Brett Kandell v. .Dror Niv
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Opinion
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
BRETT KANDELL, Derivatively on ) Behalf of Nominal Defendant, FXCM, ) Inc., ) ) Plaintiff, ) ) v. ) C.A. No. 11812-VCG ) DROR NIV, WILLIAM AHDOUT, ) KENNETH GROSSMAN, DAVID ) SAKHAI, EDUARD YUSUPOV, ) JAMES G. BROWN, ROBIN DAVIS, ) PERRY FISH, ARTHUR GRUEN, ERIC ) LEGOFF, BRYAN REYHANI, and ) RYAN SILVERMAN, ) ) Defendants, ) and ) ) FXCM, INC., ) ) Nominal Defendant. )
MEMORANDUM OPINION
Date Submitted: June 12, 2017 Date Decided: September 29, 2017
Peter B. Andrews, Craig J. Springer, David M. Sborz, of ANDREWS & SPRINGER, LLC, Wilmington, Delaware; OF COUNSEL: Joseph E. White, III, Jorge A. Amador, Jonathan M. Stein, Adam Warden, of SAXENA WHITE, P.A., Boca Raton, Florida, Attorneys for Plaintiff.
Kenneth J. Nachbar, Thomas P. Will, of MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; OF COUNSEL: Paul R. Bessette, Israel Dahan, of KING & SPALDING LLP, New York, New York; Michael J. Biles, Tyler W. Highful, S. Saliya Subasinghe, of KING & SPALDING LLP, Austin, Texas, Attorneys for Defendants and Nominal Defendant. GLASSCOCK, Vice Chancellor This matter is before me on a Motion to Dismiss an action brought by a
stockholder, purportedly derivatively for the benefit of his corporation, nominal
defendant FXCM, Inc. (“FXCM” or “the Company”). FXCM is a foreign exchange
(“FX”) broker. The cause of action advanced is a suit against FXCM directors for
losses associated with the so-called “Flash Crash” in the value of the euro relative to
the Swiss franc, which happened when the Swiss unexpectedly decoupled the two
currencies. As this Court has had numerous opportunities to explain, a chose in
action is a corporate asset, subject, in our model, to the control of the corporation’s
directors. A stockholder who believes the asset is being poorly deployed must make
a demand on the board; only if the board breaches its duty in response may the
stockholder pursue the matter derivatively. The exception is where an impediment
renders a majority of directors unable to bring their business judgment to bear on
behalf of the corporation to consider the issue; in that case, demand is excused and
the stockholder may litigate in the corporate interest. Under the facts here, the
Plaintiff contends that demand is excused.
The bulk of the Company’s business, at the time at issue, involved retail FX
trades. With retail customers, FXCM employed an agency trading model under
which the Company made, on customer order, offsetting currency trades in the FX
market on behalf of the customer. That is, the Company made a purchase in the
market, and made a corresponding sale to the customer. As is industry practice,
1 customers’ trades were highly leveraged. Where the customer’s position took a loss
as a result of trading activity, it was FXCM’s policy, in light of which it marketed
its services, to retain the investment which the customer had paid, but not to pursue
the customer for additional amounts owed FXCM; in other words, FXCM did the
offsetting trades, the customer made an up-front and leveraged investment payment
to FXCM, and any losses above that amount were retained by FXCM. FXCM sought
to avoid such situations by selling out the customer’s interest when losses beyond
investment threatened. This it was generally able to do when the market was
relatively stable and liquid.
FXCM’s policy, however, entailed both business and regulatory risk. The
business risk involved situations where the market became neither stable nor liquid;
where customer’s accounts were on the wrong side of such a market, FXCM could
find itself liable for the large potential losses in excess of its customers’ investments.
Such a situation occurred when the euro lost value in the Flash Crash. FXCM
suffered large losses, as a result of which it was required to borrow funds under
onerous conditions, and in light of which the board took a number of actions. These
losses and actions are the main focus of the Plaintiff’s Complaint. Since I conclude
that a majority of the directors were independent and disinterested, and because I
find no likelihood that they face a substantial threat of liability for what were (costly)
business decisions, I conclude that the Plaintiff has failed to demonstrate that the
2 directors’ ability to exercise business judgment is impaired, and demand is not
excused with respect to these allegations. The exception to this is the loan
transaction itself, with respect to which a majority of the directors were not
independent and disinterested: with respect to that transaction, demand is excused,
and the Motion to Dismiss must be denied.
The more difficult issue here involves the legal and regulatory risk engendered
by FXCM’s business model. The Complaint points out that, at least since the time
of the 2010 Dodd-Frank reforms, 17 C.F.R. § 5.16 (“Regulation 5.16”) has
prohibited FX traders from representing that they will limit clients’ trading losses.
According to the Plaintiff, that was exactly what FXCM was doing when it informed
customers that, in certain circumstances, it would not pursue their losses beyond
their initial investment. He notes that, during the pendency of this matter, the
Commodity Futures Trading Commission (“CFTC”) has brought an action alleging
precisely that. The Defendants argue that the Plaintiff’s reading is but one way to
interpret the Regulation. They note that the Plaintiff has failed to allege that, up to
the time pertinent, the CFTC had ever publicly taken a position that the model used
by FXCM was in violation of Regulation 5.16, much less that the directors were
aware of such. They point out that the Complaint is silent as to any “red flag,”
warning, or report to the directors suggesting that FXCM was not in compliance with
the Regulation. The allegations of the Complaint are limited to these: First, the
3 directors were aware of Regulation 5.16, as demonstrated by the Company’s Form
10-K disclosures, which, in each year pertinent, referenced Regulation 5.16. The
Complaint notes that in these Form 10-Ks, the Company discloses as a risk that
CFTC rules forbid making guarantees against loss to retail FX customers. Second,
the directors were aware of the Company’s advertised policy not to pursue customer
losses beyond investment, a matter that the Defendants do not seriously contest. And
third, that nonetheless the directors failed to ensure that the Company was brought
into compliance with the Regulation.
Where directors knowingly cause or permit a Delaware corporation to violate
positive law, they have acted in bad faith, and are liable to the corporation for
resulting damages. Where, as here, the directors serve with the benefit of an
exculpatory clause, they are not liable for non-compliance with law resulting from
their negligence or gross negligence, however; only where they knowingly cause the
violation, or knowingly ignore a duty to act, is bad faith in violation of the duty of
loyalty invoked, leading to liability. Demand will be excused only where the facts
alleged, together with reasonable inferences therefrom, if true make it substantially
likely that any illegality on the part of the Company arose from the directors’ bad
faith.
Typically, directors are not charged with preventing illegal actions by
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IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
BRETT KANDELL, Derivatively on ) Behalf of Nominal Defendant, FXCM, ) Inc., ) ) Plaintiff, ) ) v. ) C.A. No. 11812-VCG ) DROR NIV, WILLIAM AHDOUT, ) KENNETH GROSSMAN, DAVID ) SAKHAI, EDUARD YUSUPOV, ) JAMES G. BROWN, ROBIN DAVIS, ) PERRY FISH, ARTHUR GRUEN, ERIC ) LEGOFF, BRYAN REYHANI, and ) RYAN SILVERMAN, ) ) Defendants, ) and ) ) FXCM, INC., ) ) Nominal Defendant. )
MEMORANDUM OPINION
Date Submitted: June 12, 2017 Date Decided: September 29, 2017
Peter B. Andrews, Craig J. Springer, David M. Sborz, of ANDREWS & SPRINGER, LLC, Wilmington, Delaware; OF COUNSEL: Joseph E. White, III, Jorge A. Amador, Jonathan M. Stein, Adam Warden, of SAXENA WHITE, P.A., Boca Raton, Florida, Attorneys for Plaintiff.
