‘London Whale’ Appeal Mired by Murky Laws

     (CN) – Delaware law does not offer clear direction on how to judge whether JPMorgan Chase’s board adequately investigated its executives’ actions and alleged misstatements in the London Whale debacle, the Second Circuit said.
     Bruno Iskil, the former head of Chase’s Synthetic Credit Portfolio, earned the London Whale nickname when he was blamed for $6.3 billion in losses in 2012, stemming from bad bets on credit default swaps he made for the bank.
     The bank paid $920 million to U.S. and U.K. regulators in 2013 for its “unsafe and unsound practices” that led to the scandal.
     Shareholders, led by Ernesto Espinoza, sued JPMorgan derivatively, seeking to hold its board liable for failing to oversee its traders.
     Espinoza challenges JPMorgan’s decision not to take any further action against the alleged wrongdoers, contending that the board’s investigation into his demand was unreasonably narrow.
     “Specifically, Espinoza alleges that the board’s investigation only looked into the underlying trading losses, but did not explore certain alleged misstatements that JPMorgan executives made about those losses. Espinoza asserts that these misstatements exposed JPMorgan to significant liability, and should have led the board to take action against the executives involved,” according to the appeal court’s Wednesday opinion.
     In particular, CEO James Dimon stated in April 2012 that the media’s attention on the losses were a “complete tempest in a teapot.” Espinoza asserts that this misstatement exposed JPMorgan to litigation, regulatory liability, and inflated the bank’s share price by misleading investors about the scope of JPMorgan’s risk exposure.
     Espinoza argues that because the board never investigated the misstatements made by Dimon and others, it never exercised any business judgment that could be entitled to protection under the business-judgment rule.
     A New York federal judge dismissed the complaint, but on appeal the Second Circuit re-opened the possibility shareholders may pursue their claims.
     “We conclude that Delaware law is unclear on how to handle Espinoza’s argument that the scope of the board’s investigation was too narrow,” Chief Judge Robert Katzmann said, writing for the three-judge panel. “Although several Delaware cases hold that a board has wide discretion about the procedures it uses when investigating a demand, no case addresses allegations that the substantive scope of an investigation was too narrow.”
     Cases cited by the district court do not handle any situation where a board was asked to investigate two separate but related instances of alleged wrongdoing, but only investigated one of them, the panel found.
     “As a matter of simple common sense, it seems apparent that such allegations must sometimes amount to gross negligence. A board that bypasses the core of a shareholder’s demand and instead focuses its entire investigation on some minor secondary aspect of the demand has surely failed ‘to inform [itself] . . . of all material information reasonably available to them,'” Katzmann continued.
     Given that Espinoza’s claim raises an issue of first impression, Katzmann said the legal question must be certified to the Delaware Supreme Court.
     The Second Circuit certified the following question: “If a shareholder demands that a board of directors investigate both an underlying wrongdoing and subsequent misstatements by corporate officers about that wrongdoing, what factors should a court consider in deciding whether the board acted in a grossly negligent fashion by focusing its investigation solely on the underlying wrongdoing?”
     The Delaware Supreme Court’s answer may have an impact in another derivative suit against JPMorgan. The Delaware Chancery Court rejected      a suit in May, led by Asbestos Workers Local 42 Pension Fund, based in part on the New York district court’s decision in this case.

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