A lawsuit filed by a major U.S. pension fund against executives and directors of Wal-Mart Stores, Inc. marks the latest chapter in the fallout from the company’s alleged bribery scheme in Mexico, detailed last month in an investigation by The New York Times.
The suit, a derivative action filed in the Delaware Court of Chancery, hails from the California State Teachers’ Retirement System, the second-largest pension fund in the country and a Wal-Mart stockholder to the tune of more than 5.3 million shares.
As a derivative action, the plaintiffs are suing company officials on behalf of the company itself; any recovery would be returned to the company. In a statement, CalSTRS said it is seeking corporate governance reform and "truly independent directors who will set the right tone from the top” in the wake of the Times article.
The suit names 27 company officials past and present as defendants, including company president, CEO, and board member Michael Duke; former president and CEO, and current board member H. Lee Scott Jr.; and Eduardo Castro-Wright, the ex-CEO of Wal-Mart’s subsidiary in Mexico.
Former Wal-Mart general counsel Thomas Mars, currently executive vice president and chief administrative officer for Wal-Mart Stores U.S., along with Thomas Hyde, the company’s former executive vice president for legal and corporate affairs, were also named as defendants.
The CalSTRS claim [PDF] “arises from highly credible allegations of rampant corruption at the Company’s largest foreign subsidiary,” according to the suit, “as a result of which the Company now faces the combined scrutiny of the Department of Justice and the Securities and Exchange Commission, as well as potentially hundreds of millions of dollars of liability for violations of the Foreign Corrupt Practices Act of 1977 . . .”
Wal-Mart did not respond to a request for comment.
On Friday, the California pension system’s CEO, Jack Ehnes, said the allegations of widespread bribery in Mexico “could well be the Fortune 100 version of Watergate,” Reuters reported.
The litigation is an unusual move for CalSTRS, which has never filed a derivative action before.
Given that the shareholders are essentially asking the court to disqualify the board of directors, which in this instance would be replaced by the shareholders, “we are dealing with something a little extraordinary,” says Columbia Law School professor and corporate governance expert John Coffee.
“What makes the claim at least colorable is that Wal-Mart appears to have known about Mexican bribery since at least 2006,” he adds.
But the critical first hurdle in any derivative action is whether the court decides that the board can even be disqualified—known as “excusing demand on the board.”
“Whether demand is excused is usually the make-or-break question in a derivative action,” Coffee says.
The Delaware court has a long history of “being fairly protective of directors and officers in derivative litigation,” Coffee explains. “Delaware is very cautious and very reluctant to excuse demand in the case of publicly held corporations.”
Delaware has a special mechanism for excusing demand, with derives from Aronson v. Lewis (1984). Under Aronson, plaintiffs must either show that the board of directors is not disinterested or not independent, or raise a reasonable doubt that the board’s conduct was not justified by the business judgment rule.
Coffee notes that the last major case in which the court excused demand was that of American International Group, Inc. [PDF], and the company’s former chairman and CEO Hank Greenberg, in 2009.
Coffee says that it would also be possible for the board to appoint several directors, who are clearly independent, to a special committee. That committee could recommend dismissal of the action. “That allows the corporation a second line of defense,” he says.
Ultimately, it’s up to the court to choose whether or not to accept a recommendation from a special committee.
In most circumstances, derivative actions almost never go to trial, Coffee adds. They tend to go to settlement instead—particularly when there’s a potential for facts to emerge that could impact a criminal investigation. In the Wal-Mart case, “there is a real prospect of criminal enforcement,” says Coffee.
Charles Elson, the director of the Weinberg Center for Corporate Governance at the University of Delaware, points out that while derivative suits historically don’t fare all that well in Delaware, CalSTRS makes for a “well-known” and “well-respected” plaintiff.
“That gives some weight to the claim,” he says.
See also: “The Wal-Mart Bribery Scandal on CorpCounsel.com,” CorpCounsel, April 2012.
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