J&J Wins Shareholder Suit Over Board Misconduct

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

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

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

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

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

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

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

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

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

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

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

Another example: She pointed out that, while the board may have been aware of whistleblower lawsuits by way of the 10K filings with the US Securities and Exchange Commission, there was no proof the board ever received the lawsuits. "To the extent the existence of the suits is reported in a 10-K form, that does not communicate to the directors anything about the nature of the claims asserted. Without that information, the court cannot discern whether the board knew that (J&J's) Janssen unit...continued to engage in kickback behavior after the 2005 subpoenas were issued."

And while Wolfson found allegations about J&J's DePuy unit "troubling" in connection with a 2007 settlement of kickback charges, "the allegations do not sufficiently demonstrate that the directors knew that DePuy systematically and continuously engaged in illicit conduct." A 10k disclosed that a Corporate Integrity Agreement and a Deferred Prosecution Agreement were signed, but she found "no basis for inferring from the directors’ signature on the various 10Ks that they were aware of the extent of DePuy’s misconduct and that the directors failed, in bad faith, to act in response to that misconduct."

Why? The agreement noted that it is “neither an admission of any facts or liability by DePuy nor a concession by the US that its claims are not well founded.” As a result, Wolfson decided that "it is not clear whether the settlement itself suggested to the board that DePuy had engaged in illegal behavior.

Of course, one could argue that the board should have known from the large amount of the settlement - $85 million - that DePuy must have engaged in illicit conduct. But, on the other hand, the board may have reasonably concluded that the settlement reflected nothing more than a business decision on DePuy’s part."

Wolfson also reasoned taht the CIA did not place a specific obligation on the board to oversee DePuy, which have might suggested that "individual directors could face a substantial likelihood of personal liability for failing to act in accordance with their contractual obligation.

As to manufacturing problems at McNeil Consumer Health, Wolfson determined that the shareholders "have not alleged facts from which the court could conclude that the board had knowledge of the warning letters and, in bad faith, failed to address systemic misconduct." And she pointed to a statement made last year by Weldon that the recalls "were reported to the board" and that "in 2008, there were adverse events reported that we knew."

But Wolfson didn't buy the argument. "The statement that the problems 'were reported to the board' does not detail when, or to which directors, the problems were reported. Similarly, Weldon’s alleged statement that 'we knew' of the problems does not specify whether 'we' refers to his colleagues on the board, officers of the corporation, or upper management generally. Nor does that statement name specific directors. To the extent this allegation implicates Weldon’s own knowledge, it is insufficient to suggest that a majority of the board members had knowledge."

From there, Wolfson argues that Weldon appeared to be focusing on corporate behavior, rather than board behavior. She maintains that the shareholder insistence on citing actions taken or not taken by J&J do not "reveal anything about what the board knew or did not know."

And so, under the analysis she applied, shareholders should have alleged the directors knew or should have known that laws were violated and, in either event, that directors took no steps in good faith to prevent or fix the problems. "Because plaintiffs fail to allege that each specific director knew or should have known that the manufacturing defects at the various plants, or the problems with the orthopedic devices, constituted actual violations of law, plaintiffs fail to satisfy" the legal standard she cited.

One more example involved the Risperdal antipsychotic, which was is the subject of off-label marketing allegations in various lawsuits. Again, Wolfson maintained the shareholders failed to show that J&J directors were disinterested or acted in bad faith. "The FDA warning letters and subpoenas do not, alone, provide sufficient basis for this court to infer director knowledge and acquiescence.

"In addition, existence of internal J&J reports do not provide a sufficient basis for inferring knowledge and acquiescence unless (the) allegations state, with particularity, that the reports were provided to the board, and that the directors had 'actual or constructive knowledge' that their conduct was legally improper...again, as with other allegations that Weldon may have known about the off-label marketing does not speak to whether a majority of the board knew and consciously chose to disregard their duty of oversight."