in the complaint for purposes of Rule 23.1. We are satisfied that discretionary review by the Court of Chancery of complaints alleging specific facts pointing to bias on a particular board will be sufficient for determining demand futility.^[30]

In the present case, the plaintiff attempted to plead affinity beyond mere friendship between Stewart and the other directors, but her attempt is not sufficient to demonstrate demand futility. Even if the alleged friendships may have preceded the directors' membership on MSO's board and did not necessarily arise out of that membership, these relationships are of the same nature as those giving rise to the structural bias argument.

Allegations that Stewart and the other directors moved in the same social circles, attended the same weddings, developed business relationships before joining the board, and described each other as "friends," even when coupled with Stewart's 94% voting power, are insufficient, without more, to rebut the presumption of independence. They do not provide a sufficient basis from which reasonably to infer that Martinez, Moore and Seligman may have been beholden to Stewart. Whether they arise before board membership or later as a result of collegial relationships among the board of directors, such affinities — standing alone — will not render presuit demand futile.

The Court of Chancery in the first instance, and this Court on appeal, must review the complaint on a case-by-case basis to determine whether it states with particularity facts indicating that a relationship — whether it preceded or followed board membership — is so close that the director's independence may reasonably be doubted. This doubt might arise either because of financial ties, familial affinity, a particularly close or intimate personal or business affinity or because of evidence that in the past the relationship caused the director to act non-independently vis à vis an interested director. No such allegations are made here. Mere allegations that they move in the same business and social circles, or a characterization that they are close friends, is not [1052] enough to negate independence for demand excusal purposes.

That is not to say that personal friendship is always irrelevant to the independence calculus. But, for presuit demand purposes, friendship must be accompanied by substantially more in the nature of serious allegations that would lead to a reasonable doubt as to a director's independence. That a much stronger relationship is necessary to overcome the presumption of independence at the demand futility stage becomes especially compelling when one considers the risks that directors would take by protecting their social acquaintances in the face of allegations that those friends engaged in misconduct.^[31] To create a reasonable doubt about an outside director's independence, a plaintiff must plead facts that would support the inference that because of the nature of a relationship or additional circumstances other than the interested director's stock ownership or voting power, the non-interested director would be more willing to risk his or her reputation than risk the relationship with the interested director.^[32]

Specific Allegations Concerning Seligman and Moore^[33]

1. Seligman

Beam's allegations concerning Seligman's lack of independence raise an additional [1053] issue not present in the Moore and Martinez relationships. Those allegations are not necessarily based on a purported friendship between Seligman and Stewart. Rather, they are based on a specific past act by Seligman that, Beam claims, indicates Seligman's lack of independence from Stewart. Beam alleges that Seligman called John Wiley & Sons (Wiley) at Stewart's request in order to prevent an unfavorable publication reference to Stewart. The Chancellor concluded, properly in our view, that this allegation does not provide particularized facts from which one may reasonably infer improper influence.

The bare fact that Seligman contacted Wiley, on whose board Seligman also served, to dissuade Wiley from publishing unfavorable references to Stewart, even if done at Stewart's request, is insufficient to create a reasonable doubt that Seligman is capable of considering presuit demand free of Stewart's influence. Although the court should draw all reasonable inferences in Beam's favor, neither improper influence by Stewart over Seligman nor that Seligman was beholden to Stewart is a reasonable inference from these allegations.

Indeed, the reasonable inference is that Seligman's purported intervention on Stewart's behalf was of benefit to MSO and its reputation, which is allegedly tied to Stewart's reputation, as the Chancellor noted.^[34] A motivation by Seligman to benefit the company every bit as much as Stewart herself is the only reasonable inference supported by the complaint, when all of its allegations are read in context.^[35]

2. Moore

The Court of Chancery concluded that the plaintiff's allegations with respect to Moore's social relationship with Stewart [1054] presented "quite a close call" and suggested ways that the "balance could have been tipped."^[36] Although we agree that there are ways that the balance could be tipped so that mere allegations of social relationships would become allegations casting reasonable doubt on independence, we do not agree that the facts as alleged present a "close call" with respect to Moore's independence. These allegations center on: (a) Moore's attendance at a wedding reception for the daughter of Stewart's lawyer where Stewart and Waksal were also present; (b) a Fortune magazine article focusing on the close personal relationships among Moore, Stewart and Beers; and (c) the fact that Moore replaced Beers on the MSO board. In our view, these bare social relationships clearly do not create a reasonable doubt of independence.

3. Stewart's 94% Stock Ownership

Beam attempts to bolster her allegations regarding the relationships between Stewart and Seligman and Moore by emphasizing Stewart's overwhelming voting control of MSO. That attempt also fails to create a reasonable doubt of independence. A stockholder's control of a corporation does not excuse presuit demand on the board without particularized allegations of relationships between the directors and the controlling stockholder demonstrating that the directors are beholden to the stockholder.^[37] As noted earlier, the relationships alleged by Beam do not lead to the inference that the directors were beholden to Stewart and, thus, unable independently to consider demand. Coupling those relationships with Stewart's overwhelming voting control of MSO does not close that gap.^[38]

A Word About the Oracle Case

In his opinion, the Chancellor referred several times^[39] to the Delaware Court of Chancery decision in In re Oracle Corp. Derivative Litigation.^[40] Indeed, the plaintiff relies on the Oracle case in this appeal. Oracle involved the issue of the independence of the Special Litigation Committee (SLC) appointed by the Oracle board to [1055] determine whether or not the corporation should cause the dismissal of a corporate claim by stockholder-plaintiffs against directors. The Court of Chancery undertook a searching inquiry of the relationships between the members of the SLC and Stanford University in the context of the financial support of Stanford by the corporation and its management. The Vice Chancellor concluded, after considering the SLC Report and the discovery record, that those relationships were too close for purposes of the SLC analysis of independence.^[41]

An SLC is a unique creature that was introduced into Delaware law by Zapata v. Maldonado in 1981.^[42] The SLC procedure is a method sometimes employed where presuit demand has already been excused and the SLC is vested with the full power of the board to conduct an extensive investigation into the merits of the corporate claim with a view toward determining whether — in the SLC's business judgment — the corporate claim should be pursued. Unlike the demand-excusal context, where the board is presumed to be independent, the SLC has the burden of establishing its own independence by a yardstick that must be "like Caesar's wife" — "above reproach."^[43] Moreover, unlike the presuit demand context, the SLC analysis contemplates not only a shift in the burden of persuasion but also the availability of discovery into various issues, including independence.

We need not decide whether the substantive standard of independence in an SLC case differs from that in a presuit demand case. As a practical matter, the procedural distinction relating to the diametrically-opposed burdens and the availability of discovery into independence may be outcome-determinative on the issue of independence.^[44] Moreover, because the members of an SLC are vested with enormous power to seek dismissal of a derivative suit brought against their director-colleagues in a setting where presuit demand is already excused, the Court of Chancery must exercise careful oversight of the bona fides of the SLC and its process. Aside from the procedural distinctions, the Stanford connections in Oracle are factually distinct from the relationships present here.^[45]

[1056] Section 220

Beam's failure to plead sufficient facts to support her claim of demand futility may be due in part to her failure to exhaust all reasonably available means of gathering facts. As the Chancellor noted,^[46] had Beam first brought a Section 220 action seeking inspection of MSO's books and records,^[47] she might have uncovered facts that would have created a reasonable doubt. For example, irregularities or "cronyism" in MSO's process of nominating board members might possibly strengthen her claim concerning Stewart's control over MSO's directors. A books and records inspection might have revealed whether the board used a nominating committee to select directors and maintained a separation between the director-selection process and management. A books and records inspection might also have revealed whether Stewart unduly controlled the nominating process or whether the process incorporated procedural safeguards to ensure directors' independence.^[48] Beam might also have reviewed the minutes of the board's meetings to determine how the directors handled Stewart's proposals or conduct in various contexts. Whether or not the result of this exploration might create a reasonable doubt would be sheer speculation at this stage. But the point is that it was within the plaintiff's power to explore these matters and she elected not to make the effort.

In general, derivative plaintiffs are not entitled to discovery in order to demonstrate demand futility.^[49] The general unavailability^[50] of discovery to assist plaintiffs with pleading demand futility does not leave plaintiffs without means of gathering information to support their allegations of demand futility, however. Both this Court and the Court of Chancery have continually advised plaintiffs who seek to plead facts establishing demand futility that the plaintiffs might successfully have used a Section 220 books and records inspection to uncover such facts.^[51]

[1057] Because Beam did not even attempt to use the fact-gathering tools available to her by seeking to review MSO's books and records in support of her demand futility claim, we cannot know if such an effort would have been fruitless, as Beam claimed on appeal. Beam's failure to seek a books and records inspection that may have uncovered the facts necessary to support a reasonable doubt of independence has resulted in substantial cost to the parties and the judiciary.^[52]

Conclusion

Because Beam did not plead facts sufficient to support a reasonable inference that at least one MSO director in addition to Stewart and Patrick was incapable of considering demand, Beam was required to make demand on the board before pursuing a derivative suit. Hence, presuit demand was not excused. The Court of Chancery did not err by dismissing Count 1 under Rule 23.1. The judgment of the Court of Chancery is AFFIRMED.

It is ordered that the time within which a motion for reargument may be timely filed under Supreme Court Rule 18 is shortened to five days from the date of this opinion. This is due to the impending change in the composition of the Supreme Court, arising from the retirement of the Chief Justice in April 2004.

[1] Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 833 A.2d 961 (Del.Ch. 2003).

[2] The action against Doerr was dismissed with prejudice and no appeal was taken. Therefore, nothing involving Mr. Doerr is before this Court.

[3] Stewart was, at all relevant times, MSO's chairman and chief executive. She controls over 94% of the shareholder vote. Beam, 833 A.2d at 966. She also personifies MSO's brands and was its primary creative force. Id. at 968.

[4] Patrick is the president and chief operating officer of MSO. Id. at 966.

[5] Id. at 977-78.

[6] The Court of Chancery did not address Ubben's ability to consider demand in its Rule 23.1 analysis of Count 1. The parties also do not press the issue here, perhaps because Beam's demand futility allegations with respect to Ubben related more to a claim that was dismissed under Rule 12(b)(6) than to the Rule 23.1 dismissal of Count 1. Because the parties do not argue and the court below did not address the issue of Ubben's independence, we do not address it. Thus, we assume for purposes of this appeal that the presumption of Ubben's independence is unrebutted. The plaintiff also appears to have waived her claim that Martinez is not independent. See infra note 33.

[7] Amended Complaint at 2-4, 19-20, Beam, 833 A.2d 961 (emphasis added).

[8] If three directors of a six person board are not independent and three directors are independent, there is not a majority of independent directors and demand would be futile. See Beneville v. York, 769 A.2d 80, 85-86 (Del.Ch.2000) (holding that demand is excused where a board is evenly divided between interested and disinterested directors).

[9] Beam, 833 A.2d at 979-81 (footnotes omitted) (emphasis added).

[10] White v. Panic, 783 A.2d 543, 549 (Del. 2001); Brehm v. Eisner, 746 A.2d 244, 253 (Del.2000).

[11] Brehm, 746 A.2d at 253.

[12] White, 783 A.2d at 549.

[13] Id.

[14] See Aronson v. Lewis, 473 A.2d 805, 814 (Del.1984) (setting forth two steps of a demand futility analysis: whether (1) "the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment").

[15] Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993); see also DEL. CH. R. 23.1 (providing the demand requirements for initiation of derivative suits by stockholders).

[16] See Aronson, 473 A.2d at 812 ("It is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.").

[17] Levine v. Smith, 591 A.2d 194, 205-06 (Del.1991); Grobow v. Perot, 539 A.2d 180, 187-89 (Del.1988).

[18] Rales, 634 A.2d at 934.

[19] Id.

[20] See Grimes v. Donald, 673 A.2d 1207, 1216 (Del.1996) ("The basis for claiming excusal would normally be that: (1) a majority of the board has a material financial or familial interest; (2) a majority of the board is incapable of acting independently for some other reason such as domination or control; or (3) the underlying transaction is not the product of a valid exercise of business judgment." (footnotes omitted)); see also In re EBAY, Inc. Shareholders Litig., C.A. No. 19988-NC, 2004 WL 253521, 2004 Del.Ch. LEXIS 4 (Del.Ch. Feb. 11, 2004) (demand was excused where futility analysis turned not on personal relationship but on allegations that compensation to non-interested directors in the form of not-yet-vested stock options created a reasonable doubt of their independence for presuit pleading purposes; although allegations were made of "personal ties," the analysis addressed only the financial ties and whether that raised the pleading inference that the non-interested directors were beholden to the interested directors).

[21] Cf. Rales, 634 A.2d at 936 ("A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders. Directorial interest also exists where a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders." (citation omitted)).

[22] Id.

[23] Id. (quoting Aronson v. Lewis, 473 A.2d 805, 816 (Del.1984)).

[24] Id.

[25] Grimes, 673 A.2d at 1217 (footnote omitted).

[26] Id. In her reply brief the plaintiff seemingly argues that our use of the phrases "reason to doubt" and "reasonable belief" in Grimes has somehow watered down the pleading threshold set forth in our jurisprudence. Reply Brief at 3-4. Nothing in Grimes was intended to weaken the traditional, objective reasonable doubt standard to be applied to the pleading threshold. See Grimes, 673 A.2d at 1217 n. 17 ("The concept of reasonable belief is an objective test and is found in various corporate contexts."); see also Grobow v. Perot, 539 A.2d 180, 186 (Del.1988) (noting that determination of demand futility "[n]ecessarily ... involves an objective analysis of the facts").

[27] Litt v. Wycoff, C.A. 19083-NC, 2003 WL 1794724, at *4, 2003 Del.Ch. LEXIS 23, at *16 (Del.Ch. Mar. 28, 2003).

[28] Beam, 833 A.2d at 979 (footnotes omitted).

[29] See DENNIS J. BLOCK ET AL., THE BUSINESS JUDGMENT RULE 1765 (5th ed.1998) (describing the "`structural bias' viewpoint.... [as holding] that the judgment of seemingly disinterested directors — who are not defendants in a litigation or participants in wrongdoing alleged in a litigation — is inherently corrupted by the `common cultural bond' and `natural empathy and collegiality' shared by most directors"); Michael P. Dooley & E. Norman Veasey, The Role of the Board in Derivative Litigation: Delaware Law and the Current ALI Proposals Compared, 44 BUS. LAW. 503, 534 (1989) ("As we understand the argument, it is that no professional colleague can be expected to be as neutral on questions of management misbehavior as a court to whom the alleged malefactor is a stranger.").

[30] 473 A.2d 805, 815 n. 8 (Del.1984). Although the Aronson Court spoke of "discretionary" review by the Court of Chancery, a concept that was changed by this Court in Brehm v. Eisner, 746 A.2d 244, 253 (Del. 2000), when we stated that our review of the Court of Chancery decision on presuit demand is de novo, the same principles apply as stated in Aronson.

[31] See Dooley & Veasey, supra note 29, at 535 ("[O]utside directors tend to be men and women who have considerable investments in reputation but who have invested most of their human capital elsewhere.").

[32] See id. ("The structural bias argument asks us to believe that outside directors generally are more willing to risk reputation and future income than they are to risk the social embarrassment of calling a colleague to account."); Bryan Ford, In Whose Interest: An Examination of the Duties of Directors and Officers in Control Contests, 26 ARIZ. ST. L.J. 91, 127 (1994) (recognizing that many factors — including personal integrity, honesty, concern about their business reputations, and the threat of liability to shareholders — may motivate directors to exercise their judgment independently of corporate executives); cf. Cal. Pub. Employees' Ret. Sys. v. Coulter, C.A. No. 19191, 2002 WL 31888343, at *9, 2002 Del.Ch. LEXIS 144, at *28-29 (Del.Ch. Dec. 18, 2002) (observing that an allegation of a lifelong friendship with an interested party is not alone sufficient to raise a reasonable doubt of a director's disinterest or independence); Kohls v. Duthie, 765 A.2d 1274, 1284 (Del.Ch.2000) (holding that a personal friendship between a member of a special committee of the board and an interested party to the challenged transaction, as well as the fact that the interested party had once given the director a summer job, were insufficient to challenge the director's ability to exercise his independent judgment with respect to the transaction); Benerofe v. Jung Woong Cha, C.A. No. 14614, 1998 WL 83081, at *3, 1998 Del.Ch. LEXIS 28, at *9 (Del.Ch. Feb. 20, 1998) (stating that an allegation of a longtime friendship was not sufficient to raise a reasonable doubt about a director's ability to exercise his judgment independently of his friend); E. Norman Veasey, The Defining Tension in Corporate Governance in America, 52 BUS. LAW. 393, 406 (1997) ("Friendship, golf companionship, and social relationships are not factors that necessarily negate independence.... [T]here is nothing to suggest that, on an issue of questioning the loyalty of the CEO, the bridge partner of the CEO cannot act independently as a director. To make a blanket argument otherwise would create a dubious presumption that the director would sell his or her soul for friendship."); cf. also Lynn A. Stout, On the Proper Motives of Corporate Directors (Or, Why You Don't Want to Invite Homo Economicus to Join Your Board), 28 DEL. J. CORP. L. 1, 8-9 (2003) (proposing an "other-regarding" theory of directorial behavior in which directors are motivated to "do a good job" not only by external pressures, but also by internal pressures such as "a director's sense of honor; her feelings of responsibility; her sense of obligation to the firm and its shareholders; and, her desire to `do the right thing'").

[33]In her reply brief in this Court the plaintiff appears to have abandoned any serious contention that she has properly alleged a reasonable doubt that Martinez is independent, focusing instead on her contention that the Chancellor erred in dismissing her complaint as to Moore and Seligman. In her reply brief the plaintiff states:

What Plaintiff has asked is that the Court apply the law of Delaware to the allegations in the Amended Complaint. Had the Court of Chancery done so and heeded its expressed doubts, it would not have dismissed the Amended Complaint, because Moore and Seligman (as well as Stewart and Patrick) are not capable of impartially considering demand.

Reply Brief at 3 (footnotes omitted). Accordingly, we do not analyze separately the allegations concerning Martinez. Moreover, since it is clear that the plaintiff has not pleaded facts raising a reasonable doubt as to Seligman and Moore, a fortiori, the plaintiff's weaker allegations concerning Martinez must fail.

[34] Beam, 833 A.2d at 980-81.

[35] The complaint alleges:

16. The Company is highly dependent upon Stewart; as the Company's prospectus for the public offering indicated:

* * *

We are highly dependent upon our founder, Chairman and Chief Executive Officer, Martha Stewart .... The diminution or loss of the services of Martha Stewart, and any negative market or industry perception arising from that diminution or loss, would have a material adverse effect on our business .... Martha Stewart remains the personification of our brands as well as our senior executive and primary creative force.

17. The prospectus for the public offering also warned that the Company's business would be affected adversely if "Martha Stewart's public image or reputation were to be tarnished. Martha Stewart, as well as her name, her image and the trademarks and other intellectual property rights relating to these, are integral to our marketing efforts and form the core of our brand name. Our continued success and the value of our brand name therefore depends, to a large degree, on the reputation of Martha Stewart."

Amended Complaint at paras. 16-17, Beam, 833 A.2d 961.

[36] The Chancellor concluded as follows:

To my mind, this is quite a close call. Perhaps the balance could have been tipped by additional, more detailed allegations about the closeness or nature of the friendship, details of the business and social interactions between the two, or allegations raising additional considerations that might inappropriately affect Moore's ability to impartially consider pursuit of a lawsuit against Stewart. On the facts pled, however, I cannot say that I have a reasonable doubt of Moore's ability to properly consider demand.

Beam, 833 A.2d at 980.

[37] See Aronson v. Lewis, 473 A.2d 805, 815 (Del.1984) ("[I]n the demand context even proof of majority ownership of a company does not strip the directors of the presumptions of independence, and that their acts have been taken in good faith and in the best interests of the corporation. There must be coupled with the allegation of control such facts as would demonstrate that through personal or other relationships the directors are beholden to the controlling person."); Stroud v. Milliken Enters., Inc., 585 A.2d 1306, 1307 (Del.Ch.1988) (stating that control of a corporation by a majority stockholder who nominates or elects the directors is not sufficient to raise a reasonable doubt about a director's independence; rather, the nature of the relationships between them must demonstrate that the director is beholden to the stockholder).

[38] The plaintiff's counsel was asked at oral argument in this Court if she had any authority for the proposition that social friendship plus such strong voting power of the interested director was sufficient to create a reasonable doubt of independence alone. Counsel admitted that she could point to no such authority.

[39] E.g., Beam, 833 A.2d at 979 n. 60; id. at 980 n. 63.

[40] 824 A.2d 917 (Del.Ch.2003).

[41] Oracle, 824 A.2d at 921. It is noteworthy that the Vice Chancellor was concerned and expressed "some shock" that the extent of the Stanford ties was not revealed in the Report of the SLC and was unearthed only in discovery. He noted that "the plain facts are a striking departure from the picture presented in the Report." Id. at 929-30.

[42] 430 A.2d 779 (Del.Supr.1981).

[43] Lewis v. Fuqua, 502 A.2d 962, 967 (Del.Ch. 1985).

[44] In Oracle we declined to accept an interlocutory appeal last year. Oracle Corp. v. Barone, No. 341, 2003, 2003 WL 21756131, 2003 Del. LEXIS 392 (Del. July 28, 2003). That matter may come before us at some time in the future.

[45] The analysis applied to determine the independence of a special committee in a merger case also has its own special procedural characteristics. In such cases, courts evaluate not only whether the relationships among members of the committee and interested parties placed them in a position objectively to consider a proposed transaction, but also whether the committee members in fact functioned independently. See, e.g., Kahn v. Tremont Corp., 694 A.2d 422, 429-30 (Del. 1997) ("[T]he Special Committee ... did not function independently.... From its inception, the Special Committee failed to operate in a manner which would create the appearance of objectivity in Tremont's decision to purchase the NL stock. As this Court has previously stated in defining director independence: `it is the care, attention and sense of individual responsibility to the performance of one's duties ... that generally touches on independence.' The record amply demonstrates that neither Stafford nor Boushka possessed the `care, attention and sense of responsibility' necessary to afford them the status of independent directors. The result was that Stein, arguably the least detached member of the Special Committee, became, de facto, a single member committee — a tenuous role."' (fourth alteration in original) (citation omitted)).

[46] Beam, 833 A.2d at 981-83 & nn. 65-66.

[47] See DEL. CODE ANN. tit. 8, § 220 (Supp.2003) (providing that stockholders have the right to inspect a corporation's books and records for "any proper purpose").

[48] Although not mandated by Delaware law, it is relevant to note that the New York Stock Exchange listing requirements, for example, require that listed companies have an independent and effective nominating committee. See New York Stock Exchange Corporate Governance Rule 303A.04 (2003), available at http://www.nyse.com/pdfs/finalcorpgo-vrules.pdf; Nat'l Ass'n Sec. Dealers Rule 4350(c)(4), NASD Manual Online (2003), http://cchwallstreet.com/NASD/NASD_Rules. Although these requirements may not have been in effect at times relevant to this complaint, it is relevant to note that MSO is an NYSE listed company.

[49] See Rales v. Blasband, 634 A.2d 927, 934 n. 10 (Del.1993) ("[D]erivative plaintiffs ... are not entitled to discovery to assist their compliance with Rule 23.1 ...."); Levine v. Smith, 591 A.2d 194, 209 (Del.1991) (refusing to extend the availability of limited discovery to either demand refused cases or demand excused cases, absent the Zapata context relating to an SLC).

[50] We need not decide if some precise and limited discovery would ever be appropriate in the discretion of the Court of Chancery in the eventuality that a books and records inspection under Section 220 uncovered a significant ambiguity, the resolution of which could be essential to determining the issue of independence.

[51] The Chancellor cited an extensive string of cases in which our courts have emphasized the availability of the Section 220 action as a possible method of securing facts to support a demand futility claim. Beam, 833 A.2d at 981 nn. 65-66. Note in particular the discussion of the Disney case where the plaintiffs were permitted to replead, then used the Section 220 procedure, and the new complaint survived a motion to dismiss on the ground that presuit demand was excused. Id. at 983-84. See In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 279 (Del.Ch.2003).

[52] We agree with the Chancellor's point about cost and drain on resources in weak cases where the plaintiff does not seek books and records. In White v. Panic, 783 A.2d 543, 549-50 (Del.2001) (discussed by the Chancellor in Beam, 833 A.2d at 982 n. 66), we approved the Vice Chancellor's admonition in that case that a plaintiff should pursue a books and records inspection in order to secure the facts necessary to support an allegation of demand futility if the factual allegations would otherwise fall short. At the same time, we said that a failure to use Section 220 should not alter the standard to be applied to consideration of an allegation of demand futility. White, 783 A.2d at 549-50. A plaintiff's use of, or failure to use, a books and records inspection does not change the standard to be applied to review of the complaint. Regardless of whether the plaintiff secured any facts alleged in her complaint through a Section 220 inspection, the court must draw all reasonable inferences in the plaintiff's favor and determine whether those facts create a reasonable doubt of the directors' independence. The allegations of demand futility made in the complaint, and the reasonable inferences drawn therefrom, continue to be the sole basis on which the court should make its demand futility determination. If the particularized facts alleged in the complaint, even if pleaded without benefit of a Section 220 inspection, together with the reasonable inferences from those facts create a reasonable doubt of the independence of a majority of the board, then the complaint is indeed "well-pleaded," despite the fact that a books and records inspection might have gleaned additional facts to support the demand futility claim.

Pamela S. Tikellis, Robert J. Kriner and Tiffany J. Cramer, of CHIMICLES & TIKELLIS LLP, Wilmington, Delaware; OF COUNSEL: John F. Harnes, Gregory E. Keller and Carol S. Shahmoon, of CHITWOOD HARLEY HARNES LLP, Great Neck, New York, Attorneys for Plaintiffs.

Gregory V. Varallo and Rudolf Koch, of RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; OF COUNSEL: Gandolfo V. DiBlasi, Richard H. Klapper, Theodore Edelman and David M.J. Rein, of SULLIVAN & CROMWELL LLP, New York, New York, Attorneys for Defendants.

MEMORANDUM OPINION

GLASSCOCK, Vice Chancellor.

The Delaware General Corporation Law is, for the most part, enabling in nature. It provides corporate directors and officers with broad discretion to act as they find appropriate in the conduct of corporate affairs. It is therefore left to Delaware case law to set a boundary on that otherwise unconstrained realm of action. The restrictions imposed by Delaware case law set this boundary by requiring corporate officers and directors to act as faithful fiduciaries to the corporation and its stockholders. Should these corporate actors perform in such a way that they are violating their fiduciary obligations—their core duties of care or loyalty—their faithless acts properly become the subject of judicial action in vindication of the rights of the stockholders. Within the boundary of fiduciary duty, however, these corporate actors are free to pursue corporate opportunities in any way that, in the exercise of their business judgment on behalf of the corporation, they see fit. It is this broad freedom to pursue opportunity on behalf of the corporation, in the myriad ways that may be revealed to creative human minds, that has made the corporate structure a supremely effective engine for the production of wealth. Exercising that freedom is precisely what directors and officers are elected by their shareholders to do. So long as such individuals act within the boundaries of their fiduciary duties, judges are ill-suited by training (and should be disinclined by temperament) to second-guess the business decisions of those chosen by the stockholders to fulfill precisely that function. This case, as in so many corporate matters considered by this Court, involves whether actions taken by certain director defendants fall outside of the fiduciary boundaries existing under Delaware case law—and are therefore subject to judicial oversight—or whether the acts complained of are within those broad boundaries, where a law-trained judge should refrain from acting.

This matter is before me on a motion to dismiss, pursuant to Court of Chancery Rule 23.1, for failure to make a pre-suit demand upon the board, and Court of Chancery Rule 12(b)(6) for failure to state a claim. The Plaintiffs contend that Goldman's compensation structure created a divergence of interest between Goldman's management and its stockholders. The Plaintiffs allege that because Goldman's directors have consistently based compensation for the firm's management on a percentage of net revenue, Goldman's employees had a motivation to grow net revenue at any cost and without regard to risk.

The Plaintiffs allege that under this compensation structure, Goldman's employees would attempt to maximize short-term profits, thus increasing their bonuses at the expense of stockholders' interests. The Plaintiffs contend that Goldman's employees would do this by engaging in highly risky trading practices and by over-leveraging the company's assets. If these practices turned a profit, Goldman's employees would receive a windfall; however, losses would fall on the stockholders.

The Plaintiffs allege that the Director Defendants breached their fiduciary duties by approving the compensation structure discussed above. Additionally, the Plaintiffs claim that the payments under this compensation structure constituted corporate waste. Finally, the Plaintiffs assert that this compensation structure led to overly-risky business decisions and unethical and illegal practices, and that the Director Defendants failed to satisfy their oversight responsibilities with regard to those practices.

The Defendants seek dismissal of this action on the grounds that the Plaintiffs have failed to make a pre-suit demand on the board and have failed to state a claim. For the reasons stated below, I find that the Plaintiffs' complaint must be dismissed.

I. FACTS

The facts below are taken from the second amended complaint. All reasonable inferences are drawn in the Plaintiffs' favor.^[1]

A. Parties

Co-Lead plaintiffs Southeastern Pennsylvania Transportation Authority and International Brotherhood of Electrical Workers Local 98 Pension Fund ("the Plaintiffs") are stockholders of Goldman Sachs Group, Inc. ("Goldman"), and have continuously held Goldman stock during all relevant times.

Defendant Goldman is a global financial services firm which provides investment banking, securities, and investment management services to consumers, businesses, and governments. Goldman is a Delaware corporation with its principal executive offices in New York, NY.

The complaint also names fourteen individual current and former directors and officers of Goldman as defendants: Lloyd C. Blankfein, Gary D. Cohn, John H. Bryan, Claes Dahlback, Stephen Friedman, William W. George, Rajat K. Gupta, James A. Johnson, Lois D. Juliber, Lakshmi N. Mittal, James J. Schiro, Ruth J. Simmons, David A. Viniar, and J. Michael Evans (together with Goldman, "the Defendants").

Blankfein, Cohn, Bryan, Dahlback, Friedman, George, Gupta, Johnson, Juliber, Mittal, Schiro, and Simmons are current and former directors of Goldman, and are collectively referred to as the "Director Defendants." Evans and Viniar are officers of the company; Evans, Viniar, Cohn, and Blankfein are collectively referred to as the "Executive Officer Defendants." Bryan, Dahlback, Friedman, George, Gutpa, Johnson, Juliber, Mittal, and Schiro served as members of the Board's Audit Committee (collectively, the "Audit Committee Defendants"). Finally, defendants Byran, Dahlback, Friedman, George, Gutpa, Johnson, Juliber, Mittal, Schiro, and Simmons served as members of the Board's Compensation Committee, and are collectively referred to as the "Compensation Committee Defendants."

B. Background

Goldman engages in three principal business segments: investment banking, asset management and securities services, and trading and principal investments. The majority of Goldman's revenue comes from the trading and principal investment segment.^[2] In that segment Goldman engages in market making, structuring and entering into a variety of derivative transactions, and the proprietary trading of financial instruments.^[3]

Since going public in 1999, Goldman's total assets under management and common stockholder equity have substantially increased.^[4] In 1999, Goldman had $258 billion of assets under management and $10 billion of common shareholder equity.^[5] By 2010, those numbers had grown to $881 billion of assets under management and $72.94 billion of common shareholder equity.^[6] Corresponding with this increase in assets under management and common shareholder equity was a hike in the percentage of Goldman's revenue that was generated by the trading and principal investment segment.^[7] In 1999, the trading and principal investment segment generated 43% of Goldman's revenue; by 2007 the segment generated over 76% of Goldman's revenue.^[8]

As the revenue generated by the trading and principal investment segment grew, so did the trading department's stature within Goldman. The traders "became wealthier and more powerful in the bank."^[9] The Plaintiffs allege that the compensation for these traders was not based on performance and was unjustifiable because Goldman was doing "nothing more than compensat[ing] employees for results produced by the vast amounts of shareholder equity that Goldman ha[d] available to be deployed."^[10]

C. Compensation

Goldman employed a "pay for performance" philosophy linking the total compensation of its employees to the company's performance.^[11] Goldman has used a Compensation Committee since at least 2006 to oversee the development and implementation of its compensation scheme.^[12] The Compensation Committee was responsible for reviewing and approving the Goldman executives' annual compensation.^[13] To fulfill their charge, the Compensation Committee consulted with senior management about management's projections of net revenues and the proper ratio of compensation and benefits expenses to net revenues (the "compensation ratio").^[14] Additionally, the Compensation Committee compared Goldman's compensation ratio to that of Goldman's competitors such as Bear Stearns, Lehman Brothers, Merrill Lynch, and Morgan Stanley. The Compensation Committee would then approve a ratio and structure that Goldman would use to govern Goldman's compensation to its employees.^[15]

The Plaintiffs allege that from 2007 through 2009, the Director Defendants approved a management-proposed compensation structure that caused management's interests to diverge from those of the stockholders.^[16] According to the Plaintiffs, in each year since 2006 the Compensation Committee approved the management-determined compensation ratio, which governed "the total amount of funds available to compensate all employees including senior executives," without any analysis.^[17] Although the total compensation paid by Goldman varied significantly each year, total compensation as a percentage of net revenue remained relatively constant.^[18] Because management was awarded a relatively constant percentage of total revenue, management could maximize their compensation by increasing Goldman's total net revenue and total stockholder equity.^[19] The Plaintiffs contend that this compensation structure led management to pursue a highly risky business strategy that emphasized short term profits in order to increase their yearly bonuses.^[20]

D. Business Risk

The Plaintiffs allege that management achieved Goldman's growth "through extreme leverage and significant uncontrolled exposure to risky loans and credit risks."^[21] The trading and principal investment segment is the largest contributor to Goldman's total revenues; it is also the segment to which Goldman commits the largest amount of capital.^[22] The Plaintiffs argue that this was a risky use of Goldman's assets, pointing out that Goldman's Value at Risk (VAR) increased between 2007 and 2009, and that in 2007 Goldman had a leverage ratio of 25 to 1, exceeding that of its peers.^[23]

The Plaintiffs charge that this business strategy was not in the best interest of the stockholders, in part, because the stockholders did not benefit to the same degree that management did. Stockholders received roughly 2% of the revenue generated in the form of dividends—but if the investment went south, it was the stockholders' equity at risk, not that of the traders.

