Stone v. Ritter
911 A.2d 362 (Del.Supr. 2006)

  • Hamric and Nance were operating a fraudulent ‘Ponzi scheme’. They did this with the help of a bank called AmSouth, who provided Hamric and Nance with accounts and distributed interest payments.
    • Had bank employees been paying attention they would have easily uncovered Hamric and Nance’s scheme.
  • After the scheme fell apart, AmSouth was forced to pay $50M in fines and penalties for helping the scam. AmSouth’s shareholders instituted a derivative lawsuit against the directors for wasting corporate money.
    • The shareholders argued that AmSouth’s compliance program lacked adequate board and management oversight, and that reporting to management for the purposes of monitoring and oversight of compliance activities was materially deficient.
      • Basically, since the directors weren’t doing their job and investigating what the employees were doing, the shareholders were out $50M.
  • The Trial Court found for AmSouth and the directors. The shareholders appealed.
    • The Trial Court looked to In re Caremark International Inc. Derivative Litigation (698 A.2d 959 (Del. Ch. 1996)), and found that when shareholders claim that the directors were ignorant to liabilities, the shareholder can only win if they show that there was a “sustained or systemic failure of the board to establish oversight.”
  • The Delaware Supreme Court affirmed.
    • The Delaware Supreme Court found that the standard for determining whether directors can be liable for failure to exercise oversight of employees who fail to comply with their duties was a “lack of good faith as evidenced by a sustained or systematic failure of a director to exercise reasonable oversight.” That’s the same standard that was given in Caremark.
      • The Court noted that this was a very high standard to meet.
        • See ATR-Kim Eng Financial Corp. v. Araneta (2006 WL 3783520 (Del. Ch. Dec. 21 2006)) for a case that met this standard.
    • The Court found that there are two conditions necessary for liability under the standard set by Caremark:
      • The directors utterly failed to implement any reporting or information system or controls; or
      • 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.
      • In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.
    • The Court found that there is no duty of good faith that forms a basis, independent of the duties of care and loyalty, for director liability.
      • The Court found that just because there was a bad outcome in this case, that was not evidence of bad faith on the part of the directors.
  • Basically, this case said that directors are not responsible for ensuring the legality of every act by the corporation’s personnel, even if the illegal conduct would have been discovered if there hadn’t been a failure of the corporate compliance program.