The opinion of the court was delivered by: Wolfson, United States District Judge:
This consolidated shareholder derivative action arises out of allegations that essentially accuse certain former and current officers and directors of nominal defendant company Johnson & Johnson ("J&J") of breaching their fiduciary duties by permitting and fostering a culture of systematic, calculated and widespread legal violations. In that sense, in the Consolidated Amended Complaint (the "Complaint"), the plaintiff-shareholders ("Plaintiffs") intimate that these board members deliberately and knowingly took no actions in curbing various illegal activities which occurred throughout J&J's business segments.
In the instant matter, J&J moves to dismiss the Complaint. Having failed to first make a demand to the Board of Directors (the "Board") of J&J, the Court must assess the sufficiency of plaintiff Shareholders' allegations through the lens of Rule 23.1, which requires a heightened pleading standard. In that regard, while under the constraints of Rule 23.1, the Court finds that demand would not have been futile, the troubling and pervasive allegations against the Board may pose a greater difficulty for J&J if the Complaint were analyzed under a more liberal pleading standard. As this current motion stands, the Court will grant the relief J&J seeks and dismiss the Complaint for the reasons that follow.
On a motion to dismiss, I take, as I must, Plaintiffs' allegations as true. Plaintiffs' complaint generally consists of allegations of a series of "red flags" that Plaintiffs allege placed the Board on notice of serious corporate conduct that occurred in various divisions, or subsidiary corporations, of J&J. In this background section, I provide an overview of the extensive allegations found in Plaintiffs' ninety-seven page complaint. I provide further detail about Plaintiffs' allegations, where appropriate, in connection with my analysis later in this Opinion.
J&J, a global health care company incorporated in New Jersey, is a
holding company that consists of over 250 subsidiaries.*fn1
While some of these subsidiaries are
domestic, others operate abroad. J&J categorizes its subsidiaries into
three segments: consumer, pharmaceutical, and medical devices. See
Compl., ¶ 47. For each of its subsidiaries, J&J employs principles of
decentralized management. So, foreign subsidiaries are generally
managed by citizens of the country where the subsidiary is located. As
described in more detail below, Plaintiffs' allegations relate to
seven of J&J's 250 subsidiaries.
The members of the Board, at the time of Plaintiffs' initial complaint, were Defendants Mary Sue Coleman, Ph.D., James Cullen, Susan Lindquist, Ph.D., Leo Mullin, David Satcher, M.D., Ph.D., William Weldon, Anne Mulcahy, Michael Johns, M.D., William Perez, Arnold Langbo, and Charles Prince. Of these directors, most of them served during the entire time frame addressed in the Complaint, 2003 through 2010. All the directors are outside directors, with the exception of William Weldon, J&J's Chairman and Chief Executive Officer ("CEO"). The Complaint does not make any allegations of wrongdoing against Mulcahy, thus, the Court's demand-futility analysis will focus on the other ten directors.
Altogether, Plaintiffs' allegations describe several types of red flags from which the Court should infer that the ten directors attained knowledge of J&J's untoward corporate acts. These red flags take the form of FDA warning letters, an FDA report, state attorney general subpoenas, qui tam complaints, a criminal plea, a settlement agreement with the U.S. Department of Justice ("DOJ"), and a DOJ subpoena. The red flags cover three substantive categories of alleged corporate misconduct: (a) product recalls; (b) off-label marketing of drugs; and (c) illegal kick-backs. I describe Plaintiffs' specific red flag allegations in the context of these categories.
A. Product Recall Allegations
Plaintiffs generally allege that three J&J subsidiaries violated federal drug regulations and that, as a result, J&J was required to recall four sets of products.*fn2 The first three recalls relate to J&J subsidiary McNeil Consumer Healthcare ("McNeil"). Plaintiffs first allege that McNeil engaged in a "phantom recall" of certain packages of Motrin. See Compl., ¶¶ 95-102. The second recall was also by McNeil, and refers specifically to over-the-counter ("OTC") products manufactured at its Las Piedras Plant where the delayed discovery of chemically-treated wood pallets caused "uncharacteristic odors" to seep into the OTC products. See id. at ¶¶ 103-12. The complaint alleges that the FDA mailed J&J a warning letter addressed to Weldon in 2008, and inspected the facility in 2010.