Kenneth J. Nachbar, Thomas P. Will, of MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; OF COUNSEL: Paul R. Bessette, Israel Dahan, of KING & SPALDING LLP, New York, New York; Michael J. Biles, Tyler W. Highful, S. Saliya Subasinghe, of KING & SPALDING LLP, Austin, Texas, Attorneys for Defendants and Nominal Defendant. GLASSCOCK, Vice Chancellor This matter is before me on a Motion to Dismiss an action brought by a
stockholder, purportedly derivatively for the benefit of his corporation, nominal
defendant FXCM, Inc. (“FXCM” or “the Company”). FXCM is a foreign exchange
(“FX”) broker. The cause of action advanced is a suit against FXCM directors for
losses associated with the so-called “Flash Crash” in the value of the euro relative to
the Swiss franc, which happened when the Swiss unexpectedly decoupled the two
currencies. As this Court has had numerous opportunities to explain, a chose in
action is a corporate asset, subject, in our model, to the control of the corporation’s
directors. A stockholder who believes the asset is being poorly deployed must make
a demand on the board; only if the board breaches its duty in response may the
stockholder pursue the matter derivatively. The exception is where an impediment
renders a majority of directors unable to bring their business judgment to bear on
behalf of the corporation to consider the issue; in that case, demand is excused and
the stockholder may litigate in the corporate interest. Under the facts here, the
Plaintiff contends that demand is excused.
The bulk of the Company’s business, at the time at issue, involved retail FX
trades. With retail customers, FXCM employed an agency trading model under
which the Company made, on customer order, offsetting currency trades in the FX
market on behalf of the customer. That is, the Company made a purchase in the
market, and made a corresponding sale to the customer. As is industry practice,
1 customers’ trades were highly leveraged. Where the customer’s position took a loss
as a result of trading activity, it was FXCM’s policy, in light of which it marketed
its services, to retain the investment which the customer had paid, but not to pursue
the customer for additional amounts owed FXCM; in other words, FXCM did the
offsetting trades, the customer made an up-front and leveraged investment payment
to FXCM, and any losses above that amount were retained by FXCM. FXCM sought
to avoid such situations by selling out the customer’s interest when losses beyond
investment threatened. This it was generally able to do when the market was
relatively stable and liquid.
FXCM’s policy, however, entailed both business and regulatory risk. The
business risk involved situations where the market became neither stable nor liquid;
where customer’s accounts were on the wrong side of such a market, FXCM could
find itself liable for the large potential losses in excess of its customers’ investments.
Such a situation occurred when the euro lost value in the Flash Crash. FXCM
suffered large losses, as a result of which it was required to borrow funds under
onerous conditions, and in light of which the board took a number of actions. These
losses and actions are the main focus of the Plaintiff’s Complaint. Since I conclude
that a majority of the directors were independent and disinterested, and because I
find no likelihood that they face a substantial threat of liability for what were (costly)
business decisions, I conclude that the Plaintiff has failed to demonstrate that the
2 directors’ ability to exercise business judgment is impaired, and demand is not
excused with respect to these allegations. The exception to this is the loan
transaction itself, with respect to which a majority of the directors were not
independent and disinterested: with respect to that transaction, demand is excused,
and the Motion to Dismiss must be denied.
The more difficult issue here involves the legal and regulatory risk engendered
by FXCM’s business model. The Complaint points out that, at least since the time
of the 2010 Dodd-Frank reforms, 17 C.F.R. § 5.16 (“Regulation 5.16”) has
prohibited FX traders from representing that they will limit clients’ trading losses.
According to the Plaintiff, that was exactly what FXCM was doing when it informed
customers that, in certain circumstances, it would not pursue their losses beyond
their initial investment. He notes that, during the pendency of this matter, the
Commodity Futures Trading Commission (“CFTC”) has brought an action alleging
precisely that. The Defendants argue that the Plaintiff’s reading is but one way to
interpret the Regulation. They note that the Plaintiff has failed to allege that, up to
the time pertinent, the CFTC had ever publicly taken a position that the model used
by FXCM was in violation of Regulation 5.16, much less that the directors were
aware of such. They point out that the Complaint is silent as to any “red flag,”
warning, or report to the directors suggesting that FXCM was not in compliance with
the Regulation. The allegations of the Complaint are limited to these: First, the
3 directors were aware of Regulation 5.16, as demonstrated by the Company’s Form
10-K disclosures, which, in each year pertinent, referenced Regulation 5.16. The
Complaint notes that in these Form 10-Ks, the Company discloses as a risk that
CFTC rules forbid making guarantees against loss to retail FX customers. Second,
the directors were aware of the Company’s advertised policy not to pursue customer
losses beyond investment, a matter that the Defendants do not seriously contest. And
third, that nonetheless the directors failed to ensure that the Company was brought
into compliance with the Regulation.
Where directors knowingly cause or permit a Delaware corporation to violate
positive law, they have acted in bad faith, and are liable to the corporation for
resulting damages. Where, as here, the directors serve with the benefit of an
exculpatory clause, they are not liable for non-compliance with law resulting from
their negligence or gross negligence, however; only where they knowingly cause the
violation, or knowingly ignore a duty to act, is bad faith in violation of the duty of
loyalty invoked, leading to liability. Demand will be excused only where the facts
alleged, together with reasonable inferences therefrom, if true make it substantially
likely that any illegality on the part of the Company arose from the directors’ bad
faith.
Typically, directors are not charged with preventing illegal actions by
company employees unless certain “red flags” make it inescapable that the board
4 acted with illegal intent, or in bad faith ignored a duty to act to prevent a violation.
The pleading standard for such scienter on the part of directors is high. This case
involves no notice to the Board by legal advisors that Company policy—soliciting
customers by touting limited risk—was illegal, and the Complaint is silent regarding
other such red flags. However, the Regulation itself is so clear on its face that,
drawing the appropriate plaintiff-friendly inferences, I find it reasonably likely that
the directors knowingly condoned illegal behavior. Of course, whether that high
burden is substantively met awaits a developed record, and circumstances not
apparent on the face of the pleadings may well show lack of bad faith. The question
here, however, is whether this Board could bring its independent business judgment
to bear on behalf of the corporate interest in responding to a liability demand. I find
that the substantial likelihood of liability faced by the Defendants prevents such an
exercise of business judgment, and demand on this cause of action is excused. A
more detailed statement of the facts and my analysis follows.