The Plaintiffs point to Goldman's performance in 2008 as evidence of these alleged diverging interests. In that year, "the Trading and Principal Investment segment produced $9.06 billion in net revenue, but as a result of discretionary bonuses paid to employees lost more than $2.7 billion."^[24] This contributed to Goldman's 2008 net income falling by $9.3 billion.^[25] The Plaintiffs contend that, but for a cash infusion from Warren Buffet, federal government intervention and Goldman's conversion into a bank holding company, Goldman would have gone into bankruptcy.^[26]

The Plaintiffs acknowledge that during this time Goldman had an Audit Committee in charge of overseeing risk.^[27] The Audit Committee's purpose was to assist the board in overseeing "the Company's management of market, credit, liquidity, and other financial and operational risks."^[28] The Audit Committee was also required to review, along with management, the financial information that was provided to analysts and ratings agencies and to discuss "management's assessment of the Company's market, credit, liquidity and other financial and operational risks, and the guidelines, policies and processes for managing such risks."^[29]

In addition to having an Audit Committee in place, Goldman managed risk associated with the trading and principal investment section by hedging its positions—sometimes taking positions opposite to the clients that it was investing with, advising, and financing.^[30] Since 2002, Goldman has acknowledged that possible conflicts could occur and that it seeks to "manage" these conflicts.^[31] The Plaintiffs allege that if the Audit Committee had been properly functioning, the board should have been forewarned about conflicts of interest between Goldman and its clients.^[32]

The Plaintiffs contend that these conflicts of interest came to a head during the mortgage and housing crisis. In December 2006, Goldman's CFO, in a meeting with Goldman's mortgage traders and risk managers, concluded that the firm was over-exposed to the subprime mortgage market and decided to reduce Goldman's overall exposure.^[33] In 2007, as the housing market began to decline, a committee of senior executives, including Viniar, Cohn, and Blankfein, took an active role in monitoring and overseeing the mortgage unit.^[34] The committee's job was to examine mortgage products and transactions while protecting Goldman against risky deals.^[35] The committee eventually decided to take positions that would allow Goldman to profit if housing prices declined.^[36] When the subprime mortgage markets collapsed, not only were Goldman's long positions hedged, Goldman actually profited more from its short positions than it lost from its long positions.^[37] The Plaintiffs allege that Goldman's profits resulted from positions that conflicted with its clients' interests to the detriment of the company's reputation.^[38]

As an example of these conflicts of interest, the Plaintiffs point to the infamous Abacus transaction. In the Abacus transaction, hedge fund manager John Paulson, a Goldman client, had a role in selecting the mortgages that would ultimately be used to back a collateralized debt obligation (CDO).^[39] Paulson took a short position that would profit if the CDO fell in value.^[40] Goldman sold the long positions to other clients without disclosing Paulson's involvement.^[41] On April 16, 2010, the SEC charged Goldman and a Goldman employee with fraud for their actions related to the Abacus transaction.^[42] On July 14, 2010, Goldman settled the case with the SEC and agreed to pay a civil penalty of $535 million and to disgorge the $15 million in profits it made on the transaction.^[43] Goldman also agreed to review its internal processes related to mortgage securities transactions.^[44]

To demonstrate further examples of conflicts of interest, the Plaintiffs rely on a April 26, 2010 memorandum, from Senators Carl Levin and Tom Coburn to the Members of the Permanent Subcommittee on Investigations, entitled "Wall Street and the Financial Crisis: The Role of Investment Banks" ("Permanent Subcommittee Report"), that highlighted three mortgage-related products that Goldman sold to its clients.^[45] These transactions involved synthetic CDOs,^[46] where Goldman sold long positions to clients while Goldman took the short positions.^[47] Unlike the Abacus transaction, these three transactions did not end with SEC involvement,^[48] but the Plaintiffs allege that investors who lost money are "reviewing their options, including possibly bringing lawsuits."^[49]

E. The Plaintiffs' Claims

The Plaintiffs allege that the Director Defendants breached their fiduciary duties by (1) failing to properly analyze and rationally set compensation levels for Goldman's employees and (2) committing waste by "approving a compensation ratio to Goldman employees in an amount so disproportionately large to the contribution of management, as opposed to capital as to be unconscionable."^[50]

The Plaintiffs also allege that the Director Defendants violated their fiduciary duties by failing to adequately monitor Goldman's operations and by "allowing the Firm to manage and conduct the Firm's trading in a grossly unethical manner."^[51]

II. LEGAL STANDARDS

The Plaintiffs have brought this action derivatively on behalf of Goldman "to redress the breaches of fiduciary duty and other violations of law by [the] Defendants."^[52] The Defendants have moved to dismiss, pursuant to Court of Chancery Rule 23.1, for failure to make a pre-suit demand upon the board, and Court of Chancery Rule 12(b)(6) for failure to state a claim.

A. Rule 12(b)(6)

As our Supreme Court has recently made clear, "the governing pleading standard in Delaware to survive a motion to dismiss is reasonable `conceivability.'"<sup>[53]</sup> Under this minimal standard, when considering a motion to dismiss, the trial court must accept "even vague allegations in the Complaint as `well-pleaded' if they provide the defendant notice of the claim."^[54] The trial court must "draw all reasonable inferences in favor of the plaintiff, and deny the motion unless the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof."^[55] This is true even if, "as a factual matter," it may "ultimately prove impossible for the plaintiff to prove his claims at a later stage of a proceeding."^[56]

B. Rule 23.1

"[T]he pleading burden imposed by Rule 23.1 . . . is more onerous than that demanded by Rule 12(b)(6)."^[57] Though a complaint may plead a "conceivable" allegation that would survive a motion to dismiss under Rule 12(b)(6), "vague allegations are . . . insufficient to withstand a motion to dismiss pursuant to Rule 23.1."^[58] This difference reflects the divergent reasons for the two rules: Rule 12(b)(6) is designed to ensure a decision on the merits of any potentially valid claim, excluding only clearly meritless claims; Rule 23.1 is designed to vindicate the authority of the corporate board, except in those cases where the board will not or (because of conflicts) cannot exercise its judgment in the interest of the corporation. Rule 23.1 requires that "a plaintiff shareholder . . . make a demand upon the corporation's current board to pursue derivative claims owned by the corporation before a shareholder is permitted to pursue legal action on the corporation's behalf."^[59] Demand is required because "[t]he decision whether to initiate or pursue a lawsuit on behalf of the corporation is generally within the power and responsibility of the board of directors."^[60] Accordingly, the complaint must allege "with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort."^[61]

C. Demand Futility

If, as here, a stockholder does not first demand that the directors pursue the alleged cause of action, he must establish that demand is excused by satisfying "stringent [pleading] requirements of factual particularity" by "set[ting] forth particularized factual statements that are essential to the claim" in order to demonstrate that making demand would be futile.^[62] Pre-suit demand is futile if a corporation's board is "deemed incapable of making an impartial decision regarding the pursuit of the litigation."^[63]

Under the two-pronged test, first explicated in Aronson, when a plaintiff challenges a conscious decision of the board, a plaintiff can show demand futility by alleging particularized facts that create a reasonable doubt that either (1) the directors are disinterested and independent or (2) "the challenged transaction was otherwise the product of a valid exercise of business judgment."^[64]

On the other hand, when a plaintiff complains of board inaction, "there is no `challenged transaction,' and the ordinary Aronson analysis does not apply."^[65] Instead, the board's inaction is analyzed under Rales v. Blasband.^[66] Under the Rales test, a plaintiff must plead particularized facts that "create a reasonable doubt that, as of the time the complaint [was] filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand."^[67]

Here, the Plaintiffs concede that they have not made demand upon Goldman's board of directors, but they assert that such demand would be futile for numerous reasons. First, they argue that Goldman's board of directors is interested or lacks independence because of financial ties between the Director Defendants and Goldman.^[68] Next, they allege that there is a reasonable doubt as to whether the board's compensation structure was the product of a valid exercise of business judgment.^[69] The Plaintiffs further assert that there is a substantial likelihood that the Director Defendants will face personal liability for the dereliction of their duty to oversee Goldman's operations.^[70]

I evaluate the Plaintiffs' claims involving active decisions by the board under Aronson. I evaluate the Plaintiffs' oversight claims against the Director Defendants for the failure to monitor Goldman's operations under Rales.

III. ANALYSIS

A. Approval of the Compensation Scheme

The Plaintiffs challenge the Goldman board's approval of the company's compensation scheme on three grounds. They allege (1) that the majority of the board was interested or lacked independence when it approved the compensation scheme, (2) the board did not otherwise validly exercise its business judgment, and (3) the board's approval of the compensation scheme constituted waste. Because the approval of the compensation scheme was a conscious decision by the board, the Plaintiffs must satisfy the Aronson test to successfully plead demand futility. I find that under all three of their challenges to the board's approval of the compensation scheme, the Plaintiffs have failed to adequately plead demand futility.

1. Independence and Disinterestedness of the Board

A plaintiff successfully pleads demand futility under the first prong of Aronson when he alleges particularized facts that create a reasonable doubt that "a `majority' of the directors could [have] impartially consider[ed] a demand" either because they were interested or lacked independence, as of the time that suit was filed.^[71] Generally, "[a] director's interest may be shown by demonstrating a potential personal benefit or detriment to the director as a result of the decision."^[72] A director is independent if the "director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences."^[73]

When the complaint was originally filed, Goldman's board had 12 directors: Blankfein, Cohn, Bryan, Dahlback, Friedman, George, Gupta, Johnson, Juliber, Mittal, Schiro, and Simmons.^[74] The Plaintiffs fail to allege that George and Schiro were interested or lacked independence. It can be assumed that Blankfein and Cohn, as officials of Goldman, would be found to be interested or lack independence. Therefore, the Plaintiffs must satisfy Aronson with respect to at least four of the remaining eight directors.^[75]

The Plaintiffs argue that demand is excused because a majority of the Director Defendants lacked independence or were interested as a result of significant financial relationships with Goldman. The Plaintiffs contend that directors Bryan, Friedman, Gupta, Johnson, Juliber, and Simmons were interested because the private Goldman Sachs Foundation ("the Goldman Foundation") has made contributions to charitable organizations that the directors were affiliated with.^[76] The Plaintiffs assert that directors Dahlback, Friedman, and Mittal were interested because of financial interactions with Goldman.

Below I provide the specific allegations found in the complaint about the Director Defendants. Since the Plaintiffs do not allege that the Director Defendants (aside from Blankfein and Cohn) were interested in the compensation decisions, I analyze whether the director lacks independence.

a. Directors and Charitable Contributions.

i. John H. Bryan

Bryan has served as a Goldman director since 1999.^[77] He was also a member of Goldman's Audit Committee and Goldman's Compensation Committee.^[78] His charitable works included chairing a successful campaign to raise $100 million for the renovation of the Chicago Lyric Opera House and Orchestra Hall, and acting as a life trustee of the University of Chicago.^[79] The Plaintiffs state that part of Bryan's responsibility, as a trustee, was to raise money for the University. The Plaintiffs note that Goldman has made "substantial contributions"^[80] to the campaign to renovate the Chicago Lyric Opera House and Orchestra Hall and that the Goldman Foundation donated $200,000 to the University in 2006 and allocated an additional $200,000 in 2007.^[81]

The Plaintiffs allege that because Goldman and the Goldman Foundation have assisted Bryan in his fund raising responsibilities, Bryan lacks independence.^[82]

This Court has previously addressed directorial independence and charitable contributions. Hallmark^[83] involved a special committee member who served on a variety of charitable boards where the charity received donations from the defendant corporation. The Hallmark Court noted that, even though part of the member's role was to act as a fund raiser, the member did not receive a salary for his work and did not actively solicit donations from the defendant corporation; therefore, the plaintiff failed to sufficiently show that the member was incapable of "exercising independent judgment."^[84]

This Court also addressed charitable contributions in J.P. Morgan.^[85] In that case, the plaintiff challenged the independence of a director who was the President and a trustee of the American Natural History Museum, another director who was a trustee of the American Natural History Museum, and a director who was the President and CEO of the United Negro College Fund.^[86] The plaintiff alleged that because the defendant corporation made donations to these organizations and was a significant benefactor, the directors lacked independence.^[87] The Court decided that without additional facts showing, for instance, how the donations would affect the decision making of the directors or what percentage of the overall contribution was represented by the corporation's donations, the plaintiff had failed to demonstrate that the directors were not independent.^[88]

In the case at bar, nothing more can be inferred from the complaint than the facts that the Goldman Foundation made donations to a charity that Bryan served as trustee, that part of Bryan's role as a trustee was to raise money, and that Goldman made donations to another charity where Bryan chaired a renovation campaign. The Plaintiffs do not allege that Bryan received a salary for either of his philanthropic roles, that the donations made by the Goldman Foundation or Goldman were the result of active solicitation by Bryan, or that Bryan had other substantial dealings with Goldman or the Goldman Foundation. The Plaintiffs do not provide the ratios of the amounts donated by Goldman, or the Goldman Foundation, to overall donations, or any other information demonstrating that the amount would be material to the charity. Crucially, the Plaintiffs fail to provide any information on how the amounts given influenced Bryan's decision-making process.^[89] Because the complaint lacks such particularized details, the Plaintiffs have failed to create a reasonable doubt as to Bryan's independence.

ii. Rajat K. Gupta

Gupta has served as a Goldman director since 2006.^[90] He was also a member of Goldman's Audit Committee and Goldman's Compensation Committee.^[91] Gupta is chairman of the board of the Indian School of Business, to which the Goldman Foundation has donated $1.6 million since 2002.^[92] Gupta is also a member of the dean's advisory board of Tsinghua University School of Economics and Management, to which the Foundation has donated at least $3.5 million since 2002.^[93] Finally, Gupta is a member of the United Nations Commission on the Private Sector and Development and he is a special advisor to the UN Secretary General on UN Reform.^[94] Since 2002, the Foundation has donated around $1.6 million to the Model UN program.^[95] The Plaintiffs allege that as "a member of these boards and commission, it is part of Gupta's job to raise money."^[96]

The Plaintiffs challenge to Gupta's independence fails for reasons similar to Bryan's. The Plaintiffs allegations only provide information that shows that Gupta was engaged in philanthropic activities and that the Goldman foundation made donations to charities to which Gupta had ties. The Plaintiffs do not mention the materiality of the donations to the charities or any solicitation on the part of Gupta. The Plaintiffs do not state how Gupta's decision-making was altered by the donations. Without such particularized allegations, the Plaintiffs fail to raise a reasonable doubt that Gupta was independent.

iii. James A. Johnson

Johnson has served as a Goldman director since 1999.^[97] He was also a member of Goldman's Audit Committee and Goldman's Compensation Committee.^[98] Johnson is an honorary trustee of the Brookings Institution.^[99] The Plaintiffs allege that part of Johnson's role as a trustee is to raise money and that the Foundation donated $100,000 to the Brookings Institution in 2006.^[100]

Again the Plaintiffs fail to provide any information other than that a director was affiliated with a charity and the Goldman Foundation made a donation to that charity. Without more, the Plaintiffs fail to provide particularized factual allegations that create a reasonable doubt in regards to Johnson's independence.

iv. Lois D. Juliber

Juliber has served as a Goldman director since 2004.^[101] She was also a member of Goldman's Audit Committee and Goldman's Compensation Committee.^[102] Juliber is a member of the board of Girls Incorporated, a charitable organization, to which the Plaintiffs contend that the Goldman Foundation donated $400,000 during 2006 and 2007.^[103] The Plaintiffs allege that part of Juliber's job as a Girls Incorporated board member is to raise money.^[104]

For the same reasons that the Plaintiffs' allegations fall short for directors Bryan, Gupta, and Johnson, the Plaintiffs' allegations fall short here. The Plaintiffs do not plead facts sufficient to create a reasonable doubt whether Juliber was independent.

v. Ruth J. Simmons

Simmons has served as a Goldman director since 2000.^[105] She was also a member of Goldman's Compensation Committee.^[106] Simmons is President of Brown University, and the Plaintiffs allege that part of her job is to raise money for the University.^[107] The Plaintiffs note that "[t]he [Goldman] Foundation has pledged funding in an undisclosed amount to share in the support of a position of Program Director at The Swearer Center for Public Service at Brown University," and so far $200,000 has been allocated to this project.^[108]

Simmons differs from the other directors in that, rather than sitting on a charitable board, as the other defendants do, Simmons livelihood as President of Brown University does directly depend on her fundraising abilities;^[109] however, the Plaintiffs fail to allege particularized factual allegations that create a reasonable doubt that Simmons was independent.

The Plaintiffs provide the amount donated to Brown University, but do not give any additional information showing the materiality of the donation to Brown University. The Plaintiffs do not provide the percentage this amount represented of the total amount raised by Brown, or even how this amount was material to the Swearer Center. Additionally, the Plaintiffs' allegations do not provide information that Simmons actively solicited this amount or how this or potential future donations would affect Simmons. The facts pled are insufficient to raise the inference that Simmons feels obligated to the foundation or Goldman management. Consequently, the factual allegations pled by the Plaintiffs fail to raise a reasonable doubt that, despite Simmons's position as President of Brown University, she remained independent.

b. Directors with Other Alleged Interests.

The Plaintiffs allege that three directors have, in addition (in the case of Mr. Friedman) to charitable connections to Goldman or the Goldman Foundation, business dealings with Goldman that render them dependent for purposes of the first prong of the Aronson analysis. Having already found that a majority of the Goldman board was independent, I could simply omit analysis of the independence of these directors under Aronson. I will briefly address the Plaintiffs contentions with respect to the directors below.

i. Stephen Friedman

Friedman has served as a Goldman director since 2005.^[110] He was also a member of Goldman's Audit Committee and Goldman's Compensation Committee.^[111] The Plaintiffs allege that Friedman lacks independence for two reasons. First, the Plaintiffs allege that Friedman is not independent because of his philanthropic work and Goldman's advancement thereof. Second, the Plaintiffs allege that Friedman is not independent due to his business dealings with Goldman.

Friedman is an emeritus trustee of Columbia University.^[112] The Plaintiffs contend that part of his job as a trustee is to raise money for Columbia University and that since 2002 the Goldman foundation has donated at least $765,000 to Columbia University.^[113]

Taken by themselves, the facts pled, concerning Friedman's charitable connection to the Goldman Foundation, are insufficient to create a reasonable doubt that Friedman was independent. Similar to the Plaintiffs' other allegations concerning defendants with charitable connections to the Goldman Foundation, the Plaintiffs only allege that Friedman is a trustee of Columbia University, that part of his job as a trustee is to raise money, and that the Foundation has donated money to the University. The complaint fails to allege that Friedman solicited money from the Goldman Foundation, that he receives any salary for his work as trustee, or that he had any substantial dealings with the Goldman Foundation.

Besides their allegations concerning Friedman's charitable endeavors, the Plaintiffs also allege that Goldman "has invested at least $670 million in funds managed by Friedman."^[114] This is the entirety of the pleadings regarding Friedman's business involvement with Goldman. Contrary to the contentions in the Plaintiffs' Answering Brief, the complaint does not allege that Friedman relies on the management of these funds for his livelihood; that contention, if buttressed by factual allegations in the complaint, might reasonably demonstrate lack of independence. The complaint is insufficient, as written, for that purpose.

ii. Claes Dahlback

Dahlback has served as a Goldman director since 2003.^[115] He was also a member of Goldman's Audit Committee and Goldman's Compensation Committee.^[116] Besides serving on Goldman's board, Dahlback is a senior advisor to an entity described in the complaint as "Investor AB."^[117] The Plaintiffs note that Goldman has invested more than $600 million in funds to which Dahlback is an adviser (presumably, but not explicitly, Investor AB).^[118] The Plaintiffs contend that because Dahlback had substantial financial relationships with Goldman, he lacked independence.

The Plaintiffs' allegations regarding Dahlback are sparse and tenuous. "[T]he complaint contains no allegations of fact tending to show that [any] fees paid were material to [Dahlback]."^[119] The Plaintiffs only note that Dahlback is an advisor to Investor AB, and that Goldman has invested more than $600 million in funds with an entity to which Dahlback is an advisor. Contrary to the statements by the Plaintiffs in the answering brief, the complaint does not allege that Dahlback's "livelihood depends on his full-time job as an advisor." The Plaintiffs fail to allege that Dahlback derives a substantial benefit from being an advisor to Investor AB, that Dahlback solicited funds from Goldman, that Investor AB received funds because of Dahlback's involvement, or any other fact that would tend to raise a reasonable doubt that Dahlback's future employment with Investor AB is independent of Goldman's investment. As with defendant Friedman, the pleadings are insufficient to raise a reasonable doubt as to Dahlback's independence.

iii. Lakshmi N. Mittal

Mittal has served as a Goldman director since 2008.^[120] He was also a member of Goldman's Audit Committee and Goldman's Compensation Committee.^[121] Mittal is the chairman and CEO of ArcelorMittal.^[122] The Plaintiffs allege that "Goldman has arranged or provided billions of euros in financing to his company" and that "[d]uring 2007 and 2008 alone, the Company had made loans to AcelorMittal [sic] in the aggregate amount of 464 million euros."^[123]

Goldman is an investment bank. The fact "[t]hat it provided financing to large . . . companies should come as no shock to anyone. Yet this is all that the plaintiffs allege."^[124] The Plaintiffs fail to plead facts that show anything other than a series of market transactions occurred between ArcelorMittal and Goldman. For instance, the Plaintiffs have not alleged that ArcelorMittal is receiving a discounted interest rate on the loans from Goldman, that Mittal was unable to receive financing from any other lender, or that loans from Goldman compose a substantial part of ArcelorMittal's funding.^[125] The pleadings fail to raise a reasonable doubt as to the independence of Mittal.

B. Otherwise the Product of a Valid Exercise of Business Judgment

Having determined that the Plaintiffs have not pled particularized factual allegations that raise a reasonable doubt as to a majority of the Director Defendants' disinterestedness and independence, I must now apply the second prong of Aronson and determine whether the Plaintiffs have pled particularized facts that raise a reasonable doubt that Goldman's compensation scheme was otherwise the product of a valid exercise of business judgment.^[126] To successfully plead demand futility under the second prong of Aronson, the Plaintiffs must allege "particularized facts sufficient to raise (1) a reason to doubt that the action was taken honestly and in good faith or (2) a reason to doubt that the board was adequately informed in making the decision."^[127] Goldman's charter has an 8 Del. C. § 102(b)(7) provision, providing that the directors are exculpated from liability except for claims based on `bad faith' conduct; therefore, the Plaintiffs must also plead particularized facts that demonstrate that the directors acted with scienter; i.e., there was an "intentional dereliction of duty" or "a conscious disregard" for their responsibilities, amounting to bad faith.^[128]

The Plaintiffs assert that the Director Defendants owed "a fiduciary duty to assess continually Goldman's compensation scheme to ensure that it reasonably compensated employees and reasonably allocated the profit of Goldman's activities according to the contributions of shareholder capital and the employees of the Company."^[129] The Plaintiffs contend that the entire compensation structure put in place by the Director Defendants was done in bad faith and that the Director Defendants were not properly informed when making compensation awards.^[130] I find that the Plaintiffs have not provided particularized factual allegations that raise a reasonable doubt whether the process by which Goldman's compensation scheme allocated profits between the employees and shareholders was implemented in good faith and on an informed basis.

1. Good Faith

"[A] failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence)."^[131] Examples of this include situations where the fiduciary intentionally breaks the law, "where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation," or "where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties."^[132] While this is not an exclusive list, "these three are the most salient."^[133]

The third category above falls between "conduct motivated by subjective bad intent," and "conduct resulting from gross negligence."^[134] "Conscious disregard" involves an "intentional dereliction of duty" which is "more culpable than simple inattention or failure to be informed of all facts material to the decision."^[135]

The Plaintiffs' main contention is that Goldman's compensation scheme itself was approved in bad faith. The Plaintiffs allege that "[n]o person acting in good faith on behalf of Goldman consistently could approve the payment of between 44% and 48% of net revenues to Goldman's employees year in and year out"^[136] and that accordingly the Director Defendants abdicated their duties by engaging in these "practices that overcompensate management."^[137] The complaint is entirely silent with respect to any individual salary or bonus; the Plaintiffs' allegation is that the scheme so misaligns incentives that it cannot have been the product of a good faith board decision.

The Plaintiffs' problems with the compensation plan structure can be summarized as follows: Goldman's compensation plan is a positive feedback loop where employees reap the benefits but the stockholders bear the losses. Goldman's plan incentivizes employees to leverage Goldman's assets and engage in risky behavior in order to maximize yearly net revenue and their yearly bonuses. At the end of the year, the remaining revenue that is not paid as compensation, with the exception of small dividend payments to stockholders, is funneled back into the company. This increases the quantity of assets Goldman employees have available to leverage and invest. Goldman employees then start the process over with a greater asset base, increase net revenue again, receive even larger paychecks the next year, and the cycle continues. At the same time, stockholders are only receiving a small percentage of net revenue as dividends; therefore, the majority of the stockholders' assets are simply being cycled back into Goldman for the Goldman employees to use.

The stockholders' and Goldman employees' interests diverge most notably, argue the Plaintiffs, when there is a drop in revenue. If net revenues fall, the stockholders lose their equity, but the Goldman employees do not share this loss.^[138]

The decision as to how much compensation is appropriate to retain and incentivize employees, both individually and in the aggregate, is a core function of a board of directors exercising its business judgment. The Plaintiffs' pleadings fall short of creating a reasonable doubt that the Directors Defendants have failed to exercise that judgment here. The Plaintiffs acknowledge that the compensation plan authorized by Goldman's board, which links compensation to revenue produced, was intended to align employee interests with those of the stockholders and incentivize the production of wealth. To an extent, it does so: extra effort by employees to raise corporate revenue, if successful, is rewarded. The Plaintiffs' allegations mainly propose that the compensation scheme implemented by the board does not perfectly align these interests; and that, in fact, it may encourage employee behavior incongruent with the stockholders' interest. This may be correct, but it is irrelevant. The fact that the Plaintiffs may desire a different compensation scheme does not indicate that equitable relief is warranted. Such changes may be accomplished through directorial elections, but not, absent a showing unmet here, through this Court.

Allocating compensation as a percentage of net revenues does not make it virtually inevitable that management will work against the interests of the stockholders. Here, management was only taking a percentage of the net revenues. The remainder of the net revenues was funneled back into the company in order to create future revenues; therefore, management and stockholder interests were aligned. Management would increase its compensation by increasing revenues, and stockholders would own a part of a company which has more assets available to create future wealth.

The Plaintiffs' focus on percentages ignores the reality that over the past 10 years, in absolute terms, Goldman's net revenue and dividends have substantially increased.^[139] Management's compensation is based on net revenues. Management's ability to generate that revenue is a function of the total asset base, which means management has an interest in maintaining that base (owned, of course, by the Plaintiffs and fellow shareholders) in order to create future revenues upon which its future earnings rely.

The Plaintiffs argue that there was an intentional dereliction of duty or a conscious disregard by the Director Defendants in setting compensation levels; however, the Plaintiffs fail to plead with particularity that any of the Director Defendants had the scienter necessary to give rise to a violation of the duty of loyalty.^[140] The Plaintiffs do not allege that the board failed to employ a metric to set compensation levels; rather, they merely argue that a different metric, such as comparing Goldman's compensation to that of hedge fund managers rather than to compensation at other investment banks, would have yielded a better result.^[141] But this observance does not make the board's decision self-evidently wrong, and it does not raise a reasonable doubt that the board approved Goldman's compensation structure in good faith.

2. Adequately Informed

The Plaintiffs also contend that the board was uninformed in making its compensation decision. "Pre-suit demand will be excused in a derivative suit only if the . . . particularized facts in the complaint create a reasonable doubt that the informational component of the directors' decisionmaking process, measured by concepts of gross negligence, included consideration of all material information reasonably available."^[142] Here, Goldman's charter has a 8 Del. C. § 102(b)(7) provision, so gross negligence, by itself, is insufficient basis upon which to impose liability. The Plaintiffs must allege particularized facts creating a reasonable doubt that the directors acted in good faith.

The Plaintiffs allege that the Director Defendants fell short of this reasonableness standard in several ways. They point out that the Director Defendants never "analyzed or assessed the extent to which management performance, as opposed to the ever-growing shareholder equity and assets available for investment, has contributed to the generation of net revenues."^[143] The Plaintiffs also argue that because the amount of stockholder equity and assets available for investment was responsible for the total revenue generated, the Director Defendants should have used other metrics, such as compensation levels at shareholder funds and hedge funds, to decide compensation levels at Goldman.^[144] The Plaintiffs allege that Goldman's performance, on a risk adjusted basis, lagged behind hedge fund competitors, yet the percentage of net revenue awarded did not substantially vary, and that the Director Defendants never adequately adjusted compensation in anticipation of resolving future claims.^[145]

Nonetheless, the Plaintiffs acknowledge that Goldman has a compensation committee that reviews and approves the annual compensation of Goldman's executives.^[146] The Plaintiffs also acknowledge that Goldman has adopted a "pay for performance" philosophy, that Goldman represents as a way to align employee and shareholder interests.^[147] The Plaintiffs further acknowledge that Goldman's compensation committee receives information from Goldman's management concerning Goldman's net revenues and the ratio of compensation and benefits expenses to net revenues.^[148] Finally, the Plaintiffs note that the compensation committee reviewed information relating to the compensation ratio of Goldman's "core competitors that are investment banks (Bear Stearns, Lehman Brothers, Merrill Lynch, and Morgan Stanley)."^[149]

Rather than suggesting that the Director Defendants acted on an uninformed basis, the Plaintiffs' pleadings indicate that the board adequately informed itself before making a decision on compensation. The Director Defendants considered other investment bank comparables, varied the total percent and the total dollar amount awarded as compensation, and changed the total amount of compensation in response to changing public opinion.^[150] None of the Plaintiffs' allegations suggests gross negligence on the part of the Director Defendants, and the conduct described in the Plaintiffs' allegations certainly does not rise to the level of bad faith such that the Director Defendants would lose the protection of an 8 Del. C. § 102(b)(7) exculpatory provision.

At most, the Plaintiffs' allegations suggest that there were other metrics not considered by the board that might have produced better results. The business judgment rule, however, only requires the board to reasonably inform itself; it does not require perfection or the consideration of every conceivable alternative.^[151] The factual allegations pled by the Plaintiffs, therefore, do not raise a reasonable doubt that the board was informed when it approved Goldman's compensation scheme.

3. Waste

The Plaintiffs also contend that Goldman's compensation levels were unconscionable and constituted waste. To sustain their claim that demand would be futile, the Plaintiffs must raise a reasonable doubt that Goldman's compensation levels were the product of a valid business judgment. Specifically, to excuse demand on a waste claim, the Plaintiffs must plead particularized allegations that "overcome the general presumption of good faith by showing that the board's decision was so egregious or irrational that it could not have been based on a valid assessment of the corporation's best interests."^[152]

"[W]aste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade."^[153] Accordingly, if "there is any substantial consideration received by the corporation, and if there is a good faith judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste."^[154] The reason being, "[c]ourts are ill-fitted to attempt to weigh the `adequacy' of consideration under the waste standard or, ex post, to judge appropriate degrees of business risk."^[155] Because of this, "[i]t is the essence of business judgment for a board to determine if a particular individual warrant[s] large amounts of money."^[156]

The Plaintiffs' waste allegations revolve around three premises: that Goldman's pay per employee is significantly higher than its peers, that Goldman's compensation ratios should be compared to hedge funds and other shareholder funds to reflect Goldman's increasing reliance on proprietary trading as opposed to traditional investment banking services, and that Goldman's earnings and related compensation are only the result of risk taking.

The Plaintiffs consciously do not identify a particular individual or person who received excessive compensation, but instead focus on the average compensation received by each of Goldman's 31,000 employees.^[157] The Plaintiffs allege that "Goldman consistently allocated and distributed anywhere from two to six times the amounts that its peers distributed to each employee,"^[158] and the Plaintiffs provide comparisons of Goldman's average pay per employee to firms such as Morgan Stanley, Bear Stearns, Merrill Lynch, Citigroup, and Bank of America.^[159] The Plaintiffs note that these firms are investment banks, but do not provide any indication of why these firms are comparable to Goldman or their respective primary areas of business. The Plaintiffs do not compare trading segment to trading segment or any other similar metric. A broad assertion that Goldman's board devoted more resources to compensation than did other firms, standing alone, is not a particularized factual allegation creating a reasonable doubt that Goldman's compensation levels were the product of a valid business judgment.

The Plaintiffs urge that, in light of Goldman's increasing reliance on proprietary trading, Goldman's employees' compensation should be compared against a hedge fund or other shareholder fund.^[160] The Plaintiffs allege that Goldman's compensation scheme is equal to 2% of net assets and 45% of the net income produced, but a typical hedge fund is only awarded 2% of net assets and 20% of the net income produced.^[161] The Plaintiffs paradoxically assert that "no hedge fund manager may command compensation for managing assets at the annual rate of 2% of net assets and 45% of net revenues," but then immediately acknowledge that in fact there are hedge funds that have such compensation schemes.^[162] It is apparent to me from the allegations of the complaint that while the majority of hedge funds may use a "2 and 20" compensation scheme, this is not the exclusive method used too set such compensation. Even if I were to conclude that a hedge fund or shareholder fund would be an appropriate yardstick with which to measure Goldman's compensation package and "even though the amounts paid to defendants exceeded the industry average," I fail to see a "shocking disparity" between the percentages that would render them "legally excessive."^[163]

In the end, while the Goldman employees may not have been doing, in the words of the complaint and Defendant Blankfein, "God's Work,"^[164] the complaint fails to present facts that demonstrate that the work done by Goldman's 31,000 employees was of such limited value to the corporation that no reasonable person in the directors' position would have approved their levels of compensation.^[165] Absent such facts, these decisions are the province of the board of directors rather than the courts.^[166] Without examining the payment to a specific individual, or group of individuals, and what was specifically done in exchange for that payment, I am unable to determine whether a transaction is "so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration."^[167]

The closest the Plaintiffs come to pleading waste with any factual particularity is in regards to the payment to the Trading and Principal Investment segment in 2008. The Plaintiffs allege that in 2008 "the Trading and Principal Investments segment produced $9.06 billion in net revenue, but, as a result of discretionary bonuses paid to employees, lost more than $2.7 billion for the [stockholders]."^[168] The Plaintiffs' allegations, however, are insufficient to raise a reasonable doubt that Goldman's compensation levels in this segment were the product of a valid business judgment. As a strictly pedagogic exercise, imagine a situation where one half of the traders lost money, and the other half made the same amount of money, so that the firm broke even. Even if no bonus was awarded to the half that lost money, a rational manager would still want to award a bonus to the half that did make money in order to keep that talent from leaving. Since net trading gains were $0, these bonuses would cause a net loss, but there would not be a waste of corporate assets because there was adequate consideration for the bonuses. Without specific allegations of unconscionable transactions and details regarding who was paid and for what reasons they were paid, the Plaintiffs fail to adequately plead demand futility on the basis of waste.

Finally, the Plaintiffs herald the fact that during the sub-prime crisis the Director Defendants continued to allocate similar percentages of net revenue as compensation while the firm was engaged in risky transactions; however, "there should be no finding of waste, even if the fact finder would conclude ex post that the transaction was unreasonably risky. Any other rule would deter corporate boards from the optimal rational acceptance of risk."^[169] Because this complaint lacks a particular pleading that an individual or group of individuals was engaged in transactions so unconscionable that no rational director could have compensated them, the Plaintiffs have failed to raise a reasonable doubt that the compensation decisions were not the product of a valid business judgment.