The third recall relates to McNeil's Fort Washington Plant where children's and infants' versions of Tylenol, Motrin, Zyrtec, and Benadryl were manufactured. Id. at ¶¶ 113-25. That facility was inspected by the FDA in April 2010 and, subsequently, between October and December of that year. On April 30, 2010, the Complaint alleges, J&J initiated a recall of infant and children's liquid medicines on account of manufacturing deficiencies at the Fort Washington Plant. Id. at ¶ 122.
Finally, Plaintiffs allege that two other subsidiaries recalled medial products. According to Plaintiffs, J&J's Vision Care, Inc. subsidiary instituted a voluntary recall on August 18, 2010, following complaints of irritation and pain by users of Acuvue contact lenses. Id. at ¶¶ 126-27. Similarly, Plaintiffs allege that J&J subsidiary DePuy Orthopaedics ("DePuy") recalled certain hip replacement devices on August 24, 2010. Id. at ¶ 135. This recall was necessary in light of the FDA's ordering of J&J to cease selling the Corail Hip System because J&J had been marketing the hip system for unapproved use. Id.
For the various recalls, Plaintiffs allege that several newspaper articles, statements by confidential witnesses, qui tam suits, civil suits, congressional testimony and FDA documents constitute "red flags" that placed the Board on notice of systemic violations within J&J. Furthermore, Plaintiffs allege that McNeil is under federal criminal investigation. Id. at ¶ 158. However, the Complaint does not specify the nature or subject matter of this investigation.
Plaintiffs allege that several J&J subsidiaries engaged in an extensive off-label marketing campaign for three drugs-Risperdal, Topomax, and Natrecor-over several years. While doctors may prescribe FDA approved drugs for uses for which the drug is not approved, it is illegal for drug companies to market drugs for such "off-label" use. Buckman Co. v. Plaintiffs' Legal Comm., 531 U.S. 341, 350-51 (2001). In support of its off-label allegations, the Complaint details a hodge-podge of internal J&J reports, news articles, and FDA warning letters issued to J&J, from 1999 onward, for both the Risperdal and Topomax medications. See Compl., ¶¶ 171-208. Plaintiffs' Natrecor allegations, in contrast, relate both to J&J's acquisition of the company that initially developed the drug, as well as the post-acquisition off-label marketing of the drug.
With respect to Risperdal, an antipsychotic drug, Plaintiffs allege that the J&J subsidiary Janssen Pharmaceutica, Inc. ("Janssen"), marketed the drug for off-label uses. See id. at ¶¶ 168-92. For Topomax, Plaintiffs allege that J&J subsidiary Ortho-McNeil Pharmaceutical, Inc. ("Ortho") aggressively marketed off-label uses after the drug was respectively approved in 1996, 1999, and 2004 for three distinct, but specific, uses.*fn3 Id. at ¶ 193. With respect to Natrecor, Plaintiffs allege that drug was initially developed by Scios, Inc. ("Scios"), a company subsequently acquired by J&J in 2003 with board approval, "following comprehensive due diligence." Id. at ¶ 209, 213. According to Plaintiffs, Scios marketed Natrecor for off-label uses although it was approved only for treating patients with congestive heart failure. See id. at ¶¶ 209-40.
Finally, Plaintiffs allege that J&J subsidiary Cordis Corporation ("Cordis") was marketing biliary stents for off-label uses. Id. at ¶¶ 241-53. Biliary stents are medical devices implanted in the bile duct of cancer patients to aid drainage. Id. Plaintiffs allege that Cordis induced physicians to prescribe the stents for use in the vascular system. Id. at ¶ 242.