5 I. BACKGROUND1
A. The Parties
Plaintiff Brett Kandell was a stockholder of nominal defendant FXCM, Inc.
at all times relevant to this case and maintains his ownership interest today.2 The
Plaintiff seeks to bring this action derivatively on behalf of FXCM. 3 FXCM, a
Delaware corporation, “is an online provider of foreign exchange trading and related
services.”4
Defendant Dror Niv has served as Chairman of the FXCM Board of Directors
since 2010, when FXCM went public.5 Beginning in 1999, Niv was also a director
for FXCM’s predecessor FXCM Holdings, LLC.6 Niv was one of the founders of
FXCM, and he has served as the Company’s CEO since 1999.7
Defendants William Ahdout, Kenneth Grossman, David Sakhai, and Eduard
Yusupov were also founding partners of FXCM.8 Like Niv, these defendants have
1 The facts, drawn from the Plaintiff’s Verified Third Amended Shareholder Derivative Complaint (“Complaint” or “Third Amended Complaint”), from documents incorporated by reference therein, and from matters of which I may take judicial notice, are presumed true for purposes of evaluating the Defendants’ Motion to Dismiss. 2 Compl. ¶¶ 11, 159. 3 Id. ¶ 158. 4 Id. ¶ 12. On February 21, 2017, FXCM announced, among other things, that it would change its name to “Global Brokerage, Inc.” Defs.’ Resp. in Opp’n to Pl.’s Mot. for Leave to File a Supplement to the Compl. 9 n.2. Nonetheless, I refer to the Company as FXCM throughout this Memorandum Opinion, and I do not take note of other changes that have occurred at FXCM since the filing of the Plaintiff’s Complaint. 5 Compl. ¶ 13. 6 Id. 7 Id. 8 Id. ¶¶ 14–17. 6 been members of FXCM’s Board since 2010 and began serving on the Holdings
Board in 1999.9 Ahdout serves as “FXCM’s Chief Dealer and is a Managing
Director.”10 Grossman is also a Managing Director at FXCM.11 Sakhai serves as
FXCM’s COO,12 and Yusupov “is FXCM’s Global Head of Dealing” in addition to
serving as a Managing Director.13
Defendant James G. Brown has been a member of the FXCM Board since
2010 and began serving on the Holdings Board in 2008.14 “Brown is the ‘Presiding
Independent Director’ and is a member of the Board’s Audit Committee,
Compensation Committee, and Corporate Governance and Nominating
Committee.”15 Defendant Robin Davis has served on the FXCM Board since 2010
and is a member of the Board’s Audit Committee.16 Defendant Arthur Gruen has
been an FXCM Board member since 2010 and serves on the Audit and
Compensation Committees.17 Gruen is the founder and Vice President of Broker
Online Exchange (“BOX”), a startup founded in 2013.18 BOX “incurred net losses
9 Id. 10 Id. ¶ 14. 11 Id. ¶ 15. 12 Id. ¶ 16. 13 Id. ¶ 17. 14 Id. ¶ 18. 15 Id. 16 Id. ¶ 19. 17 Id. ¶ 21. 18 Id. ¶ 178(b). 7 of $17,498.00 and $25,542.53, in 2013 and 2014, respectively.” 19 Defendants Eric
LeGoff and Ryan Silverman have served on FXCM’s Board since 2010.20 Silverman
chairs the Board’s Corporate Governance and Nominating Committee, and he is the
CEO of “MSR Solutions, Inc., a financial consulting firm.”21 The Complaint alleges
on information and belief that “MSR Solution, Inc.’s annual revenue is $130,000.”22
Defendant Perry Fish was a member of FXCM’s Board from 2010 to February
1, 2016.23 During that time, Fish chaired the Board’s Compensation Committee and
served on the Corporate Governance and Nominating Committee.24 Fish worked as
a lawyer “at the Law Offices of Perry Gary Fish” until 2014, and FXCM’s 2015
annual proxy “does not indicate that Fish has been employed since 2014.”25
Defendant Bryan Reyhani has served on FXCM’s Board since February 1, 2016.26
With the exception of Reyhani, all of these defendants signed FXCM’s annual
reports (filed on SEC Form 10-K) from fiscal year 2010 through fiscal year 2015.27
FXCM’s 2014 annual proxy revealed that Niv, Sakhai, Ahdout, Yusupov, and
Grossman held “over 27.7% of the Company’s voting power through their stock
19 Id. 20 Id. ¶¶ 22, 24. 21 Id. ¶¶ 24, 178(c). 22 Id. ¶ 178(c). 23 Id. ¶ 20. 24 Id. 25 Id. ¶ 178(a). 26 Id. ¶ 23. 27 Id. ¶¶ 13–22, 24. 8 ownership.”28 According to the 2014 annual proxy, the Defendants collectively held
29.9% of FXCM’s voting power, “making them the single largest group of FXCM
shareholders.”29 And from fiscal year 2011 through fiscal year 2015, Gruen, Brown,
Fish, LeGoff, Silverman, and David each received $150,000 in annual director
compensation.30
B. Factual Overview
1. FXCM’s Business Model
FXCM, which was founded in 1999 and went public in 2010, “provides online
foreign exchange . . . trading services to nearly 200,000 customers globally.” 31
FXCM’s business is divided into two primary components: “retail trading, in which
its customers are individual investors trading on their own personal accounts, and
institutional trading, where the Company offers foreign exchange trading services to
banks, hedge funds and other institutional customers.”32 FXCM obtains most of its
profits from its retail segment, “with 76.6% of its 2014 trading revenues derived
from retail and 23.4% from institutional customers.”33 Indeed, FXCM is the largest
FX broker for retail customers in the United States.34 Despite FXCM’s prominence
28 Id. ¶ 63. 29 Id. ¶ 26. 30 Id. ¶ 178. 31 Id. ¶ 28. 32 Id. 33 Id. 34 Id. 9 in the U.S. market, most of its “retail customer trading volume was derived from
customers residing outside of the U.S., according to FXCM’s . . . Form 10-K filed
with the SEC on March 16, 2015.”35
FXCM’s trading platform employs what it describes as an “agency model” to
carry out trades.36 FXCM provided the following description of its agency model in
its 2013 Form 10-K:
Our agency model is fundamental to our core business philosophy because we believe that it aligns our interests with those of our customers and reduces our risks. In the agency model, when our customer executes a trade on the best price quotation offered by our FX market makers, we act as a credit intermediary, or riskless principal, simultaneously entering into offsetting trades with both the customer and the FX market maker. We earn trading fees and commissions by adding a markup to the price provided by the FX market makers.37
FXCM allows its customers to trade currency pairs, purchasing one currency at the
same time as they sell another.38 According to the Complaint, FXCM maintained a
“policy of extending massive amounts of leverage to its customers,”39 “with leverage
of as much as 50:1 extended to U.S. customers and 200:1 for overseas customers.”40
FXCM’s leverage policy stemmed from the nature of FX markets, in which “daily
35 Id. ¶ 30. 36 Id. ¶ 33. 37 Id. (emphasis and footnote omitted). 38 Id. ¶ 32. 39 Id. ¶ 34. 40 Id. ¶ 2. 10 currency fluctuations are usually very small.”41 Leverage therefore enables FX
traders “to increase the value of potential currency movements.”42
FXCM maintains several policies designed to reduce its customers’ risk of
incurring trading losses. It touts its “margin-watcher feature,” which purports to
“automatically close[] out open positions if a customer’s account is at risk of going
into a negative balance as a result of a trading position losing value and reaching the
minimum margin threshold.”43 The Complaint notes that “market conditions” may
prevent FXCM from closing out a customer’s account before she is at risk of
suffering losses greater than her margin.44 When that happens, “FXCM’s stated
policy [as set out in the Company’s Form 10-Ks] is ‘generally not to pursue claims
for negative equity against our customers.’”45 In other words, where FXCM is
unable to close out a customer account before its losses exceed the amount the
customer invested, FXCM, and not the customer, takes the loss.
FXCM’s policy regarding customer losses is embodied in its Client
Agreement, which customers must sign before they open an account. 46 The Client
Agreement provides, among other things, that “[if] the Client incurs a negative
balance through trading activity, the Client should inform FXCM’s trade audit team.