D. The Plaintiffs' Caremark Claim

In addition to the claims addressed above, the Plaintiffs assert that the board breached its duty to monitor the company as required under Caremark.^[170] Because this claim attacks a failure to act, rather than a specific transaction, the Rales standard applies.^[171] The Rales standard addresses whether the "board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations."^[172] To properly plead demand futility under Rales, a plaintiff must allege particularized facts which create a reasonable doubt that "the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand."^[173]

"Under Rales, defendant directors who face a substantial likelihood of personal liability are deemed interested in the transaction and thus cannot make an impartial decision."^[174] A simple allegation of potential directorial liability is insufficient to excuse demand, else the demand requirement itself would be rendered toothless, and directorial control over corporate litigation would be lost. The likelihood of directors' liability is significantly lessened where, as here, the corporate charter exculpates the directors from liability to the extent authorized by 8 Del. C. § 102(b)(7).^[175] Because Goldman's charter contains such a provision, shielding directors from liability for breaches of the duty of care (absent bad faith) "a serious threat of liability may only be found to exist if the plaintiff pleads a non-exculpated claim against the directors based on particularized facts."^[176] This means that "plaintiffs must plead particularized facts showing bad faith in order to establish a substantial likelihood of personal directorial liability."^[177]

The Plaintiffs' contentions that the Director Defendants face a substantial likelihood of personal liability are based on oversight liability, as articulated by then-Chancellor Allen in Caremark. In Caremark, Chancellor Allen held that a company's board of directors could not "satisfy [its] obligation to be reasonably informed . . . without assuring [itself] that information and reporting systems exist[ed] in the organization."^[178] These systems are needed to provide the board with accurate information so that the board may reach "informed judgments concerning both the corporation's compliance with law and its business performance."^[179] A breach of oversight responsabilities is a breach of the duty of loyalty, and thus not exculpated under section 102(b)(7).

To face a substantial likelihood of oversight liability for a Caremark claim, the Director Defendants must have "(a) . . . utterly failed to implement any reporting or information system or controls" (which the Plaintiffs concede is not the case here); "or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention."^[180] Furthermore, "where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation . . . only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system [exists] —will establish the lack of good faith that is a necessary condition to liability."^[181]

The Plaintiffs specifically contend that the Director Defendants created a compensation structure that caused management's interests to diverge from the stockholders' interests. As a result, management took risks which eventually led to unethical behavior and illegal conduct that exposed Goldman to financial liability. According to the Plaintiffs, after the Director Defendants created Goldman's compensation structure, they had a duty to ensure protection from abuses by management, which were allegedly made more likely due to the form of that structure. Instead of overseeing management, however, the Director Defendants abdicated their oversight responsibilities.^[182]

Unlike the original and most subsequent Caremark claims, where plaintiffs alleged that liability was predicated on a failure to oversee corporate conduct leading to violations of law,^[183] the Plaintiffs here argue that the Director Defendants are also liable for oversight failure relating to Goldman's business performance.^[184] Because the oversight of legal compliance and the oversight of business risk raise distinct concerns, I shall examine those issues separately.

1. Unlawful Conduct

As described above, the Plaintiffs must plead particularized facts suggesting that the board failed to implement a monitoring and reporting system or consciously disregarded the information provided by that system.^[185] Here, the Plaintiffs assert that the Goldman employees engaged in unethical trading practices in search of short term revenues.^[186] Although the Plaintiffs' allegations fall short of the florid contentions about the corporation made elsewhere,^[187] the Plaintiffs provide examples, based on the Permanent Subcommittee report, of conduct they believe was unethical and harmful to the company.^[188] The Plaintiffs argue that the Director Defendants should have been aware of purportedly unethical conduct such as securitizing high risk mortgages, shorting the mortgage market, using naked credit default swaps, and "magnifying risk" through the creation of synthetic CDOs.^[189] The Plaintiffs also allege that Goldman's trading business often put Goldman in potential conflicts of interest with its own clients and that the Director Defendants were aware of this and have embraced this goal.

Illegal corporate conduct is not loyal corporate conduct. "[A] fiduciary of a Delaware corporation cannot be loyal to a Delaware corporation by knowingly causing it to seek profit by violating the law."^[190] The "unethical" conduct the Plaintiffs allege here, however, is not the type of wrongdoing envisioned by Caremark. The conduct at issue here involves, for the most part, legal business decisions that were firmly within management's judgment to pursue. There is nothing intrinsic in using naked credit default swaps or shorting the mortgage market that makes these actions illegal or wrongful. These are actions that Goldman managers, presumably using their informed business judgment, made to hedge the Corporation's assets against risk or to earn a higher return. Legal, if risky, actions that are within management's discretion to pursue are not "red flags" that would put a board on notice of unlawful conduct.

Similarly, securitizing and selling high risk mortgages is not illegal or wrongful per se. The Plaintiffs take issue with actions where Goldman continued to sell mortgage related products to its clients while profiting from the decline of the mortgage market. In particular, the Plaintiffs point to three transactions where Goldman took the short side of synthetic CDOs while simultaneously being long on the underlying reference assets, or sold a long position while being, itself, short.

The three transactions referenced by the Plaintiffs as "disloyal and unethical trading practices" are not sufficient pleadings of wrongdoing or illegality necessary to establish a Caremark claim—the only inferences that can be made are that Goldman had risky assets and that Goldman made a business decision, involving risk, to sell or hedge these assets. The Hudson Mezzanine 2006-1 and Anderson Mezzanine Funding 2007-1 were synthetic CDOs that referenced RMBS securities.^[191] Timberwolf I was a "hybrid cash/synthetic CDO squared" where "a significant portion of the referenced assets were CDO securities."^[192] Goldman structured all three securities and took short positions because it was trying to reduce its mortgage holdings.^[193] All three securities eventually were downgraded, and the investors who had taken long positions lost money.^[194] The fact that another party would make money from such a decline was obvious to those investors—inherent in the structure of a synthetic CDO is that another party is taking a short position. The Plaintiffs' allegations can be boiled down to the fact that these three securities lost money when Goldman may have had a conflict of interest. Though these transactions involved risk, including a risk of damaging the company's reputation, these are not "red flags" that would give rise to an actionable Caremark claim—reputational risk exists in any business decision.

To act in bad faith, there must be scienter on the part of the defendant director.^[195] The Plaintiffs argue that, as Goldman increased its proprietary trading, the Director Defendants were aware of the possible conflicts of interest and that the conflicts had to be addressed.^[196] The three transactions referenced by the Plaintiffs do not indicate that the Director Defendants "acted inconsistent[ly] with [their] fiduciary duties [or], most importantly, that the director[s] knew [they were] so acting."^[197] A conflict of interest may involve wrongdoing, but is not wrongdoing itself. An active management of conflicts of interest is not an abdication of oversight duties, and an inference cannot be made that the Director Defendants were acting in bad faith.

The Plaintiffs also posit the theory that the credit rating agencies were beholden to Goldman and that Goldman unduly influenced them to give higher credit ratings to certain products. These allegations are purely conclusory. The complaint is silent as to any mechanism (other than that inherent in the relationship of a credit agency to a large financial player) by which Goldman coerced or colluded with the ratings agencies or (more to the point in a Caremark context) that the Director Defendants disregarded any such actions in bad faith.

The heart of the Plaintiffs' Caremark claim is in the allegation that Goldman's "trading practices have subjected the Firm to civil liability, via, inter alia, an SEC investigation and lawsuit."^[198] Once the legal, permissible business decisions are removed, what the Plaintiffs are left with is a single transaction that Goldman settled with the SEC.

In 2007 Goldman designed a CDO, Abacus 2007-AC1, with input from the hedge fund founder John Paulson.^[199] The Plaintiffs allege that Paulson helped select a set of mortgages that would collateralize the CDO and then took a short position, betting that the same mortgages would fall in value.^[200] The Plaintiffs point out that meanwhile Goldman was selling long positions in the CDO without disclosing Paulson's role in selecting the underlying collateral or Paulson's short position.^[201] The Plaintiffs allege that "Goldman's clients who took long positions in Abacus 2007-AC1 lost their entire $1 billion investment."^[202] As a result, on April 16, 2010 the SEC charged Goldman and a Goldman Vice President with fraud for their roles in creating and marketing Abacus 2007-AC1.^[203] On July 14, 2010, Goldman settled the case with the SEC.^[204] As part of the settlement, Goldman agreed to disgorge its profits on the Abacus transaction, pay a large civil penalty, and evaluate various compliance programs.^[205]

The Abacus transaction, with its disclosure problems, is unique. The complaint does not plead with factual particularity that the other highlighted transactions contain disclosure omissions similar to Abacus, and the Abacus transaction on its own cannot demonstrate the willful ignorance of "red flags" on the part of the Defendants that might lead to a reasonable apprehension of liability.^[206] Though the Plaintiffs allege that the "Abacus deals are likely just the tip of the iceberg," conclusory statements are not particularized pleadings.^[207] The single Abacus transaction without more is insufficient to provide a reasonable inference of bad faith on the part of the Director Defendants.

2. Business Risk

Part of the Plaintiffs' Caremark claim stems from the Director Defendants' oversight of Goldman's business practices. As a preliminary matter, this Court has not definitively stated whether a board's Caremark duties include a duty to monitor business risk. In Citigroup, then-Chancellor Chandler posited that "it may be possible for a plaintiff to meet the burden under some set of facts."^[208] Indeed, the Caremark court seemed to suggest the possibility of such a claim:

[I]t would . . . be a mistake to conclude that . . . corporate boards may satisfy their obligation to be reasonably informed concerning the corporation without assuring themselves that information and reporting systems exist in the organization that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation's compliance with law and its business performance.^[209]

As was the case in Citigroup, however, the facts pled here do not give rise to a claim under Caremark, and thus I do not need to reach the issue of whether the duty of oversight includes the duty to monitor business risk.

As the Court observed in Citigroup, "imposing Caremark-type duties on directors to monitor business risk is fundamentally different" from imposing on directors a duty to monitor fraud and illegal activity.^[210] Risk is "the chance that a return on an investment will be different than expected."^[211] Consistent with this, "a company or investor that is willing to take on more risk can earn a higher return."^[212] The manner in which a company "evaluate[s] the trade-off between risk and return" is "[t]he essence of . . . business judgment."^[213] The Plaintiffs here allege that Goldman was over-leveraged, engaged in risky business practices, and did not set enough money aside for future losses.^[214] As a result, the Plaintiffs assert, Goldman was undercapitalized, forcing it to become a bank holding company and to take on an onerous loan from Warren Buffet.^[215]

Although the Plaintiffs have molded their claims with an eye to the language of Caremark, the essence of their complaint is that I should hold the Director Defendants "personally liable for making (or allowing to be made) business decisions that, in hindsight, turned out poorly for the Company."^[216] If an actionable duty to monitor business risk exists, it cannot encompass any substantive evaluation by a court of a board's determination of the appropriate amount of risk. Such decisions plainly involve business judgment.^[217]

The Plaintiffs' remaining allegations in essence seek to hold the Director Defendants "personally liable to the Company because they failed to fully recognize the risk posed by subprime securities."^[218] The Plaintiffs charge that the entire board was aware of, or should have been aware of, "the details of the trading business of Goldman and failed to take appropriate action."^[219] The Plaintiffs note that "[a]s the housing market began to fracture in early 2007, a committee of senior Goldman executives . . . including Defendants Viniar, Cohn, and Blankfein and those helping to manage Goldman's mortgage, credit and legal operations, took an active role in overseeing the mortgage unit."^[220] "[This] committee's job was to vet potential new products and transactions, being wary of deals that exposed Goldman to too much risk."^[221] This committee eventually decided that housing prices would decline and decided to take a short position in the mortgage market.^[222] The Plaintiffs contend that the Director Defendants were "fully aware of the extent of Goldman's RMBS and CDO securities market activities."^[223] The Plaintiffs point out that the Director Defendants were informed about the business decisions Goldman made during the year including an "intensive effort to not only reduce its mortgage risk exposure, but profit from high risk RMBS and CDO Securities incurring losses."^[224] The Plaintiffs further allege that because of this the Director Defendants "understood that these efforts involved very large amounts of Goldman's capital that exceeded the Company's Value-at-Risk measures."^[225] Finally, the Plaintiffs allege that the practices allowed by the board, including transactions in which Goldman's risk was hedged, imposed reputational risk upon the corporation.^[226]

Thus, the Plaintiffs do not plead with particularity anything that suggests that the Director Defendants acted in bad faith or otherwise consciously disregarded their oversight responsibilities in regards to Goldman's business risk. Goldman had an Audit Committee in place that was "charged with assisting the Board in its oversight of the Company's management of market, credit liquidity and other financial and operational risks."^[227] The Director Defendants exercised their business judgment in choosing and implementing a risk management system that they presumably believed would keep them reasonably informed of the company's business risks. As described in detail above, the Plaintiffs admit that the Director Defendants were "fully aware of the extent of Goldman's RMBS and CDO securities market activities."^[228]

"Oversight duties under Delaware law are not designed to subject directors, even expert directors, to personal liability for failure to predict the future and to properly evaluate business risk."^[229] No reasonable inference can be made from the pleadings that the Director Defendants consciously disregarded their duty to be informed about business risk (assuming such a duty exists). On the contrary, the pleadings suggest that the Director Defendants kept themselves reasonably informed and fulfilled their duty of oversight in good faith.^[230] Good faith, not a good result, is what is required of the board.

Goldman's board and management made decisions to hedge exposure during the deterioration of the housing market, decisions that have been roundly criticized in Congress and elsewhere. Those decisions involved taking objectively large risks, including particularly reputational risks. The outcome of that risk-taking may prove ultimately costly to the corporation. The Plaintiffs, however, have failed to plead with particularity that the Director Defendants consciously and in bad faith disregarded these risks; to the contrary, the facts pled indicate that the board kept itself informed of the risks involved. The Plaintiffs have failed to plead facts showing a substantial likelihood of liability on the part of the Director Defendants under Caremark.

IV. CONCLUSION

The Delaware General Corporation law affords directors and officers broad discretion to exercise their business judgment in the fulfillment of their obligations to the corporation. Consequently, Delaware's case law imposes fiduciary duties on directors and officers to ensure their loyalty and care toward the corporation. When an individual breaches these duties, it is the proper function of this Court to step in and enforce those fiduciary obligations.

Here, the Plaintiffs allege that the Director Defendants violated fiduciary duties in setting compensation levels and failing to oversee the risks created thereby. The facts pled in support of these allegations, however, if true, support only a conclusion that the directors made poor business decisions. Through the business judgment rule, Delaware law encourages corporate fiduciaries to attempt to increase stockholder wealth by engaging in those risks that, in their business judgment, are in the best interest of the corporation "without the debilitating fear that they will be held personally liable if the company experiences losses."^[231] The Plaintiffs have failed to allege facts sufficient to demonstrate that the directors were unable to properly exercise this judgment in deciding whether to bring these claims. Since the Plaintiffs have failed to make a demand upon the Corporation, this matter must be dismissed; therefore, I need not reach the Defendant's motion to dismiss under Rule 12 (b)(6).

For the foregoing reasons, the Defendants' motion to dismiss is granted, and the Plaintiffs' claims are dismissed with prejudice.

An Order has been entered consistent with this Opinion.

[1] See Section II for a discussion of the applicable standard in a motion to dismiss.

[2] Compl. ¶ 37.

[3] Compl. ¶ 42. "Proprietary Trading" refers to a firm's trades for its own benefit with its own money.

[4] Compl. ¶ 36.

[5] Compl. ¶ 36.

[6] Id.

[7] Compl. ¶ 109.

[8] Id.

[9] Compl. ¶ 49; see also Compl. ¶ 109.

[10] Compl. ¶ 92.

[11] Compl. ¶ 87.

[12] Compl. ¶ 89.

[13] Id.

[14] Id.

[15] Compl. ¶¶ 89-90.

[16] Compl. ¶ 91.

[17] Compl. ¶¶ 90-91. Goldman's total net revenue was $46 billion in 2007, $22.2 billion in 2008, and $45.2 billion in 2009. Compl. ¶ 115. Goldman paid its employees total compensation of $20.2 billion in 2007, $10.9 billion in 2008, and $16.2 billion in 2009. Compl. ¶ 116. As a percentage of total net revenue, the total compensation paid by Goldman was 44% in 2007, 48% in 2008, and 36% in 2009. Compl. ¶ 115. The total compensation initially approved in 2007, by the Compensation Committee, was $16.7 billion or 47% of total revenue; however, this amount was changed after public outcry. Compl. ¶ 113.

[18] Compl. ¶ 115.

[19] Compl. ¶¶ 109-24.

[20] See Compl. ¶¶ 108, 124.

[21] Compl. ¶ 95.

[22] Compl. ¶¶ 37, 44. The segment generated 76% of Goldman's revenues in 2009, and as of December 2009, the segment also utilized 78% of the firm's assets. Compl. ¶ 43.

[23] Compl. ¶¶ 95, 136.

[24] Compl. ¶ 92.

[25] Compl. ¶ 95.

[26] Compl. ¶¶ 132-33.

[27] Compl. ¶ 78.

[28] Id.

[29] Id.

[30] Compl. ¶¶ 51-52.

[31] Compl. ¶ 52.

[32] Compl. ¶ 78.

[33] Compl. ¶ 54.

[34] Compl. ¶ 59.

[35] Id.

[36] Compl. ¶ 60.

[37] Compl. ¶ 61.

[38] Compl. ¶¶ 64, 77, 84.

[39] Compl. ¶ 65. A CDO is a type of asset-backed security backed by a pool of bonds, loans, or other assets. The underlying assets' cash flow is used to make interest and principal payments to the holders of the CDO securities. CDO securities are issued in different classes, or tranches, that vary by their level of risk and maturity date. The senior tranches are paid first, while the junior tranches have higher interest rates or lower prices to compensate for the higher risk of default.

[40] Id.

[41] Id.

[42] Compl. ¶ 72.

[43] Compl. ¶ 73.

[44] Id.

[45] Compl. ¶¶ 75, 147.

[46] Synthetic CDOs are CDOs structured out of credit default swaps. A credit default swap (CDS) can essentially be thought of as an insurance policy on an asset such as a CDO or CDO tranche. The purchaser of the CDS pays a fixed amount at certain intervals to the seller of the CDS. If the CDO maintains its value, the seller of the CDS retains the money paid by the purchaser of the CDS; however, if the CDO falls in value, the seller of the CDS must pay the purchaser of the CDS for losses. Synthetic CDOs package CDSs together and use the cash flows from the CDSs to pay the purchasers of the CDO.

[47] Compl. ¶ 75.

[48] Id.

[49] Compl. ¶ 76.

[50] Compl. ¶¶ 175-77.

[51] Compl. ¶ 186.

[52] Compl. ¶ 142.

[53] Cent. Mortgage Capital Holdings v. Morgan Stanley, 2011 WL 3612992, at *5 (Del. Aug. 18, 2011). That is, the pleading standard at the motion to dismiss stage in Delaware is "conceivability" as opposed to the higher "plausibility" standard that applies to federal civil actions. Id. (citing Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 556 (2007); Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009)). The difference, according to our Supreme Court, is that "[o]ur governing `conceivability' standard is more akin to `possibility,' while the federal `plausibility' standard falls somewhere beyond mere `possibility' but short of `probability.'" Central Mortgage, 2011 WL 3612992, at *5 n.13.

[54] Id. at *5.

[55] Id.

[56] Id.

[57] McPadden v. Sidhu, 964 A.2d 1262, 1269 (Del. Ch. 2008).

[58] Id.

[59] In re J.P. Morgan Chase & Co. S'holder Litig., 906 A.2d 808, 820 (Del. Ch. 2005) (quoting Jacobs v. Yang, 2004 WL 1728521, at *2 (Del. Ch. Aug. 2, 2004), aff'd, 867 A.2d 902 (Del. 2005)).

[60] In re Citigroup Inc. S'holder Derivative Litig., 964 A.2d 106, 120 (Del. Ch. 2009).

[61] Ch. Ct. R. 23.1(a).

[62] Citigroup, 964 A.2d at 120-21 (internal quotations omitted); McPadden, 964 A.2d at 1269.

[63] Beam v. Stewart, 845 A.2d 1040, 1048 (Del. 2004).

[64] Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984).

[65] Citigroup, 964 A.2d at 120.

[66] 634 A.2d 927 (Del. 1993).

[67] Id. at 934.

[68] Compl. ¶ 153.

[69] Compl. ¶¶ 169-79.

[70] Compl. ¶ 152.

[71] Beneville v. York, 769 A.2d 80, 82 (Del. Ch. 2000).

[72] Beam, 845 A.2d at 1049; Aronson, 473 A.2d at 812 (To be considered disinterested, "directors can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing, as opposed to a benefit which devolves upon the corporation or all stockholders generally.").

[73] Aronson, 473 A.2d at 816.

[74] Compl. ¶¶ 17-26.

[75] See In re The Limited, Inc. S'holders Litig., 2002 WL 537692, at *7 (Del Ch. Mar. 27, 2002) ("[W]here the challenged actions are those of a board consisting of an even number of directors, plaintiffs meet their burden of demonstrating the futility of making demand on the board by showing that half of the board was either interested or not independent.").

[76] As an initial matter, the Plaintiffs fail to plead particularized facts that adequately create a reasonable doubt in regard to the Goldman Foundation's independence from Goldman. The Plaintiffs state that the Goldman Foundation's president is a managing director of Goldman and that, of the Goldman Foundation's eight board members, four "are or were managing directors of the Company." Compl. ¶ 155 (emphasis added). From the phrase "are or were," I can infer that at least one of the four board members affiliated with Goldman is no longer a managing director of Goldman; therefore, the Goldman Foundation's board had at least four members unaffiliated with Goldman and at least one member who was no longer affiliated with Goldman. Presumably these directors are independent and bound by the duties of loyalty and care to the Goldman Foundation. The Plaintiffs offer only conclusory statements that Goldman's management controls the Goldman Foundation. Without more, I have no basis to make an inference that Goldman's management dominated or controlled the Goldman Foundation. Regardless, even if the Plaintiffs had made an adequate showing that the Goldman Foundation was controlled by Goldman's management, the Plaintiffs do not plead particularized facts that create a reasonable doubt that the Defendants were interested or lacked independence based on the contributions from the Goldman Foundation, as described below.

[77] Compl. ¶ 17.

[78] Id.

[79] Compl. ¶ 157.

[80] The Plaintiffs do not state the amount that Goldman donated, only that it was "substantial." Id.

[81] Id.

[82] Compl. ¶ 163.

[83] S. Muoio & Co. LLC v. Hallmark Entm't Inv. Co., 2011 WL 863007 (Del. Ch. Mar. 09, 2011).

[84] Hallmark, 2011 WL 863007, at *10.

[85] J.P. Morgan, 906 A.2d at 808.

[86] Id. at 814-15.

[87] Id.

[88] Id.

[89] The Plaintiffs state that "[t]he Foundation's contributions to their fund raising responsibilities were material" because "[t]he SEC views a contribution for each director to be material if it equals or exceeds $10,000 per year." Compl. ¶ 163. The Plaintiffs argument is misguided. The Plaintiffs base this argument on 17 C.F.R. § 229.402(k)(2)(vii), which addresses director disclosure of perquisites and other benefits. As a threshold matter, 17 C.F.R. § 229.402(k)(2)(vii) is not Delaware law, does not define "materiality," and does not say that amounts over $10,000 are material. 17 C.F.R. § 229.402(k)(2)(vii) merely provides instruction for disclosure of perquisites and other benefits over $10,000. In any event, the Plaintiffs fail to provide any facts showing that the amounts would be material to any of the charitable organizations or the directors.

[90] Compl. ¶ 21.

[91] Id.

[92] Compl. ¶ 159.

[93] Id.

[94] Id.

[95] Id.

[96] Id.

[97] Compl. ¶ 22.

[98] Johnson is listed as both an Audit Committee Defendant and a Compensation Committee Defendant. Compl. ¶¶ 32-33. The Plaintiffs state in Compl. ¶ 22., which discusses Johnson's role at Goldman, that "Defendant Dahlback has served as a member of both the Audit Committee and the Compensation Committee during the relevant period." I assume that the Plaintiffs made a typographical error and meant to refer to Johnson rather than Dahlback.

[99] Compl. ¶ 158.

[100] Id.

[101] Compl. ¶ 23.

[102] Id.

[103] Compl. ¶ 161; see Compl. ¶ 156.

[104] Compl. ¶ 161.

[105] Compl. ¶ 26.

[106] Id.

[107] Compl. ¶ 162.

[108] Id.

[109] Though the Plaintiffs do not make an explicit statement in the complaint, I make a reasonable inference that Simmons role, as an employee of the University, is different from the roles of other defendants who sit on charitable boards.

[110] Compl. ¶ 19.

[111] Id.

[112] Compl. ¶ 160.

[113] Id.

[114] Id. (emphasis added). The use of the word "has" does not necessarily suggest that Goldman's investment currently is this amount, nor does it indicate that such funds were invested during the relevant period.

[115] Compl. ¶ 18.

[116] Id.

[117] Compl. ¶ 165. The complaint also alleges that Dahlback was an executive director of a second entity, "Thisbe AB." Id.

[118] Id.

[119] White v. Panic, 793 A.2d 356, 366 (Del. Ch. 2000).

[120] Compl. ¶ 24.

[121] Id.

[122] Compl. ¶ 166.

[123] Id.

[124] J.P. Morgan, 906 A.2d at 822.

[125] If anything, the Plaintiffs' allegations suggest that Goldman may be dependent on Mittal for future fees generated by underwriting his debt offerings.

[126] Aronson, 473 A.2d at 814; Brehm v. Eisner, 746 A.2d 244, 256 (Del. 2000).

[127] J.P. Morgan, 906 A.2d at 824 (quoting In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 286 (Del. Ch. 2003) (Disney II)).

[128] In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 755 (Del. Ch. 2005) (Disney III).

[129] Compl. ¶ 170.

[130] See Compl. ¶¶ 169-79.

[131] Stone v. Ritter, 911 A.2d 362, 369 (Del. 2006).

[132] In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 67 (Del. 2006) (Disney IV).

[133] Id.

[134] See Id. at 66.

[135] Id.

[136] Compl. ¶ 172.

[137] Compl. ¶ 176. Actually, the percentage of revenue devoted to compensation was 44%, 48%, and 36% for the years 2007, 2008, and 2009, respectively. Compl. ¶ 123.

[138] In actuality, of course, a drop in revenue does have a direct negative impact on employees, because their income is tied to revenue.

[139] Compl. ¶ 123.

[140] See Compl. ¶¶ 169-76.

[141] Compl. ¶ 89.

[142] Brehm, 746 A.2d at 259.

[143] Compl. ¶ 171.

[144] Id.

[145] Compl. ¶¶ 7, 131; see also Compl. ¶¶ 104-06.

[146] Compl. ¶ 89.

[147] Compl. ¶¶ 85-88

[148] Compl. ¶ 89.

[149] Id.

[150] Compl. ¶¶ 86, 89, 113, 115.

[151] See Brehm, 746 A.2d at 259 ("[T]he standard for judging the informational component of the directors' decisionmaking does not mean that the Board must be informed of every fact.").

[152] Citigroup, 964 A.2d at 136 (quoting White v. Panic, 783 A.2d 543, 554 n.36 (Del. 2001)).

[153] Lewis v. Vogelstein, 699 A.2d 327, 336 (Del. Ch. 1997).

[154] Id.

[155] Id.

[156] Brehm, 746 A.2d at 263 (internal quotations omitted).

[157] Compl. ¶¶ 119-20.

[158] Compl. ¶ 91.

[159] Compl. ¶ 119.

[160] Compl. ¶¶ 117-18.

[161] Compl. ¶ 117. The Defendants dispute the Plaintiffs allegations that Goldman's compensation scheme is equal to 2% of net assets under management and 45% of the net income produced. In the Defendants' reply brief, in further support of their motion to dismiss the second amended complaint, the Defendants state that if a 2 and 20 compensation scheme would have been used the total 2009 compensation awarded by Goldman would have been $19.7 billion, as opposed to the $16.2 billion actually awarded. Regardless, for the reasons I have noted above, I conclude that the Plaintiffs have not pled particularized facts necessary to carry their burden.

[162] Compl. ¶ 118.

[163] Saxe v. Brady, 184 A.2d 602, 610 (Del. Ch. 1962).

[164] Compl. ¶ 126.

[165] Brehm, 746 A.2d at 263.

[166] Id.

[167] Id. (quoting In re Walt Disney Co. Deriv. Litig., 731 A.2d 342, 362 (Del. Ch. 1998) (Disney I)).

[168] Compl. ¶ 92.

[169] Lewis, 699 A.2d at 336.

[170] In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996).

[171] In re Dow Chem. Co. Derivative Litig., 2010 WL 66769, at *12 (Del. Ch. Jan. 11, 2010).

[172] Rales, 634 A.2d at 934.

[173] Id.

[174] In re Dow Chem. Co. Derivative Litig., 2010 WL 66769, at *12 (internal quotations omitted; emphasis added); Guttman v. Huang, 823 A.2d 492, 501 (Del. Ch. 2003) ("[I]f the directors face a "substantial likelihood" of personal liability, their ability to consider a demand impartially is compromised under Rales, excusing demand.").

[175] Guttman, 823 A.2d at 501.

[176] Id.

[177] In re Dow Chem. Co. Derivative Litig., 2010 WL 66769, at *12; see also Citigroup, 964 A.2d at 124-25.

[178] Caremark, 698 A.2d at 970.

[179] Id.

[180] Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006).

[181] Caremark, 698 A.2d at 971; see also Stone, 911 A.2d at 370 ("Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.").

[182] The Plaintiffs argue that under the facts pled here, I should impose an oversight requirement higher than that required by the standard Caremark analysis. At oral argument the Plaintiffs asserted that Forsythe v. ESC Fund Mgmt. Co. (U.S.), Inc., 2007 WL 2982247 (Del. Ch. Oct. 9, 2007), calls for a heightened level of oversight by directors when management's incentives are not aligned with those of the shareholders. In Forsythe, the Court addressed whether a partnership's general partner violated its oversight duty to the partnership. The Forsythe Court decided that the language of the partnership agreement, rather than the common law, provided the proper standard of liability, but it also noted that a Caremark analysis would be not applicable because "Caremark rests importantly on the observation that corporate boards sit atop command-style management structures in which those to whom management duties are delegated generally owe their loyalty to the corporation," a structure unlike that in the Forsythe partnership. 2007 WL 2982247, at *7. Instead, Forsythe involved a "nominally independent general partner" that had "delegated nearly all of its managerial responsibilities to conflicted entities who acted through persons employed by and loyal to a third party." Id. The holding in Forsythe is, therefore, by its own terms not applicable to directors in a hierarchical corporation.

[183] See Stone, 911 A.2d 362 (failure to monitor violations of the Bank Secrecy Act); In re Am. Int'l Group, Inc., 965 A.2d 763 (Del Ch. 2009) (failure to monitor illegal and fraudulent transactions); David B. Shaev Profit Sharing Account v. Armstrong, 2006 WL 391931 (Del. Ch. Feb. 13, 2006) (failure to monitor fraudulent business practices); Caremark, 698 A.2d 959 (failure to monitor violations of the Anti-Referral Payments Law).

[184] Cf. Citigroup, 964 A.2d at 123 (dealing with a failure to monitor business risk).

[185] Stone, 911 A.2d at 370.

[186] Compl. ¶ 186.

[187] See Matt Taibbi, The Great American Bubble Machine, Rolling Stone Magazine, July 9-23, 2009, at 52 ("[Goldman] is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.").

[188] Compl. ¶¶ 147, 151.

[189] Compl. ¶ 151.

[190] In re Massey Energy, 2011 WL 2176479 at *20 (Del. Ch. May 31, 2011).

[191] Compl. ¶ 75.

[192] Id.

[193] Id.

[194] Id.

[195] See generally In re Massey Energy, 2011 WL 2176479, at *16.

[196] Compl. ¶ 52.

[197] In re Massey Energy, 2011 WL 2176479, at *22.

[198] Compl. ¶ 75.

[199] Compl. ¶ 65.

[200] Id.

[201] Id.

[202] Compl. ¶ 69.

[203] Compl. ¶ 72.

[204] Compl. ¶ 73.

[205] Id.

[206] See Stone, 911 A.2d at 373 (holding that in the absence of "red flags," courts assess bad faith of the board only in the context of actions to insure that a reasonable reporting system exists, and not by assessing adverse outcomes).

[207] Compl. ¶ 75.

[208] Citigroup, 964 A.2d at 126.

[209] Caremark, 698 A.2d at 970 (emphasis added).

[210] Citigroup, 964 A.2d at 131.

[211] Id. at 126.

[212] Id.

[213] Id.

[214] Compl. ¶ 131, see Compl. ¶¶ 93-141.

[215] Compl. ¶¶ 133-34.

[216] Id. at 124.

[217] While a valid claim against a board of directors in a hierarchical corporation for failure to monitor risk undertaken by corporate employees is a theoretical possibility, it would be, appropriately, a difficult cause of action on which to prevail. Assuming excessive risk-taking at some level becomes the misconduct contemplated by Caremark, the plaintiff would essentially have to show that the board consciously failed to implement any sort of risk monitoring system or, having implemented such a system, consciously disregarded red flags signaling that the company's employees were taking facially improper, and not just ex-post ill-advised or even bone-headed, business risks. Such bad-faith indifference would be formidably difficult to prove.

This heavy burden serves an important function in preserving the effectiveness of 8 Del. C. § 102(b)(7) exculpatory provisions. If plaintiffs could avoid the requirement of showing bad faith by twisting their duty of care claims into Caremark loyalty claims, such a scenario would eviscerate the purpose of 8 Del. C. § 102(b)(7) and could potentially chill the service of qualified directors.

[218] Citigroup, 964 A.2d at 124.

[219] Compl. ¶ 147.

[220] Compl. ¶ 59.

[221] Id.

[222] Compl. ¶¶ 60-61.

[223] Compl. ¶ 147.

[224] Compl. ¶ 148.

[225] Compl. ¶ 149.

[226] Compl. ¶¶ 64, 77, 84.

[227] Compl. ¶ 78 (internal quotations omitted).

[228] Compl. ¶ 147.

[229] Citigroup, 964 A.2d at 131.

[230] Id. at 126.

[231] Citigroup, 964 A.2d at 139.

Joseph A. Rosenthal, Kevin Gross, Rosenthal, Monhait, Gross & Goddess, Wilmington, Delaware; Steven G. Schulman (argued), Edith M. Kallas, U. Seth Ottensoser, Milberg Weiss Bershad Hynes & Lerach, New York City, for appellants.

R. Franklin Balotti (argued), Anne C. Foster, Srinivas M. Raju, Peter B. Ladig, Richards, Layton and Finger, Wilmington, Delaware, for director appellees.

David C. McBride, Young, Conaway, Stargatt & Taylor, Wilmington, Delaware; Ronald L. Olson, George M. Garvey, Mark H. Epstein (argued) Munger, Tolles & Olson, Los Angeles, California, for appellee Ovitz.

Andre G. Bouchard, Joel Friedlander, Bouchard, Friedlander & MaloneyHuss, Wilmington, Delaware; Edward J. Nowak, Jay S. Handlin, Burbank, California; David S. McLeod, John P. Flynn, Dewey Ballantine, Los Angeles, California, for appellee The Walt Disney Company.