Plaintiffs allege that several red flags alerted the directors to each of these off-label marketing schemes. As with Plaintiffs' recall allegations, the alleged red flags range from qui tam complaints and medical journal articles, to FDA warning letters and government agency subpoenas.
C. Omnicare and DePuy Kick-Back Allegations
Plaintiffs' kickback allegations focus on the Board's conduct in failing to remedy J&J's subsidiaries' use of illegal kickbacks to bolster sales. Specifically, the Complaint first alleges that J&J subsidiaries' Janssen and Johnson & Johnson Health Care Systems, Inc. ("HCS") paid kickbacks to Omnicare, Inc. ("Omnicare"). Id. at ¶ 255. Omnicare is a company that provides pharmacy-related services to nursing home-based patients. Id. In assisting those patients, Omnicare submits reimbursement claims on the patients' behalf. It is alleged that J&J entered into a "Drug Supply Agreement" with Omnicare that provided rebates to Omnicare based on the amount of J&J drugs that Omnicare purchased. Id. at ¶ 258. On account of the agreement, Omnicare convinced the nursing home patients' physicians to switch the patients from non-J&J drugs to J&J drugs. Id. at ¶ 270.
Plaintiffs allege, among other things, that Omnicare entered into a settlement agreement with the DOJ on November 2, 2009, to resolve allegations by the DOJ, that Omnicare solicited and received kickbacks from J&J. Id. Thereafter, in early 2010, the DOJ intervened in a qui tam suit against J&J related to J&J's role in encouraging Omnicare to promote its drugs. Id. at ¶ 271. Plaintiffs' Complaint does not address the result of the qui tam action, perhaps because the DOJ intervened only several months prior to the filing of the instant Complaint. Finally, Plaintiffs allege that the directors "understood" that the kickbacks violated the Federal Anti-Kickback Statute and were illegal. Id. at ¶ 257.
With respect to DuPuy, Plaintiffs allege that DuPuy paid kickbacks to surgeons from January 2002 through December 2006 to induce them to use DePuy hip and knee replacements and reconstructive products. Id. at ¶¶ 273-77. According to the Complaint, the company received a DOJ subpoena in 2005, and a criminal complaint was filed against DuPuy in September of 2007. That criminal complaint was ultimately settled, which settlement resulted in a payment by J&J of $84.7 million dollars, Deferred Prosecution Agreement, and a Corporate Integrity Agreement ("CIA"). Id. at ¶ 274. None of Plaintiffs' DePuy allegations point to any specific board members, or suggest how any of the directors knew that J&J was engaging in illicit conduct at that time. As with Plaintiffs' other allegations, the Complaint asserts these various red flags placed the Board on notice, and that the Board failed to properly respond.
Plaintiffs, further, allege that several of the directors served on the Board's audit committee, public policy advisory committee, and science and technology committee. Based upon the directors' participation in these committees, Plaintiffs allege that the directors "had substantial knowledge relating to the allegations above and with such knowledge, knowingly permitted the Company to continue to pursue its unlawful and unethical business practices and strategies." Id. at ¶ 301.
In addition, Plaintiffs allege that all the directors signed the company's 10-K forms, "which disclosed many of the red flags and which the Director Defendants on the Board at the time of each Form 10-K reviewed and executed." Id. at ¶ 279 (emphasis added). Plaintiffs' counsel clarified, at oral argument, that the 10-Ks disclosed subpoenas that had been filed against certain J&J employees. No further specific allegations are made with respect to the knowledge, actions, or inactions of each director. Based on these allegations, the Complaint asserts two counts: (1) Count I -breach of fiduciary duties against the directors; and (2) Count II - breach of fiduciary duties against the officers.
On April 21, 2010, co-lead plaintiff Jeanne M. Calamore filed her derivative complaint. Over the course of the next several months, other shareholders filed five additional derivative complaints. Each of these shareholders filed suit without having first made a demand on J&J's Board.