41 Id. ¶ 30. 42 Id. 43 Id. ¶ 35. 44 Id. 45 Id. 46 Id. ¶ 43. 11 FXCM will evaluate the inquiry and credit the Client’s Account with the amount of
the negative balance where the debit was due to trading activity.”47 The Client
Agreement clarifies that this policy does not apply in various situations, including
“in the case of a force majeure event,” or where “FXCM determines, in its sole and
absolute discretion, that the negative balance is unrelated to the Client’s trading
activity.”48
The Complaint points to a bevy of FXCM materials designed to draw attention
to the Company’s policy regarding customer losses. In December 2014, FXCM’s
U.S. website stated that while “account equity” may “become[] negative,” “FXCM
will not hold traders responsible for deficit balances in this scenario.”49 And from
March 2011 to March 2015, FXCM’s U.S. website answered in the negative the
following questions: “Is there a debit balance risk? Can I lose more money than I
deposit?”50 The site elaborated that FXCM “guarantee[s] you can never pay a debit
balance. One of the greatest concerns traders have about leverage is that a sizable
loss could result in owing money to their broker. At FXCM, your maximum risk of
loss is limited by the amount in your account.”51 A July 6, 2010 FXCM Australia
press release noted that “[u]nlike margin trading with other providers, FXCM
47 Id. 48 Id. 49 Id. ¶ 47 (emphasis omitted). 50 Id. ¶ 48 (emphasis omitted). 51 Id. (emphasis omitted). 12 guarantees that you will never have to pay a deficit balance as a result of trading!”52
FXCM also used social media to promote its policy regarding customer losses. For
example, on June 30, 2011, FXCM UK’s Twitter page stated that “FXCM traders
have peace of mind knowing that they are not responsible for account deficit
balances as a result of trading.”53 And a now-removed YouTube video posted on
FXCM’s YouTube channel touted that “customers would ‘NEVER OWE A
DEFICIT AS A RESULT OF TRADING.’”54
2. CTFC Regulations and FXCM
The CFTC regulates FXCM.55 The Complaint alleges in conclusory fashion
that “[s]ince at least 1981, the CFTC has prohibited companies like FXCM from
offering guarantees or limiting customer losses.”56 The Plaintiff, however, does not
quote the language of this prohibition.57 Instead, he points to Regulation 5.16, which
the CFTC adopted in September 2010, as part of the Dodd-Frank reforms.58 Under
Regulation 5.16,
a) No retail foreign exchange dealer, futures commission merchant or introducing broker may in any way represent that it will, with respect to any retail foreign exchange transaction in any account carried by a
52 Id. ¶ 49. 53 Id. ¶ 53. 54 Id. ¶ 54. 55 Id. ¶ 38. 56 Id. 57 It appears that the Plaintiff is referring to 17 C.F.R. § 1.56, which contains prohibitions similar to those found in Regulation 5.16. 58 Compl. ¶ 38. 13 retail foreign exchange dealer or futures commission merchant for or on behalf of any person: (1) Guarantee such person against loss; (2) Limit the loss of such person; or (3) Not call for or attempt to collect security deposits, margin, or other deposits as established for retail forex customers.59
According to the CFTC, the purpose of adopting Regulation 5.16 was threefold.
First, Regulation 5.16 provides protection for FX companies in the event of extreme
volatility in the currency market.60 Second, Regulation 5.16 helps ensure that FX
companies remain financially viable, because a firm that agrees to eat its customers’
losses is at risk of undercapitalization, which may ultimately necessitate
bankruptcy.61 Third, the CFTC was concerned that policies guaranteeing or limiting
customer losses had often gone hand in hand with illegal conduct on the part of FX
companies.62
FXCM’s business model—“highly leveraged forex trading” combined with a
policy that customers, typically, would not bear losses beyond what they deposited
into their account—allegedly led to significant increases in the Company’s retail
trading volume.63 To support this assertion, the Plaintiff points out that “retail
customer trading volume for December 2014 ‘was 61% higher than December
59 17 C.F.R. § 5.16. 60 Compl. ¶ 39. 61 Id. ¶ 40. 62 Id. ¶ 41. 63 Id. ¶ 44. 14 2013.’”64 The Plaintiff charges that this business strategy, despite increasing profits
for the Company, was premised on violations of Regulation 5.16. According to the
Complaint, “the Individual Defendants ignored Regulation 5.16 in order to attract
customers lured by the guarantee that they would never be financially responsible
for a negative balance incurred on their account.”65
The Complaint alleges that the Defendants “could not help but know about
FXCM’s violations of Regulation 5.16 due to its scope and pervasiveness at the
Company.”66 Specifically, the Complaint asserts that because “Regulation 5.16 was
part of a significant overhaul of the CFTC’s regulations in connection with the
highly publicized Dodd-Frank Act in 2010, the Company’s Board knew or should
have known that the Company’s zero debit policy was a violation of Regulation
5.16.”67 The Complaint also alleges that the Defendants were aware of FXCM’s
purported violations of Regulation 5.16 because of the Company’s “extensive
marketing materials and its client agreements offering guarantees to customers.”68
Finally, the Complaint attempts to establish the Defendants’ knowledge of
impropriety by pointing to FXCM’s SEC filings, which refer to Regulation 5.16.69
For instance, FXCM’s Form 10-Ks for 2010 to 2014 noted that one of the risks
64 Id. 65 Id. ¶ 43. 66 Id. ¶ 45. 67 Id. 68 Id. ¶ 46. 69 Id. ¶ 55. 15 facing the Company involved the CFTC’s adoption of “final rules which, among
other things, ‘prohibit the making of guarantees against loss to retail FX
customers.’”70
On August 18, 2016, the CFTC brought a complaint against FXCM, alleging
that it had “improperly guarantee[d] its customers against loss, limit[ed] the loss of
customers, or not call[ed] for or attempt[ed] to collect security deposits, margin, or
other deposits of customers.”71 “The CFTC . . . [sought] damages in the billions of
dollars as a result of FXCM’s violations of Regulation 5.16.”72 In February 2017,
FXCM entered into a consent order with the CFTC in which it agreed to pay a
$650,000 fine for, among other things, violations of Regulation 5.16 resulting from
its no-debit policy.73 FXCM did not admit or deny the consent order’s allegations
or conclusions,74 and the order provides scant factual detail regarding the Company’s
implementation of the no-debit policy. It states that “FXCM represented to
customers that it would limit customer losses . . . . by advertising that if the customer
incurred a negative balance through trading activity FXCM would credit the
customer account with the amount of the negative balance.”75 The consent order
70 Id. The Plaintiff alleges that Niv wrote several letters to the CFTC in 2010 in opposition to some of the proposed regulations. Id. ¶ 45. But the Plaintiff does not assert that any of these letters referred to Regulation 5.16. 71 Id. ¶ 58. 72 Id. 73 Consent Order ¶¶ 37–38, 40. 74 Id. ¶ 11. 75 Id. ¶ 31. 16 also notes that the no-debit policy “was memorialized in FXCM’s customer account
opening documents.”76
3. The “Flash Crash”
From September 2011 to January 15, 2015, the Swiss National Bank (“SNB”)
maintained a policy of pegging the Swiss franc to the euro.77 During this time, the
SNB worked to prevent the Swiss franc from “appreciat[ing] beyond the level of 1.2
euros per franc.”78 The SNB adopted this policy “during the Eurozone debt crisis .
