This letter resolves Defendants' motion to dismiss Plaintiffs' Verified Amended Stockholder Derivative Complaint (the "Complaint"). The Complaint alleges that the Qualcomm Inc. ("Qualcomm") board's conscious disregard for red flags resulted in violations of the Foreign Corrupt Practices Act ("FCPA") and a March 2016 U.S. Securities and Exchange Commission ("SEC") cease-and-desist order. Plaintiffs' Complaint asserts claims for breach of fiduciary duty, waste, and unjust enrichment against the Qualcomm directors and former Chief Financial Officer. Defendants moved to dismiss under Court of Chancery Rule 23.1 for failure to make demand or allege demand futility and Rule 12(b)(6) for failure to state a claim. For the reasons stated herein, I grant Defendants' Rule 23.1 motion to dismiss all counts in Plaintiffs' Complaint.
The facts in this opinion derive from the Complaint, the documents attached to it, and the documents incorporated by reference into the Complaint.
A. The Foreign Corrupt Practices Act
On March 1, 2016, the SEC determined that between 2002 and 2012, Qualcomm violated the FCPA. The FCPA is a federal anti-bribery statute that forbids illicit payments to foreign government officials to obtain or retain business overseas.
B. The Red Flags
Plaintiffs allege that the Qualcomm board pursued a business expansion plan emphasizing the Asia Pacific region, particularly China, which resulted in FCPA violations. According to the Complaint, China is a country of focus for U.S. FCPA regulators because of the large number of state-owned enterprises and the culture of gift giving.
The Complaint alleges that the Qualcomm board and its Audit Committee knew of several red flags regarding FCPA compliance in China and Korea. On April 20, 2009, the Qualcomm Audit Committee was presented with an Internal Audit Update, which showed that certain gifts were not being appropriately logged on the Qualcomm gift logs. At the Audit Committee's July 20, 2009 meeting, committee members received reports of potential FCPA violations. And in December 2009, the Audit Committee learned of whistleblower allegations of FCPA violations. In addition, a presentation given at the January 25, 2010 Audit Committee meeting shows that "[a] large number of activities such as business meals, business entertainment, marketing and gifts with known government related entities have not been recorded in the Qualcomm China Gift logs."
C. The SEC Cease-and-Desist Order
On March 1, 2016, the SEC determined that cease-and-desist proceedings should be instituted against Qualcomm as a result of alleged FCPA violations. In anticipation of the institution of cease-and-desist proceedings, Qualcomm reached a settlement with the SEC, which was announced simultaneously with the cease-and-desist proceedings. The SEC released the terms of the settlement in the form of a cease-and-desist order.
The cease-and-desist order shows that the SEC found that Qualcomm violated the FCPA in the following ways: (1) from 2002 until 2012, Qualcomm provided frequent meals, gifts, and entertainment to Chinese officials who were considering whether to adopt Qualcomm technology; (2) Qualcomm hired relatives of Chinese officials, including a Chinese executive's son that Qualcomm's human resources department originally determined was not "a skills match" and should not be hired; (3) Qualcomm's books and records did not fairly and accurately account for the illegal gifts but rather recorded them as generic marketing or sales expenses; and (4) Qualcomm lacked adequate internal controls to provide reasonable assurances that only authorized transactions were executed and that all transactions were accurately recorded. The order required that Qualcomm pay a penalty of $7.5 million and make periodic reports to the SEC for two years.
A. Standard for Demand Futility
Stockholders bringing derivative claims must satisfy the demand requirement in Court of Chancery Rule 23.1 by either making demand on the board of directors or alleging that demand would be futile. In cases challenging board inaction, Delaware courts analyze demand futility under the test established in Rales v. Blasband.
B. The Complaint Fails to Allege Demand Futility as to Count I
Count I of the Complaint alleges a breach of fiduciary duty claim for improper oversight, also known as a Caremark claim. The Delaware Supreme Court in Stone v. Ritter reiterated the two bases on which directors may be held liable on a Caremark claim as: "(a) the directors utterly failed to implement any reporting or information system or controls; 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."