Stuart M. Grant, Jay W. Eisenhofer, Megan D. McIntyre, Grant & Eisenhofer, Wilmington, Delaware, for Amicus Curiae Council of Institutional Investors.

Before VEASEY, C.J., WALSH, HOLLAND, HARTNETT and BERGER, JJ., constituting the Court en Banc.

[248] VEASEY, Chief Justice:

In this appeal from the Court of Chancery, we agree with the holding of the Court of Chancery that the stockholder derivative Complaint^[1] was subject to dismissal for failure to set forth particularized facts creating a reasonable doubt that the director defendants were disinterested and independent or that their conduct was protected by the business judgment rule.^[2] Our affirmance, however, is in part based on a somewhat different analysis than that of the Court below or the parties. Accordingly, in the interests of justice, we reverse only to the extent of providing that one aspect of the dismissal shall be without prejudice, and we remand to the Court of Chancery to provide plaintiffs a reasonable opportunity to file a further amended complaint consistent with this opinion.

The claims before us are that: (a) the board of directors of The Walt Disney Company ("Disney") as it was constituted in 1995 (the "Old Board") breached its fiduciary duty in approving an extravagant and wasteful Employment Agreement of Michael S. Ovitz as president of Disney; (b) the Disney board of directors as it was constituted in 1996 (the "New Board") breached its fiduciary duty in agreeing to a "non-fault" termination of the Ovitz Employment Agreement, a decision that was [249] extravagant and wasteful; and (c) the directors were not disinterested and independent.^[3]

The Complaint, consisting of 88 pages and 285 paragraphs, is a pastiche of prolix invective. It is permeated with conclusory allegations of the pleader and quotations from the media, mostly of an editorial nature (even including a cartoon). A pleader may rely on factual statements in the media as some of the "tools at hand"^[4] from which the pleader intends to derive the particularized facts necessary to comply with Chancery Rule 11(b)(3) and Chancery Rule 23.1. But many of the quotations from the media in the Complaint simply echo plaintiffs' conclusory allegations. Accordingly, they serve no purpose other than to complicate the work of reviewing courts.

This is potentially a very troubling case on the merits. On the one hand, it appears from the Complaint that: (a) the compensation and termination payout for Ovitz were exceedingly lucrative, if not luxurious, compared to Ovitz' value to the Company; and (b) the processes of the boards of directors in dealing with the approval and termination of the Ovitz Employment Agreement were casual, if not sloppy and perfunctory. On the other hand, the Complaint is so inartfully drafted that it was properly dismissed under our pleading standards for derivative suits. From what we can ferret out of this deficient pleading, the processes of the Old Board and the New Board were hardly paradigms of good corporate governance practices. Moreover, the sheer size of the payout to Ovitz, as alleged, pushes the envelope of judicial respect for the business judgment of directors in making compensation decisions. Therefore, both as to the processes of the two Boards and the waste test, this is a close case.

But our concerns about lavish executive compensation and our institutional aspirations that boards of directors of Delaware corporations live up to the highest standards of good corporate practices do not translate into a holding that these plaintiffs have set forth particularized facts excusing a pre-suit demand under our law and our pleading requirements.

This appeal presents several important issues, including: (1) the scope of review that this Court applies to an appeal from the dismissal of a derivative suit; (2) the extent to which the pleading standards required by Chancery Rule 23.1 exceed those required by Rule 8 of that Court; and (3) the scope of the business judgment rule as it interacts with the relevant pleading requirements. To some extent, the principles enunciated in this opinion restate and clarify our prior jurisprudence.

Facts

This statement of facts is taken from the Complaint. We have attempted to summarize here the essence of Plaintiffs' factual allegations on the key issues before us, disregarding the many conclusions that are not supported by factual allegations.

A. The 1995 Ovitz Employment Agreement

By an agreement dated October 1, 1995, Disney hired Ovitz as its president. He was a long-time friend of Disney Chairman and CEO Michael Eisner. At the time, Ovitz was an important talent broker in Hollywood. Although he lacked experience managing a diversified public company, other companies with entertainment operations had been interested in hiring him for high-level executive positions. [250] The Employment Agreement was unilaterally negotiated by Eisner and approved by the Old Board. Their judgment was that Ovitz was a valuable person to hire as president of Disney, and they agreed ultimately with Eisner's recommendation in awarding him an extraordinarily lucrative contract.

Ovitz' Employment Agreement had an initial term of five years and required that Ovitz "devote his full time and best efforts exclusively to the Company," with exceptions for volunteer work, service on the board of another company, and managing his passive investments.^[5] In return, Disney agreed to give Ovitz a base salary of $1 million per year, a discretionary bonus, and two sets of stock options (the "A" options and the "B" options) that collectively would enable Ovitz to purchase 5 million shares of Disney common stock.

The "A" options were scheduled to vest in three annual increments of 1 million shares each, beginning on September 30, 1998 (i.e., at the end of the third full year of employment) and continuing for the following two years (through September 2000). The agreement specifically provided that the "A" options would vest immediately if Disney granted Ovitz a non-fault termination of the Employment Agreement. The "B" options, consisting of 2 million shares, differed in two important respects. Although scheduled to vest annually starting in September 2001 (i.e., the year after the last "A" option would vest), the "B" options were conditioned on Ovitz and Disney first having agreed to extend his employment beyond the five-year term of the Employment Agreement. Furthermore, Ovitz would forfeit the right to qualify for the "B" options if his initial employment term of five years ended prematurely for any reason, even if from a non-fault termination.

The Employment Agreement provided for three ways by which Ovitz' employment might end. He might serve his five years and Disney might decide against offering him a new contract. If so, Disney would owe Ovitz a $10 million termination payment.^[6] Before the end of the initial term, Disney could terminate Ovitz for "good cause" only if Ovitz committed gross negligence or malfeasance, or if Ovitz resigned voluntarily. Disney would owe Ovitz no additional compensation if it terminated him for "good cause." Termination without cause (non-fault termination) would entitle Ovitz to the present value of his remaining salary payments through September 30, 2000, a $10 million severance payment, an additional $7.5 million for each fiscal year remaining under the agreement, and the immediate vesting of the first 3 million stock options (the "A" Options).

Plaintiffs allege that the Old Board knew that Disney needed a strong second-in-command. Disney had recently made several acquisitions, and questions lingered about Eisner's health due to major heart surgery. The Complaint further alleges that "Eisner had demonstrated little or no capacity to work with important or well-known subordinate executives who wanted to position themselves to succeed him," citing the departures of Disney executives Jeffrey Katzenberg, Richard Frank, and Stephen Bollenbach as examples. Thus, the Board knew that, to increase the chance for long-term success, it had to take extra care in reviewing a decision to hire Disney's new president.

But Eisner's decision that Disney should hire Ovitz as its president was not entirely well-received. When Eisner told three members of the Old Board in mid-August 1995 that he had decided to hire Ovitz, all three "denounced the decision." Although [251] not entirely clear from the Complaint, the vote of the Old Board approving the Ovitz Employment Agreement two months later appears to have been unanimous. Aside from a conclusory attack that the Old Board followed Eisner's bidding, the Complaint fails to allege any particularized facts that the three directors changed their initial reactions through anything other than the typical process of further discussion and individual contemplation.

The Complaint then alleges that the Old Board failed properly to inform itself about the total costs and incentives of the Ovitz Employment Agreement, especially the severance package. This is the key allegation related to this issue on appeal. Specifically, plaintiffs allege that the Board failed to realize that the contract gave Ovitz an incentive to find a way to exit the Company via a non-fault termination as soon as possible because doing so would permit him to earn more than he could by fulfilling his contract. The Complaint alleges, however, that the Old Board had been advised by a corporate compensation expert, Graef Crystal, in connection with its decision to approve the Ovitz Employment Agreement. Two public statements by Crystal form the basis of the allegation that the Old Board failed to consider the incentives and the total cost of the severance provisions, but these statements by Crystal were not made until after Ovitz left Disney in December 1996, approximately 14½ months after being hired.

The first statement, published in a December 23, 1996 article in the web-based magazine Slate, quoted Crystal as saying, in part, "Of course, the overall costs of the package would go up sharply in the event of Ovitz's termination (and I wish now that I'd made a spreadsheet showing just what the deal would total if Ovitz had been fired at any time)."^[7] The second published statement appeared in an article about three weeks later in the January 13, 1997 edition of California Law Business. The article appears first to paraphrase Crystal: "With no one expecting failure, the sleeper clauses in Ovitz's contract seemed innocuous, Crystal says, explaining that no one added up the total cost of the severance package." The article then quotes Crystal as saying that the amount of Ovitz' severance was "shocking" and that "[n]obody quantified this and I wish we had."^[8] One of the charging paragraphs of the Complaint concludes:

57. As has been conceded by Graef Crystal, the executive compensation consultant who advised the Old Board with respect to the Ovitz Employment Agreement, the Old Board never considered the costs that would be incurred by Disney in the event Ovitz was terminated from the Company for a reason other than cause prior to the natural expiration of the Ovtiz Employment Agreement.

Although repeated in various forms in the Complaint, these quoted admissions by Crystal constitute the extent of the factual support for the allegation that the Old Board failed properly to consider the severance elements of the agreement. This Court, however, must juxtapose these allegations with the legal presumption that the Old Board's conduct was a proper exercise of business judgment. That presumption includes the statutory protection for a board that relies in good faith on an expert advising the Board.^[9] We must decide whether plaintiffs' factual allegations, if proven, would rebut that presumption.

B. The New Board's Actions in Approving the Non-Fault Termination

Soon after Ovitz began work, problems surfaced and the situation continued to deteriorate during the first year of his employment. To support this allegation, [252] the plaintiffs cite various media reports detailing internal complaints and providing external examples of alleged business mistakes. The Complaint uses these reports to suggest that the New Board had reason to believe that Ovitz' performance and lack of commitment met the gross negligence or malfeasance standards of the termination-for-cause provisions of the contract.

The deteriorating situation, according to the Complaint, led Ovitz to begin seeking alternative employment and to send Eisner a letter in September 1996 that the Complaint paraphrases as stating his dissatisfaction with his role and expressing his desire to leave the Company.^[10] The Complaint also admits that Ovitz would not actually resign before negotiating a non-fault severance agreement because he did not want to jeopardize his rights to a lucrative severance in the form of a "nonfault termination" under the terms of the 1995 Employment Agreement.

On December 11, 1996, Eisner and Ovitz agreed to arrange for Ovitz to leave Disney on the non-fault basis provided for in the 1995 Employment Agreement. Eisner then "caused" the New Board^[11] "to rubber-stamp his decision (by `mutual consent')." This decision was implemented by a December 27, 1996 letter to Ovitz from defendant Sanford M. Litvack, an officer and director of Disney. That letter stated:

This will confirm the terms of your agreement with the Company as follows:

1. The Term of your employment under your existing Employment Agreement with The Walt Disney Company will end at the close of business today. Consequently, your signature confirms the end of your service as an officer, and your resignation as a director, of the Company and its affiliates.

2. This letter will for all purposes of the Employment Agreement be treated as a "Non-Fault Termination." By our mutual agreement, the total amount payable to you under your Employment Agreement, including the amount payable under Section 11(c) in the event of a "Non-Fault Termination," is $38,888,230.77, net of withholding required by law or authorized by you. By your signature on this letter, you acknowledge receipt of all but $1,000,000 of such amount. Pursuant to our mutual agreement, this will confirm that payment of the $1,000,000 balance has been deferred until February 5, 1997, pending final settlement of accounts.

3. This letter will further confirm that the option to purchase 3,000,000 shares of the Company's Common Stock granted to you pursuant to Option A described in your Employment Agreement will vest as of today and will expire in accordance with its terms on September 30, 2002.

Although the non-fault termination left Ovitz with what essentially was a very lucrative severance agreement, it is important to note that Ovitz and Disney had negotiated for that severance payment at the time they initially contracted in 1995, and in the end the payout to Ovitz did not exceed the 1995 contractual benefits. Consequently, Ovitz received the $10 million termination payment, $7.5 million for part of the fiscal year remaining under the [253] agreement and the immediate vesting of the 3 million stock options (the "A" options). As a result of his termination Ovitz would not receive the 2 million "B" options that he would have been entitled to if he had completed the full term of the Employment Agreement and if his contract were renewed.^[12]

The Complaint charges the New Board with waste, computing the value of the severance package agreed to by the Board at over $140 million, consisting of cash payments of about $39 million and the value of the immediately vesting "A" options of over $101 million. The Complaint quotes Crystal, the Old Board's expert, as saying in January 1997 that Ovitz' severance package was a "shocking amount of severance."

The allegation of waste is based on the inference most favorable to plaintiffs that Disney owed Ovitz nothing, either because he had resigned (de facto) or because he was unarguably subject to firing for cause. These allegations must be juxtaposed with the presumption that the New Board exercised its business judgment in deciding how to resolve the potentially litigable issues of whether Ovitz had actually resigned or had definitely breached his contract. We must decide whether plaintiffs' factual allegations, if proven, would rebut that presumption.

Scope of Review

Certain dicta in our jurisprudence suggest that this Court will review under a deferential abuse of discretion standard a decision of the Court of Chancery on a Rule 23.1 motion to dismiss a derivative suit. These statements, apparently beginning in 1984 in Aronson v. Lewis, state that the Court of Chancery's decision is discretionary in determining whether the allegations of the complaint support the contention that pre-suit demand is excused.

Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.^[13]

By implication, therefore, these dicta would suggest that our review is deferential, limited to a determination of whether the Court of Chancery abused its discretion. Indeed, all parties to this appeal agree that our review is for abuse of discretion.

The view we express today, however, is designed to make clear that our review of decisions of the Court of Chancery applying Rule 23.1 is de novo and plenary. We apply the law to the allegations of the Complaint as does the Court of Chancery. Our review is not a deferential review that requires us to find an abuse of discretion. We see no reason to perpetuate the concept of discretion in this context. The nature of our analysis of a complaint in a derivative suit is the same as that applied by the Court of Chancery in making its decision in the first instance.

Analyzing a pleading for legal sufficiency is not, for example, the equivalent of the [254] deferential review of certain discretionary rulings, such as: an administrative agency's findings of fact;^[14] a trial judge's evaluation of witness credibility;^[15] findings of the Court of Chancery in a statutory stock appraisal;^[16] a decision whether to grant or deny injunctive relief or the scope of that relief;^[17] or what rate of interest to apply.^[18] In a Rule 23.1 determination of pleading sufficiency, the Court of Chancery, like this Court, is merely reading the English language of a pleading and applying to that pleading statutes, case law and Rule 23.1 requirements. To that extent, our scope of review is analogous to that accorded a ruling under Rule 12(b)(6).

Therefore, our scope of review must be de novo. To the extent Aronson and its progeny contain dicta expressing or suggesting an abuse of discretion scope of review, that language is overruled. We now proceed to decide de novo whether the Complaint was properly dismissed for failure to set forth particularized facts to support the plaintiffs' claim that demand is excused.

Pleading Requirements in Derivative Suits

Pleadings in derivative suits are governed by Chancery Rule 23.1,^[19] just as pleadings alleging fraud are governed by Chancery Rule 9(b).^[20] Those pleadings must comply with stringent requirements of factual particularity that differ substantially from the permissive notice pleadings governed solely by Chancery Rule 8(a).^[21] Rule 23.1 is not satisfied by conclusory statements or mere notice pleading. On the other hand, the pleader is not required to plead evidence.^[22] What the pleader must set forth are particularized factual statements that are essential to the claim. Such facts are sometimes referred to as "ultimate facts," "principal facts" or "elemental facts."^[23] Nevertheless, the particularized factual statements that are required to comply with the Rule 23.1 pleading rules must also comply with the mandate of Chancery Rule 8(e) that they be "simple, concise and direct."^[24] A prolix complaint larded with conclusory language, like the Complaint here, does not comply with these fundamental pleading mandates.

Chancery Rule 23.1 requires, in part, that the plaintiff must allege with particularity facts raising a reasonable doubt that the corporate action being questioned was properly the product of [255] business judgment.^[25] The rationale of Rule 23.1 is two-fold. On the one hand, it would allow a plaintiff to proceed with discovery and trial if the plaintiff complies with this rule and can articulate a reasonable basis to be entrusted with a claim that belongs to the corporation. On the other hand, the rule does not permit a stockholder to cause the corporation to expend money and resources in discovery and trial in the stockholder's quixotic pursuit of a purported corporate claim based solely on conclusions, opinions or speculation. As we stated in Grimes v. Donald:

The demand requirement serves a salutary purpose. First, by requiring exhaustion of intracorporate remedies, the demand requirement invokes a species of alternative dispute resolution procedure which might avoid litigation altogether. Second, if litigation is beneficial, the corporation can control the proceedings. Third, if demand is excused or wrongfully refused, the stockholder will normally control the proceedings.

The jurisprudence of Aronson and its progeny is designed to create a balanced environment which will: (1) on the one hand, deter costly, baseless suits by creating a screening mechanism to eliminate claims where there is only a suspicion expressed solely in conclusory terms; and (2) on the other hand, permit suit by a stockholder who is able to articulate particularized facts showing that there is a reasonable doubt either that (a) a majority of the board is independent for purposes of responding to the demand, or (b) the underlying transaction is protected by the business judgment rule.^[26]

In setting up its analysis of the amended complaint, the Court of Chancery in this case stated that the standard by which the Complaint is to be tested is as follows: "Where under any set of facts consistent with the facts alleged in the complaint the plaintiff would not be entitled to judgment, the complaint may be dismissed as legally defective."^[27] The Court attempted to paraphrase the Court of Chancery decision in Lewis v. Vogelstein for this formulation. The Vogelstein quote is that "[w]here under any state of facts consistent with the factual allegations of the complaint the plaintiff would be entitled to a judgment, the complaint may not be dismissed as legally defective."^[28]

Plaintiffs argue that the formulation used by the Court of Chancery was error in that it is the opposite of the Vogelstein formulation. Defendants, on the other hand, argue that the formulations are identical. We need not resolve what is essentially a semantic debate. In our view, the formulation by the Court of Chancery here is confusing and unhelpful, but not reversible error, particularly in light of our de novo review. The issue is whether plaintiffs have alleged particularized facts creating a reasonable doubt that the actions of the defendants were protected by the business judgment rule. Plaintiffs are entitled to all reasonable factual inferences that logically flow from the particularized facts alleged, but conclusory allegations are not considered as expressly pleaded facts or factual inferences.

Principles of Corporation Law Compared with Good Corporate Governance Practices

This is a case about whether there should be personal liability of the directors of a Delaware corporation to the corporation for lack of due care in the decisionmaking process and for waste of corporate assets. This case is not about the failure [256] of the directors to establish and carry out ideal corporate governance practices.

All good corporate governance practices include compliance with statutory law and case law establishing fiduciary duties. But the law of corporate fiduciary duties and remedies for violation of those duties are distinct from the aspirational goals of ideal corporate governance practices. Aspirational ideals of good corporate governance practices for boards of directors that go beyond the minimal legal requirements of the corporation law are highly desirable, often tend to benefit stockholders, sometimes reduce litigation and can usually help directors avoid liability. But they are not required by the corporation law and do not define standards of liability.^[29]

The inquiry here is not whether we would disdain the composition, behavior and decisions of Disney's Old Board or New Board as alleged in the Complaint if we were Disney stockholders. In the absence of a legislative mandate,^[30] that determination is not for the courts. That decision is for the stockholders to make in voting for directors, urging other stockholders to reform or oust the board, or in making individual buy-sell decisions involving Disney securities. The sole issue that this Court must determine is whether the particularized facts alleged in this Complaint provide a reason to believe that the conduct of the Old Board in 1995 and the New Board in 1996 constituted a violation of their fiduciary duties.

Independence of the Disney Board

The test of demand futility is a two-fold test under Aronson and its progeny. The first prong of the futility rubric is "whether, under the particularized facts alleged, a reasonable doubt is created that... the directors are disinterested and independent."^[31] The second prong is whether the pleading creates a reasonable doubt that "the challenged transaction was otherwise the product of a valid exercise of business judgment."^[32] These prongs are in the disjunctive. Therefore, if either prong is satisfied, demand is excused.^[33]

[257] In this case, the issues of disinterestedness and independence involved in the first prong of Aronson are whether a majority of the New Board, which presumably was in office when plaintiffs filed this action, was disinterested and independent. That is, were they incapable, due to personal interest or domination and control, of objectively evaluating a demand, if made, that the Board assert the corporation's claims that are raised by plaintiffs or otherwise remedy the alleged injury?^[34] This rule is premised on the principle that a claim of the corporation should be evaluated by the board of directors to determine if pursuit of the claim is in the corporation's best interests.^[35] That is the analysis the Court of Chancery brought to bear on the matter,^[36] and it is that analysis we now examine to the extent necessary for appropriate appellate review.

The facts supporting plaintiffs' claim that the New Board was not disinterested or independent turn on plaintiffs' central allegation that a majority of the Board was beholden to Eisner. It is not alleged that they were beholden to Ovitz. Plaintiffs' theory is that Eisner was advancing Ovitz' interests primarily because a lavish contract for Ovtiz would redound to Eisner's benefit since Eisner would thereby gain in his quest to have his own compensation increased lavishly. This theory appears to be in the nature of the old maxim that a "high tide floats all boats." But, in the end, this theory is not supported by well-pleaded facts, only conclusory allegations. Moreover, the Court of Chancery found that these allegations were illogical and counterintuitive:

Plaintiffs' allegation that Eisner was interested in maximizing his compensation at the expense of Disney and its shareholders cannot reasonably be inferred from the facts alleged in Plaintiffs' amended complaint. At all times material to this litigation, Eisner owned several million options to purchase Disney stock. Therefore, it would not be in Eisner's economic interest to cause the Company to issue millions of additional options unnecessarily and at considerable cost. Such a gesture would not, as Plaintiffs suggest, "maximize" Eisner's own compensation package. Rather, it would dilute the value of Eisner's own very substantial holdings. Even if the impact on Eisner's option value were relatively small, such a large compensation package would, and did, draw largely negative attention to Eisner's own performance and compensation. Accordingly, no reasonable doubt can exist as to Eisner's disinterest in the approval of the Employment Agreement, as a matter of law. Similarly, the Plaintiffs have not demonstrated a reasonable doubt that Eisner was disinterested in granting Ovitz a Non-Fault Termination, thus allowing Ovitz to receive substantial severance benefits under the terms of the Employment Agreement. Nothing alleged by Plaintiffs generates a reasonable inference that Eisner would benefit personally from allowing [258] Ovitz to leave Disney without good cause.^[37]

The Court of Chancery held that "no reasonable doubt can exist as to Eisner's disinterest in the approval of the Employment Agreement, as a matter of law," and similarly that plaintiffs "have not demonstrated a reasonable doubt that Eisner was disinterested in granting Ovitz a Non-Fault Termination."^[38] Plaintiffs challenge this conclusion, but we agree with the Court of Chancery and we affirm that holding.

The Complaint then proceeds to detail the various associations that each member of the New Board had with Eisner. In an alternative holding, the Court of Chancery proceeded meticulously to analyze each director's ties to Eisner to see if they could have exercised business judgment independent of Eisner.^[39] Because we hold that the Complaint fails to create a reasonable doubt that Eisner was disinterested in the Ovitz Employment Agreement, we need not reach or comment on the analysis of the Court of Chancery on the independence of the other directors for this purpose.^[40]

In this case, therefore, that part of plaintiffs' Complaint raising the first prong of Aronson, even though not pressed by plaintiffs in this Court,^[41] has been dismissed with prejudice. Our affirmance of that dismissal is final and dispositive of the first prong of Aronson.^[42] We now turn to the primary issues in this case that implicate the second prong of Aronson: whether the Complaint sets forth particularized facts creating a reasonable doubt that the decisions of the Old Board and the New Board were protected by the business judgment rule.

Analytical Framework for the Informational Component of Directorial Decisionmaking

Plaintiffs claim that the Court of Chancery erred when it concluded that a board of directors is "not required to be informed of every fact, but rather is required to be reasonably informed."^[43] Applying that conclusion, the Court of Chancery held that the Complaint did not create a reasonable doubt that the Old Board had satisfied the requisite informational component when it approved the Ovitz contract in 1995.^[44] In effect, Plaintiffs argue that being "reasonably informed" is too lax a standard to satisfy Delaware's legal test for the informational component of board decisions. They contend that the Disney directors on the Old Board did not avail themselves of all material information reasonably available in approving Ovitz' 1995 [259] contract, and thereby violated their fiduciary duty of care.^[45]

The "reasonably informed" language used by the Court of Chancery here may have been a short-hand attempt to paraphrase the Delaware jurisprudence that, in making business decisions, directors must consider all material information reasonably available, and that the directors' process is actionable only if grossly negligent.^[46] The question is whether the trial court's formulation is consistent with our objective test of reasonableness, the test of materiality and concepts of gross negligence. We agree with the Court of Chancery that the standard for judging the informational component of the directors' decisionmaking does not mean that the Board must be informed of every fact. The Board is responsible for considering only material facts that are reasonably available, not those that are immaterial or out of the Board's reasonable reach.^[47]

We conclude that the formulation of the due care test by the Court of Chancery in this case, while not necessarily inconsistent with our traditional formulation, was too cryptically stated to be a helpful precedent for future cases. Presuit demand will be excused in a derivative suit only if the Court of Chancery in the first instance, and this Court in its de novo review, conclude that the particularized facts in the complaint create a reasonable doubt that the informational component of the directors' decisionmaking process, measured by concepts of gross negligence, included consideration of all material information reasonably available.^[48] Thus, we now apply this analytical framework to the particularized facts pleaded, juxtaposed with the presumption of regularity of the Board's process.

Plaintiffs' Contention that the Old Board Violated the Process Duty of Care in Approving the Ovitz Employment Agreement

Certainly in this case the economic exposure of the corporation to the payout scenarios of the Ovitz contract was material, particularly given its large size, for purposes of the directors' decisionmaking process.^[49] And those dollar exposure [260] numbers were reasonably available because the logical inference from plaintiffs' allegations is that Crystal or the New Board could have calculated the numbers. Thus, the objective tests of reasonable availability and materiality were satisfied by this Complaint. But that is not the end of the inquiry for liability purposes.

The Court of Chancery interpreted the Complaint to allege that only Crystal (the Board's expert) — and not the Board itself — failed to bring to bear all the necessary information because he (Crystal) did not quantify for the Board the maximum payout to Ovitz under the non-fault termination scenario. Alternatively, the Court of Chancery reasoned that even if the Old Board failed to make the calculation, that fact does not raise a reasonable doubt of due care because Crystal did not consider it critical to ascertain the potential costs of Ovitz' severance package. The Court's language is as follows:

With regard to the alleged breach of the duty of care, Plaintiffs claim that the directors were not properly informed before they adopted the Employment Agreement because they did not know the value of the compensation package offered to Ovitz. To that end, Plaintiffs offer several statements made by Graef Crystal, the financial expert who advised the Board on the Employment Agreement, including his admission that "[n]obody quantified the total cost of the severance package and I wish we had."

The fact that Crystal did not quantify the potential severance benefits to Ovitz for terminating early without cause (under the terms of the Employment Agreement) does not create a reasonable inference that the Board failed to consider the potential cost to Disney in the event that they decided to terminate Ovitz without cause. But, even if the Board did fail to calculate the potential cost to Disney, I nevertheless think that this allegation fails to create a reasonable doubt that the former Board exercised due care. Disney's expert did not consider an inquiry into the potential cost of Ovitz's severance benefits to be critical or relevant to the Board's consideration of the Employment Agreement. Merely because Crystal now regrets not having calculated the package is not reason enough to overturn the judgment of the Board then. It is the essence of the business judgment rule that a court will not apply 20/20 hindsight to second guess a board's decision, except "in rare cases [where] a transaction may be so egregious on its face that the board approval cannot meet the test of business judgment." Because the Board's reliance on Crystal and his decision not to fully calculate the amount of severance lack "egregiousness," this is not that rare case. I think it a correct statement of law that the duty of care is still fulfilled even if a Board does not know the exact amount of a severance payout but nonetheless is fully informed about the manner in which such a payout would be calculated. A board is not required to be informed of every fact, but rather is required to be reasonably informed. Here the Plaintiffs have failed to plead facts giving rise to a reasonable doubt that the Board, as a matter of law, was reasonably informed on this issue.^[50]

We believe, however, that the Complaint, fairly read, charges that Crystal admitted that "nobody" — not Crystal and not the directors — made that calculation, although all the necessary information presumably was at hand to do so. Thus the reading given by the Court of Chancery to [261] this aspect of the amended complaint was too restrictive because the Court's reading fails to appreciate the breadth of the allegation — i.e., that neither Crystal nor the Old Board made the calculations that Crystal — the expert — now believes he should have made. Moreover, the Court's alternative analysis that "Disney's expert did not consider an inquiry into the potential costs ... to be critical or relevant to the board's consideration" is inappropriately simplistic at the pleading stage to state a comprehensive analysis of the issue.

We regard the Court's language as harmless error, however, for the following reason. The Complaint, fairly construed, admits that the directors were advised by Crystal as an expert and that they relied on his expertise. Accordingly, the question here is whether the directors are to be "fully protected" (i.e., not held liable) on the basis that they relied in good faith on a qualified expert under Section 141(e) of the Delaware General Corporation Law.^[51] The Old Board is entitled to the presumption^[52] that it exercised proper business judgment, including proper reliance on the expert. In fact, the Court of Chancery refers to the "Board's reliance on Crystal and his decision not to fully calculate the amount of severance."^[53] The Court's invocation here of the concept of the protection accorded directors who rely on experts, even though no reference is made to the statute itself, is on the right track, but the Court's analysis is unclear and incomplete.^[54]

Although the Court of Chancery did not expressly predicate its decision on Section 141(e), Crystal is presumed to be an expert on whom the Board was entitled to rely in good faith under Section 141(e) in order to be "fully protected."^[55] Plaintiffs must rebut the presumption that the directors properly exercised their business judgment, including their good faith reliance on Crystal's expertise. What Crystal now believes in hindsight that he and the Board should have done in 1995 does not provide that rebuttal. That is not to say, however, that a rebuttal of the presumption of proper reliance on the expert [262] under Section 141(e) cannot be pleaded consistent with Rule 23.1 in a properly framed complaint setting forth particularized facts creating reason to believe that the Old Board's conduct was grossly negligent.

To survive a Rule 23.1 motion to dismiss in a due care case where an expert has advised the board in its decisionmaking process, the complaint must allege particularized facts (not conclusions) that, if proved, would show, for example, that: (a) the directors did not in fact rely on the expert; (b) their reliance was not in good faith; (c) they did not reasonably believe that the expert's advice was within the expert's professional competence; (d) the expert was not selected with reasonable care by or on behalf of the corporation, and the faulty selection process was attributable to the directors; (e) the subject matter (in this case the cost calculation) that was material and reasonably available was so obvious that the board's failure to consider it was grossly negligent regardless of the expert's advice or lack of advice; or (f) that the decision of the Board was so unconscionable as to constitute waste or fraud.^[56] This Complaint includes no particular allegations of this nature, and therefore it was subject to dismissal as drafted.^[57]

Plaintiffs also contend that Crystal's latter-day admission is "valid and binding" on the Old Board. This argument is without merit. Crystal was the Board's expert ex ante for purposes of advising the directors on the Ovitz Employment Agreement. He was not their agent ex post to make binding admissions.

We conclude that, although the language of the Court of Chancery was flawed in formulating the proper legal test to be used and in its reading of the Complaint, that pleading, as drafted, fails to create a reasonable doubt that the Old Board's decision in approving the Ovitz Employment Agreement was protected by the business judgment rule. Plaintiffs will be provided an opportunity to replead on this issue.

Plaintiffs' Contention that the Old Board Violated "Substantive Due Care" Requirements and Committed Waste Ab Initio with Ovitz' Employment Agreement

Plaintiffs allege not only that the Old Board committed a procedural due care violation in the process of approving the Ovitz 1995 Employment Agreement but also that the Board committed a "substantive due care" violation constituting waste. They contend that the Court of Chancery erred in holding that the Complaint failed to set forth particularized facts creating a reasonable doubt that the directors' decision to enter into the Ovitz Employment Agreement was a product of the proper exercise of business judgment.

Plaintiffs' principal theory is that the 1995 Ovitz Employment Agreement [263] was a "wasteful transaction for Disney ab initio" because it was structured to "incentivize" Ovitz to seek an early non-fault termination. The Court of Chancery correctly dismissed this theory as failing to meet the stringent requirements of the waste test, i.e., "`an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.'"<sup>[58]</sup> Moreover, the Court concluded that a board's decision on executive compensation is entitled to great deference. It is the essence of business judgment for a board to determine if "a `particular individual warrant[s] large amounts of money, whether in the form of current salary or severance provisions.'"^[59]

Specifically, the Court of Chancery inferred from a reading of the Complaint that the Board determined it had to offer an expensive compensation package to attract Ovitz and that they determined he would be valuable to the Company. The Court also concluded that the vesting schedule of the options actually was a disincentive for Ovitz to leave Disney.^[60] When he did leave pursuant to the nonfault termination, the Court noted that he left 2 million options (the "B" options) "on the table."^[61] Although we agree with the conclusion of the Court of Chancery that this particular Complaint is deficient, we do not foreclose the possibility that a properly framed complaint could pass muster.

Plaintiffs' disagreement on appeal with the decision of the Court of Chancery is basically a quarrel with the Old Board's judgment in evaluating Ovitz' worth vis à vis the lavish payout to him. We agree with the analysis of the Court of Chancery that the size and structure of executive compensation are inherently matters of judgment.^[62] As former Chancellor Allen stated in Vogelstein:

The judicial standard for determination of corporate waste is well developed. Roughly, a waste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade. Most often the claim is associated with a transfer of corporate assets that serves no corporate purpose; or for which no consideration at all is received. Such a transfer is in effect a gift. If, however, there is any substantial consideration received by the corporation, and if there is a good faith judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste, even if the fact finder would conclude ex post that the transaction was unreasonably risky. Any other rule would deter corporate boards from the optimal rational acceptance of risk, for reasons explained elsewhere. Courts are ill-fitted to attempt to weigh the "adequacy" of consideration under the waste standard or, ex post, to judge appropriate degrees of business risk.^[63]

To be sure, there are outer limits, but they are confined to unconscionable cases where directors irrationally squander or give away corporate assets. Here, however, we [264] find no error in the decision of the Court of Chancery on the waste test.

As for the plaintiffs' contention that the directors failed to exercise "substantive due care," we should note that such a concept is foreign to the business judgment rule. Courts do not measure, weigh or quantify directors' judgments. We do not even decide if they are reasonable in this context.^[64] Due care in the decisionmaking context is process due care only. Irrationality^[65] is the outer limit of the business judgment rule. Irrationality may be the functional equivalent of the waste test or it may tend to show that the decision is not made in good faith, which is a key ingredient of the business judgment rule.^[66]

Plaintiffs' Contention that the New Board Committed Waste in Its Decision That Ovitz' Contract Should be Terminated on a "Non-Fault" Basis

The plaintiffs contend in this Court that Ovitz resigned or committed acts of gross negligence or malfeasance that constituted grounds to terminate him for cause. In either event, they argue that the Company had no obligation to Ovitz and that the directors wasted the Company's assets by causing it to make an unnecessary and enormous payout of cash and stock options when it permitted Ovitz to terminate his employment on a "non-fault" basis. We have concluded, however, that the Complaint currently before us does not set forth particularized facts that he resigned or unarguably breached his Employment Agreement.