. . , when, in response to a weakening euro and fears of the euro’s ongoing viability
as a common currency, an influx of money flowed into Switzerland, creating upward
pressure on the Swiss franc.”79 The introduction of this currency peg caused what
the Complaint describes as “the largest price swing of any ‘G-10’ currency in recent
memory (other than when the peg was removed on January 15, 2015), with the Swiss
franc falling 8.8% against the euro on the day of the announcement.”80 Nevertheless,
as a result of the SNB’s efforts, the EUR/CHF currency pair remained stable for
several years, and FX traders took “large positions in the pair.”81 FXCM, for its part,
promoted trading in the EUR/CHF pair through a Company-owned website and
76 Id. 77 Compl. ¶¶ 65, 68. 78 Id. ¶ 65. 79 Id. 80 Id. 81 Id. ¶ 66. 17 online videos.82 At least two of FXCM’s competitors—Gain Capital Group and
Saxo Bank—saw a potential downside in the growth of trading positions that were
long on EUR and short on CHF.83 As a result, these two companies “increased their
margin requirements for the pair.”84 FXCM, however, took no such precautionary
measures.85
In response to concerns that the European Central Bank was about to “creat[e]
downward pressure on the euro” via “pumping in money through bond purchases,”
the SNB “announced on January 15, 2015 that it would allow its currency to float
freely against the euro.”86 The announcement led to extreme volatility in the
EUR/CHF currency pair, with the Swiss franc appreciating rapidly.87 The franc rose
“more than 41% against the euro, eventually settling at an 18% rise over the course
of the day.”88 As a result of this volatility, FX markets were drained of liquidity,
effectively preventing FXCM from executing stop orders or margin calls until
approximately forty-five minutes after the announcement.89 But “[b]y that time,
customers on the wrong side of the EUR/CHF pair [that is, long on EUR, short on
82 Id. 83 Id. ¶ 67. 84 Id. 85 Id. 86 Id. ¶ 68. 87 Id. ¶ 69. 88 Id. (emphasis added). 89 Id. 18 CHF] had locked in significant losses.”90 Many of these customers incurred negative
account balances, and their losses were compounded by their reliance on leverage in
their trading strategies.91
The Flash Crash proved catastrophic for FXCM. On the evening of January
15, FXCM put out a press release announcing that FXCM’s customers had suffered
large losses, leading to “negative equity balances owed to FXCM of approximately
$225 million,” a figure later revised upward to $276 million.92 FXCM also stated
that these negative balances potentially put it “in breach of certain regulatory capital
requirements.”93 FXCM was hampered in its ability to collect on these accounts
because of its policy regarding customer losses, which put “the Company . . . on the
hook for these losses.”94 The Complaint describes in great detail the FXCM Board’s
response to these events, to which I now turn.
4. The Board’s Response to the Flash Crash
The FXCM board first met to address the Flash Crash at 3:00 pm on January
15, 2015.95 Niv gave background on the events of the day, and noted that FXCM
customers had suffered $200 million in losses that the Company may not be able to
90 Id. 91 Id. 92 Id. ¶ 71 n.37. 93 Id. ¶ 71. 94 Id. ¶ 2. 95 Id. ¶ 79. 19 collect.96 Niv also pointed out that FXCM might be breaching its revolving credit
agreement, so that the Company “had to raise a total of at least $250 million.”97
According to Niv, FXCM’s regulators “threatened a ‘temporary’ suspension of the
Company’s operations if sufficient funds were not raised by the next morning.”98
Niv told the Board that, to address this crisis, FXCM had sought the services of UBS,
which “only advised FXCM in its capacity as placement agent in exploring financing
alternatives, and did not advise the Company on debt financing.”99 Niv also
suggested that “as a backup plan,” FXCM could obtain capital from its
competitors.100
The FXCM board met again on the evening of January 15.101 Niv gave an
update on the situation, describing UBS’s ongoing efforts to obtain financing for the
Company.102 Niv mentioned that Jeffries Group LLC, “an investment banking
subsidiary of the holding company Leucadia,” was in FXCM’s offices and was
considering providing financing to the Company.103 At this meeting, Niv stated that
a suspension of trading “would not necessarily put the Company out of business but
96 Id. 97 Id. 98 Id. ¶ 82. 99 Id. ¶ 81. 100 Id. 101 Id. ¶ 84. 102 Id. 103 Id. 20 could cause a dramatic reduction in the value of the Company.”104 The Plaintiff
emphasizes that, while the Board received updates and information from Niv about
the situation and potential next steps, the Board did not obtain “a financial advisor
to counsel the directors on issues that were essential to the Company’s very existence
as a going concern.”105 Specifically, neither UBS nor any other investment bank
provided advice as to debt financing or the loan FXCM eventually obtained from
Leucadia.106
The next morning, at 8:30 am, the Board convened for a third time. 107 Niv
informed the Board that “regulators from the CFTC and the [National Futures
Association] were in the Company’s offices and had threatened to shut down the
Company’s operations if FXCM did not immediately receive sufficient capital to
stay in regulatory compliance.”108 Robert Lande, FXCM’s CFO, mentioned that the
Company was working on a deal with Leucadia in which “Leucadia would extend a
two year secured loan of up to $300 million . . . to FXCM, with an interest rate of
10%, increasing 1% per quarter.”109 At this time, FXCM had contacted several other
parties, but none “were willing to execute a transaction within the time frame
104 Id. ¶ 85. 105 Id. 106 Id. ¶ 168. 107 Id. ¶ 86. 108 Id. 109 Id. 21 demanded by the regulators.”110 Niv reiterated his view that a shutdown would wipe
out FXCM’s enterprise value, but that “some value could be preserved in a
transaction prior to a shutdown.”111
The Board met yet again at 11:15 am, and the directors learned that the
regulators would force the Company into liquidation if it did not obtain enough
capital to bring it into regulatory compliance by noon.112 Niv then told the Board
that the loan offered by Leucadia was FXCM’s only option if it was to continue to
operate.113 The Complaint alleges that while UBS had been unable to secure equity
financing from other parties with whom it or the Company had negotiated, “UBS
and the Company failed to propose a loan from these parties similar to the Leucadia
Loan, but with better terms for the Company.”114
At this meeting, Niv also set out the terms of the proposed Leucadia deal.115
In exchange for loaning FXCM $300 million, Leucadia would receive interest at the
rate of 10% per annum, increasing by 1.5% every quarter.116 The loan was set to
mature in two years, and after repayment, “net proceeds of asset sales, as well as
certain other distributions from the operating subsidiaries, would be split, with the
110 Id. ¶ 87. 111 Id. ¶ 88. 112 Id. ¶ 89. 113 Id. 114 Id. 115 Id. ¶ 90. 116 Id. 22 Company receiving 25% and Jefferies/Leucadia receiving 75%.”117 Further, after
three calendar years, Leucadia could force a sale of the Company.118 After Niv
explained these terms, Brown, the “Presiding Independent Director” of FXCM, said
he was interested in “personally participating in the transaction.”119 Niv then stated
his belief that FXCM would likely enter receivership if the Board did not approve
the loan from Leucadia, “and that this would be a worse option for shareholders, as
customers would lose money (because not all customer funds are segregated) and
there would be substantial litigation and potential governmental issues.”120 The
Plaintiff downplays the urgency of the situation facing the Board, pointing to CFTC
Regulation 5.7, which gives companies a ten-day extension if they can demonstrate
that they are able to comply with capital requirements.121 According to the
Complaint, the Board never sought an extension under Regulation 5.7, though the
Plaintiff admits that Niv informed the directors of his view that the regulators would
not give the Company additional time to explore alternative transactions.122 All the
