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Matter of Prudential Ins. Co. Derivative Litigation

February 10, 1995


Weiss, A.j.s.c.

The opinion of the court was delivered by: Weiss



Plaintiffs Richard Golebiowski and Louis Romano, Prudential Insurance Company (Prudential) policyholders, bring this derivative suit against: (1) the executives of Prudential Securities Incorporated (PSI), a Prudential subsidiary; (2) certain Prudential executives; (3) the Prudential Board of Directors (also "the Board" or "the director defendants"); and (4) Prudential, as a nominal defendant. Plaintiff Romano additionally sues on behalf of a class of similarly situated policyholders.

The amended consolidated complaint claims breach of fiduciary duty (Count I); waste, mismanagement and gross negligence (Count II); intentional misrepresentation (Count III); and negligent misrepresentation (Count IV). The amended complaint alleges, among other things improper sale of limited partnerships by PSI improper involvement of Prudential insurance agents in the sale of these and other investments; and the overvaluation of real estate property in certain Prudential funds.

Pursuant to R. 4:6-2(e) and R. 4:32-5, defendants move to dismiss the derivative claims asserted in Counts I and II of the amended complaint for plaintiffs' failure to either make demand upon the Board of Directors or adequately plead why demand should be excused. In determining whether the amended complaint pleads demand futility with the requisite particularity, the court is called upon to interpret the scope of R. 4:32-5. R. 4:32-5 mandates that in a derivative action where the plaintiff has not made a demand upon the board of directors, the complaint shall set forth with particularity the reasons why demand is excused.


Procedural History

This action originated in two separate lawsuits: 1) Golebiowski v. Ball, ESX-L-16392-93 and 2) Romano v. Ball, ESX-L-16423-93, initially filed in the Law Division of this court on December 3, 1993. Both suits alleged derivative claims for the benefit of Prudential based on charges that the director and executive defendants were responsible for failing to discover and prevent the conduct underlying certain claims made against employees of Prudential's subsidiary, PSI, and certain real estate funds in ongoing litigations. The Romano action also asserted purported class action claims on behalf of Prudential policyholders, claiming breaches of fiduciary duty and fraud arising from the same allegations upon which the derivative claims were based.

On January 31, 1994, defendants moved to transfer the Golebiowski and Romano cases to the Chancery Division and also to dismiss the complaints. Defendants contended that plaintiffs had failed to comply with New Jersey law because they had neither made a demand on Prudential's Board of Directors before filing their derivative suit, nor explained why such a demand was excused. Defendants moved to dismiss the class action claims in the Romano complaint for lack of standing to bring an action on behalf of policyholders, arguing that plaintiff had not and could not allege an injury to himself, as a policyholder, resulting from defendants' actions. In addition, defendants moved to dismiss for failure to plead with sufficient specificity. R. 4:32-5.

Plaintiffs consented both to the consolidation of the actions and to transfer of the consolidated action to the Chancery Division. At an April 8, 1994 conference, the court gave plaintiffs until May 9, 1994, to file an amended complaint in this consolidated proceeding. As the deadline approached, plaintiffs instead advised this court that they were filing a lawsuit in the United States District Court for the Southern District of New York, Romano v. Ball, 94 Civ. No. 3527. The federal complaint sought to place before the federal court the same basic claims then pending before this court.

After filing the federal suit, plaintiffs moved before this court to voluntarily dismiss the consolidated action, without prejudice. Plaintiffs asserted that they wanted to pursue their claims in the federal court in New York in conjunction with a number of investor class action lawsuits which had been transferred there by the Judicial Panel on Multidistrict Litigation. Defendants objected to plaintiffs' application, contending that it was more appropriate for a New Jersey state court to interpret the questions of first impression raised under New Jersey law by the demand futility allegations. Finding defendants' reasoning persuasive, this court denied plaintiffs' application in order to determine the single issue of demand futility. The court also granted plaintiffs leave to file a consolidated amended complaint and then set a new briefing schedule for defendants' renewed motion.

Plaintiffs filed the amended complaint "under protest" on June 27, 1994. Defendants filed this motion to dismiss the amended complaint on July 18, 1994.

On September 14, 1994, plaintiffs filed an appeal of this court's denial of plaintiffs' application to voluntarily dismiss the consolidated action. Resolution of defendants' motion to dismiss was stayed pending plaintiffs' appeal. Defendants filed a motion to dismiss the appeal. On November 3, 1994, the Appellate Division dismissed plaintiffs' appeal as interlocutory. Oral argument on defendants' motion to dismiss was heard on January 25, 1995.

Summary of Alleged Facts

In considering defendants' motion to dismiss, the court is limited to examining the allegations in the Amended Complaint. See Rieder v. State Dept. of Trans., 221 N.J. Super. 547, 552 (App. Div. 1987). Therefore, although defendants dispute many of plaintiffs' allegations, the court sets forth the following as a summary of the facts alleged in the amended complaint. *fn1

Prudential is a mutual insurance company owned by its policyholders and operated by its Board of Directors. Prudential is incorporated under the laws of New Jersey and is headquartered in Newark, New Jersey.

In 1981, Prudential acquired Bache Group, renamed Prudential-Bache Securities, Inc. and eventually renamed Prudential Securities, Inc. (PSI), a securities brokerage house specializing in retail brokerage. In 1982, George Ball was installed as Chief Executive Officer of PSI. Ball was also Chairman of PSI's Board of Directors and a member of Prudential's Executive Committee.