The Complaint does not allege facts that would show that Ovitz had, in fact, resigned before the Board acted on his nonfault termination. Plaintiffs contend, in effect, that the sum total of Ovitz' actions constituted a de facto resignation. But the Complaint does not allege that Ovitz had actually resigned. It alleges merely that he: (a) was dissatisfied with his role; (b) was underperforming; (c) was seeking and entertaining other job offers; and (d) had written to Eisner on September 5, 1996, "express[ing] his desire to quit." These are not particularized allegations that he resigned, either actually or constructively.

Additionally, the Complaint is internally inconsistent with plaintiffs' argument that Ovitz had resigned. The Complaint alleges that Ovitz would not actually resign before he could achieve a lucrative payout under the generous terms of his 1995 Employment Agreement. The clear inference from the Complaint is that he would lose all leverage by resigning. For example, the Complaint paraphrases Robert Slater's recent biography of Ovitz as stating that "the only reason Ovitz did not simply state outright that he quit his position at Disney was his realization that doing so would deprive him of all severance benefits" of his Employment Agreement. The Court of Chancery correctly concluded:

As for Plaintiffs' contention that Ovitz actually or impliedly tendered his resignation before the Board approved the Non-Fault Termination, I do not believe [265] this conclusion can reasonably be drawn from the facts alleged by Plaintiffs. While I would agree that Ovitz's September 5 letter to Eisner and his search for another job provide strong evidence of Ovitz's lack of commitment to the Company, they are not legally tantamount to a voluntary resignation.^[67]

The Complaint alleges that it was waste for the Board to pay Ovitz essentially the full amount he was due on the nonfault termination basis because he should have been fired for cause. Ovitz' contract provided that he could be fired for cause only if he was grossly negligent or committed acts of malfeasance. Plaintiffs contend that ample grounds existed to fire Ovitz for cause under these terms. The Court of Chancery correctly concluded:

The terms of the Employment Agreement limit "good cause" for terminating Ovitz's employment to gross negligence or malfeasance, or a voluntary resignation without the consent of the Company. I have reviewed the amended complaint and listened to the parties' arguments at the hearing in connection with Defendants' motion to dismiss. Still, I am unable to conclude that any of the facts alleged by Plaintiffs, even accepted as true, demonstrate that Ovitz's conduct was either grossly negligent or malfeasant during his tenure at Disney, or that Ovitz resigned voluntarily. For example, Plaintiffs allege that Ovitz sought alternative employment while he was the president of Disney. But Plaintiffs fail to explain how looking for another job constitutes gross negligence or malfeasance. The same holds true for Plaintiffs' allegation that Ovitz failed to follow Eisner's directive to meet with Director Defendant Stephen F. Bollenbach, who was then the senior executive vice president and chief financial officer of Disney. This allegation may demonstrate that Ovitz failed to become familiar with Disney's finances or that he bucked authority at Disney. However, it does not demonstrate, without more, that Ovitz was grossly negligent or committed malfeasance. None of Plaintiffs' allegations rise to the level of gross negligence or malfeasance.^[68]

Construed most favorably to plaintiffs, the facts in the Complaint (disregarding conclusory allegations) show that Ovitz' performance as president was disappointing at best, that Eisner admitted it had been a mistake to hire him, that Ovitz lacked commitment to the Company, that he performed services for his old company, and that he negotiated for other jobs (some very lucrative) while being required under the contract to devote his full time and energy to Disney.

All this shows is that the Board had arguable grounds to fire Ovitz for cause. But what is alleged is only an argument — perhaps a good one — that Ovitz' conduct constituted gross negligence or malfeasance. First, given the facts as alleged, Disney would have had to persuade a trier of fact and law of this argument in any litigated dispute with Ovitz. Second, that process of persuasion could involve expensive litigation, distraction of executive time and company resources, lost opportunity costs, more bad publicity and an outcome that was uncertain at best and, at worst, could have resulted in damages against the Company.

The Complaint, in sum, contends that the Board committed waste by agreeing to the very lucrative payout to Ovitz under the non-fault termination provision because it had no obligation to him, thus taking the Board's decision outside the protection of the business judgment rule. Construed most favorably to plaintiffs, the Complaint contends that, by reason of the New Board's available arguments of resignation and good cause, it had the leverage [266] to negotiate Ovitz down to a more reasonable payout than that guaranteed by his Employment Agreement. But the Complaint fails on its face to meet the waste test because it does not allege with particularity facts tending to show that no reasonable business person would have made the decision that the New Board made under these circumstances.

We agree with the conclusion of the Court of Chancery:

The Board made a business decision to grant Ovitz a Non-Fault Termination. Plaintiffs may disagree with the Board's judgment as to how this matter should have been handled. But where, as here, there is no reasonable doubt as to the disinterest of or absence of fraud by the Board, mere disagreement cannot serve as grounds for imposing liability based on alleged breaches of fiduciary duty and waste. There is no allegation that the Board did not consider the pertinent issues surrounding Ovitz's termination. Plaintiffs' sole argument appears to be that they do not agree with the course of action taken by the Board regarding Ovitz's separation from Disney. This will not suffice to create a reasonable doubt that the Board's decision to grant Ovitz a Non-Fault Termination was the product of an exercise of business judgment. As demand is not excused as to Plaintiffs' claims in connection with the current Board's decision to grant Ovitz's Non-Fault Termination, these claims must be dismissed.^[69]

To rule otherwise would invite courts to become super-directors, measuring matters of degree in business decisionmaking and executive compensation. Such a rule would run counter to the foundation of our jurisprudence.

Nevertheless, plaintiffs will have another opportunity — if they are able to do so consistent with Chancery Rule 11^[70] — to file a short and plain statement^[71] alleging particularized facts creating a reasonable doubt that the New Board's decision regarding the Ovitz non-fault termination was protected by the business judgment rule.

No Discovery Permitted; Books and Records May be Available

Plaintiffs complain, in effect, that the system of requiring a stockholder to plead particularized facts in a derivative suit is basically unfair because the Court will not permit discovery under Chancery Rules 26-37 to marshal the facts necessary to establish that pre-suit demand is excused.^[72] This is a common complaint, one that is echoed in the amicus brief of the Council of Institutional Investors on this appeal. But this argument has been answered by this Court on several occasions.

Plaintiffs may well have the "tools at hand" to develop the necessary facts for pleading purposes.^[73] For example, plaintiffs may seek relevant books and records of the corporation under Section 220 of the Delaware General Corporation Law,^[74] if they can ultimately bear the burden of showing a proper purpose and make specific and discrete identification, with rifled precision, of the documents sought. Further, [267] they must establish that each category of books and records is essential to the accomplishment of their articulated purpose for the inspection.^[75] We do not presume to direct the Court of Chancery how it should decide any proceeding under Section 220. From a timing perspective, however, we note that such a proceeding is a summary one that should be managed expeditiously.

Conclusion

One can understand why Disney stockholders would be upset with such an extraordinarily lucrative compensation agreement and termination payout awarded a company president who served for only a little over a year and who underperformed to the extent alleged. That said, there is a very large — though not insurmountable — burden on stockholders who believe they should pursue the remedy of a derivative suit instead of selling their stock or seeking to reform or oust these directors from office.

Delaware has pleading rules and an extensive judicial gloss on those rules that must be met in order for a stockholder to pursue the derivative remedy. Sound policy supports these rules, as we have noted. This Complaint, which is a blunderbuss of a mostly conclusory pleading, does not meet that burden, and it was properly dismissed.

The order of the Court of Chancery dismissing the Complaint was set forth in three paragraphs.^[76] Each paragraph stated that certain counts were dismissed. That dismissal operates as an adjudication on the merits.^[77] That is, the dismissal is with prejudice as to all counts. To the extent that plaintiffs have appealed the order of the Court of Chancery, we affirm that dismissal in all respects, except that paragraph 1 of the order is affirmed in part, reversed in part and remanded.

The portion of paragraph 1 that dismissed "plaintiffs claims for breach of fiduciary duty and waste, as set forth in Counts I and II of the amended complaint... for failure to make a demand under Court of Chancery Rule 23.1," is reversed only to the extent that the dismissal ordered by the Court of Chancery was with prejudice.^[78] Because of the unusual nature of this case and the rulings in this opinion, the interests of justice require that the dismissal ordered in paragraph 1 of the Order of the Court of Chancery shall be without prejudice. Accordingly, we remand to the Court of Chancery to permit plaintiffs to file an amended complaint in accordance with the rulings of this Court as set forth in this opinion.

HARTNETT, Justice, concurring:

I agree that the complaint leaves much to be desired and that plaintiffs be given an opportunity to file an amended complaint. In my view, however, the present complaint is adequate as to some of the asserted claims, if only barely so.

Chancery Rules 23.1 and 12(b)(6) are predicated on the Federal Rules of Civil Procedure. The federal precedents therefore carry great weight.^[79]

[268] Rule 23.1 does not abrogate Rule 12(b)(6), and therefore, in order for the defendants to have obtained a dismissal for failure to state a claim upon which relief can be granted under Rule 12(b)(6), it must have appeared "with reasonable certainty that the plaintiffs would not have been entitled to the relief sought under any set of facts which could be proven to support the action."^[80] Moreover, as is true in other contexts, the plaintiffs' wellpleaded factual allegations must be taken as true and the complaint has to be read in the light most favorable to the plaintiffs.^[81] The reason for Rule 23.1 is judicial economy. It is not intended to preclude a judicial inquiry where the pleaded facts, if true, and any inferences that may be drawn from them, in the light most favorable to the plaintiffs, show the likelihood of misconduct by the directors. Because of the absence of a precise formula in the Rule for pleading compliance with the demand requirement, the sufficiency of a complaint under Rule 23.1 is determined on the basis of the facts of each case.^[82]

I agree that the complaint does not create a reasonable doubt as to the disinterestedness or independence of the Board. In my opinion, however, from the totality of the factual allegations in the complaint, a reasonable doubt that the business judgment rule precludes judicial inquiry already exists as to some of the other claims, such as whether the directors were aware of the total cost of Ovitz' compensation package when they approved it or whether Ovitz had actually resigned before he struck his termination deal.

Plaintiffs must not be held to a too-high standard of pleading because they face an almost impossible burden when they must plead facts with particularity and the facts are not public knowledge. Brushing aside technicalities, the issue here is whether this suit should have been dismissed by the Court of Chancery at this stage of the litigation without any discovery or whether the allegations in the complaint were sufficient to justify at least some discovery. In my opinion, the complaint already sufficiently alleges facts to warrant some limited discovery as to some of the claims.

---------

[1] According to the docket entries in the Court of Chancery for C.A. No. 15452, the original complaint was filed on January 8, 1997. After some procedural steps that are not relevant to this appeal, an amended complaint was filed on May 28, 1997, apparently by agreement among the parties and in full substitution for the Complaint filed in the constituent actions. It is this amended complaint that was dismissed with prejudice by the Court of Chancery. We will, for convenience, refer to it as "the Complaint."

[2] See In re The Walt Disney Co. Derivative Litig., Del.Ch., 731 A.2d 342, 350-65, 380 (1998).

[3] The Complaint sets forth other claims decided by the Court of Chancery. These included a disclosure claim along with contract and other claims against Ovitz. See In re The Disney Co. Derivative Litig., 731 A.2d at 365-80. No appeal was taken from the judgment of the Court of Chancery dismissing those claims with prejudice. Thus, those claims are not before us and the dismissal is final as to them.

[4] See Rales v. Blasband, Del.Supr., 634 A.2d 927, 935 n. 10 (1993).

[5] The agreement implicitly emphasized the importance of having Disney receive Ovitz' full attention by mentioning, in a section stating the unique nature of Ovitz' services, that the Company would specifically be entitled to equitable relief if Ovitz failed to provide it with "the exclusivity of his services."

[6] All the "A" options would have vested, but he would not receive the "B" options.

[7] Emphasis is in the Complaint.

[8] Emphasis is in the Complaint.

[9] See 8 Del.C. § 141(e), quoted infra at note 51.

[10] The plaintiffs allegedly have never seen the actual letter.

[11] The composition of the New Board differed slightly from the composition of the Old Board. The Old Board and the New Board both included Michael D. Eisner, Roy E. Disney, Stanley P. Gold, Sanford M. Litvack, Richard A. Nunis, Sidney Poitier, Irwin E. Russell, Robert A.M. Stern, E. Cardon Walker, Raymond L. Watson, Gary L. Wilson, Reveta F. Bowers, Ignacio E. Lozano Jr. and George J. Mitchell. The Old Board included Stephen F. Bollenbach, who was not on the New Board. The New Board included Leo J. O'Donovan and Thomas S. Murphy, neither of whom was on the Old Board. Although the Complaint included Ovitz as a member of the New Board, his resignation appeared to have occurred before the New Board approved the non-fault termination. See In re The Walt Disney Co. Derivative Litig., 731 A.2d at 351 n. 3.

[12] Under the 1995 Employment Agreement, Ovitz' "B" options to purchase 2,000,000 shares were scheduled to vest "in increments of 1,000,000 shares on each of September 30, 2001 and September 30, 2002." But they would not vest if Ovitz' employment "shall have terminated for any reason whatsoever more than three months prior to such scheduling date." If Ovitz' employment should terminate before October 1, 2000 (the expiration of the 1995 agreement), the "B" options "shall thereupon irrevocably terminate."

[13] Aronson v. Lewis, Del.Supr., 473 A.2d 805, 814 (1984) (emphasis added). This language in Aronson was followed, sequentially, by: Pogostin v. Rice, Del.Supr., 480 A.2d 619, 624-25 (1984); Grobow v. Perot, Del.Supr., 539 A.2d 180, 186 (1988); Levine v. Smith, Del. Supr., 591 A.2d 194, 207 (1991); Heineman v. Datapoint Corp., Del.Supr., 611 A.2d 950, 952 (1992); Grimes v. Donald, Del.Supr., 673 A.2d 1207, 1217 n. 15 (1996); and Scattered Corp. v. Chicago Stock Exch., Del.Supr., 701 A.2d 70, 72-73 (1997).

[14] See Public Water Supply Co. v. DiPasquale, Del.Supr., 735 A.2d 378, 381 (1999).

[15] See Schock v. Nash, Del.Supr., 732 A.2d 217, 234 (1999).

[16] See M.P.M. Enterprises, Inc. v. Gilbert, Del. Supr., 731 A.2d 790, 795 (1999).

[17] See SI Management L.P. v. Wininger, Del. Supr., 707 A.2d 37, 40 (1998).

[18] See Shell Petroleum, Inc. v. Smith, Del. Supr., 606 A.2d 112, 117 (1992).

[19] Rule 23.1 provides, in part: "The complaint shall ... allege with particularity the efforts, if any, ... to obtain the action the plaintiff desires from the directors ... and the reasons for the plaintiff's failure to obtain the action or for not making the effort."

[20] Rule 9(b) provides, in part: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity."

[21] Rule 8(a) provides, in part: "A pleading... shall contain ... a short and plain statement of the claim showing that the pleader is entitled to relief...."

[22] See Aronson, 473 A.2d at 816.

[23] Black's Law Dictionary 610-12 (7th ed.1999); see also 2 James Wm. Moore et al., Moore's Federal Practice ¶ 9.03[1] (3d ed.1999); 5 James Wm. Moore et al., Moore's Federal Practice ¶ 23.1.08[1] (3d ed.1999).

[24] This parallels the pleading rules contained in the Federal Rules of Civil Procedure. See 2 James Wm. Moore et al., Moore's Federal Practice ¶ 9.03[1][b] at 9-19 (3d ed.1999); Deborah A. DeMott, Shareholder Derivative Actions: Law and Practice § 4:02, at 41 (1999 Cum.Supp.).

[25] This is the so-called second prong of Aronson, the central focus of this case.

[26] Grimes, 673 A.2d at 1216-17 (footnotes omitted).

[27] In re The Walt Disney Co. Derivative Litig., 731 A.2d at 353 (emphasis added).

[28] Lewis v. Vogelstein, Del.Ch., 699 A.2d 327, 338 (1997) (emphasis added).

[29] See id. at 332; see also E. Norman Veasey, An Economic Rationale for Judicial Decisionmaking in Corporate Law, 53 Bus.Law. 681, 699-700 (1998) (listing seven suggestions of aspirational norms for good corporate practice that are "purely precatory" and do "not foreshadow how any case should be decided," but "may be in the nature of safe harbors in certain circumstances"). For example, the Complaint quotes a Wall Street Journal article critical of the Board's functioning: the directors own little stock; they do not "hold a regular retreat"; they "don't meet regularly in the absence of company executives such as Mr. Eisner"; and they do not "give Mr. Eisner a written assessment of his performance" as do "89% of the nation's biggest industrial corporations." These are very desirable practices to be sure, but they are not required by the corporation law.

[30] See Williams v. Geier, Del.Supr., 671 A.2d 1368, 1385 n. 36 (1996) (noting that this court will not impose requirements or exceptions that are essentially legislative because that is the province of the General Assembly and further because it would "introduce an undesirable degree of uncertainty into the corporation law"). For example, the Council of Institutional Investors, an eminently prestigious corporate governance organization, has argued in a very interesting amicus brief in this Court that the Disney Board should have taken steps to assure even greater independence of directors. See also National Association of Corporate Directors, Report of the NACD Blue Ribbon Commission on Director Professionalism 7-14, 37-40 (1996) (containing definitions of independence from this very influential organization and urging corporations to insist on paradigms of strengthened independence); American Law Institute, Principles of Corporate Governance § 3A-01 (1992) ("Composition of the Board of Publicly Held Corporations"). Many of the recommendations of the Council of Institutional Investors, the American Law Institute and the NACD are desirable but are not mandated by our law.

[31] Aronson, 473 A.2d at 814; see also id. at 816 ("Independence means that a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences.").

[32] Id. at 814.

[33] For an excellent analysis of the Delaware demand rule in this context, see 2 Dennis J. Block et al., The Business Judgment Rule 1467-1543 (5th ed.1998).

[34] It is no answer to say that demand is necessarily futile because (a) the directors "would have to sue themselves, thereby placing the conduct of the litigation in hostile hands," or (b) that they approved the underlying transaction. See Aronson, 473 A.2d at 817-18; see also Block, supra note 33.

[35] See Dennis J. Block et al., Derivative Litigation: Current Law Versus the American Law Institute, 48 Bus.Law. 1443, 1444 (1993) ("[C]ourts both in and out of Delaware have ruled with near unanimity .... that the business judgment rule is the appropriate standard of judicial review in cases where an independent majority of a corporation's board of directors determines that litigation on behalf of the corporation will not serve the best interests of the corporation.").

[36] See In re The Walt Disney Co. Derivative Litig., 731 A.2d at 354-56. The independence and disinterestedness of the Old Board in authorizing the Ovitz Employment Agreement and the New Board in authorizing a non-fault termination of that agreement is subsumed in the business judgment rule analysis of those issues under the second prong of Aronson. See Aronson, 473 A.2d at 815.

[37] In re The Walt Disney Co. Derivative Litig., 731 A.2d at 355-56.

[38] Id.

[39] See In re The Walt Disney Co. Derivative Litig., 731 A.2d at 356-61.

[40] Thus, we need not address the very interesting arguments and recommendations of the amicus brief filed on behalf of the Council of Institutional Investors.

[41] Apparently plaintiffs, as appellants in this Court, lacked a motivation to have us review this issue at all since they do not mention it in their brief. The issue was fully briefed by the amicus, the Council of Institutional Investors and by the corporate defendant, Disney. Despite the irregular procedure, see Turnbull v. Fink, Del.Supr., 644 A.2d 1322 (1994), we agreed to consider the issue because the deficiency was not raised by the appellees, who were not prejudiced and who fully briefed all issues before us. See Brehm v. Eisner, Del. Supr., No. 469, 1998, Walsh, J. (May 25, 1999) (ORDER). This departure from proper practice before this Court is a unique exception and should not be considered a precedent.

[42] This issue is not one that plaintiffs shall be permitted to relitigate if they elect to file an amended complaint setting forth particularized facts relating to the second prong of Aronson.

[43] In re The Walt Disney Co. Derivative Litig., 731 A.2d at 361-62.

[44] See id.

[45] See Aronson, 473 A.2d at 812; Smith v. Van Gorkom, Del. Supr., 488 A.2d 858, 872-73 (1985).

[46] See Aronson, 473 A.2d at 812.

[47] Compare the American Law Institute test, which requires that a director must be "informed... to the extent the director reasonably believes to be appropriate under the circumstances." Principles of Corporate Governance, supra note 30, at § 4.01(c)(2). Because this test also is based on the objective test of reasonableness, it could be argued that it is essentially synonymous with the Delaware test. But there is room to argue that the Delaware test is stricter. See Roswell Perkins, ALI Corporate Governance Project in Midstream, 41 Bus.Law. 1195, 1210-11 (1986). In the end, the debate may be mostly semantic.

[48] See Aronson, 473 A.2d at 812.

[49] The term "material" is used in this context to mean relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in decisionmaking. In this sense, it is distinct from the use of the term "material" in the quite different context of disclosure to stockholders in which "[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." O'Malley v. Boris, Del.Supr., 742 A.2d 845, 850 (1999) (quoting Rosenblatt v. Getty Oil Co., Del.Supr., 493 A.2d 929, 944 (1985)) (reflecting the general federal materiality standard from TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976)); accord Loudon v. Archer-Daniels-Midland Co., Del.Supr., 700 A.2d 135, 143 (1997). One must also keep in mind that the size of executive compensation for a large public company in the current environment often involves huge numbers. This is particularly true in the entertainment industry where the enormous revenues from one "hit" movie or enormous losses from a "flop" place in perspective the compensation of executives whose genius or misjudgment, as the case may be, may have contributed substantially to the "hit" or "flop." See Lori B. Marino, Comment, Executive Compensation and the Misplaced Emphasis on Increasing Shareholder Access to the Proxy, 147 U.Pa. L.Rev. 1205, 1235 (1999) ("Executive compensation makes up such a small percentage of a firm's assets that even excessive pay packages will likely not cause a blip in a firm's stock value."); cf. id. (contrasting executive compensation with decisions by a company's board regarding takeovers, which have a great effect on a company's stock price).

[50] In re The Walt Disney Co. Derivative Litig., 731 A.2d at 361-62 (emphasis in original) (footnotes omitted).

[51] Section 141(e) provides:

A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.

8 Del.C. § 141(e) (emphasis added). This protection, however, is not without limitation, as in a case of corporate waste.

[52] See Grobow, 539 A.2d at 187-88.

[53] In re The Walt Disney Co. Derivative Litig., 731 A.2d at 362.

[54] The Court of Chancery seemed, however, to key the reliance issue not to the statute but to the lack of "egregiousness," a concept that is misplaced in this context. The Court said:

It is the essence of the business judgment rule that a court will not apply 20/20 hindsight to second guess a board's decision, except "in rare cases [where] a transaction may be so egregious on its face that the board approval cannot meet the test of business judgment." Because the Board's reliance on Crystal and his decision not to fully calculate the amount of severance lack "egregiousness," this is not that rare case. I think it a correct statement of law that the duty of care is still fulfilled even if a Board does not know the exact amount of a severance payout but nonetheless is fully informed about the manner in which such a payout would be calculated. A board is not required to be informed of every fact, but rather is required to be reasonably informed.

Id.

[55] The directors do, however, obliquely cite Section 141(e) and various Delaware cases in a footnote to their brief in this Court. See Ans. Br. of Defendants Below-Appellees at 18 n. 10.

[56] To be sure, directors have the power, authority and wide discretion to make decisions on executive compensation. See 8 Del.C. § 122(5). As the often-cited Court of Chancery decision by Chancellor Seitz in Saxe v. Brady warns, there is an outer limit to that discretion, at which point a decision of the directors on executive compensation is so disproportionately large as to be unconscionable and constitute waste. Del.Ch., 184 A.2d 602, 610 (1962); see Grimes, 673 A.2d at 1215 (noting that compensation decisions by an independent board are protected by the business judgment rule "unless the facts show that such amounts, compared with the services to be received in exchange, constitute waste or could not otherwise be the product of a valid exercise of business judgment") (citing Saxe, 184 A.2d at 610); see also Marino, supra note 49, at 1237-45.

[57] It is no excuse for plaintiffs to argue that they are unable to allege these particularized facts because they are cut off from access to discovery at the pre-suit demand stage of a derivative suit. Plaintiffs have the opportunity to use the "tools at hand" to learn facts relating to Crystal's report and the Board's consideration through an interview with Crystal or by seeking appropriate and precisely identified corporate records in a Section 220 proceeding. See infra text accompanying notes 73-75.

[58] In re The Walt Disney Co. Derivative Litig., 731 A.2d at 362 (quoting Glazer v. Zapata Corp., Del.Ch., 658 A.2d 176, 183 (1993)).

[59] Id. (quoting Grimes, 673 A.2d at 1215).

[60] See id. at 362-63.

[61] Id. at 363. This statement, however, is somewhat misleading in that the "B" options would not have come into being unless the employment were extended beyond the original five years. It is correct, however, that this non-fault termination cut off the possibility of Ovitz receiving those options and that those options had been a potentially valuable incentive for Ovitz to remain in Disney's employ, an incentive that Ovitz relinquished.

[62] See id. at 350.

[63] Vogelstein, 699 A.2d at 336 (emphasis in original) (citations omitted); accord Grimes, 673 A.2d at 1214.

[64] Cf. Williams v. Geier, Del.Supr., 671 A.2d 1368, 1377 (1996) (noting the inapplicability of a reasonableness analysis in a case that "does not involve either unilateral director action in the face of a claimed threat or an act of disenfranchisement").

[65] Directors' business "decisions will not be disturbed if they can be attributed to any rational business purpose." Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717, 720 (1971).

[66] The business judgment rule has been well formulated by Aronson and other cases. See, e.g., Aronson, 473 A.2d at 812 ("It is a presumption that in making a business decision the directors ... acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation."). Thus, directors' decisions will be respected by courts unless the directors are interested or lack independence relative to the decision, do not act in good faith, act in a manner that cannot be attributed to a rational business purpose or reach their decision by a grossly negligent process that includes the failure to consider all material facts reasonably available.

[67] In re The Walt Disney Co. Derivative Litig., 731 A.2d at 364.

[68] Id. at 363-64.

[69] In re The Walt Disney Co. Derivative Litig., 731 A.2d at 364 (footnote omitted).

[70] Rule 11(b) provides, in part, that subject to sanctions for violating the rule, an attorney "[b]y presenting to the Court ... a [signed] pleading ... is certifying that to the best of the [attorney's] knowledge, information and belief, formed after an inquiry reasonable under the circumstances ... the allegations and other factual contentions have evidentiary support or, if specifically so identified, are likely to have evidentiary support after a reasonable opportunity for further investigation or discovery."

[71] See Ct.Ch.R. 8(a).

[72] See Levine, 591 A.2d at 208-210.

[73] See Grimes, 673 A.2d at 1216 n. 11, 1218; Scattered Corp., 701 A.2d at 78; Rales v. Blasband, Del.Supr., 634 A.2d 927, 935 n. 10 (1993).

[74] 8 Del.C. § 220; see note 57 supra.

[75] See Security First Corp. v. U.S. Die Casting & Dev. Corp., Del.Supr., 687 A.2d 563, 567-569 (1997) (noting that "[i]t is well established that investigation of mismanagement is a proper purpose for a Section 220 books and records inspection" but that a party needs to show, by a preponderance of the evidence, that there is a legitimate chance that their reason for suspecting mismanagement is credible — a "threshold [that] may be satisfied... through documents, logic, testimony or otherwise"); see also DeMott, supra note 24, § 4:15, at 90.

[76] See In re The Walt Disney Co. Derivative Litig., 731 A.2d at 380.

[77] See Ct.Ch.R. 41(b).

[78] Compare Malone v. Brincat, Del.Supr., 722 A.2d 5, 14 (1998), where we similarly affirmed a dismissal but reversed to the extent that the dismissal was with prejudice, thus permitting plaintiff to replead.

[79] See Kay v. Scott, Del.Supr., 233 A.2d 52 (1967).

[80] Rabkin v. Philip A. Hunt Chemical Corp., Del.Supr., 498 A.2d 1099, 1104 (1985).

[81] See 7C Charles Alan Wright et al., Federal Practice and Procedure: Federal Rules of Civil Procedure Rules 23.1 to 25 § 1836 (2d ed.1986) (citing Mayflower Hotel Stockholders Protective Comm. v. Mayflower Hotel Corp., D.C.Cir., 173 F.2d 416 (1949); Overfield v. Pennroad Corp., 3d Cir., 113 F.2d 6 (1940); Citrin v. Greater New York Indus., Inc., S.D.N.Y., 79 F.Supp. 692 (1948); and Issner v. Aldrich, D.Del., 254 F.Supp. 696 (1966)).

[82] See id. at § 1871.

Robert K. Payson, (argued) of Potter, Anderson & Corroon, Wilmington, and Thomas F. Curnin, Thomas J. Kavaler, P. Kevin Castel and Edward P. Krugman of Cahill, Gordon & Reindel, New York City, of counsel, for defendant-appellant.

Charles F. Richards, Jr. of Richards, Layton & Finger, Wilmington, for individual defendants.

Irving Morris and Joseph A. Rosenthal of Morris & Rosenthal, Wilmington, Sidney L. Garwin (argued), and Bruce E. Gerstein of Garwin, Bronzaft & Gerstein, New York City, of counsel, for plaintiff-appellee.

Arthur G. Connolly, Jr. of Connolly, Bove & Lodge, Wilmington, for amici curiae.

Before DUFFY, QUILLEN and HORSEY, JJ.

[780] QUILLEN, Justice:

This is an interlocutory appeal from an order entered on April 9, 1980, by the Court of Chancery denying appellant-defendant Zapata Corporation's (Zapata) alternative motions to dismiss the complaint or for summary judgment. The issue to be addressed has reached this Court by way of a rather convoluted path.

In June, 1975, William Maldonado, a stockholder of Zapata, instituted a derivative action in the Court of Chancery on behalf of Zapata against ten officers and/or directors of Zapata, alleging, essentially, breaches of fiduciary duty. Maldonado did not first demand that the board bring this action, stating instead such demand's futility because all directors were named as defendants and allegedly participated in the acts specified.^[1] In June, 1977, Maldonado commenced an action in the United States District Court for the Southern District of New York against the same defendants, save one, alleging federal security law violations as well as the same common law claims made previously in the Court of Chancery.

[781] By June, 1979, four of the defendant-directors were no longer on the board, and the remaining directors appointed two new outside directors to the board. The board then created an "Independent Investigation Committee" (Committee), composed solely of the two new directors, to investigate Maldonado's actions, as well as a similar derivative action then pending in Texas, and to determine whether the corporation should continue any or all of the litigation. The Committee's determination was stated to be "final, ... not ... subject to review by the Board of Directors and ... in all respects ... binding upon the Corporation."

Following an investigation, the Committee concluded, in September, 1979, that each action should "be dismissed forthwith as their continued maintenance is inimical to the Company's best interests...." Consequently, Zapata moved for dismissal or summary judgment in the three derivative actions. On January 24, 1980, the District Court for the Southern District of New York granted Zapata's motion for summary judgment, Maldonado v. Flynn, S.D.N.Y., 485 F.Supp. 274 (1980), holding, under its interpretation of Delaware law, that the Committee had the authority, under the "business judgment" rule, to require the termination of the derivative action. Maldonado appealed that decision to the Second Circuit Court of Appeals.

On March 18, 1980, the Court of Chancery, in a reported opinion, the basis for the order of April 9, 1980, denied Zapata's motions, holding that Delaware law does not sanction this means of dismissal. More specifically, it held that the "business judgment" rule is not a grant of authority to dismiss derivative actions and that a stockholder has an individual right to maintain derivative actions in certain instances. Maldonado v. Flynn, Del.Ch., 413 A.2d 1251 (1980) (herein Maldonado). Pursuant to the provisions of Supreme Court Rule 42, Zapata filed an interlocutory appeal with this Court shortly thereafter. The appeal was accepted by this Court on June 5, 1980. On May 29, 1980, however, the Court of Chancery dismissed Maldonado's cause of action, its decision based on principles of res judicata, expressly conditioned upon the Second Circuit affirming the earlier New York District Court's decision.^[2] The Second Circuit appeal was ordered stayed, however, pending this Court's resolution of the appeal from the April 9th Court of Chancery order denying dismissal and summary judgment.

Thus, Zapata's observation that it sits "in a procedural gridlock" appears quite accurate, and we agree that this Court can and should attempt to resolve the particular question of Delaware law.^[3] As the Vice Chancellor noted, 413 A.2d at 1257, "it is the law of the State of incorporation which determines whether the directors have this power of dismissal, Burks v. Lasker, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979)". We limit our review in this interlocutory appeal to whether the Committee has the power to cause the present action to be dismissed.

We begin with an examination of the carefully considered opinion of the Vice Chancellor which states, in part, that the "business judgment" rule does not confer power "to a corporate board of directors to terminate a derivative suit", 413 A.2d at 1257. His conclusion is particularly pertinent because several federal courts, applying Delaware law, have held that the business judgment rule enables boards (or their committees) to terminate derivative suits, decisions now in conflict with the holding below.^[4]

[782] As the term is most commonly used, and given the disposition below, we can understand the Vice Chancellor's comment that "the business judgment rule is irrelevant to the question of whether the Committee has the authority to compel the dismissal of this suit". 413 A.2d at 1257. Corporations, existing because of legislative grace, possess authority as granted by the legislature. Directors of Delaware corporations derive their managerial decision making power, which encompasses decisions whether to initiate, or refrain from entering, litigation,^[5] from 8 Del.C. § 141 (a).^[6] This statute is the fount of directorial powers. The "business judgment" rule is a judicial creation that presumes propriety, under certain circumstances, in a board's decision.^[7] Viewed defensively, it does not create authority. In this sense the "business judgment" rule is not relevant in corporate decision making until after a decision is made. It is generally used as a defense to an attack on the decision's soundness. The board's managerial decision making power, however, comes from § 141(a). The judicial creation and legislative grant are related because the "business judgment" rule evolved to give recognition and deference to directors' business expertise when exercising their managerial power under § 141(a).

In the case before us, although the corporation's decision to move to dismiss or for summary judgment was, literally, a decision resulting from an exercise of the directors' (as delegated to the Committee) business judgment, the question of "business judgment", in a defensive sense, would not become relevant until and unless the decision to seek termination of the derivative lawsuit was attacked as improper. Maldonado, 413 A.2d at 1257. Accord, Abella v. Universal Leaf Tobacco Co., Inc., E.D.Va., 495 F.Supp. 713 (1980) (applying Virginia law); Maher v. Zapata Corp., S.D.Tex., 490 F.Supp. 348 (1980) (applying Delaware law). See also, Dent, supra note 5, 75 Nw.U.L. Rev. at 101-02, 135. This question was not reached by the Vice Chancellor because he determined that the stockholder had an individual right to maintain this derivative action. Maldonado, 413 A.2d at 1262.