directors (save Brown, who abstained) voted to approve the Leucadia deal.123
117 Id. 118 Id. 119 Id. ¶ 91. 120 Id. ¶ 92. 121 Id. 122 Id. ¶ 92 n.41. 123 Id. ¶ 93. 23 Shortly after the preliminary vote, it emerged that Steven Cohen Asset
Management (“SACAM”) was interested in offering a more advantageous deal to
FXCM than that proposed by Leucadia.124 But this deal later fell through because
Steven Cohen, SACAM’s head, could not obtain from the regulators “certain
assurances he was seeking due to prior regulatory violations by his firm.” 125
The final board meeting in the immediate aftermath of the Flash Crash took
place approximately four hours later.126 At 3:05 pm, right before the Board was set
to approve the Leucadia loan, CFTC regulators entered the room and announced that
“if the Board did not approve the transaction at that very moment, they would shut
down the Company’s operations immediately and force FXCM into liquidation.”127
The Board (again with the exception of the abstaining Brown) then approved the
transaction.128 Despite the compressed timeframe within which the Board was
forced to act, the Plaintiff faults the Board for failing to form “a special committee
of independent directors to cleanse the process of conflicts of interest.” 129 As an
example of such a conflict of interest, the Plaintiff points out that five out of eleven
124 Id. 125 Id. 126 Id. ¶ 94. 127 Id. 128 Id. 129 Id. ¶ 95. 24 FXCM board members were insiders who were “not listed as ‘independent’ in the
Company’s annual proxies.”130
5. The Aftermath
On January 19, 2015, FXCM issued a press release announcing the Leucadia
loan.131 It described the terms of the loan, which included, as noted above, an initial
interest rate of 10% per annum that would increase by 1.5% each quarter the loan
remained outstanding until the cap of 20.5% was reached, and an agreement that
FXCM would pay Leucadia a share of the proceeds resulting from certain
transactions, including a sale of assets, dividends or distributions, and the sale of the
Company.132 Under this value-sharing agreement, once the Leucadia loan and
associated fees were paid off, Leucadia would be entitled to 50% of the next $350
million of sale proceeds, dividends, or distributions, 90% of the “[n]ext amount
equal to 2 times the balance outstanding on the term loan and fees as of April 16,
2015, such amount not to be less than $500 million or more than $680 million,” and
60% of “[a]ll aggregate amounts thereafter.”133 The loan also contained several
restrictive covenants limiting FXCM’s ability to enter mergers and other significant
130 Id. 131 Id. ¶ 97. 132 Id. 133 Id. 25 transactions.134 And, as discussed above, Leucadia held the right to force a sale of
FXCM after three years.135
According to the Complaint, market reaction to the Leucadia deal was
negative. The Plaintiff points out that on January 15, 2015, FXCM stock closed at
$12.63, and when trading in the stock began again on January 20, FXCM stock
opened at $1.58 and closed at $1.60.136 The Complaint also quotes financial analysts
who expressed the view that the Leucadia loan had significantly reduced the value
of FXCM stock.137 As a result of FXCM’s inability to pay down the Leucadia loan
with revenue from its businesses, the Company has had to sell several of its
subsidiaries.138 Another consequence of the Flash Crash was that FXCM “increased
margin requirements for global clients who trade currencies.”139 FXCM also
stopped allowing customers to trade fourteen currency pairs that it deemed too
risky.140
FXCM implemented several other changes in the wake of the Flash Crash and
the Leucadia loan. On January 30, 2015, “the Board announced that it had adopted
a Stockholder Rights Plan [“Rights Plan”] . . . , declaring a dividend distribution of
134 Id. 135 Id. 136 Id. ¶ 99. 137 Id. ¶¶ 101–03. 138 Id. ¶ 104. 139 Id. ¶ 106. 140 Id. 26 one right on each outstanding share of the Company’s Class A common stock.”141
The Rights Plan had a 10% ownership trigger, and when UBS made a presentation
to FXCM on the Plan, it noted that “only 19% of rights plans then in-effect by S&P
600 companies employed ownership triggers of less than 15%.”142 FXCM’s press
release announcing the Plan stated that it was “designed to reduce the likelihood that
any person or group would gain control of the Company by open market
accumulation or other coercive takeover tactics without paying a control premium
for all shares.”143 Approximately one year later, FXCM amended the Rights Plan to
lower the ownership trigger to 4.9%.144 According to the Complaint, FXCM adopted
and amended the Rights Plan even though the Company “had neither a history of
contentious shareholder activism nor any implicit threat of action by outside activist
investors.”145
In March 2015, FXCM announced that Niv, Sakhai, Adhout, and Yusupov
had entered into new severance agreements with the Company.146 If these executives
were fired, they “would be entitled to[, among other things,] (1) two times their
annual base salary on the termination date, [and] (2) their annual target bonus (which
141 Id. ¶ 107. 142 Id. ¶ 109 n.48. 143 Id. ¶ 107. 144 Id. ¶ 110. 145 Id. ¶ 111. 146 Id. ¶ 113. 27 is 200% of the executive’s annual base salary).”147 Each of these executives received
an annual base salary of $800,000.148 Under their previous severance agreements,
they were entitled only to twice their base salary, so that the new agreements
“add[ed] an additional $1.6 million (double their annual base salary) to each
executive’s severance package.”149 Moreover, Niv, Sakhai, Adhout, Yusupov, and
Lande (FXCM’s CFO) received yearly incentive bonus plans tied to “EBITDA
growth, repayments of the Leucadia Loan, and an ‘Individual Objective Portion.’”150
The result of this new incentive plan was that Niv, Sakhai, Ahdout, and Yusupov
saw their compensation more than double between 2014 and 2015.151 The Plaintiff
takes issue with the decision to tie bonuses to repayment of the Leucadia loan,
describing it as a way of “accomplishing a goal that was already contractually
mandated.”152 The Plaintiff also attacks Niv’s compensation in 2015, alleging that
he “is the second highest paid CEO in his peer group . . . despite FXCM having the
lowest market capitalization, fifth lowest total assets, third lowest total revenues, and
the worst earnings in its peer group.”153
147 Id. 148 Id. 149 Id. ¶ 115 (emphasis omitted). 150 Id. ¶ 117. 151 Id. 152 Id. ¶ 118. 153 Id. ¶ 121. 28 In April 2016, FXCM amended the bonus plans to remove the Leucadia loan
component of the bonus calculation and increase the EBITDA portion. 154 The
amendment also “reduce[d] the 2016 EBITDA target from $80.5 million to $40
million—more than a 50% decrease despite a 100% increase in its weighted
significance for the bonus calculation.”155 The Plaintiff alleges that the Board
enacted this amendment because it would enhance these executives’ ability to obtain
bonuses.156 To support this allegation, the Plaintiff points out that while “FXCM’s
adjusted EBITDA in 2013 was approximately $158 million and in 2014 was
approximately $107 million, under the amended Annual Incentive Bonus Plan the
adjusted EBITDA target for 2015 is only $70 million, and in 2016 is only $40
million.”157
On March 10, 2016, FXCM announced that it had entered a memorandum of
understanding (“MOU”) with Leucadia to amend the Leucadia loan.158 The Plaintiff
emphasizes that in exchange for giving FXCM an additional year to pay off the loan,
“Leucadia will acquire 49.9% common membership interest in the newly named
FXCM Group.”159 The MOU also modified the value-sharing schedule discussed
above; now, FXCM management is “guaranteed between 10% and 14% of the post-
154 Id. ¶ 123. 155 Id. 156 Id. ¶ 124. 157 Id. 158 Id. ¶ 126. 159 Id. ¶ 128. 29 loan proceeds.”160 More specifically, after the Leucadia loan is paid off, “FXCM
senior management will be entitled to receive $35 million of the first $350 million
in proceeds, $60 million of the next $500 million in proceeds, and 14% of the
Company’s proceeds for the indefinite future.”161 While “[t]he amendments were
expected to be completed by June 2016, . . . to date the MOU has not been
finalized.”162