Thereafter, on August 17, 2010, the Court consolidated the six derivative cases into the instant action titled In re Johnson & Johnson Derivative Litigation, Case No. 10-cv-2033. On December 17, 2010, Plaintiffs filed the Consolidated Amended Complaint that is the subject of this motion. Therein, Plaintiffs assert that they did not make a demand because demand would have been futile. Following the filing of the Consolidated Amended Complaint, nine other shareholders made demands upon J&J's Board with respect to matters alleged in the Complaint. J&J filed the instant motion to dismiss and to stay the litigation, pending the Board's appointment of a Special Committee to review and investigate the demand shareholders' assertions, on February 21, 2011. That same day, the individual defendants, officers and directors alike, named in Plaintiffs' Complaint joined J&J's motion to dismiss.
Meanwhile, in April 2010, the Board appointed the Special Committee to consider the demand shareholders' assertions and the allegations made in the Complaint. The Special Committee was comprised of four independent directors, Michael Johns, Anne Mulcahy, William Perez, and Charles Prince, which directors had most recently joined the Board at the time the Committee was formed. The Special Committee, further, retained independent counsel. The investigation took over one year to complete.
On July 18, 2011, while the instant motion to dismiss and to stay was pending, the Special Committee issued its recommendation that the Board take no action with respect to the instant litigation. The Board subsequently adopted the Special Committee's recommendation. Shortly after the Board adopted the report, the Court held oral argument on the instant motion on July 28, 2010.
Because the Board has responded to the demand shareholders' requests, that aspect of J&J's motion seeking a stay is now moot. J&J's motion to dismiss, however, is now ripe for decision. In that motion, J&J argues that Plaintiffs fail to satisfy the heightened pleading standard applicable to shareholder derivative actions found in Federal Rule of Civil Procedure 23.1. To be clear, those plaintiffs in the related actions that presented their demand to the Board are not subject to dismissal under Rule 23.1. This motion is pertinent to the Plaintiffs in this matter simply because they chose to file their complaint without first giving the Board the opportunity to address a demand. Keeping in mind the heightened standard applicable to plaintiffs who, like here, chose to proceed without first filing a demand on the Board, the Court agrees that Plaintiffs have failed to satisfy Rule 23.1 and grants J&J's motion to dismiss without prejudice. Plaintiffs are, further, granted leave to amend their complaint in a manner consistent with the strictures of this Opinion.
A. Motion to Dismiss Standard
In reviewing a motion to dismiss for failure to state a claim under 12(b)(6), a court must take all allegations in the complaint as true, viewed in the light most favorable to the plaintiff "and determine whether, under any reasonable reading of the complaint, the plaintiff may be entitled to relief." Phillips v. County of Allegheny, 515 F.3d 224, 233 (3d Cir. 2008) (citation and quotations omitted). In Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007), the Supreme Court "retired" the language in Conley v. Gibson, 355 U.S. 41, 45--46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957), that "a complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Twombly, 550 U.S. at 561 (quoting Conley, 355 U.S. at 45--46). Rather, the factual allegations in a complaint "must be enough to raise a right to relief above the speculative level." Id. at 555. In short, "a complaint must do more than allege the plaintiff's entitlement to relief. A complaint has to 'show' such an entitlement with its facts." Fowler v. UPMC Shadyside, 578 F.3d 203, 211 (3d Cir. 2009).