Thus, the focus in this case is on the power to speak for the corporation as to whether the lawsuit should be continued or terminated. As we see it, this issue in the current appellate posture of this case has three aspects: the conclusions of the Court below concerning the continuing right of a stockholder to maintain a derivative action; the corporate power under Delaware law of an authorized board committee to cause dismissal of litigation instituted for the benefit of the corporation; and the role of the Court of Chancery in resolving conflicts between the stockholder and the committee.

Accordingly, we turn first to the Court of Chancery's conclusions concerning the right of a plaintiff stockholder in a derivative action. We find that its determination that a stockholder, once demand is made and refused, possesses an independent, individual right to continue a derivative suit for breaches of fiduciary duty over objection by the corporation, Maldonado, 413 A.2d at 1262-63, as an absolute rule, is erroneous. The Court of Chancery relied principally upon Sohland v. Baker, Del.Supr., 141 A. [783] 277 (1927), for this statement of the Delaware rule. Maldonado, 413 A.2d at 1260-61. Sohland is sound law. But Sohland cannot be fairly read as supporting the broad proposition which evolved in the opinion below.

In Sohland, the complaining stockholder was allowed to file the derivative action in equity after making demand and after the board refused to bring the lawsuit. But the question before us relates to the power of the corporation by motion to terminate a lawsuit properly commenced by a stockholder without prior demand. No Delaware statute or case cited to us directly determines this new question and we do not think that Sohland addresses it by implication.

The language in Sohland relied on by the Vice Chancellor negates the contention that the case stands for the broad rule of stockholder right which evolved below. This Court therein stated that "a stockholder may sue in his own name for the purpose of enforcing corporate rights ... in a proper case if the corporation on the demand of the stockholder refuses to bring suit." 141 A. at 281 (emphasis added). The Court also stated that "whether ["[t]he right of a stockholder to file a bill to litigate corporate rights"] exists necessarily depends on the facts of each particular case." 141 A. at 282 (emphasis added). Thus, the precise language only supports the stockholder's right to initiate the lawsuit. It does not support an absolute right to continue to control it.

Additionally, the issue and context in Sohland are simply different from this case. Baker, a stockholder, suing on behalf of Bankers' Mortgage Co., sought cancellation of stock issued to Sohland, a director of Bankers', in a transaction participated in by a "great majority" of Bankers' board. Before instituting his suit, Baker requested the board to assert the cause of action. The board refused. Interestingly, though, on the same day the board refused, it authorized payment of Baker's attorneys fees so that he could pursue the claim; one director actually escorted Baker to the attorneys suggested by the board. At this chronological point, Sohland had resigned from the board, and it was he, not the board, who was protesting Baker's ability to bring suit. In sum, despite the board's refusal to bring suit, it is clear that the board supported Baker in his efforts.^[8] It is not surprising then that he was allowed to proceed as the corporation's representative "for the prevention of injustice", because "the corporation itself refused to litigate an apparent corporate right." 141 A. at 282.

Moreover, McKee v. Rogers, Del.Ch., 156 A. 191 (1931), stated "as a general rule" that "a stockholder cannot be permitted... to invade the discretionary field committed to the judgment of the directors and sue in the corporation's behalf when the managing body refuses. This rule is a well settled one." 156 A. at 193.^[9]

The McKee rule, of course, should not be read so broadly that the board's refusal will be determinative in every instance. Board members, owing a well-established fiduciary duty to the corporation, will not be allowed to cause a derivative suit to be dismissed when it would be a breach of their fiduciary duty. Generally [784] disputes pertaining to control of the suit arise in two contexts.

Consistent with the purpose of requiring a demand, a board decision to cause a derivative suit to be dismissed as detrimental to the company, after demand has been made and refused, will be respected unless it was wrongful.^[10] See, e. g., United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-64, 37 S.Ct. 509, 510, 61 L.Ed. 1119, 1124 (1917); Stockholder Derivative Actions, supra note 5, 44 U.Chi. L.Rev. at 169, 191-92; Note, Demand on Directors and Shareholders as a Prerequisite to a Derivative Suit, 73 Har.L.Rev. 746, 748, 759 (1960); 13 W. Fletcher, Cyclopedia of the Law of Private Corporations § 5969 (rev.perm.ed. 1980). A claim of a wrongful decision not to sue is thus the first exception and the first context of dispute. Absent a wrongful refusal, the stockholder in such a situation simply lacks legal managerial power. Compare Maldonado, 413 A.2d at 1259-60.

But it cannot be implied that, absent a wrongful board refusal, a stockholder can never have an individual right to initiate an action. For, as is stated in McKee, a "well settled" exception exists to the general rule.

"[A] stockholder may sue in equity in his derivative right to assert a cause of action in behalf of the corporation, without prior demand upon the directors to sue, when it is apparent that a demand would be futile, that the officers are under an influence that sterilizes discretion and could not be proper persons to conduct the litigation."

156 A. at 193 (emphasis added). This exception, the second context for dispute, is consistent with the Court of Chancery's statement below, that "[t]he stockholders' individual right to bring the action does not ripen, however, ... unless he can show a demand to be futile." Maldonado, 413 A.2d at 1262.^[11]

These comments in McKee and in the opinion below make obvious sense. A demand, when required and refused (if not wrongful), terminates a stockholder's legal ability to initiate a derivative action.^[12] But where demand is properly excused, the stockholder does possess the ability to initiate the action on his corporation's behalf.

These conclusions, however, do not determine the question before us. Rather, they merely bring us to the question to be decided. It is here that we part company with the Court below. Derivative suits enforce corporate rights and any recovery obtained goes to the corporation. Taormina v. Taormina Corp., Del.Ch., 78 A.2d 473, 476 (1951); Keenan v. Eshleman, Del.Supr., 2 A.2d 904, 912-13 (1938). "The right of a stockholder to file a bill to litigate corporate rights is, therefore, solely for the purpose of preventing injustice where it is apparent that material corporate rights would not otherwise be protected." Sohland, 141 A. at 282. We see no inherent reason why the "two phases" of a derivative suit, the stockholder's suit to compel the corporation to sue and the corporation's suit (see 413 A.2d at 1261-62), should automatically result in the placement in the hands of the [785] litigating stockholder sole control of the corporate right throughout the litigation. To the contrary, it seems to us that such an inflexible rule would recognize the interest of one person or group to the exclusion of all others within the corporate entity. Thus, we reject the view of the Vice Chancellor as to the first aspect of the issue on appeal.

The question to be decided becomes: When, if at all, should an authorized board committee be permitted to cause litigation, properly initiated by a derivative stockholder in his own right, to be dismissed? As noted above, a board has the power to choose not to pursue litigation when demand is made upon it, so long as the decision is not wrongful. If the board determines that a suit would be detrimental to the company, the board's determination prevails. Even when demand is excusable, circumstances may arise when continuation of the litigation would not be in the corporation's best interests. Our inquiry is whether, under such circumstances, there is a permissible procedure under § 141(a) by which a corporation can rid itself of detrimental litigation. If there is not, a single stockholder in an extreme case might control the destiny of the entire corporation. This concern was bluntly expressed by the Ninth Circuit in Lewis v. Anderson, 9th Cir., 615 F.2d 778, 783 (1979), cert. denied, ___ U.S. ___, 101 S.Ct. 206, 66 L.Ed.2d 89 (1980): "To allow one shareholder to incapacitate an entire board of directors merely by leveling charges against them gives too much leverage to dissident shareholders." But, when examining the means, including the committee mechanism examined in this case, potentials for abuse must be recognized. This takes us to the second and third aspects of the issue on appeal.

Before we pass to equitable considerations as to the mechanism at issue here, it must be clear that an independent committee possesses the corporate power to seek the termination of a derivative suit. Section 141(c) allows a board to delegate all of its authority to a committee.^[13] Accordingly, a committee with properly delegated authority would have the power to move for dismissal or summary judgment if the entire board did.

Even though demand was not made in this case and the initial decision of whether to litigate was not placed before the board, Zapata's board, it seems to us, retained all of its corporate power concerning litigation decisions. If Maldonado had made demand on the board in this case, it could have refused to bring suit. Maldonado could then have asserted that the decision not to sue was wrongful and, if correct, would have been allowed to maintain the suit. The board, however, never would have lost its statutory managerial authority. The demand requirement itself evidences that the managerial power is retained [786] by the board. When a derivative plaintiff is allowed to bring suit after a wrongful refusal, the board's authority to choose whether to pursue the litigation is not challenged although its conclusion — reached through the exercise of that authority — is not respected since it is wrongful. Similarly, Rule 23.1, by excusing demand in certain instances, does not strip the board of its corporate power. It merely saves the plaintiff the expense and delay of making a futile demand resulting in a probable tainted exercise of that authority in a refusal by the board or in giving control of litigation to the opposing side. But the board entity remains empowered under § 141(a) to make decisions regarding corporate litigation. The problem is one of member disqualification, not the absence of power in the board.

The corporate power inquiry then focuses on whether the board, tainted by the self-interest of a majority of its members, can legally delegate its authority to a committee of two disinterested directors. We find our statute clearly requires an affirmative answer to this question. As has been noted, under an express provision of the statute, § 141(c), a committee can exercise all of the authority of the board to the extent provided in the resolution of the board. Moreover, at lest by analogy to our statutory section on interested directors, 8 Del.C. § 141, it seems clear that the Delaware statute is designed to permit disinterested directors to act for the board.^[14] Compare Puma v. Marriott, Del.Ch., 283 A.2d 693, 695-96 (1971).

We do not think that the interest taint of the board majority is per se a legal bar to the delegation of the board's power to an independent committee composed of disinterested board members. The committee can properly act for the corporation to move to dismiss derivative litigation that is believed to be detrimental to the corporation's best interest.

Our focus now switches to the Court of Chancery which is faced with a stockholder assertion that a derivative suit, properly instituted, should continue for the benefit of the corporation and a corporate assertion, properly made by a board committee acting with board authority, that the same derivative suit should be dismissed as inimical to the best interests of the corporation.

At the risk of stating the obvious, the problem is relatively simple. If, on the one hand, corporations can consistently wrest bona fide derivative actions away from well-meaning derivative plaintiffs through the use of the committee mechanism, the derivative suit will lose much, if not all, of its generally-recognized effectiveness as an intra-corporate means of policing boards of directors. See Dent, supra note 5, 75 Nw.U. L.Rev. at 96 & n. 3, 144 & n. 241. If, on the other hand, corporations are unable to rid themselves of meritless or harmful litigation [787] and strike suits, the derivative action, created to benefit the corporation, will produce the opposite, unintended result. For a discussion of strike suits, see Dent, supra, 75 Nw.U.L.Rev. at 137. See also Cramer v. General Telephone & Electronics Corp., 3d Cir., 582 F.2d 259, 275 (1978), cert. denied, 439 U.S. 1129, 99 S.Ct. 1048, 59 L.Ed.2d 90 (1979). It thus appears desirable to us to find a balancing point where bona fide stockholder power to bring corporate causes of action cannot be unfairly trampled on by the board of directors, but the corporation can rid itself of detrimental litigation.

As we noted, the question has been treated by other courts as one of the "business judgment" of the board committee. If a "committee, composed of independent and disinterested directors, conducted a proper review of the matters before it, considered a variety of factors and reached, in good faith, a business judgment that [the] action was not in the best interest of [the corporation]", the action must be dismissed. See, e. g., Maldonado v. Flynn, supra, 485 F.Supp. at 282, 286. The issues become solely independence, good faith, and reasonable investigation. The ultimate conclusion of the committee, under that view, is not subject to judicial review.

We are not satisfied, however, that acceptance of the "business judgment" rationale at this stage of derivative litigation is a proper balancing point. While we admit an analogy with a normal case respecting board judgment, it seems to us that there is sufficient risk in the realities of a situation like the one presented in this case to justify caution beyond adherence to the theory of business judgment.

The context here is a suit against directors where demand on the board is excused. We think some tribute must be paid to the fact that the lawsuit was properly initiated. It is not a board refusal case. Moreover, this complaint was filed in June of 1975 and, while the parties undoubtedly would take differing views on the degree of litigation activity, we have to be concerned about the creation of an "Independent Investigation Committee" four years later, after the election of two new outside directors. Situations could develop where such motions could be filed after years of vigorous litigation for reasons unconnected with the merits of the lawsuit.

Moreover, notwithstanding our conviction that Delaware law entrusts the corporate power to a properly authorized committee, we must be mindful that directors are passing judgment on fellow directors in the same corporation and fellow directors, in this instance, who designated them to serve both as directors and committee members. The question naturally arises whether a "there but for the grace of God go I" empathy might not play a role. And the further question arises whether inquiry as to independence, good faith and reasonable investigation is sufficient safeguard against abuse, perhaps subconscious abuse.

There is another line of exploration besides the factual context of this litigation which we find helpful. The nature of this motion finds no ready pigeonhole, as perhaps illustrated by its being set forth in the alternative. It is perhaps best considered as a hybrid summary judgment motion for dismissal because the stockholder plaintiff's standing to maintain the suit has been lost. But it does not fit neatly into a category described in Rule 12(b) of the Court of Chancery Rules nor does it correspond directly with Rule 56 since the question of genuine issues of fact on the merits of the stockholder's claim are not reached.

It seems to us that there are two other procedural analogies that are helpful in addition to reference to Rules 12 and 56. There is some analogy to a settlement in that there is a request to terminate litigation without a judicial determination of the merits. See Perrine v. Pennroad Corp., Del. Supr., 47 A.2d 479, 487 (1946). "In determining whether or not to approve a proposed settlement of a derivative stockholders' action [when directors are on both sides of the transaction], the Court of Chancery is called upon to exercise its own business judgment." Neponsit Investment Co. v. Abramson, Del.Supr., 405 A.2d 97, 100 (1979) and cases therein cited. In this case, [788] the litigating stockholder plaintiff facing dismissal of a lawsuit properly commenced ought, in our judgment, to have sufficient status for strict Court review.

Finally, if the committee is in effect given status to speak for the corporation as the plaintiff in interest, then it seems to us there is an analogy to Court of Chancery Rule 41(a)(2) where the plaintiff seeks a dismissal after an answer. Certainly, the position of record of the litigating stockholder is adverse to the position advocated by the corporation in the motion to dismiss. Accordingly, there is perhaps some wisdom to be gained by the direction in Rule 41(a)(2) that "an action shall not be dismissed at the plaintiff's instance save upon order of the Court and upon such terms and conditions as the Court deems proper."

Whether the Court of Chancery will be persuaded by the exercise of a committee power resulting in a summary motion for dismissal of a derivative action, where a demand has not been initially made, should rest, in our judgment, in the independent discretion of the Court of Chancery. We thus steer a middle course between those cases which yield to the independent business judgment of a board committee and this case as determined below which would yield to unbridled plaintiff stockholder control. In pursuit of the course, we recognize that "[t]he final substantive judgment whether a particular lawsuit should be maintained requires a balance of many factors — ethical, commercial, promotional, public relations, employee relations, fiscal as well as legal." Maldonado v. Flynn, supra, 485 F.Supp. at 285. But we are content that such factors are not "beyond the judicial reach" of the Court of Chancery which regularly and competently deals with fiduciary relationships, disposition of trust property, approval of settlements and scores of similar problems. We recognize the danger of judicial overreaching but the alternatives seem to us to be outweighed by the fresh view of a judicial outsider. Moreover, if we failed to balance all the interests involved, we would in the name of practicality and judicial economy foreclose a judicial decision on the merits. At this point, we are not convinced that is necessary or desirable.

After an objective and thorough investigation of a derivative suit, an independent committee may cause its corporation to file a pretrial motion to dismiss in the Court of Chancery. The basis of the motion is the best interests of the corporation, as determined by the committee. The motion should include a thorough written record of the investigation and its findings and recommendations. Under appropriate Court supervision, akin to proceedings on summary judgment, each side should have an opportunity to make a record on the motion. As to the limited issues presented by the motion noted below, the moving party should be prepared to meet the normal burden under Rule 56 that there is no genuine issue as to any material fact and that the moving party is entitled to dismiss as a matter of law.^[15] The Court should apply a two-step test to the motion.

First, the Court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. Limited discovery may be ordered to facilitate such inquiries.^[16] The corporation should have the burden of proving independence, good faith and a reasonable investigation, rather than presuming independence, good faith and reasonableness.^[17] [789] If the Court determines either that the committee is not independent or has not shown reasonable bases for its conclusions, or, if the Court is not satisfied for other reasons relating to the process, including but not limited to the good faith of the committee, the Court shall deny the corporation's motion. If, however, the Court is satisfied under Rule 56 standards that the committee was independent and showed reasonable bases for good faith findings and recommendations, the Court may proceed, in its discretion, to the next step.

The second step provides, we believe, the essential key in striking the balance between legitimate corporate claims as expressed in a derivative stockholder suit and a corporation's best interests as expressed by an independent investigating committee. The Court should determine, applying its own independent business judgment, whether the motion should be granted.^[18] This means, of course, that instances could arise where a committee can establish its independence and sound bases for its good faith decisions and still have the corporation's motion denied. The second step is intended to thwart instances where corporate actions meet the criteria of step one, but the result does not appear to satisfy its spirit, or where corporate actions would simply prematurely terminate a stockholder grievance deserving of further consideration in the corporation's interest. The Court of Chancery of course must carefully consider and weigh how compelling the corporate interest in dismissal is when faced with a non-frivolous lawsuit. The Court of Chancery should, when appropriate, give special consideration to matters of law and public policy in addition to the corporation's best interests.

If the Court's independent business judgment is satisfied, the Court may proceed to grant the motion, subject, of course, to any equitable terms or conditions the Court finds necessary or desirable.

The interlocutory order of the Court of Chancery is reversed and the cause is remanded for further proceedings consistent with this opinion.

[*] The appeal was argued on Oct. 16, 1980 but certain procedural matters required by this Court were not accomplished until the date indicated.

[1] Court of Chancery Rule 23.1 states in part:

"The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and the reasons for his failure to obtain the action or for not making the effort."

[2] Maldonado v. Flynn, Del.Ch., 417 A.2d 378 (1980). Proceedings in the Trial Court are not automatically stayed during the pendency of an interlocutory appeal. Supreme Court Rule 42(d).

[3] The District Court for the Southern District of Texas, in Maher v. Zapata Corp., S.D.Tex., 490 F.Supp. 348 (1980), denied Zapata's motions to dismiss or for summary judgment in an opinion consistent with Maldonado.

[4] Abbey v. Control Data Corp., 8th Cir., 603 F.2d 724 (1979), cert. denied, 444 U.S. 1017, 100 S.Ct. 670, 62 L.Ed.2d 647 (1980); Lewis v. Adams, N.D.Okl., No. 77-266C (November 15, 1979); Siegal v. Merrick, S.D.N.Y., 84 F.R.D. 106 (1979); and, of course, Maldonado v. Flynn, S.D.N.Y., 485 F.Supp. 274 (1980). See also Abramowitz v. Posner, S.D.N.Y., 513 F.Supp. 120, (1981) which specifically rejected the result reached by the Vice Chancellor in this case.

[5] See Dent, The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit? 75 Nw.U.L.Rev. 96, 98 & n. 14 (1980); Comment, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U.Chi.L.Rev. 168, 192 & nn. 153-54 (1976) (herein Stockholder Derivative Actions).

[6] 8 Del.C. § 141(a) states:

"The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation."

[7] See Arsht, The Business Judgment Rule Revisited, 8 Hofstra L.Rev. 93, 97, 130-33 (1979).

[8] Compare Baker v. Bankers' Mortgage Co., Del.Ch., 129 A. 775, 776-77 (1925), the lower Sohland. In Baker, Chancellor Wolcott posed a rhetorical question that is entirely consistent with the result we reach today: "[W]hy should not a stockholder, if the managing body absolutely refuses to act, be permitted to assert on behalf of himself and other stockholders a complaint, not against matters lying in sound discretion and honest judgment, but against frauds perpetrated by an officer in clear breach of his trust?" 129 A. at 777.

[9] To the extent that Mayer v. Adams, Del. Supr., 141 A.2d 458, 462 (1958) and Ainscow v. Sanitary Co. of America, Del.Ch., 180 A. 614, 615 (1935), relied upon in Maldonado, 413 A.2d at 1262, contain language relating to the rule in McKee, we note that each decision is dissimilar from the one we examine today. Mayer held that demand on the stockholders was not required before maintaining a derivative suit if the wrong alleged could not be ratified by the stockholders. Ainscow found defective a complaint that neither alleged demand on the directors, nor reasons why demand was excusable.

[10] In other words, when stockholders, after making demand and having their suit rejected, attack the board's decision as improper, the board's decision falls under the "business judgment" rule and will be respected if the requirements of the rule are met. See Dent, supra note 5, 75 Nw.U.L.Rev. at 100-01 & nn. 24-25. That situation should be distinguished from the instant case, where demand was not made, and the power of the board to seek a dismissal, due to disqualification, presents a threshold issue. For examples of what has been held to be a wrongful decision not to sue, see Stockholder Derivative Actions, supra note 5, 44 U.Chi.L. Rev. at 193-98. We recognize that the two contexts can overlap in practice.

[11] These statements are consistent with Rule 23.1's "reasons for ... failure" to make demand. See also the other cases cited by the Vice Chancellor, 413 A.2d at 1262: Ainscow v. Sanitary Co. of America, supra note 9, 180 A. at 615; Mayer v. Adams, supra note 9, 141 A.2d at 462; Dann v. Chrysler Corp., Del.Ch., 174 A.2d 696, 699-700 (1961).

[12] Even in this situation, it may take litigation to determine the stockholder's lack of power, i. e., standing.

[13] 8 Del.C. § 141(c) states:

"The board of directors may, by resolution passed by a majority of the whole board, designate 1 or more committees, each committee to consist of 1 or more of the directors of the corporation. The board may designate 1 or more directors as alternative members of any committee, who may replace any absent or disqualified member at any meeting of the committee. The bylaws may provide that in the absence or disqualification of a member of a committee, the member or members present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the board of directors, or in the bylaws of the corporation, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it; but no such committee shall have the power or authority in reference to amending the certificate of incorporation, adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease or exchange of all or substantially all of the corporation's property and assets, recommending to the stockholders a dissolution of the corporation or a revocation of a dissolution, or amending the bylaws of the corporation; and, unless the resolution, bylaws, or certificate of incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend or to authorize the issuance of stock."

[14] 8 Del.C. § 144 states:

"§ 144. Interested directors; quorum.

(a) No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because his or their votes are counted for such purpose, if:

(1) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or

(2) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the shareholders; or

(3) The contract or transaction is fair to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee, or the shareholders.

(b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction."

[15] We do not foreclose a discretionary trial of factual issues but that issue is not presented in this appeal. See Lewis v. Anderson, supra, 615 F.2d at 780. Nor do we foreclose the possibility that other motions may proceed or be joined with such a pretrial summary judgment motion to dismiss, e. g., a partial motion for summary judgment on the merits.

[16] See, e. g., Galef v. Alexander, 2d Cir., 615 F.2d 51, 56 (1980); Maldonado v. Flynn, supra, 485 F.Supp. at 285-86; Rosengarten v. International Telephone & Telegraph Corp., S.D.N.Y., 466 F.Supp. 817, 823 (1979); Gall v. Exxon Corp., S.D.N.Y., 418 F.Supp. 508, 520 (1976). Compare Dent, supra note 5, 75 Nw.U.L.Rev. at 131-33.

[17] Compare Auerbach v. Bennett, 47 N.Y.2d 619, 419 N.Y.S.2d 920, 928-29, 393 N.E.2d 994 (1979). Our approach here is analogous to and consistent with the Delaware approach to "interested director" transactions, where the directors, once the transaction is attacked, have the burden of establishing its "intrinsic fairness" to a court's careful scrutiny. See, e. g., Sterling v. Mayflower Hotel Corp., Del.Supr., 93 A.2d 107 (1952).

[18] This step shares some of the same spirit and philosophy of the statement by the Vice Chancellor: "Under our system of law, courts and not litigants should decide the merits of litigation." 413 A.2d at 1263.

[920] Robert D. Goldberg, Esquire, Biggs & Battaglia, Wilmington, Delaware; Lee D. Rudy, Esquire and Robert B. Weiser, Esquire, Schiffrin & Barroway, LLP, Bala Cynwyd, Pennsylvania; Samuel Rudman, Esquire and Douglas Wilens, Esquire, Cauley, Geller, Bowman & Rudman, LLP, Boca Raton, Florida, Attorneys for Plaintiffs.

Kenneth J. Nachbar, Esquire, Morris, Nichols, Arsht & Tunnell, Wilmington, Delaware, Attorney for the Individual Defendants.

David C. McBride, Esquire, Adam W. Poff, Esquire, and Christian Douglas Wright, Esquire, Young Conaway Stargatt & Taylor, LLP, Wilmington, Delaware; George M. Newcombe, Esquire and James G. Kreissman, Esquire, Simpson Thacher & Bartlett, LLP, Palo Alto, California, Attorneys for Nominal Defendant Oracle Corporation.

OPINION

STRINE, Vice Chancellor.

In this opinion, I address the motion of the special litigation committee ("SLC") of Oracle Corporation to terminate this action, "the Delaware Derivative Action," and other such actions pending in the name of Oracle against certain Oracle directors and officers. These actions allege that these Oracle directors engaged in insider trading while in possession of material, non-public information showing that Oracle would not meet the earnings guidance it gave to the market for the third quarter of Oracle's fiscal year 2001. The SLC bears the burden of persuasion on this motion and must convince me that there is no material issue of fact calling into doubt its independence. This requirement is set forth in Zapata Corp. v. Maldonado^[1] and its progeny.^[2]

The question of independence "turns on whether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind."^[3] That is, the independence test ultimately "focus[es] on impartiality and objectivity."^[4] In this case, the SLC has failed to demonstrate that no material factual question exists regarding its independence.

During discovery, it emerged that the two SLC members — both of whom are professors at Stanford University — are being asked to investigate fellow Oracle directors who have important ties to Stanford, too. Among the directors who are accused by the derivative plaintiffs of insider trading are: (1) another Stanford professor, who taught one of the SLC members when the SLC member was a Ph.D. candidate and who serves as a senior fellow and a steering committee member alongside that SLC member at the Stanford Institute for Economic Policy Research or "SIEPR"; (2) a Stanford alumnus who has directed millions of dollars of contributions to Stanford during recent years, serves as Chair of SIEPR's Advisory Board and has a conference center named for him at SIEPR's facility, and has contributed nearly $600,000 to SIEPR and the Stanford Law School, both parts of Stanford with which one of the SLC members is closely affiliated; and (3) Oracle's CEO, who has made millions of dollars in donations to Stanford through a personal [921] foundation and large donations indirectly through Oracle, and who was considering making donations of his $100 million house and $170 million for a scholarship program as late as August 2001, at around the same time period the SLC members were added to the Oracle board. Taken together, these and other facts cause me to harbor a reasonable doubt about the impartiality of the SLC.

It is no easy task to decide whether to accuse a fellow director of insider trading. For Oracle to compound that difficulty by requiring SLC members to consider accusing a fellow professor and two large benefactors of their university of conduct that is rightly considered a violation of criminal law was unnecessary and inconsistent with the concept of independence recognized by our law. The possibility that these extraneous considerations biased the inquiry of the SLC is too substantial for this court to ignore. I therefore deny the SLC's motion to terminate.

I. Factual Background

A. Summary of the Plaintiffs' Allegations

The Delaware Derivative Complaint centers on alleged insider trading by four members of Oracle's board of directors — Lawrence Ellison, Jeffrey Henley, Donald Lucas, and Michael Boskin (collectively, the "Trading Defendants"). Each of the Trading Defendants had a very different role at Oracle.

Ellison is Oracle's Chairman, Chief Executive Officer, and its largest stockholder, owning nearly twenty-five percent of Oracle's voting shares. By virtue of his ownership position, Ellison is one of the wealthiest men in America. By virtue of his managerial position, Ellison has regular access to a great deal of information about how Oracle is performing on a week-to-week basis.

Henley is Oracle's Chief Financial Officer, Executive Vice President, and a director of the corporation. Like Ellison, Henley has his finger on the pulse of Oracle's performance constantly.

Lucas is a director who chairs Oracle's Executive Committee and its Finance and Audit Committee. Although the plaintiffs allege that Lucas's positions gave him access to material, non-public information about the company, they do so cursorily. On the present record, it appears that Lucas did not receive copies of week-to-week projections or reports of actual results for the quarter to date. Rather, his committees primarily received historical financial data.

Boskin is a director, Chairman of the Compensation Committee, and a member of the Finance and Audit Committee. As with Lucas, Boskin's access to information was limited mostly to historical financials and did not include the week-to-week internal projections and revenue results that Ellison and Henley received.

According to the plaintiffs, each of these Trading Defendants possessed material, non-public information demonstrating that Oracle would fail to meet the earnings and revenue guidance it had provided to the market in December 2000. In that guidance, Henley projected—subject to many disclaimers, including the possibility that a softening economy would hamper Oracle's ability to achieve these results — that Oracle would earn 12 cents per share and generate revenues of over $2.9 billion in the third quarter of its fiscal year 2001 ("3Q FY 2001"). Oracle's 3Q FY 2001 ran from December 1, 2000 to February 28, 2001.

The plaintiffs allege that this guidance was materially misleading and became even more so as early results for the quarter came in. To start with, the plaintiffs assert that the guidance rested on an untenably [922] rosy estimate of the performance of an important new Oracle product, its "Suite 1li" systems integration product that was designed to enable a business to run all of its information systems using a complete, integrated package of software with financial, manufacturing, sales, logistics, and other applications features that were "inter-operable." The reality, the plaintiffs contend, was that Suite 11i was riddled with bugs and not ready for prime time. As a result, Suite 11i was not in a position to make a material contribution to earnings growth.

In addition, the plaintiffs contend more generally that the Trading Defendants received material, non-public information that the sales growth for Oracle's other products was slowing in a significant way, which made the attainment of the earnings and revenue guidance extremely difficult. This information grew in depth as the quarter proceeded, as various sources of information that Oracle's top managers relied upon allegedly began to signal weakness in the company's revenues. These signals supposedly included a slowdown in the "pipeline" of large deals that Oracle hoped to close during the quarter and weak revenue growth in the first month of the quarter.

During the time when these disturbing signals were allegedly being sent, the Trading Defendants engaged in the following trades:

• On January 3, 2001, Lucas sold 150,000 shares of Oracle common stock at $30 per share, reaping proceeds of over $4.6 million. These sales constituted 17% of Lucas's Oracle holdings.

• On January 4, 2001, Henley sold one million shares of Oracle stock at approximately $32 per share, yielding over $32.3 million. These sales represented 7% of Henley's Oracle holdings.

• On January 17, 2001, Boskin sold 150,000 shares of Oracle stock at over $33 per share, generating in excess of $5 million. These sales were 16% of Boskin's Oracle holdings.

• From January 22 to January 31, 2001, Ellison sold over 29 million shares at prices above $30 per share, producing over $894 million. Despite the huge proceeds generated by these sales, they constituted the sale of only 2% of Ellison's Oracle holdings.

Into early to mid-February, Oracle allegedly continued to assure the market that it would meet its December guidance. Then, on March 1, 2001, the company announced that rather than posting 12 cents per share in quarterly earnings and 25% license revenue growth as projected, the company's earnings for the quarter would be 10 cents per share and license revenue growth only 6%. The stock market reacted swiftly and negatively to this news, with Oracle's share price dropping as low as $15.75 before closing at $16.88 — a 21% decline in one day. These prices were well below the above $30 per share prices at which the Trading Defendants sold in January 2001.

Oracle, through Ellison and Henley, attributed the adverse results to a general weakening in the economy, which led Oracle's customers to cut back sharply on purchases. Because (the company claimed) most of its sales close in the late days of quarters, the company did not become aware that it would miss its projections until shortly before the quarter closed. The reasons given by Ellison and Henley subjected them to sarcastic rejoinders from analysts, who noted that they had only recently suggested that Oracle was better-positioned than other companies to continue to deliver growth in a weakening economy.

B. The Plaintiffs' Claims in the Delaware Derivative Action

The plaintiffs make two central claims in their amended complaint in the Delaware [923] Derivative Action. First, the plaintiffs allege that the Trading Defendants breached their duty of loyalty by misappropriating inside information and using it as the basis for trading decisions. This claim rests its legal basis on the venerable case of Brophy v. Cities Service Co.^[5] Its factual foundation is that the Trading Defendants were aware (or at least possessed information that should have made them aware) that the company would miss its December guidance by a wide margin and used that information to their advantage in selling at artificially inflated prices.

Second, as to the other defendants — who are the members of the Oracle board who did not trade — the plaintiffs allege a Caremark^[6] violation, in the sense that the board's indifference to the deviation between the company's December guidance and reality was so extreme as to constitute subjective bad faith.

C. The Various Litigations

Oracle's failure to meet its earnings and revenue guidance, and the sales by the Trading Defendants, inevitably generated a spate of lawsuits. Several derivative actions were filed in the state and federal courts of California. Those actions are, in substance, identical to the Delaware Derivative Action. Those suits have now all been stayed in deference to the SLC's investigation and the court's ruling on this motion.

Federal class actions were also filed, and the consolidated complaint in those actions formed the basis for much of the amended complaint in the Delaware Derivative Action. By now, the "Federal Class Action" has been dismissed for failure to state a claim upon which relief can be granted for the third time; this time the order addressing the second amended complaint dismissed the Federal Class Action with prejudice.^[7]

D. The Formation of the Special Litigation Committee

On February 1, 2002, Oracle formed the SLC in order to investigate the Delaware Derivative Action and to determine whether Oracle should press the claims raised by the plaintiffs, settle the case, or terminate it. Soon after its formation, the SLC's charge was broadened to give it the same mandate as to all the pending derivative actions, wherever they were filed.

The SLC was granted full authority to decide these matters without the need for approval by the other members of the Oracle board.

E. The Members of the Special Litigation Committee

Two Oracle board members were named to the SLC. Both of them joined the Oracle board on October 15, 2001, more than a half a year after Oracle's 3Q FY 2001 closed. The SLC members also share something else: both are tenured professors at Stanford University.

Professor Hector Garcia-Molina is Chairman of the Computer Science Department at Stanford and holds the Leonard Bosack and Sandra Lerner Professorship in the Computer Science and Electrical Engineering Departments at Stanford. A renowned expert in his field, Garcia-Molina was a professor at Princeton before coming to Stanford in 1992. Garcia-Molina's appointment at Stanford represented a homecoming of some sort, because he obtained both his undergraduate and graduate degrees from Stanford.