C. This Litigation
The Plaintiff filed his initial complaint on December 15, 2015, and filed an
amended complaint on March 4, 2016. After the Plaintiff filed another amended
complaint on May 31, 2016, the Defendants moved to dismiss, whereupon the
Plaintiff filed the Complaint currently before the Court. The Complaint asserts six
counts against the Defendants. Count I alleges that the Defendants breached their
fiduciary duties of loyalty and care by allowing the Company to violate Regulation
5.16; approving the Leucadia loan, the severance agreements and bonus plans, and
the Rights Plan; failing to obtain the services of a financial advisor to opine on the
merits of the Leucadia loan or other debt financing options; and exposing the
Company to undue risk.163 Count II is brought against the insider defendants (Niv,
160 Id. ¶ 129. 161 Id. ¶ 131. 162 Id. ¶ 126. 163 Id. ¶¶ 192–96. 30 Sakhai, Adhout, Yusupov, and Grossman) for breaching their fiduciary duties by
“caus[ing] the Company to enter into the Leucadia Loan and the MOU, despite the
fact that the terms of the Leucadia Loan were grossly unfair to the Company.” 164
Count III seeks indemnification and contribution from the Defendants in the event
that FXCM is found liable for conduct for which the Defendants are responsible.165
Counts IV and V allege that the Leucadia loan, the severance agreements and bonus
plans, and the MOU constituted a waste of corporate assets.166 Finally, Count VI
asserts that Niv, Sakhai, Adhout, and Yusupov were unjustly enriched as a result of
the severance agreements and bonus plans.167 As noted above, the Plaintiff seeks to
proceed derivatively on behalf of FXCM.168 The Plaintiff chose not to make a pre-
suit demand on the FXCM board, arguing that such demand would be futile.169
The Defendants moved to dismiss the Complaint on October 17, 2016, and on
December 1, 2016, the Plaintiff moved to strike various materials relied on in the
Defendants’ motion papers. I heard oral argument on these motions on February 1,
2017. On February 13, 2017, the Plaintiff moved to file a supplement to his
Complaint based on a recent CFTC Order (“February CFTC Order”) that, among
other things, fined FXCM for failing to disclose that it retained a financial interest
164 Id. ¶ 203. 165 Id. ¶¶ 208–09. 166 Id. ¶¶ 213–14, 219–20. 167 Id. ¶ 224. 168 Id. ¶ 158. 169 Id. ¶ 161. 31 in a market maker with which FXCM’s customers often traded.170 I heard oral
argument on that motion on May 17, 2017. After the parties indicated to me that no
further argument was needed, I considered the matter fully submitted on June 12,
2017. This Memorandum Opinion addresses the pending motions.171 I turn first to
the Motion to Dismiss.
II. ANALYSIS
A. The Motion to Dismiss
The Defendants have moved to dismiss the Plaintiff’s Complaint under Court
of Chancery Rule 23.1 for failure to make a demand.172 The demand requirement is
an extension of the bedrock principle that “directors, rather than shareholders,
manage the business and affairs of the corporation.”173 Directors’ control over a
corporation embraces the disposition of its assets, including its choses in action.
Thus, under Rule 23.1, a derivative 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
170 More specifically, the CFTC announced that it intended to institute proceedings against FXCM for the conduct just described, and before those proceedings began, FXCM agreed to, among other things, pay a $7 million fine, stop violating the relevant laws, and withdraw from CFTC registration. Feb. CFTC Order 1, 12–14. FXCM neither admitted nor denied the Order’s allegations or conclusions. Id. at 1. 171 Because I do not rely on any of the materials submitted by the Defendants to which the Plaintiff objects, I need not decide the Plaintiff’s Motion to Strike. 172 The Plaintiff has also moved to dismiss under Court of Chancery Rule 12(b)(6). 173 Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) (citing 8 Del. C. § 141(a)). 32 the action or for not making the effort.”174 Where, as here, the plaintiff has failed to
make a pre-suit demand on the board, the Court must dismiss the complaint “unless
it alleges particularized facts showing that demand would have been futile.”175 The
plaintiff’s “pleadings must comply with stringent requirements of factual
particularity that differ substantially from the permissive notice pleadings governed
solely by Chancery Rule 8(a).”176
This Court analyzes demand futility under the test set out in Rales v.
Blasband.177 Rales requires a derivative plaintiff to allege particularized facts
raising a reasonable doubt that, if a demand had been made, “the board of directors
could have properly exercised its independent and disinterested business judgment
in responding to [it].”178 Aronson v. Lewis addresses the subset of cases in which
the plaintiff is challenging an action taken by the current board.179 To establish
demand futility under Aronson, the plaintiff must allege particularized facts creating
a reasonable doubt that “the directors are disinterested and independent” or the
“challenged transaction was otherwise the product of a valid exercise of business
174 Ct. Ch. R. 23.1(a). 175 Ryan v. Gursahaney, 2015 WL 1915911, at *5 (Del. Ch. Apr. 28, 2015), aff’d, 128 A.3d 991 (Table) (Del. 2015). 176 Brehm v. Eisner, 746 A.2d 244, 254 (Del. 2000). 177 634 A.2d 927 (Del. 1993). 178 Id. at 934. 179 See id. at 933–34 (explaining that Aronson does not apply unless the plaintiff is challenging a business decision by the board of directors that would be considering the demand). 33 judgment.”180 The tests articulated in Aronson and Rales are “complementary
versions of the same inquiry.”181 That inquiry asks whether the board is capable of
exercising its business judgment in considering a demand.182 “Courts assess demand
futility on a claim-by-claim basis.”183
1. The Leucadia Loan and the MOU
Because the Plaintiff first challenged the Board’s decision to approve the
Leucadia loan in his original complaint, I must consider whether demand would have
been futile with respect to the Board as it was constituted when the initial complaint
was filed—that is, when it was composed of the same directors who approved the
Leucadia loan.184 At that time, eleven directors sat on FXCM’s Board: Niv, Ahdout,
Grossman, Sakhai, Yusupov, Brown, Davis, Fish, Gruen, LeGoff, and Silverman.185
Of those eleven, Niv, Ahdout, Grossman, Sakhai and Yusupov were corporate
officers as well as directors.186 The Defendants do not argue that these Company
180 473 A.2d at 814. 181 In re China Agritech, Inc. S’holder Derivative Litig., 2013 WL 2181514, at *16 (Del. Ch. May 21, 2013); see also David B. Shaev Profit Sharing Account v. Armstrong, 2006 WL 391931, at *4 (Del. Ch. Feb. 13, 2006) (“This court has held in the past that the Rales test, in reality, folds the two-pronged Aronson test into one broader examination.”). 182 In re Duke Energy Corp. Derivative Litig., 2016 WL 4543788, at *14 (Del. Ch. Aug. 31, 2016). 183 Reiter ex rel. Capital One Fin. Corp. v. Fairbank, 2016 WL 6081823, at *6 (Del. Ch. Oct. 18, 2016). 184 See Rales, 634 A.2d at 934 (instructing courts to consider “whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations” (emphasis added)). 185 Pl.’s Verified Shareholder Derivative Compl. ¶¶ 12–22. 186 Compl. ¶¶ 61–62. 34 employees were disinterested with respect to the Leucadia loan transaction,187 and I
assume for purposes of this pleadings-stage analysis that they were not. Brown,
Davis, Fish, Gruen, LeGoff, and Silverman were outside directors,188 and they made
up a majority of the Board. The Plaintiff argues that the outside directors were not
independent with regard to the Leucadia loan because their approval of the loan
enabled them to retain their board positions and the compensation associated with
those positions. The Defendants vigorously dispute this proposition. I address the
Plaintiff’s entrenchment arguments below with respect to other claims advanced in
the Complaint. With respect to the Leucadia loan transaction, however, the issue is
irrelevant, because in any event, a majority of the directors who approved the
transaction cannot be considered disinterested.