PSI embarked on an aggressive campaign to increase revenue by selling a package of investment products. From 1981 until 1990, it marketed approximately $8 billion in limited partnership interests and other direct investments throughout the United States. Plaintiffs refer to this marketing scheme as the "Limited Partnership Program." The Limited Partnership Program was managed through, and in conjunction with, PSI's Direct Investment Group (DIG). Many, if not most, of the Limited Partnership Program offerings purportedly consisted of illiquid and highly speculative partnerships in oil and gas investments, real estate, aircraft leasing and horse breeding. Plaintiffs contend that PSI misrepresented these speculations as income-producing and suitable for safety conscious or conservative individual investors.

Certain Prudential insurance agents participated in the Limited Partnership Program after a joint-marketing group was formed in the early 1980's between Prudential and PSI. The joint-marketing group was overseen in part by individual - Prudential officers. Through this joint marketing effort, Prudential insurance agents who were not registered to sell securities promoted and sold limited partnership interests to their insurance clients, allegedly in violation of numerous securities laws and exchange regulations.

In the mid-1980's, Prudential ceased investing in oil and gas partnerships which the insurance company had determined were poor risks. During this time, PSI continued to promote energy partnerships as sound investments. Plaintiffs maintain that PSI often falsely represented that Prudential was a major investor in these partnerships.

In 1991, Ball resigned as an executive from both PSI and Prudential. Concurrently, PSI became subject to the first of thousands of legal proceedings brought by investors in the limited partnership seeking recoveries of the amounts paid and/or compensatory damages.

An investigation by the Securities and Exchange Commission (SEC) into PSI's Limited Partnership Program culminated in the SEC's filing of an Order Instituting Public Proceedings, Making Findings and Imposing Sanctions (the Order) on October 20, 1993. The SEC found that PSI had committed extensive securities fraud violations in conjunction with its marketing and sale of limited partnership interests, including misrepresenting speculative, illiquid limited partnerships as safe, income-producing investments.

Additionally, as disclosed in an October 21, 1993 litigation release, the SEC found that PSI failed to effectively comply with a 1986 SEC Order requiring PSI to implement and maintain recommendations made by a consultant as to improving its supervisory and compliance oversight procedures. The Order was grounded in findings that certain PSI employees had violated anti-fraud and other provisions of the federal securities laws and that PSI had failed to reasonably supervise those employees.

At the time the SEC announced the commencement of its action against PSI, it simultaneously announced a settlement and consent order. The consent order required PSI to establish a disgorgment fund of $330 million to be used to pay investors' compensatory damages claims arising from the Limited Partnership Program. Pursuant to the Order, Prudential agreed to take any appropriate steps in its capacity as a parent corporation to further PSI's compliance. However, the SEC specifically declined to impose any direct financial obligations on Prudential in connection with the Order.

As part of the same proceeding, the SEC fined PSI $10 million and various states assessed $26 million in penalties for violations of their securities laws. In addition, the NASD fined PSI $5 million for various security industry rule violations.

To protect against future losses resulting from the Limited Partnership Program's infractions, Prudential has established a resource of approximately $800 million. In the two years prior to the filing of the amended complaint, PSI has paid more than $250 million in judgments and settlements of investors' claims.

At the time the amended complaint was filed, Prudential's role in the Limited Partnership Program was being investigated by the U.S. Attorney for the Southern District of New York. Mark Jorgensen, the Prudential executive who managed three real estate funds in Prudential's Property Investment Separate Account, has alleged that the values of certain properties had been improperly inflated over a period of years. Jorgensen also alleged that his disclosure of the inflated valuation to senior Prudential executives resulted in their stripping him of his responsibilities as fund manager.

The amended complaint names two groups of Prudential directors as defendants: 1) those who were directors during the periods of the alleged wrongdoing; and 2) those who are currently directors. Plaintiffs allege that demand upon Prudential's current Board of Directors would be futile for the following reasons:

First, plaintiffs allege that the directors failed to supervise the management of Prudential and PSI and therefore breached their fiduciary duties. Plaintiffs also allege that the Board of Directors is self-perpetuating and that directors are not subject to challenge, ratification or election by the policyholders. The amended complaint further alleges that the Board consists of, and is dominated and controlled by, the defendants who have been at the heart of the wrongdoing at issue.

Plaintiffs claim that demand would be futile because the directors have been aware of the wrongdoing for some time and have not asserted claims against the wrongdoers by reason of a reluctance to sue themselves, their friends and business associates. Plaintiffs point out that although Prudential and PSI have established a reserve of $800 million for future losses, have agreed to pay $300 million in settlement of the SEC proceedings, have agreed to pay approximately $60 million in settlement of legal proceedings stemming from the Limited Partnership Program, and are engaged in thousands of suits brought by investors and six major class actions, the directors have not initiated an independent investigation. Rather, the directors (with one exception) are represented by the same counsel as Prudential and have moved to dismiss the amended complaint.

Plaintiffs also infer that the directors would not take action against the wrongdoers because the costs of defending such litigation would not be covered by Prudential's insurance policies. The policies in question normally cover costs of defending and indemnifying Prudential's directors and officers from liability for mismanagement and negligence, but exclude claims brought by Prudential, its directors or officers against any other directors or officers. Additional Facts

Subsequent to the filing of both the amended complaint and defendants' motion to dismiss, two Prudential policyholders made a demand upon the Board of Directors. In a letter dated September ...

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