[924] The other SLC member, Professor Joseph Grundfest, is the W.A. Franke Professor of Law and Business at Stanford University. He directs the University's well-known Directors' College^[8] and the Roberts Program in Law, Business, and Corporate Governance at the Stanford Law School. Grundfest is also the principal investigator for the Law School's Securities Litigation Clearinghouse. Immediately before coming to Stanford, Grundfest served for five years as a Commissioner of the Securities and Exchange Commission. Like Garcia-Molina, Grundfest's appointment at Stanford was a homecoming, because he obtained his law degree and performed significant post-graduate work in economics at Stanford.

As will be discussed more specifically later, Grundfest also serves as a steering committee member and a senior fellow of the Stanford Institute for Economic Policy Research, and releases working papers under the "SIEPR" banner.

For their services, the SLC members were paid $250 an hour, a rate below that which they could command for other activities, such as consulting or expert witness testimony. Nonetheless, during the course of their work, the SLC members became concerned that (arguably scandal-driven) developments in the evolving area of corporate governance as well as the decision in Telxon v. Meyerson,^[9] might render the amount of their compensation so high as to be an argument against their independence. Therefore, Garcia-Molina and Grundfest agreed to give up any SLC-related compensation if their compensation was deemed by this court to impair their impartiality.

F. The SLC Members Are Recruited to the Board

The SLC members were recruited to the board primarily by defendant Lucas, with help from defendant Boskin.^[10] The wooing of them began in the summer of 2001. Before deciding to join the Oracle board, Grundfest, in particular, did a good deal of due diligence. His review included reading publicly available information, among other things, the then-current complaint in the Federal Class Action.

Grundfest then met with defendants Ellison and Henley, among others, and asked them some questions about the Federal Class Action. The claims in the Federal Class Action are predicated on facts that are substantively identical to those on which the claims in the Delaware Derivative Action are based. Grundfest received answers that were consistent enough with what he called the "exogenous" information about the case to form sufficient confidence to at least join the Oracle board. Grundfest testified that this did not mean that he had concluded that the claims in the Federal Class Action had no merit, only that Ellison's and Henley's explanations of their conduct were plausible. Grundfest did, however, conclude that these were reputable businessmen with whom he felt comfortable serving as a fellow director, and that Henley had given very impressive answers to difficult questions regarding the way Oracle conducted its financial reporting operations.^[11]

[925] G. The SLC's Advisors

The most important advisors retained by the SLC were its counsel from Simpson Thacher & Bartlett LLP. Simpson Thacher had not performed material amounts of legal work for Oracle^[12] or any of the individual defendants before its engagement, and the plaintiffs have not challenged its independence.

National Economic Research Advisors ("NERA") was retained by the SLC to perform some analytical work. The plaintiffs have not challenged NERA's independence.

H. The SLC's Investigation and Report

The SLC's investigation was, by any objective measure, extensive. The SLC reviewed an enormous amount of paper and electronic records. SLC counsel interviewed seventy witnesses, some of them twice. SLC members participated in several key interviews, including the interviews of the Trading Defendants.

Importantly, the interviewees included all the senior members of Oracle's management most involved in its projection and monitoring of the company's financial performance, including its sales and revenue growth. These interviews combined with a special focus on the documents at the company bearing on these subjects, including e-mail communications.

The SLC also asked the plaintiffs in the various actions to identify witnesses the Committee should interview. The Federal Class Action plaintiffs identified ten such persons and the Committee interviewed all but one, who refused to cooperate. The Delaware Derivative Action plaintiffs and the other derivative plaintiffs declined to provide the SLC with any witness list or to meet with the SLC.

During the course of the investigation, the SLC met with its counsel thirty-five times for a total of eighty hours. In addition to that, the SLC members, particularly Professor Grundfest, devoted many more hours to the investigation.

In the end, the SLC produced an extremely lengthy Report totaling 1,110 pages (excluding appendices and exhibits) that concluded that Oracle should not pursue the plaintiffs' claims against the Trading Defendants or any of the other Oracle directors serving during the 3Q FY 2001. The bulk of the Report defies easy summarization. I endeavor a rough attempt to capture the essence of the Report in understandable terms, surfacing some implicit premises that I understand to have undergirded [926] the SLC's conclusions. Here goes.

Having absorbed a huge amount of material regarding Oracle's financial condition during the relevant period, the flow of information to top Oracle executives, Oracle's business and its products, and the general condition of the market at that time, the SLC concluded that even a hypothetical Oracle executive who possessed all information regarding the company's performance in December and January of 3Q FY 2001 would not have possessed material, non-public information that the company would fail to meet the earnings and revenue guidance it provided the market in December. Although there were hints of potential weakness in Oracle's revenue growth, especially starting in mid-January 2001, there was no reliable information indicating that the company would fall short of the mark, and certainly not to the extent that it eventually did.

Notably, none of the many e-mails from various Oracle top executives in January 2001 regarding the quarter anticipated that the company would perform as it actually did. Although some of these e-mails noted weakening, all are generally consistent with the proposition that Oracle executives expected to achieve the guidance. At strongest, they (in the SLC's view) can be read as indicating some doubts and the possibility that the company would fall short of the mark by a small margin, rather than the large one that ultimately resulted. Furthermore, the SLC found that the plaintiffs' allegations regarding the problems with Suite 11i were overstated and that the market had been adequately apprised of the state of that product's performance. And, as of that quarter, most of Oracle's competitors were still meeting analysts' expectations, suggesting that Oracle's assumption that general economic weakening would not stymie its ability to increase revenues in 3Q FY 2001 was not an unreasonable one.

Important to this conclusion is the SLC's finding that Oracle's quarterly earnings are subject to a so-called "hockey stick effect," whereby a large portion of each quarter's earnings comes in right at the end of the quarter. In 3Q FY 2001, the late influx of revenues that had often characterized Oracle's performance during its emergence as one of the companies with the largest market capitalization in the nation did not materialize; indeed, a large amount of product was waiting in Oracle warehouses for shipment for deals that Oracle had anticipated closing but did not close during the quarter.

Thus, taking into account all the relevant information sources, the SLC concluded that even Ellison and Henley — who were obviously the two Trading Defendants with the most access to inside information — did not possess material, nonpublic information. As to Lucas and Boskin, the SLC noted that they did not receive the weekly updates (of various kinds) that allegedly showed a weakening in Oracle's performance during 3Q FY 2001. As a result, there was even less of a basis to infer wrongdoing on their part.^[13]

In this same regard, the Report also noted that Oracle insiders felt especially confident about meeting 3Q FY 2001 guidance because the company closed a large transaction involving Covisint in December — a transaction that produced revenue giving the company a boost in meeting its guidance. Although the plaintiffs in this case argue that the Covisint transaction [927] was a unique deal that had its origins in earlier quarters when the economy was stronger and that masked a weakening in Oracle's then-current performance, the reality is that that the transaction was a real one of economic substance and that the revenue was properly accounted for in 3Q FY 2001. Combined with other indications that Oracle was on track to meet its guidance, the SLC concluded that the Covisint transaction supported their conclusion that the Trading Defendants did not possess material, non-public information contradicting the company's previous guidance.^[14]

Moreover, as the SLC Report points out, the idea that the Trading Defendants acted with scienter in trading in January 2001 was problematic in light of several factors. Implicitly the first and foremost is the reality that Oracle is a functioning business with real products of value. Although it is plausible to imagine a scenario where someone of Ellison's wealth would cash out, fearing the imminent collapse of a house of cards he had sold to an unsuspecting market, this is not the situation that Ellison faced in January 2001.

As of that time, Oracle faced no collapse, even if it, like other companies, had to deal with a slowing economy. And, as the SLC points out, Ellison sold only two percent of his holdings. A good deal of these sales were related to options that he had held for over nine years and that had to be exercised by August 2001.^[15] In view of Oracle's basic health, Ellison's huge wealth, and his retention of ninety-eight percent of his shares, the SLC concluded that any inference that Ellison acted with scienter and attempted to reap improper trading profits was untenable.

The same reasoning also motivated the SLC's conclusions as to Henley, who sold only seven percent of his stake in Oracle. Both Ellison and Henley stood to expose a great deal of their personal wealth to substantial risk by undertaking a scheme to cash out a small portion of their holdings and risking a greater injury to Oracle, a company in which they retained a far greater stake than they had sold. As important, these executives stood to risk their own personal reputations despite the absence of any personal cash crunch that impelled them to engage in risky, unethical, and illegal behavior.^[16]

Although Lucas and Boskin sold somewhat larger proportions of their Oracle holdings — sixteen percent and seventeen percent respectively — these proportions, the SLC concluded, were of the kind that federal courts had found lacking in suspicion. As with Ellison and Henley, the SLC identified no urgent need on either's part to generate cash by trading (illegally) on non-public, material information.

Of course, the amount of the proceeds each of the Trading Defendants generated was extremely large. By selling only two percent of his holdings, Ellison generated nearly a billion dollars, enough to flee to a [928] small island nation with no extradition laws and to live like a Saudi prince. But given Oracle's fundamental health as a company and his retention of ninety-eight percent of his shares, Ellison (the SLC found) had no need to take desperate — or, for that matter, even slightly risky — measures. The same goes for the other Trading Defendants; there was simply nothing special or urgent about their financial circumstances in January 2001 that would have motivated (or did motivate, in the SLC's view) the Trading Defendants to cash out because they believed that Oracle would miss its earnings guidance. And, of course, the SLC found that none of them possessed information that indicated that Oracle would, in fact, miss its mark for 3Q FY 2001.

For these and other reasons, the SLC concluded that the plaintiffs' allegations that the Trading Defendants had breached their fiduciary duty of loyalty by using inside information about Oracle to reap illicit trading gains were without merit. The SLC also determined that, consistent with this determination, there was no reason to sue the other members of the Oracle board who were in office as of 3Q FY 2001. Therefore, the SLC determined to seek dismissal of the Delaware Derivative Action and the other derivative actions.

II. The SLC Moves to Terminate

Consistent with its Report, the SLC moved to terminate this litigation. The plaintiffs were granted discovery focusing on three primary topics: the independence of the SLC, the good faith of its investigative efforts, and the reasonableness of the bases for its conclusion that the lawsuit should be terminated. Additionally, the plaintiffs received a large volume of documents comprising the materials that the SLC relied upon in preparing its Report.

III. The Applicable Procedural Standard

In order to prevail on its motion to terminate the Delaware Derivative Action, the SLC must persuade me that: (1) its members were independent; (2) that they acted in good faith; and (3) that they had reasonable bases for their recommendations.^[17] If the SLC meets that burden, I am free to grant its motion or may, in my discretion, undertake my own examination of whether Oracle should terminate and permit the suit to proceed if I, in my oxymoronic judicial "business judgment," conclude that procession is in the best interests of the company.^[18] This two-step analysis comes, of course, from Zapata.

In that case, the Delaware Supreme Court also instructed this court to apply a procedural standard akin to a summary judgment inquiry when ruling on a special litigation committee's motion to terminate. In other words, the Oracle SLC here "should be prepared to meet the normal burden under Rule 56 that there is no genuine issue as to any material fact and that [it] is entitled to dismiss as a matter of law."^[19] Candidly, this articulation of a special litigation committee's burden is an odd one, insofar as it applies a procedural standard designed for a particular purpose — the substantive dismissal of a case — with a standard centered on the determination of when a corporate committee's business decision about claims belonging to the corporation should be accepted by the court.

As I understand it, this standard requires me to determine whether, on the [929] basis of the undisputed factual record, I am convinced that the SLC was independent, acted in good faith, and had a reasonable basis for its recommendation. If there is a material factual question about these issues causing doubt about any of these grounds, I read Zapata and its progeny as requiring a denial of the SLC's motion to terminate.^[20]

In this case, the plaintiffs principally challenge the SLC's independence and the reasonableness of its recommendation. For reasons I next explain, I need examine only the more difficult question, which relates to the SLC's independence.

IV. Is the SLC Independent?

A. The Facts Disclosed in the Report

In its Report, the SLC took the position that its members were independent. In support of that position, the Report noted several factors including:

• the fact that neither Grundfest nor Garcia-Molina received compensation from Oracle other than as directors;

• the fact that neither Grundfest nor Garcia-Molina were on the Oracle board at the time of the alleged wrongdoing;

• the fact that both Grundfest and Garcia-Molina were willing to return their compensation as SLC members if necessary to preserve their status as independent;

• the absence of any other material ties between Oracle, the Trading Defendants, and any of the other defendants, on the one hand, and Grundfest and Garcia-Molina, on the other; and

• the absence of any material ties between Oracle, the Trading Defendants, and any of the other defendants, on the one hand, and the SLC's advisors, on the other.

Noticeably absent from the SLC Report was any disclosure of several significant ties between Oracle or the Trading Defendants and Stanford University, the university that employs both members of the SLC. In the Report, it was only disclosed that:

• defendant Boskin was a Stanford professor;

• the SLC members were aware that Lucas had made certain donations to Stanford; and

• among the contributions was a donation of $50,000 worth of stock that Lucas donated to Stanford Law School after Grundfest delivered a speech to a venture capital fund meeting in response to Lucas's request. It happens that Lucas's son is a partner in the fund and that approximately half the donation was allocated for use by Grundfest in his personal research.

B. The "Stanford" Facts that Emerged During Discovery

In view of the modesty of these disclosed ties, it was with some shock that a series of other ties among Stanford, Oracle, and the Trading Defendants emerged during discovery. Although the plaintiffs have embellished these ties considerably [930] beyond what is reasonable, the plain facts are a striking departure from the picture presented in the Report.

Before discussing these facts, I begin with certain features of the record — as I read it — that are favorable to the SLC. Initially, I am satisfied that neither of the SLC members is compromised by a fear that support for the procession of this suit would endanger his ability to make a nice living. Both of the SLC members are distinguished in their fields and highly respected. Both have tenure, which could not have been stripped from them for making a determination that this lawsuit should proceed.

Nor have the plaintiffs developed evidence that either Grundfest or Garcia-Molina have fundraising responsibilities at Stanford. Although Garcia-Molina is a department chairman, the record is devoid of any indication that he is required to generate contributions. And even though Grundfest heads up Stanford's Directors' College, the plaintiffs have not argued that he has a fundraising role in that regard. For this reason, it is important to acknowledge up front that the SLC members occupy positions within the Stanford community different from that of the University's President, deans, and development professionals, all of whom, it can be reasonably assumed, are required to engage heavily in the pursuit of contributions to the University.

This is an important point of departure for discussing the multitude of ties that have emerged among the Trading Defendants, Oracle, and Stanford during discovery in this case. In evaluating these ties, the court is not faced with the relatively easier call of considering whether these ties would call into question the impartiality of an SLC member who was a key fundraiser at Stanford^[21] or who was an untenured faculty member subject to removal without cause. Instead, one must acknowledge that the question is whether the ties I am about to identify would be of a material concern to two distinguished, tenured faculty members whose current jobs would not be threatened by whatever good faith decision they made as SLC members.

With this question in mind, I begin to discuss the specific ties that allegedly compromise the SLC's independence, beginning with those involving Professor Boskin.

1. Boskin

Defendant Michael J. Boskin is the T.M. Friedman Professor of Economics at Stanford University. During the Administration of President George H.W. Bush, Boskin occupied the coveted and important position of Chairman of the President's Council of Economic Advisors. He returned to Stanford after this government [931] service, continuing a teaching career there that had begun many years earlier.

During the 1970s, Boskin taught Grundfest when Grundfest was a Ph.D. candidate. Although Boskin was not Grundfest's advisor and although they do not socialize, the two have remained in contact over the years, speaking occasionally about matters of public policy.

Furthermore, both Boskin and Grundfest are senior fellows and steering committee members at the Stanford Institute for Economic Policy Research, which was previously defined as "SIEPR." According to the SLC, the title of senior fellow is largely an honorary one. According to SIEPR's own web site, however, "[s]enior fellows actively participate in SIEPR research and participate in its governance."^[22]

Likewise, the SLC contends that Grundfest went MIA as a steering committee member, having failed to attend a meeting since 1997. The SIEPR web site, however, identifies its steering committee as having the role of "advising the director [of SIEPR] and guiding [SIEPR] on matters pertaining to research and academics."^[23] Because Grundfest allegedly did not attend to these duties, his service alongside Boskin in that capacity is, the SLC contends, not relevant to his independence.

That said, the SLC does not deny that both Boskin and Grundfest publish working papers under the SIEPR rubric and that SIEPR helps to publicize their respective works. Indeed, as I will note later in this opinion, Grundfest, in the same month the SLC was formed, addressed a meeting of some of SIEPR's largest benefactors — the so-called "SIEPR Associates." The SLC just claims that the SIEPR affiliation is one in which SIEPR basks in the glow of Boskin and Grundfest, not the other way around, and that the mutual service of the two as senior fellows and steering committee members is not a collegial tie of any significance.

With these facts in mind, I now set forth the ties that defendant Lucas has to Stanford.

2. Lucas

As noted in the SLC Report, the SLC members admitted knowing that Lucas was a contributor to Stanford. They also acknowledged that he had donated $50,000 to Stanford Law School in appreciation for Grundfest having given a speech at his request. About half of the proceeds were allocated for use by Grundfest in his research.

But Lucas's ties with Stanford are far, far richer than the SLC Report lets on. To begin, Lucas is a Stanford alumnus, having obtained both his undergraduate and graduate degrees there. By any measure, he has been a very loyal alumnus.

In showing that this is so, I start with a matter of some jousting between the SLC and the plaintiffs. Lucas's brother, Richard, died of cancer and by way of his will established a foundation. Lucas became Chairman of the Foundation and serves as a director along with his son, a couple of other family members, and some non-family members. A principal object of the Foundation's beneficence has been Stanford. The Richard M. Lucas Foundation has given $11.7 million to Stanford since its 1981 founding. Among its notable contributions, the Foundation funded the establishment of the Richard M. Lucas Center [932] for Magnetic Resonance Spectroscopy and Imaging at Stanford's Medical School. Donald Lucas was a founding member and lead director of the Center.

The SLC Report did not mention the Richard M. Lucas Foundation or its grants to Stanford. In its briefs on this motion, the SLC has pointed out that Donald Lucas is one of nine directors at the Foundation and does not serve on its Grant Review Committee. Nonetheless, the SLC does not deny that Lucas is Chairman of the board of the Foundation and that the board approves all grants.

Lucas's connections with Stanford as a contributor go beyond the Foundation, however. From his own personal funds, Lucas has contributed $4.1 million to Stanford, a substantial percentage of which has been donated within the last half-decade. Notably, Lucas has, among other things, donated $424,000 to SIEPR and approximately $149,000 to Stanford Law School. Indeed, Lucas is not only a major contributor to SIEPR, he is the Chair of its Advisory Board. At SIEPR's facility at Stanford, the conference center is named the Donald L. Lucas Conference Center.

From these undisputed facts, it is inarguable that Lucas is a very important alumnus of Stanford and a generous contributor to not one, but two, parts of Stanford important to Grundfest: the Law School and SIEPR.

With these facts in mind, it remains to enrich the factual stew further, by considering defendant Ellison's ties to Stanford.

3. Ellison

There can be little doubt that Ellison is a major figure in the community in which Stanford is located. The so-called Silicon Valley has generated many success stories, among the greatest of which is that of Oracle and its leader, Ellison. One of the wealthiest men in America, Ellison is a major figure in the nation's increasingly important information technology industry. Given his wealth, Ellison is also in a position to make — and, in fact, he has made — major charitable contributions.

Some of the largest of these contributions have been made through the Ellison Medical Foundation, which makes grants to universities and laboratories to support biomedical research relating to aging and infectious diseases. Ellison is the sole director of the Foundation. Although he does not serve on the Foundation's Scientific Advisory Board that sifts through grant applications, he has reserved the right — as the Foundation's sole director — to veto any grants, a power he has not yet used but which he felt it important to retain. The Scientific Advisory Board is comprised of distinguished physicians and scientists from many institutions, but not including Stanford.

Although it is not represented on the Scientific Advisory Board, Stanford has nonetheless been the beneficiary of grants from the Ellison Medical Foundation — to the tune of nearly $10 million in paid or pledged funds. Although the Executive Director of the Foundation asserts by way of an affidavit that the grants are awarded to specific researchers and may be taken to another institution if the researcher leaves,^[24] the grants are conveyed under contracts between the Foundation and Stanford itself and purport by their terms to give Stanford the right (subject to Foundation approval) to select a substitute principal investigator if the original one becomes unavailable.^[25]

[933] During the time Ellison has been CEO of Oracle, the company itself has also made over $300,000 in donations to Stanford. Not only that, when Oracle established a generously endowed educational foundation — the Oracle Help Us Help Foundation — to help further the deployment of educational technology in schools serving disadvantaged populations, it named Stanford as the "appointing authority," which gave Stanford the right to name four of the Foundation's seven directors.^[26] Stanford's acceptance reflects the obvious synergistic benefits that might flow to, for example, its School of Education from the University's involvement in such a foundation, as well as the possibility that its help with the Foundation might redound to the University's benefit when it came time for Oracle to consider making further donations to institutions of higher learning.

Taken together, these facts suggest that Ellison (when considered as an individual and as the key executive and major stockholder of Oracle) had, at the very least, been involved in several endeavors of value to Stanford.

Beginning in the year 2000 and continuing well into 2001 — the same year that Ellison made the trades the plaintiffs contend were suspicious and the same year the SLC members were asked to join the Oracle board — Ellison and Stanford discussed a much more lucrative donation. The idea Stanford proposed for discussion was the creation of an Ellison Scholars Program modeled on the Rhodes Scholarship at Oxford. The proposed budget for Stanford's answer to Oxford: $170 million. The Ellison Scholars were to be drawn from around the world and were to come to Stanford to take a two-year interdisciplinary graduate program in economics, political science, and computer technology. During the summer between the two academic years, participants would work in internships at, among other companies, Oracle.

The omnipresent SIEPR was at the center of this proposal, which was put together by John Shoven, the Director of SIEPR. Ellison had serious discussions and contact with SIEPR around the time Shoven's proposal first surfaced.^[27] Indeed, in February 2001, Ellison delivered a speech at SIEPR — at which he was introduced by defendant Lucas. In a CD-ROM that contains images from the speech, Shoven's voice-over touts SIEPR's connections with "some of the most powerful and prominent business leaders."^[28]

As part of his proposal for the Ellison Scholars Program, Shoven suggested that three of the four Trading Defendants — Ellison, Lucas, and Boskin — be on the Program board. In the hypothetical curriculum that Shoven presented to Ellison, he included a course entitled "Legal Institutions and the Modern Economy" to be taught by Grundfest. Importantly, the Shoven proposal included a disclaimer indicating that listed faculty members may not have been consulted, and Grundfest denies that he was. The circumstances as a whole make that denial credible, although there is one confounding factor.

[934] Lucas, who was active in encouraging Ellison to form a program of this kind at Stanford, testified at his deposition that he had spoken to Grundfest about the proposed Ellison Scholars Program "a number of years ago,"^[29] Lucas seems to recall having asked Grundfest if he would be involved with the yet-to-be created Program, but his memory was, at best, hazy. At his own deposition, Grundfest was confronted more generically with whether he had heard of the Program and had agreed to teach in it if it was created, but not with whether he had discussed the topic with Lucas.^[30]

Candidly, this sort of discrepancy is not easy to reconcile on a paper record. My conclusion, however, is that Grundfest is being truthful in stating that he had not participated in shaping the Shoven proposal, had not agreed to teach in the Program, and could not recall participating in any discussions about the Program.

That said, I am not confident that Grundfest was entirely unaware, in 2001 and/or 2002 of the possibility of such a program or that he did not have a brief conversation with Lucas about it before joining the Oracle board. Nor am I convinced that the discussions about the Ellison Scholars Program were not of a very serious nature, indeed, the record evidence persuades me that they were serious. To find otherwise would be to conclude that Ellison is a man of more than ordinary whimsy, who says noteworthy things without caring whether they are true.

I say that because Ellison spoke to two of the nation's leading news outlets about the possibility of creating the Ellison Scholars Program. According to the Wall Street Journal, Ellison was considering the possibility of donating $150 million to either Harvard or Stanford for the purpose of creating an interdisciplinary (political science, economics, and technology) academic program.^[31] And, according to Fortune, Ellison said in an interview with Fortune correspondent Brent Schlender: "[O]ne of the other philanthropic things I'm doing is talking to Harvard and Stanford and MIT about creating a research program that looks at how technology impacts [sic] economics, and in turn how economics impacts the way we govern ourselves."^[32] It is significant that the latter article was published in mid-August 2001 — around the same time that the SLC members were considering whether to join the Oracle board and within a calendar year of the formation of the SLC itself. Importantly, these public statements supplement other private communications by Stanford officials treating the Ellison Scholars Program as an idea under serious consideration by Ellison.

Ultimately, it appears that Ellison decided to abandon the idea of making a major donation on the Rhodes Scholarship model to Stanford or any other institution. At least, that is what he now says by affidavit. According to Shoven of SIEPR, the Ellison Scholars Program idea is going nowhere now, and all talks with Ellison have ceased on that front.

Given the nature of this case, it is natural that there must be yet another curious [935] fact to add to the mix. This is that Ellison told the Washington Post in an October 30, 2000 article that he intended to leave his Woodside, California home — which is worth over $100 million — to Stanford upon his death.^[33] In an affidavit, Ellison does not deny making this rather splashy public statement. But, he now (again, rather conveniently) says that he has changed his testamentary intent. Ellison denies having "bequeathed, donated or otherwise conveyed the Woodside property (or any other real property that I own) to Stanford University."^[34] And, in the same affidavit, Ellison states unequivocally that he has no intention of ever giving his Woodside compound (or any other real property) to Stanford.^[35] Shortly before his deposition in this case, Grundfest asked Ellison about the Woodside property and certain news reports to the effect that he was planning to give it to Stanford. According to Grundfest, Ellison's reaction to his inquiry was one of "surprise."^[36] Ellison admitted to Grundfest that he said something of that sort, but contended that whatever he said was merely a "passing" comment.^[37] Plus, Ellison said, Stanford would, of course, not want his $100 million home unless it came with a "dowry" — i.e., an endowment to support what is sure to be a costly maintenance budget.^[38] Stanford's Vice President for Development, John Ford, claimed that to the best of his knowledge Ellison had not promised anyone at Stanford that he would give Stanford his Woodside home.^[39]

In order to buttress the argument that Stanford did not feel beholden to him, Ellison shared with the court the (otherwise private) fact that one of his children had applied to Stanford in October 2000 and was not admitted.^[40] If Stanford felt comfortable rejecting Ellison's child, the SLC contends, why should the SLC members hesitate before recommending that Oracle press insider trading-based fiduciary duty claims against Ellison?^[41]

But the fact remains that Ellison was still talking very publicly and seriously about the possibility of endowing a graduate interdisciplinary studies program at Stanford during the summer after his child was rejected from Stanford's undergraduate program.^[42]

C. The SLC's Argument

The SLC contends that even together, these facts regarding the ties among Oracle, the Trading Defendants, Stanford, and the SLC members do not impair the SLC's independence. In so arguing, the SLC places great weight on the fact that none [936] of the Trading Defendants have the practical ability to deprive either Grundfest or Garcia-Molina of their current positions at Stanford. Nor, given their tenure, does Stanford itself have any practical ability to punish them for taking action adverse to Boskin, Lucas, or Ellison — each of whom, as we have seen, has contributed (in one way or another) great value to Stanford as an institution. As important, neither Garcia-Molina nor Grundfest are part of the official fundraising apparatus at Stanford; thus, it is not their on-the-job duty to be solicitous of contributors, and fundraising success does not factor into their treatment as professors.

In so arguing, the SLC focuses on the language of previous opinions of this court and the Delaware Supreme Court that indicates that a director is not independent only if he is dominated and controlled by an interested party, such as a Trading Defendant.^[43] The SLC also emphasizes that much of our jurisprudence on independence focuses on economically consequential relationships between the allegedly interested party and the directors who allegedly cannot act independently of that director. Put another way, much of our law focuses the bias inquiry on whether there are economically material ties between the interested party and the director whose impartiality is questioned, treating the possible effect on one's personal wealth as the key to the independence inquiry. Putting a point on this, the SLC cites certain decisions of Delaware courts concluding that directors who are personal friends of an interested party were not, by virtue of those personal ties, to be labeled non-independent.^[44]

More subtly, the SLC argues that university professors simply are not inhibited types, unwilling to make tough decisions even as to fellow professors and large contributors. What is tenure about if not to provide professors with intellectual freedom, even in non-traditional roles such as special litigation committee members? No less ardently — but with no record evidence that reliably supports its ultimate point — the SLC contends that Garcia-Molina and Grundfest are extremely distinguished in their fields and were not, in fact, influenced by the facts identified heretofore. Indeed, the SLC argues, how could they have been influenced by many of these facts when they did not learn them until the post-Report discovery process? If it boils down to the simple fact that both share with Boskin the status of a Stanford professor, how material can this be when there are 1,700 others who also occupy the same position?

D. The Plaintiffs' Arguments

The plaintiffs confronted these arguments with less nuance than was helpful. Rather than rest their case on the multiple facts I have described, the plaintiffs chose to emphasize barely plausible constructions of the evidence, such as that Grundfest was lying when he could not recall being asked to participate in the Ellison Scholars Program. From these more extreme arguments, however, one can distill a reasoned core that emphasizes what academics might call the "thickness" of the social and institutional connections among [937] Oracle, the Trading Defendants, Stanford, and the SLC members. These connections, the plaintiffs argue, were very hard to miss — being obvious to anyone who entered the SIEPR facility, to anyone who read the Wall Street Journal, Fortune, or the Washington Post, and especially to Stanford faculty members interested in their own university community and with a special interest in Oracle. Taken in their totality, the plaintiffs contend, these connections simply constitute too great a bias-producing factor for the SLC to meet its burden to prove its independence.

Even more, the plaintiffs argue that the SLC's failure to identify many of these connections in its Report is not an asset proving its independence, but instead a fundamental flaw in the Report itself, which is the document in which the SLC is supposed to demonstrate its own independence and the reasonableness of its investigation. By failing to focus on these connections when they were obviously discoverable and when it is, at best, difficult for the court to believe that at least some of them were not known by the SLC — e.g., Boskin's role at SIEPR and the fact that the SIEPR Conference Center was named after Lucas — the SLC calls into doubt not only its independence, but its competence. If it could not ferret out these things, by what right should the court trust its investigative acumen?

In support of its argument, the plaintiffs note that the Delaware courts have adopted a flexible, fact-based approach to the determination of directorial independence. This test focuses on whether the directors, for any substantial reason, cannot act with only the best interests of the corporation in mind, and not just on whether the directors face pecuniary damage for acting in a particular way.

E. The Court's Analysis of the SLC's Independence

Having framed the competing views of the parties, it is now time to decide.

I begin with an important reminder: the SLC bears the burden of proving its independence. It must convince me.

But of what? According to the SLC, its members are independent unless they are essentially subservient to the Trading Defendants — i.e., they are under the "domination and control" of the interested parties.^[45] If the SLC is correct and this is the central inquiry in the independence determination, they would win. Nothing in the record suggests to me that either Garcia-Molina or Grundfest are dominated and controlled by any of the Trading Defendants, by Oracle, or even by Stanford.^[46]

But, in my view, an emphasis on "domination and control" would serve only to fetishize much-parroted language, at the cost of denuding the independence inquiry of its intellectual integrity. Take an easy example. Imagine if two brothers were on a corporate board, each successful in different businesses and not dependent in any way on the other's beneficence in order to be wealthy. The brothers are brothers, they stay in touch and consider each other family, but each is opinionated and strong-willed. A derivative action is filed targeting a transaction involving one of the brothers. The other brother is put [938] on a special litigation committee to investigate the case. If the test is domination and control, then one brother could investigate the other. Does any sensible person think that is our law? I do not think it is.

And it should not be our law. Delaware law should not be based on a reductionist view of human nature that simplifies human motivations on the lines of the least sophisticated notions of the law and economics movement. Homo sapiens is not merely homo economicus. We may be thankful that an array of other motivations exist that influence human behavior; not all are any better than greed or avarice, think of envy, to name just one. But also think of motives like love, friendship, and collegiality, think of those among us who direct their behavior as best they can on a guiding creed or set of moral values.^[47]

Nor should our law ignore the social nature of humans. To be direct, corporate directors are generally the sort of people deeply enmeshed in social institutions. Such institutions have norms, expectations that, explicitly and implicitly, influence and channel the behavior of those who participate in their operation.^[48] Some things are "just not done," or only at a cost, which might not be so severe as a loss of position, but may involve a loss of standing in the institution. In being appropriately sensitive to this factor, our law also cannot assume — absent some proof of the point — that corporate directors are, as a general matter, persons of unusual social bravery, who operate heedless to the inhibitions that social norms generate for ordinary folk.

For all these reasons, this court has previously held that the Delaware Supreme Court's teachings on independence can be summarized thusly:

At bottom, the question of independence turns on whether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind. That is, the Supreme Court cases ultimately focus on impartiality and objectivity.^[49]

This formulation is wholly consistent with the teaching of Aronson, which defines independence as meaning that "a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences."^[50] As noted by Chancellor Chandler recently, a director may be compromised if he is beholden to an interested person.^[51] Beholden in this sense does not [939] mean just owing in the financial sense, it can also flow out of "personal or other relationships" to the interested party.^[52]

Without backtracking from these general propositions, it would be less than candid if I did not admit that Delaware courts have applied these general standards in a manner that has been less than wholly consistent. Different decisions take a different view about the bias-producing potential of family relationships, not all of which can be explained by mere degrees of consanguinity.^[53] Likewise, there is admittedly case law that gives little weight to ties of friendship in the independence inquiry.^[54] In this opinion, I will not venture to do what I believe to be impossible: attempt to rationalize all these cases in their specifics.^[55] Rather, I undertake what I understand to be my duty and what is possible: the application of the independence inquiry that our Supreme Court has articulated in a manner that is faithful to its essential spirit.

1. The Contextual Nature of the Independence Inquiry Under Delaware Law

In examining whether the SLC has met its burden to demonstrate that there is no material dispute of fact regarding its independence, the court must bear in mind the function of special litigation committees under our jurisprudence. Under Delaware law, the primary means by which corporate defendants may obtain a dismissal of a derivative suit is by showing that the plaintiffs have not met their pleading burden under the test of Aronson v. Lewis,^[56] or the related standard set forth in Rales v. Blasband.^[57] In simple terms, these tests permit a corporation to terminate a derivative suit if its board is comprised of directors who can impartially consider a demand.^[58]

Special litigation committees are permitted as a last chance for a corporation to control a derivative claim in circumstances when a majority of its directors cannot [940] impartially consider a demand. By vesting the power of the board to determine what to do with the suit in a committee of independent directors, a corporation may retain control over whether the suit will proceed, so long as the committee meets the standard set forth in Zapata.

In evaluating the independence of a special litigation committee, this court must take into account the extraordinary importance and difficulty of such a committee's responsibility. It is, I daresay, easier to say no to a friend, relative, colleague, or boss who seeks assent for an act (e.g., a transaction) that has not yet occurred than it would be to cause a corporation to sue that person. This is admittedly a determination of so-called "legislative fact," but one that can be rather safely made.^[59] Denying a fellow director the ability to proceed on a matter important to him may not be easy, but it must, as a general matter, be less difficult than finding that there is reason to believe that the fellow director has committed serious wrongdoing and that a derivative suit should proceed against him.^[60]

The difficulty of making this decision is compounded in the special litigation committee context because the weight of making the moral judgment necessarily falls on less than the full board. A small number of directors feels the moral gravity — and social pressures — of this duty alone.