B. Shareholder Derivative Litigation Standard
Under Federal Rule of Civil Procedure 23.1, "a shareholder may file a derivative suit against the board of directors to claim enforcement of a right of the corporation where the corporation has failed to assert that right." Kanter v. Barella, 489 F.3d 170, 176 n.5 (3d Cir. 2007). Rule 23.1 contains specific requirements for a plaintiff's pleadings in derivative suits; a plaintiff must "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority ..., and the reasons for the plaintiff's failure to obtain the action or for not making the effort." In re PSE&G Shareholder Litig., 173 N.J. 258 (2002) ("PSE&G") (quoting Fed.R.Civ.P. 23.1).*fn4 "The purpose of Rule 23.1's demand requirement is to 'affor[d] the directors an opportunity to exercise their reasonable business judgment and waive a legal right vested in the corporation in the belief that its best interests will be promoted by not insisting on such right." Id. at 176. As a federal court hearing a shareholders' derivative suit involving state law claims, a district court must "apply the federal procedural requirement of particularized pleading, but apply state substantive law to determine whether the facts demonstrate demand would have been futile and can be excused." Id.
As with any Rule 12(b)(6) motion, in ruling on a motion to dismiss for failure to satisfy the shareholder derivative suit particularity standard, the court is "required to accept as true all allegations in the complaint and all reasonable inferences that can be drawn therefrom, and view them in the light most favorable to the plaintiff." Kanter, 489 F.3d at 177, 178 n.9. However, the Court need not credit bald assertions or legal conclusions found within a complaint. Id. at 177-78.
As noted, Defendant J&J has moved to dismiss the consolidated demand futility complaints for failure to satisfy the pleading standard set forth in Federal Rule of Civil Procedure 23.1, and the New Jersey Supreme Court decision in PSE&G. The demand-futility plaintiffs argue, in response, that they have sufficiently plead with particularity. Both parties agree that the Court should limit its review to the pleading allegations, and should not consider the J&J Board's acceptance of the report by the Special Committee. They further agree that the Court should not order discovery at this juncture. Hence my analysis focuses on the Complaint's allegations and adjudges those allegations in accordance with New Jersey law.*fn5
A. New Jersey Demand-Futility Law
Federal Rule of Civil Procedure 23.1 provides the mechanism for judging the sufficiency of shareholders' derivative pleadings against a corporation "to enforce a right of a corporation [where the corporation] failed to enforce a right which may properly be asserted by it ...." Fed.R.Civ.P. 23.1. As explained by the court in In re Veeco Instruments, Inc. Securities Litigation, 434 F.Supp.2d 267 (S.D.N.Y. 2006):
Since claims asserted in a shareholder derivative suit belong to the corporation, it is incumbent upon shareholder plaintiffs to make a demand upon the corporation's board of directors prior to commencing an action. Indeed, "A shareholder's right to bring a derivative action does not arise until he has made a demand on the board of directors to institute such an action directly, such demand has been wrongfully refused, or until the shareholder has demonstrated, with particularity, the reasons why pre-suit demand would be futile." This requirement stems from the well-settled principle that directors, rather than shareholders, manage the affairs of the corporation, and that the decision to bring or not to bring a lawsuit is a decision concerning the management of the corporation.
Id. at 273 (internal citations omitted).
In PSE&G, the New Jersey Supreme Court explained that, under its own procedural rule, New Jersey Rule of Court 4:32-3, and by drawing on case law from Delaware, that demand-futility plaintiffs must plead with particularity facts creating a reasonable doubt that: (1) the directors are disinterested and independent, or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. If either prong is satisfied, demand will be excused under [Rule 4:32-3].
PSE&G, 173 N.J. at 310. This test is referred to as the "Aronson test," named after the Delaware case upon which the PSE&G Court based its ruling, Aronson v. Lewis, 473 A.2d 805, 815 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). When applying the Aronson test, if the first prong is not satisfied, i.e., that the directors are disinterested and independent, then "there is a presumption that the Board's actions were the product of a valid exercise of business judgment." In re Intel Corp. Derivative Litig., 621 F.Supp.2d 165, 170 (D.Del. 2009) ("In re Intel") (citing Beam v. Stewart, 845 A.2d 1040, 1049 (Del. 2004)).