Plaintiffs generally "attempt to satisfy the elements of a Caremark claim by pleading that the board had knowledge of certain `red flags' indicating corporate misconduct and acted in bad faith by consciously disregarding its duty to address that misconduct."
Here, Plaintiffs do not argue that the Qualcomm board intentionally caused Qualcomm to violate the law. As such, to adequately plead bad faith, "Plaintiff[s] must plead particularized facts from which it is reasonably inferable that the [b]oard consciously disregarded its duties by `intentionally fail[ing] to act in the face of a known duty to act.'"
The Complaint in this case fails to allege particularized facts giving rise to an inference that a majority of the board faces a substantial likelihood of liability on the Caremark claim alleged. As in Melbourne, I need not address whether the alleged red flags actually constitute red flags or whether the board's response to the alleged red flags caused damage to Qualcomm because the Complaint fails to plead facts giving rise to an inference that the board acted in bad faith.
Assuming for purposes of this analysis that the various reports to the Audit Committee and the board constituted red flags, the Complaint does not allege that the board consciously disregarded the red flags. Many of the documents the Complaint cites as red flags also include planned remedial actions. For example, Plaintiffs cite the April 20, 2009 presentation to the Audit Committee, which states that "2 of the FCPA related events tested were not recorded on the gift log of the respective office."
These responses to the red flags show that the board did not act in bad faith. There is no indication that the board believed Qualcomm could continue to violate the FCPA without consequences. And no allegations suggest that the Qualcomm board consciously disregarded the red flags. The allegations in the Complaint do not adequately plead "an intentional dereliction of duty"
Further, contrary to Plaintiffs' assertions, this case is distinguishable from In re Massey Energy Co.,
Plaintiffs also argue that the FCPA establishes a statutory floor for adequate internal controls, and because the Qualcomm cease-and-desist order describes internal control violations of the FCPA, the Complaint necessarily states a claim.
Finally, Plaintiffs argue in their answering brief that Qualcomm failed to establish an effective FCPA compliance program from 2002 through 2009 while the company violated the FCPA. But the Complaint does not allege those facts, and the documents from 2004 and 2006 on which Plaintiffs rely were not attached to or incorporated into the Complaint. Further, even if Plaintiffs had challenged pre-2009 conduct in the Complaint, they do not explain why that claim would not be barred by laches. Thus, Defendants' Rule 23.1 motion to dismiss count I is granted.
C. The Complaint Fails to Allege Demand Futility as to Count II
Count II alleges a claim for waste against the individual Defendants. Plaintiffs challenge the illegal bribes that Qualcomm paid in Asia and the compensation that Qualcomm paid its directors and officers while the corporation violated the FCPA.
The board does not face a substantial likelihood of liability on count II because the Complaint does not allege that the board directed Qualcomm to enter any wasteful transaction. As to the illegal bribes, nothing in the Complaint suggests that the board authorized those payments such that the directors would face a substantial likelihood of liability on a claim for waste. The corporation may very well have a claim against the employees who provided unauthorized gifts to foreign officials, but absent any particularized allegations tying the bribery to the board, the directors are competent to decide whether Qualcomm should pursue that claim.
As to the waste claim for the compensation of Qualcomm's directors and officers, the Complaint does not allege that Qualcomm paid any compensation in exchange for inadequate consideration. The Qualcomm directors or officers did not fail to perform any services for which they were paid. Thus, Plaintiffs' Complaint does not contain particularized facts giving rise to the inference that the board is not competent to decide whether to bring the claim alleged in count II. Count II is dismissed.
D. The Complaint Fails to Allege Demand Futility as to Count III
Count III alleges a claim for unjust enrichment against the individual Defendants because the Qualcomm financial results were inflated as a result of the company's FCPA violations, and the individual Defendants' incentive compensation was based on the financial results. The Complaint, however, alleges no basis for that conclusory statement. It does not allege how the financial results were inflated or that the financial statements have been restated. Count III, as alleged, does not pose a substantial likelihood of director liability and is dismissed.
For the reasons stated herein, Defendants' motion to dismiss under Court of Chancery Rule 23.1 is granted.