For all these reasons, the independence inquiry is critically important if the special litigation committee process is to retain its integrity, a quality that is, in turn, essential to the utility of that process. As this Court wrote recently:

One of the obvious purposes for forming a special litigation committee is to promote confidence in the integrity of corporate decision making by vesting the company's power to respond to accusations of serious misconduct by high officials in an impartial group of independent directors. By forming a committee whose fairness and objectivity cannot be reasonably questioned ... the company can assuage concern among its stockholders and retain, through the SLC, control over any claims belonging to the company itself.

* * *

Zapata presents an opportunity for a board that cannot act impartially as a whole to vest control of derivative litigation in a trustworthy committee of the board — i.e., one that is not compromised in its ability to act impartially. The composition and conduct of a special litigation committee therefore must be such as to instill confidence in the judiciary and, as important, the stockholders of the company that the committee can act with integrity and objectivity.^[61]

Thus, in assessing the independence of the Oracle SLC, I necessarily examine the question of whether the SLC can independently make the difficult decision entrusted to it: to determine whether the Trading Defendants should face suit for insider trading-based allegations of breach of fiduciary duty. An affirmative answer by the SLC to that question would have potentially huge negative consequences [941] for the Trading Defendants, not only by exposing them to the possibility of a large damage award but also by subjecting them to great reputational harm. To have Professors Grundfest and Garcia-Molina declare that Oracle should press insider trading claims against the Trading Defendants would have been, to put it mildly, "news." Relatedly, it is reasonable to think that an SLC determination that the Trading Defendants had likely engaged in insider trading would have been accompanied by a recommendation that they step down as fiduciaries until their ultimate culpability was decided.

The importance and special sensitivity of the SLC's task is also relevant for another obvious reason: investigations do not follow a scientific process like an old-fashioned assembly line. The investigators' mindset and talent influence, for good or ill, the course of an investigation. Just as there are obvious dangers from investigators suffering from too much zeal, so too are dangers posed by investigators who harbor reasons not to pursue the investigation's targets with full vigor.

The nature of the investigation is important, too. Here, for example, the SLC was required to undertake an investigation that could not avoid a consideration of the subjective state of mind of the Trading Defendants. Their credibility was important, and the SLC could not escape making judgments about that, no matter how objective the criteria the SLC attempted to use.

Therefore, I necessarily measure the SLC's independence contextually, and my ruling confronts the SLC's ability to decide impartially whether the Trading Defendants should be pursued for insider trading. This contextual approach is a strength of our law, as even the best minds have yet to devise across-the-board definitions that capture all the circumstances in which the independence of directors might reasonably be questioned. By taking into account all circumstances, the Delaware approach undoubtedly results in some level of indeterminacy, but with the compensating benefit that independence determinations are tailored to the precise situation at issue.^[62]

[942] Likewise, Delaware law requires courts to consider the independence of directors based on the facts known to the court about them specifically, the so-called "subjective `actual person' standard."^[63] That said, it is inescapable that a court must often apply to the known facts about a specific director a consideration of how a reasonable person similarly situated to that director would behave, given the limited ability of a judge to look into a particular director's heart and mind. This is especially so when a special litigation committee chooses, as was the case here, to eschew any live witness testimony, a decision that is, of course, sensible lest special litigation committee termination motions turn into trials nearly as burdensome as the derivative suit the committee seeks to end. But with that sensible choice came an acceptance of the court's need to infer that the special litigation committee members are persons of typical professional sensibilities.

2. The SLC Has Not Met Its Burden to Demonstrate the Absence of a Material Dispute of Fact About Its Independence

Using the contextual approach I have described, I conclude that the SLC has not met its burden to show the absence of a material factual question about its independence. I find this to be the case because the ties among the SLC, the Trading Defendants, and Stanford are so substantial that they cause reasonable doubt about the SLC's ability to impartially consider whether the Trading Defendants should face suit. The concern that arises from these ties can be stated fairly simply, focusing on defendants Boskin, Lucas, and Ellison in that order, and then collectively.

As SLC members, Grundfest and Garcia-Molina were already being asked to consider whether the company should level extremely serious accusations of wrongdoing against fellow board members. As to Boskin, both SLC members faced another layer of complexity: the determination of whether to have Oracle press insider trading claims against a fellow professor at their university. Even though Boskin was in a different academic department from either SLC member, it is reasonable to assume that the fact that Boskin was also on faculty would — to persons possessing typical sensibilities and institutional loyalty — be a matter of more than trivial concern. Universities are obviously places of at-times intense debate, but they also see themselves as communities. In fact, Stanford refers to itself as a "community of scholars."^[64] To accuse a fellow professor — whom one might see at the faculty club or at inter-disciplinary presentations of academic papers — of insider trading cannot be a small thing — even for the most callous of academics.

As to Boskin, Grundfest faced an even more complex challenge than Garcia-Molina. Boskin was a professor who had taught him and with whom he had maintained contact over the years. Their areas of academic interest intersected, putting Grundfest in contact if not directly with Boskin, then regularly with Boskin's colleagues. Moreover, although I am told by the SLC that the title of senior fellow at SIEPR is an honorary one, the fact remains that Grundfest willingly accepted it and was one of a select number of faculty who attained that status. And, they both just happened to also be steering committee members. Having these ties, Grundfest [943] (I infer) would have more difficulty objectively determining whether Boskin engaged in improper insider trading than would a person who was not a fellow professor, had not been a student of Boskin, had not kept in touch with Boskin over the years, and who was not a senior fellow and steering committee member at SIEPR.

In so concluding, I necessarily draw on a general sense of human nature. It may be that Grundfest is a very special person who is capable of putting these kinds of things totally aside. But the SLC has not provided evidence that that is the case. In this respect, it is critical to note that I do not infer that Grundfest would be less likely to recommend suit against Boskin than someone without these ties. Human nature being what it is, it is entirely possible that Grundfest would in fact be tougher on Boskin than the would on someone with whom he did not have such connections. The inference I draw is subtly, but importantly, different. What I infer is that a person in Grundfest's position would find it difficult to assess Boskin's conduct without pondering his own association with Boskin and their mutual affiliations. Although these connections might produce bias in either a tougher or laxer direction, the key inference is that these connections would be on the mind of a person in Grundfest's position, putting him in the position of either causing serious legal action to be brought against a person with whom he shares several connections (an awkward thing) or not doing so (and risking being seen as having engaged in favoritism toward his old professor and SIEPR colleague).

The same concerns also exist as to Lucas. For Grundfest to vote to accuse Lucas of insider trading would require him to accuse SIEPR's Advisory Board Chair and major benefactor of serious wrongdoing — of conduct that violates federal securities laws. Such action would also require Grundfest to make charges against a man who recently donated $50,000 to Stanford Law School after Grundfest made a speech at his request.^[65]

And, for both Grundfest and Garcia-Molina, service on the SLC demanded that they consider whether an extremely generous and influential Stanford alumnus should be sued by Oracle for insider trading. Although they were not responsible for fundraising, as sophisticated professors they undoubtedly are aware of how important large contributors are to Stanford, and they share in the benefits that come from serving at a university with a rich endowment. A reasonable professor giving any thought to the matter would obviously consider the effect his decision might have on the University's relationship with Lucas, it being (one hopes) sensible to infer that a professor of reasonable collegiality and loyalty cares about the well-being of the institution he serves.

In so concluding, I give little weight to the SLC's argument that it was unaware of just how substantial Lucas's beneficence to Stanford has been. I do so for two key reasons. Initially, it undermines, rather than inspires, confidence that the SLC did not examine the Trading Defendant's ties to Stanford more closely in preparing its Report. The Report's failure to identify these ties is important because it is the SLC's burden to show independence. In forming the SLC, the Oracle board should have undertaken a thorough consideration of the facts bearing on the independence of the proposed SLC members from the key objects of the investigation.

[944] The purported ignorance of the SLC members about all of Lucas's donations to Stanford is not helpful to them for another reason: there were too many visible manifestations of Lucas's status as a major contributor for me to conclude that Grundfest, at the very least, did not understand Lucas to be an extremely generous benefactor of Stanford. It is improbable that Grundfest was not aware that Lucas was the Chair of SIEPR's Advisory Board, and Grundfest must have known that the Donald L. Lucas Conference Center at SIEPR did not get named that way by coincidence. And, in February 2002 — incidentally, the same month the SLC was formed — Grundfest spoke at a meeting of "SIEPR Associates," a group of individuals who had given $5,000 or more to SIEPR.^[66] Although it is not clear if Lucas attended that event, he is listed — in the same publication that reported Grundfest's speech at the Associates' meeting — as one of SIEPR's seventy-five "Associates."^[67] Combined with the other obvious indicia of Lucas's large contributor status (including the $50,000 donation Lucas made to Stanford Law School to thank Grundfest for giving a speech) and Lucas's obviously keen interest in his alma matter, Grundfest would have had to be extremely insensitive to his own working environment not to have considered Lucas an extremely generous alumni benefactor of Stanford, and at SIEPR and the Law School in particular.

Garcia-Molina is in a somewhat better position to disclaim knowledge of how generous an alumnus Lucas had been. Even so, the scope of Lucas's activities and their easy discoverability gives me doubt that he did not know of the relative magnitude of Lucas's generosity to Stanford.^[68] Furthermore, Grundfest comprised half of the SLC and was its most active member. His non-independence is sufficient alone to require a denial of the SLC's motion.^[69]

[945] In concluding that the facts regarding Lucas's relationship with Stanford are materially important, I must address a rather odd argument of the SLC's. The argument goes as follows. Stanford has an extremely large endowment. Lucas's contributions, while seemingly large, constitute a very small proportion of Stanford's endowment and annual donations. Therefore, Lucas could not be a materially important contributor to Stanford and the SLC's independence could not be compromised by that factor.

But missing from that syllogism is any acknowledgement of the role that Stanford's solicitude to benefactors like Lucas might play in the overall size of its endowment and campus facilities. Endowments and buildings grow one contribution at a time, and they do not grow by callous indifference to alumni who (personally and through family foundations) have participated in directing contributions of the size Lucas has. Buildings and conference centers are named as they are as a recognition of the high regard universities have for donors (or at least, must feign convincingly). The SLC asks me to believe that what universities like Stanford say in thank you letters and public ceremonies is not in reality true; that, in actuality, their contributors are not materially important to the health of those academic institutions. This is a proposition that the SLC has not convinced me is true, and that seems to contradict common experience.

Nor has the SLC convinced me that tenured faculty are indifferent to large contributors to their institutions, such that a tenured faculty member would not be worried about writing a report finding that a suit by the corporation should proceed against a large contributor and that there was credible evidence that he had engaged in illegal insider trading. The idea that faculty members would not be concerned that action of that kind might offend a large contributor who a university administrator or fellow faculty colleague (e.g., Shoven at SIEPR) had taken the time to cultivate strikes me as implausible and as resting on an narrow-minded understanding of the way that collegiality works in institutional settings.

In view of the ties involving Boskin and Lucas alone, I would conclude that the SLC has failed to meet its burden on the independence question. The tantalizing facts about Ellison merely reinforce this conclusion. The SLC, of course, argues that Ellison is not a large benefactor of Stanford personally, that Stanford has demonstrated its independence of him by rejecting his child for admission, and that, in any event, the SLC was ignorant of any negotiations between Ellison and Stanford about a large contribution. For these reasons, the SLC says, its ability to act independently of Ellison is clear.

I find differently. The notion that anyone in Palo Alto can accuse Ellison of insider trading without harboring some fear of social awkwardness seems a stretch. That being said, I do not mean to imply that the mere fact that Ellison is worth tens of billions of dollars and is the key force behind a very important social institution in Silicon Valley disqualifies all persons who live there from being independent of him. Rather, it is merely an acknowledgement of the simple fact that accusing such a significant person in that community of such serious wrongdoing is no small thing.

Given that general context, Ellison's relationship to Stanford itself contributes to my overall doubt, when heaped on top of the ties involving Boskin and Lucas. During the period when Grundfest and Garcia-Molina were being added to the Oracle board, Ellison was publicly considering making extremely large contributions to Stanford. Although the SLC denies [946] knowledge of these public statements, Grundfest claims to have done a fair amount of research before joining the board, giving me doubt that he was not somewhat aware of the possibility that Ellison might bestow large blessings on Stanford. This is especially so when I cannot rule out the possibility that Grundfest had been told by Lucas about, but has now honestly forgotten, the negotiations over the Ellison Scholars Program.

Furthermore, the reality is that whether or not Ellison eventually decided not to create that Program and not to bequeath his house to Stanford, Ellison remains a plausible target of Stanford for a large donation. This is especially so in view of Oracle's creation of the Oracle Help Us Help Foundation with Stanford and Ellison's several public indications of his possible interest in giving to Stanford. And, while I do not give it great weight, the fact remains that Ellison's medical research foundation has been a source of nearly $10 million in funding to Stanford. Ten million dollars, even today, remains real money.

Of course, the SLC says these facts are meaningless because Stanford rejected Ellison's child for admission. I am not sure what to make of this fact, but it surely cannot bear the heavy weight the SLC gives it. The aftermath of denying Ellison's child admission might, after all, as likely manifest itself in a desire on the part of the Stanford community never to offend Ellison again, lest he permanently write off Stanford as a possible object of his charitable aims — as the sort of thing that acts as not one, but two strikes, leading the batter to choke up on the bat so as to be even more careful not to miss the next pitch. Suffice to say that after the rejection took place, it did not keep Ellison from making public statements in Fortune magazine on August 13, 2001 about his consideration of making a huge donation to Stanford, at the same time when the two SLC members were being courted to join the Oracle board.

As an alternative argument, the SLC contends that neither SLC member was aware of Ellison's relationship with Stanford until after the Report was completed. Thus, this relationship, in its various facets, could not have compromised their independence. Again, I find this argument from ignorance to be unavailing. An inquiry into Ellison's connections with Stanford should have been conducted before the SLC was finally formed and, at the very least, should have been undertaken in connection with the Report. In any event, given how public Ellison was about his possible donations it is difficult not to harbor troublesome doubt about whether the SLC members were conscious of the possibility that Ellison was pondering a large contribution to Stanford. In so concluding, I am not saying that the SLC members are being untruthful in saying that they did not know of the facts that have emerged, only that these facts were in very prominent journals at the time the SLC members were doing due diligence in aid of deciding whether to sign on as Oracle board members. The objective circumstances of Ellison's relations with Stanford therefore generate a reasonable suspicion that seasoned faculty members of some sophistication — including the two SLC members — would have viewed Ellison as an active and prized target for the University. The objective circumstances also require a finding that Ellison was already, through his personal Foundation and Oracle itself, a benefactor of Stanford.

Taken in isolation, the facts about Ellison might well not be enough to compromise the SLC's independence. But that is not the relevant inquiry. The pertinent question is whether, given all the facts, the SLC has met its independence burden.

[947] When viewed in that manner, the facts about Ellison buttress the conclusion that the SLC has not met its burden. Whether the SLC members had precise knowledge of all the facts that have emerged is not essential, what is important is that by any measure this was a social atmosphere painted in too much vivid Stanford Cardinal red for the SLC members to have reasonably ignored it. Summarized fairly, two Stanford professors were recruited to the Oracle board in summer 2001 and soon asked to investigate a fellow professor and two benefactors of the University. On Grundfest's part, the facts are more substantial, because his connections — through his personal experiences, SIEPR, and the Law School — to Boskin and to Lucas run deeper.

It seems to me that the connections outlined in this opinion would weigh on the mind of a reasonable special litigation committee member deciding whether to level the serious charge of insider trading against the Trading Defendants. As indicated before, this does not mean that the SLC would be less inclined to find such charges meritorious, only that the connections identified would be on the mind of the SLC members in a way that generates an unacceptable risk of bias. That is, these connections generate a reasonable doubt about the SLC's impartiality because they suggest that material considerations other than the best interests of Oracle could have influenced the SLC's inquiry and judgments.

Before closing, it is necessary to address two concerns. The first is the undeniable awkwardness of opinions like this one. By finding that there exists too much doubt about the SLC's independence for the SLC to meet its Zapata burden, I make no finding about the subjective good faith of the SLC members, both of whom are distinguished academics at one of this nation's most prestigious institutions of higher learning.^[70] Nothing in this record leads me to conclude that either of the SLC members acted out of any conscious desire to favor the Trading Defendants or to do anything other than discharge their duties with fidelity. But that is not the purpose of the independence inquiry.

That inquiry recognizes that persons of integrity and reputation can be compromised in their ability to act without bias when they must make a decision adverse to others with whom they share material affiliations. To conclude that the Oracle SLC was not independent is not a conclusion that the two accomplished professors who comprise it are not persons of good faith and moral probity, it is solely to conclude that they were not situated to act with the required degree of impartiality. Zapata requires independence to ensure that stockholders do not have to rely upon special litigation committee members who must put aside personal considerations that are ordinarily influential in daily behavior in making the already difficult decision to accuse fellow directors of serious wrongdoing.

Finally, the SLC has made the argument that a ruling against it will chill the ability of corporations to locate qualified independent directors in the academy. This is overwrought. If there are 1,700 professors at Stanford alone, as the SLC says, how many must there be on the west coast of the United States, at institutions without ties to Oracle and the Trading Defendants as substantial as Stanford's? Undoubtedly, a corporation of Oracle's market capitalization could have found prominent academics willing to serve as [948] SLC members, about whom no reasonable question of independence could have been asserted.

Rather than form an SLC whose membership was free from bias-creating relationships, Oracle formed a committee fraught with them. As a result, the SLC has failed to meet its Zapata burden, and its motion to terminate must be denied. Because of this reality, I do not burden the reader with an examination of the other Zapata factors. In the absence of a finding that the SLC was independent, its subjective good faith and the reasonableness of its conclusions would not be sufficient to justify termination. Without confidence that the SLC was impartial, its findings do not provide the assurance our law requires for the dismissal of a derivative suit without a merits inquiry.

V. Conclusion

The SLC's motion to terminate is DENIED. IT IS SO ORDERED.

[1] 430 A.2d 779 (Del.1981).

[2] E.g., Lewis v. Fuqua, 502 A.2d 962 (Del.Ch. 1985).

[3] Parfi Holding AB v. Mirror Image Internet, Inc., 794 A.2d 1211, 1232 (Del.Ch.2001) (emphasis in original), rev'd in part on other grounds, 817 A.2d 149 (Del.2002), cert. denied, ___ U.S. ___, 123 S.Ct. 2076, ___ L.Ed.2d ___ (2003).

[4] Id.

[5] 70 A.2d 5 (Del.Ch.1949).

[6] In re Caremark Int'l Derivative Litig., 698 A.2d 959 (Del.Ch.1996).

[7] See In re Oracle Corp. Sec. Litig., No. C 01-0988 MJJ, slip op. at 2 (N.D.Cal. Mar. 24, 2003).

[8] In the interests of full disclosure, I spoke at the Directors' College in spring 2002.

[9] 802 A.2d 257 (Del.2002).

[10] See Grundfest Dep. at 466-69; Garcia-Molina Dep. at 15-16.

[11] The plaintiffs claim that Grundfest prejudged the Trading Defendants' culpability in a manner equivalent to that of the Chairman of the HealthSouth special litigation committee, as discussed in the recent Biondi v. Scrushy, 820 A.2d 1148 (Del.Ch.2003) decision. The two situations are not reasonably comparable. In Biondi, the HealthSouth SLC Chairman publicly announced his conclusion that the HealthSouth CEO, who was the target of the SLC's investigation, had not acted with the required scienter. He did so in a company press release in advance of the SLC's own investigation. Here, Grundfest simply made a judgment that Ellison and Henley had given a plausible accounting for themselves and were, in general, reputable businessmen with whom he was comfortable serving as a fellow director. I find credible Grundfest's contention that he took their statements for what they were, statements by persons with a self-interest in exculpation. That said, it would have been a better practice for the Report to have identified that Grundfest had inquired about the Federal Class Action in determining whether to join Oracle's board. Cf. Report at VII-1 ("The interviews commenced in April 2002 and were completed by early November 2002.").

[12] Some six years before the SLC investigation began, Simpson Thacher had performed a modest amount of legal work for Oracle. Simpson Thacher also represents Cadence Design Systems, a company of which Trading Defendant Donald Lucas is a director, and had billed Cadence less than $50,000 for that work. In 1996-1997, Simpson Thacher also billed Cadence for $62,355 for certain legal advice. The SLC determined that the Cadence work was not material to Simpson Thacher and the plaintiffs have not challenged that determination.

[13] As part of its analysis, the SLC assumed that Lucas and Boskin possessed the same information base as Ellison and Henley — that of a hypothetical fully informed executive. Nonetheless, the Report also made specific findings as to Lucas and Boskin that emphasized that they were differently situated in terms of informational access.

[14] The SLC also noted that the Trading Defendants had sold their shares during a permissible trading window under Oracle's internal policies. These policies generally discouraged trading in the last month of a quarter and channeled trading into periods after the market had absorbed SEC filings.

[15] There was also evidence in the Report that Ellison's financial advisor had been hounding him for some time to sell some shares and to diversify. The taxes due on the expiring options were also large and provided a rationale for selling, as did Ellison's and his financial advisor's desire for Ellison to reduce some debt. Although these were motives for Ellison to obtain cash, the SLC concluded that Ellison had no compelling need for funds that supported an inference of scienter.

[16] As with Ellison, both Boskin and Lucas had cash needs, in their cases related to residences, but nothing in the record created by the SLC indicates any exigency.

[17] Zapata v. Maldonado, 430 A.2d 779, 788-89 (Del.1981); Katell v. Morgan Stanley Group, 1995 WL 376952, at *5 (Del.Ch. June 15, 1995).

[18] Zapata, 430 A.2d at 789.

[19] See id. at 788.

[20] See Lewis v. Fuqua, 502 A.2d 962, 966 (Del.Ch.1985); Kaplan v. Wyatt, 484 A.2d 501, 506-08 (Del.Ch.1984), aff'd, 499 A.2d 1184 (Del.1985). Importantly, the granting of the SLC's motion using the Rule 56 standard does not mean that the court has made a determination that the claims the SLC wants dismissed would be subject to termination on a summary judgment motion, only that the court is satisfied that there is no material factual dispute that the SLC had a reasonable basis for its decision to seek termination. See Kaplan v. Wyatt, 484 A.2d 501, 519 (Del.Ch. 1984) ("[I]t is the Special Litigation Committee which is under examination at this first-step stage of the proceedings, and not the merits of the plaintiff's cause of action."), aff'd, 499 A.2d 1184 (Del.1985).

[21] Compare In re The Limited, Inc. S'holders Litig., 2002 WL 537692, at *6-*7 (Del.Ch. Mar. 27, 2002) (concluding that a university president who had solicited a $25 million contribution from a corporation's President, Chairman, and CEO was not independent of that corporate official in light of the sense of "owingness" that the university president might harbor with respect to the corporate official), and Lewis v. Fuqua, 502 A.2d 962, 966-67 (Del.Ch.1985) (finding that a special litigation committee member was not independent where the committee member was also the president of a university that received a $10 million charitable pledge from the corporation's CEO and the CEO was a trustee of the university), with In re Walt Disney Co. Derivative Litig., 731 A.2d 342, 359 (Del.Ch. 1998) (deciding that the plaintiffs had not created reasonable doubt as to a director's independence where a corporation's Chairman and CEO had given over $1 million in donations to the university at which the director was the university president and from which one of the CEO's sons had graduated), aff'd in part, rev'd in part sub nom. Brehm v. Eisner, 746 A.2d 244 (Del.2000).

[22] Stanford Institute for Economic Policy Research, SIEPR Staff and Researchers: Senior Fellows (last visited June 4, 2003), at http://siepr.stanford.edu/people/srfellows.html.

[23] Stanford Institute for Economic Policy Research, Insider SIEPR: Steering Committee (last visited June 4, 2003), at http://siepr.stanford.edu/about/steering.html.

[24] See Sprott Aff. ¶¶ 7-8.

[25] See, e.g., Pls.' Ex. H, at DID 000035-DID 000036 (stating that if any of the principal researchers are unable to carry out funded project, Stanford may nominate a replacement researcher, subject to the approval of the Foundation).

[26] The other three directors are named by Oracle. See Help Us Help Foundation, About Us (last visited June 5, 2003), at http://www.helpushelp.org/pages/AboutUs.html# board.

[27] Shovan's proposal for the Ellison Scholars Program was dated October 2000. See Pls.' Ex. H, at DID 0000181.

[28] CD-ROM: SIEPR (on file as Weiser Aff. Ex. 2); see also SLC's Supplemental Br. at 5 (identifying the CD-ROM's video clip as that of a speech given by Ellison at SIEPR in February 2001).

[29] Lucas Dep. at 25.

[30] See Grundfest Dep. at 517-18.

[31] See David Bank, Oracle CEO Ellison Will Decide Which School Gets Millions, Wall St. J., June 11, 2001, available at 2001 WL-WSJ 2866209 ("Mr. Ellison, chairman and chief executive officer of Oracle Corp., said he is deciding between Harvard University and Stanford University as the site for an interdisciplinary center he has dubbed PET, for politics, economics and technology.").

[32] Brent Schlender, Larry Ellison: The Playboy Philanthropist, Fortune, Aug. 13, 2001, available at http://www.fortune.com/fortune/print/0,15935,370710,00.html.

[33] See Mark Leibovich, The Outsider, His Business and His Billions, Wash. Post, Oct. 30, 2000, available at 2000 WL 25425247.

[34] Ellison Aff. ¶ 15.

[35] See id.

[36] See Grundfest Dep. at 520.

[37] See id.

[38] See id. at 520-21.

[39] See Ford Aff. ¶ 9.

[40] I mention this fact only with the greatest of reluctance. Ellison and the SLC injected this into the record, despite the fact that Stanford itself would have been legally prohibited from disclosing it. Because it is an argument advanced by the SLC, I must address it, although that necessarily furthers the intrusion on the privacy of Ellison's child.

[41] See SLC's Reply Br. at 31-32.

[42] See David Bank, Oracle CEO Ellison Will Decide Which School Gets Millions, Wall St. J., June 11, 2001, available at 2001 WL-WSJ 2866209; Brent Schlender, Larry Ellison: The Playboy Philanthropist, Fortune, Aug. 13, 2001, available at http://www.fortune.com/fortune/print/0,15935,370710,00.html.

[43] E.g., In re Walt Disney Co. Derivative Litig., 731 A.2d at 355.

[44] See, e.g., Crescent/Mach I Partners, L.P. v. Turner, 2000 WL 1481002, at *11 (Del.Ch. Sept. 29, 2000) (stating that an allegation of a fifteen-year professional and personal relationship between a CEO and a director does not, in itself, raise a reasonable doubt about the director's independence); In re Walt Disney Co. Derivative Litig., 731 A.2d at 354 n. 18 ("Demand is not excused, however, just because directors would have to sue `their family, friends and business associates.'" (quoting Abrams v. Koether, 766 F.Supp. 237, 256 (D.N.J.1991)).

[45] See, e.g., In re Walt Disney Co. Derivative Litig., 731 A.2d at 355.

[46] This is not to say that the facts could not be simply read as providing a basis for a professor interested in promotion within the University to be less than aggressive as an SLC member. Even tenured professors and department chairs sometimes seek different chairs, duties, or even to climb to positions like Provost, which chart the path towards a university presidency. I do not consider this factor to be of weight here, however, but note it.

[47] In an interesting work, Professor Lynn Stout has argued that there exists an empirical basis to infer that corporate directors are likely to be motivated by altruistic impulses and not simply by a concern for their own pocketbooks. See Lynn A. Stout, In Praise of Procedure: An Economic and Behavioral Defense of Smith v. VanGorkom and the Business Judgment Rule, 96 Nw. U.L.Rev. 675, 677-78 (2002).

[48] See, e.g., Margaret M. Blair & Lynn A. Stout, Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law, 149 U. Pa. L.Rev. 1735, 1780 (2001) ("[T]here is reason to believe that trust may pay an important role in the success of many business firms."); Edward B. Rock & Michael L. Wachter, Islands of Conscious Power: Laws, Norms, and the Self-Governing Corporation, 149 U. Pa.L.Rev. 1619, 1640 (2001) ("[T]he myriad transactions that take place inside the firm are largely (but not entirely) protected by a... governance mechanism ... that is almost entirely not legally enforceable.").

[49] Parfi Holding AB v. Mirror Image Internet, Inc., 794 A.2d 1211, 1232 (Del.Ch.2001) (footnotes omitted) (emphasis in original), rev'd in part on other grounds, 817 A.2d 149 (Del. 2002), cert. denied, ___ U.S. ___, 123 S.Ct. 2076, ___ L.Ed.2d ___ (2003).

[50] Aronson v. Lewis, 473 A.2d 805, 816 (Del. 1984).

[51] See Orman v. Cullman, 794 A.2d 5, 24 (Del.Ch.2002).

[52] See id. at 24 n. 47 (citing Aronson, 473 A.2d at 815); see also Parfi Holding, 794 A.2d at 1232 n. 55 (citing definitions of beholden as meaning "[o]wing something ... to another" and "under obligation").

[53] Compare Harbor Fin. Partners v. Huizenga, 751 A.2d 879, 889 (Del.Ch.1999) (CEO's brother-in-law could not impartially consider demand to sue him), and Mizel v. Connelly, 1999 WL 550369, at *4 (Del.Ch. Aug. 2, 1999) (grandson could not impartially determine whether company should accept demand that required company to sue his grandfather for rescission of an interested transaction), with Seibert v. Harper & Row, Publishers, Inc., 1984 WL 21874, at *3 (Del.Ch. Dec. 5, 1984) (a director was not disabled from considering a demand where the director's cousin was a fellow director and a corporate manager).

[54] E.g., Crescent/Mach I Partners, L.P. v. Turner, 2000 WL 1481002, at *11-*12 (Del.Ch. Sept. 29, 2000).

[55] I readily concede that the result I reach is in tension with the specific outcomes of certain other decisions. But I do not believe that the result I reach applies a new definition of independence; rather, it recognizes the importance (i.e., the materiality) of other bias-creating factors other than fear that acting a certain way will invite economic retribution by the interested directors.

[56] 473 A.2d 805 (Del.1984).

[57] 634 A.2d 927 (Del.1993).

[58] This is a simplified formulation of a more complex inquiry. One way for a plaintiff to impugn the impartiality of the board is to plead particularized facts creating a reasonable doubt that the board complied with its fiduciary duties. In that circumstance, the danger is that the board might be influenced by its desire to avoid personal liability in a lawsuit in which the plaintiffs have stated a claim under a heightened pleading burden. For a more thorough discussion of Aronson and Rales, see Guttman v. Huang, 823 A.2d 492 (Del.Ch.2003).

[59] See Kenneth Culp Davis, An Approach to Problems of Evidence in the Administrative Process, 55 Harv. L.Rev. 364, 402-03 (1942); Leo E. Strine, Jr., The Inescapably Empirical Foundation of the Common Law of Corporations, 27 Del. J. Corp. L. 499, 502-03 (2002).

[60] The parties have not cited empirical social science research bearing on any of the factual inferences about human behavior within institutional settings upon which a ruling on this motion, one way or the other, necessarily depends.

[61] Biondi v. Scrushy, 820 A.2d 1148, 1156 & 1166 (Del.Ch.2003).

[62] The recent reforms enacted by Congress and by the stock exchanges reflect a narrower conception of who they believe can be an independent director. These definitions, however, are blanket labels that do not take into account the decision at issue. Nonetheless, the definitions recognize that factors other than the ones explicitly identified in the new exchange rules might compromise a director's independence, depending on the circumstances. See Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by the New York Stock Exchange, Inc. Relating to Corporate Governance, 68 Fed.Reg. 19,051, 19,053 (Apr. 17, 2003) ("It is not possible to anticipate, or explicitly provide for, all circumstances that might signal potential conflicts of interest, or that might bear on the materiality of a director's relationship to a listed company. Accordingly, it is best that boards making `independence' determinations broadly consider all relevant facts and circumstances. In particular, when assessing the materiality of a director's relationship with the company, the board should consider the issue not merely from the standpoint of the director, but also from that of persons or organizations with which the director has an affiliation. Material relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others."); Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by the National Association of Securities Dealers, Inc. Relating to Proposed Amendments to NASD Rules 4200 and 4350 Regarding Board Independence and Independent Committees, 68 Fed.Reg. 14,451, 14,452 (Mar. 25, 2003) ("`Independent director' means a person other than an officer or employee of the company or its subsidiaries or any other individual having a relationship, which, in the opinion of the company's board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.").

[63] Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1167 (Del.1995).

[64] See Stanford University, Stanford Facts 2003 (last modified Apr. 3, 2003), available at http://www.stanford.edu/home/stanford/facts/faculty.html.

[65] As noted, Lucas has contributed $149,000 to the Law School, $424,000 to SIEPR, and millions more to other Stanford institutions.

[66] See Joseph Grundfest Talks About Enron and Auditing Process Ethics, SIEPR Persp., Spring 2002, at 9, 9, available at http://siepr.stanford.edu/about/newsletter_spring2002.pdf.

[67] See id. at 15. Notably, Lucas is not listed as a "[n]ew donor," which suggests that he attained the rank of SIEPR Associate in a previous year or years, as well. See id.

[68] Professor Garcia-Molina denied in his deposition any specific knowledge of whether any of the Trading Defendants were donors to Stanford. He might well have told the truth despite the fact that there was evidence of it around Stanford's (admittedly large) campus and in the news at the same time as he was joining Oracle's board. As I have discussed, however, the purported ignorance of the SLC does not give me confidence, given the objective and discoverable facts available to the SLC members at the time. Even if I was convinced that Garcia-Molina was totally unaware of, for example, Lucas's status as an important alumni contributor — which I am not — that would not help the SLC, because Grundfest clearly was and the Report acknowledges both SLC members' knowledge that Lucas had made contributions. Moreover, Garcia-Molina clearly knew Boskin was a fellow professor, and the objective circumstances cause me to doubt that Garcia-Molina did not also suspect that Ellison was, if not already a major donor, then, at the very least, a major target for Stanford's development officers.

[69] See In re Walt Disney Co. Derivative Litig., 731 A.2d at 354 ("[U]nder Aronson's first prong—director independence—for demand to be futile, the Plaintiffs must show a reasonable doubt as to the disinterest of at least half of the directors."); Beneville v. York, 769 A.2d 80, 82 (Del.Ch.2000) (concluding that "[w]hen one member of a two-member board of directors cannot impartially consider a stockholder litigation demand" demand is excused); In re The Limited, Inc. S'holders Litig., 2002 WL 537692, at *7 ("[W]here the challenged actions are those of a board consisting of an even number of directors, plaintiffs meet their burden of demonstrating the futility of making demand on the board by showing that half of the board was either interested or not independent.").

[70] Lewis v. Fuqua, 502 A.2d at 964-65 (noting that a non-independence finding should not be equated with a determination that an SLC member acted improperly).