When the complaint is based on the board's inaction, it is "impossible to perform the essential inquiry contemplated by [the second prong in] Aronson, whether the directors have acted in conformity with the business judgment rule in approving the challenged transaction." Kanter v. Barella, 489 F.3d 170, 177 (3d Cir. 2007) (quoting PSE&G, 173 N.J. at 309). Accordingly, where board inaction has been alleged, New Jersey courts apply the "Rales" test to determine if demand would have been futile. See Johnson v. Glassman, 401 N.J.Super. 222, 243-44 (App.Div. 2007) (applying Rales to claim of board's general "lack of action").
The Rales test, derived from Rales v. Blasband, 634 A.2d 927, 934 (Del.1993), and adopted by the PSE&G Court, asks whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.
Kanter, supra at 177 n.8 (quoting Rales, 634 A.2d at 934) (emphasis added). That the directors would face a "substantial likelihood' of personal liability by complying with a shareholder's demand to pursue litigation," is one means by which a plaintiff may adequately allege that a board could not have properly exercised independent and disinterested business judgment. In re Intel, 621 F.Supp.2d at 170-71. However, a court may not infer that a director that faces only the "mere threat of personal liability" is not disinterested. Rales, 634 A.2d at 936 (citing Aronson, 473 A.2d at 815).
As explained in In re SFBC Intern., Inc. Securities & Derivative Litig., 495 F.Supp.2d 477 (D.N.J. 2007) ("SFBC"), when "[p]laintiffs premise their theory of personal liability against the directors on their alleged failure to take any action to remedy the numerous problems plaguing [the company]," the theory of liability discussed by the Delaware Court of Chancery in In re Caremark Int'l, 698 A.2d 959 (Del.Ch.1996), applies. Id. at 484. With respect to director liability, Caremark explains:
Director liability for a breach of the duty to exercise appropriate attention may, in theory, arise in two distinct contexts. First, such liability may be said to follow from a board decision that results in a loss because that decision was ill advised or "negligent". Second, liability to the corporation for a loss may be said to arise from an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss. 698 A.2d at 967 (emphasis added).
Furthermore, the Caremark court notes that directors are often uninformed about business decisions, made by management and employees of the corporation, that "vitally affect the welfare of the corporation and its ability to achieve its various strategic and financial goals." 698 A.2d at 968. Caremark explains that
Most of the decisions that a corporation, acting through its human agents, makes are, of course, not the subject of director attention. Legally, the board itself will be required only to authorize the most significant corporate acts or transactions: mergers, changes in capital structure, fundamental changes in business, appointment and compensation of the CEO, etc.
Although directors may not be aware of the business decisions made by the corporation through its various human agents, Caremark nonetheless holds that directors may be liable for failing to ensure that the corporation has information and reporting systems . . . that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation's compliance with law and its business performance.
Id. at 970. In this way, directors may not merely place their "heads in the sand" to avoid liability and responsibility. Making clear that such behavior is unacceptable, the Caremark Court explicitly held that "a director's obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists ...." Id. In that court's view, "failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standards." Id.
Very few Caremark claims are successful, however, and the Caremark theory has often been described as "possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment." In re Caremark, 698 A.2d at 967; see Veeco, 434 F.Supp.2d at 276. Cases in the Third Circuit applying Caremark have distilled that court's holding into a three-part test:
(1) that the directors knewor (2) should have known that violations of law were occurring and, in either event, (3) that directors took no steps in a good faith effort to prevent or remedy that situation ...*fn6 King v. Baldino, 409 Fed.Appx. 535, 537-38 (3d Cir. 2010) (emphasis added). See also SFBC, 495 F.Supp.2d at 485.
"Alternatively, a plaintiff may plead facts showing that 'the directors were conscious of the fact they were not doing their jobs,' and that they 'ignored 'red flags' indicating misconduct in defiance of their duties." King, 409 Fed.Appx. at 537 (citation omitted). "Red flags' in this context are 'facts showing that the board . . . was aware that [the corporation's] ...