That is because, when presented with the proposed Leucadia loan, one of the
outside directors, Brown, expressed to the Board his intention, or wish, to become
involved in the transaction from the lender’s side.189 The Complaint is silent as to
whether he ultimately was a part of the Leucadia loan. Decisively here, however, in
apparent recognition that he was conflicted, he abstained from the vote.190 This left,
187 See, e.g., Defs.’ Opening Br. 25 (arguing that, with respect to the Leucadia loan, “[t]here can be no dispute that a majority of these eleven directors—Brown, Davis, Fish, Gruen, LeGoff and Silverman—were independent, outside directors with no personal financial stake in the [transaction]”). 188 Pl.’s Verified Shareholder Derivative Compl. ¶ 2. 189 Compl. ¶ 91. 190 Id. ¶¶ 93–94. 35 with respect to the Leucadia transaction, an effective ten-member board. With
respect to at least five of those members, the Defendants do not contend that they
can be considered disinterested for purposes of this motion. Under Aronson, then,
demand is excused. Since the facts alleged indicate that the transaction was not
approved by a Board with a majority of disinterested and independent directors, it is
reasonably likely that entire fairness review will apply here.191 In that situation, the
Board would be unable to effectively bring its independent judgment to bear on a
litigation demand, and demand is therefore excused.
Because demand is excused, I must consider the alternative ground for the
Defendants’ Motion, dismissal under Rule 12(b)(6). Under that rule, a motion to
dismiss must be denied unless, accepting as true the well-pled192 facts and the
reasonable inferences therefrom, it nonetheless is not reasonably conceivable that
the Plaintiff can prevail.193 The Defendants argue that the Board was faced with the
Leucadia loan decision when the only alternative was corporate ruin; they describe
191 See, e.g., In re Trados Inc. S’holder Litig., 73 A.3d 17, 44 (Del. Ch. 2013) (“To obtain review under the entire fairness test, the stockholder plaintiff must prove that there were not enough independent and disinterested individuals among the directors making the challenged decision to comprise a board majority.”). 192 I am well aware that pedants prefer “well-pleaded” to “well-pled.” This Court’s Webster’s Twentieth Century Dictionary (1964) describes “pled” as “colloquial or dialectal.” My personal Webster’s Third New International Dictionary (2002), on the other hand, allows it as a standard alternative to the preferred “pleaded.” The Oxford English Dictionary describes “pled” as an Americanism, which I suppose is good enough for me. In any event, I was raised with “pled”; if my continued use of the term outs me as a mumpsimus, so be it. 193 Cent. Mortg. Co. v. Morgan Stanley Mortg. Capital Holdings LLC, 27 A.3d 531, 535 (Del. 2011). 36 the vote as existential with respect to the Company. It may prove so, but I have
found it reasonably conceivable that entire fairness review is invoked here. Under
that standard of review, it is appropriate that I examine the transaction with a full
record.194 The Motion to Dismiss under Rules 23.1 and 12(b)(6) is accordingly
denied with respect to the Leucadia transaction.
The Plaintiff also alleges that a breach of duty inheres in Board approval of
the MOU to modify the Leucadia loan. The Complaint is silent as to whether Brown
voted for or abstained from the vote to approve the MOU. In light of my decision
on the Leucadia loan, I find it prudent to deny the Motion to Dismiss with respect to
the MOU pending discovery as well.
2. The Rights Plan
The Plaintiff also attacks the Board’s decision to approve (and later amend)
the Rights Plan in the aftermath of the Flash Crash. As with the Leucadia loan, the
Plaintiff first challenged the adoption of the Rights Plan in his initial complaint, at
which time the Board consisted of Niv, Ahdout, Grossman, Sakhai, Yusupov,
Brown, Davis, Fish, Gruen, LeGoff, and Silverman. Again, of those individuals,
Brown, Davis, Fish, Gruen, LeGoff, and Silverman were outside directors who
constituted a majority of the Board. The Plaintiff argues that demand is excused as
194 See Williams v. Ji, 2017 WL 2799156, at *5 (Del. Ch. June 28, 2017) (“The entire fairness standard of review ‘normally will preclude dismissal of a complaint on a Rule 12(b)(6) motion to dismiss.’” (quoting Orman v. Cullman, 794 A.2d 5, 20 n.36 (Del. Ch. 2002))). 37 to the Rights Plan under Aronson’s first prong because the outside directors
approved the Rights Plan to entrench themselves.
To excuse demand as to a stockholder rights plan under the first Aronson
prong, a plaintiff “must plead particularized facts demonstrating that the directors
had either a financial interest or an entrenchment motive in [adopting] the Rights
Plan.”195 But “a conclusory allegation of entrenchment . . . will not suffice to excuse
demand.”196 And if the allegedly entrenching transaction “could, at least as easily,
serve a valid corporate purpose as an improper purpose, such as entrenchment,” then
demand will not be excused.197 Moreover, “a board need not be faced with a specific
threat before adopting a rights plan.”198
Here, the FXCM Board adopted the Rights Plan in the aftermath of the Flash
Crash, when FXCM stock had declined by 87%. The Rights Plan initially had what
the Complaint describes as an “atypically low” 10% ownership trigger,199 which was
later reduced to 4.9%. The Plaintiff attempts to demonstrate an entrenchment motive
with respect to the Rights Plan by alleging that “the Board adopted the Rights Plan
simply to maintain their stronghold over the Company and keep the Company’s
shareholders at bay.”200 The result of the Rights Plan, according to the Plaintiff, is
195 In re Chrysler Corp. S’holders Litig., 1992 WL 181024, at *4 (Del. Ch. July 27, 1992). 196 Cottle v. Standard Brands Paint Co., 1990 WL 34824, at *8 (Del. Ch. Mar. 22, 1990). 197 Id. 198 Nomad Acquisition Corp. v. Damon Corp., 1988 WL 383667, at *5 (Del. Ch. Sept. 20, 1988). 199 Compl. ¶ 109. 200 Id. ¶ 111. 38 that “FXCM’s shareholders have effectively lost their ability to oppose management
or influence corporate policy through an established proxy process because the
Rights Plan creates an unreasonable and intentional barrier to prevent shareholders
from acquiring meaningful ownership stakes in the Company.”201 The Plaintiff also
stresses that FXCM had “neither a history of contentious shareholder activism nor
any implicit threat of action by outside activist investors.”202 These allegations do
not suffice to excuse demand under Aronson’s first prong.
For starters, the Plaintiff fails to allege any particularized facts suggesting that
the Board was motivated to entrench itself in adopting and later amending the Rights
Plan. It is not enough to offer, as the Plaintiff does here, the conclusory allegation
that “[i]n reality, the Rights Plan was designed to further entrench FXCM’s Board
and management in office by blocking any takeover efforts from third parties.”203
That is because, as noted above, “a conclusory allegation of entrenchment . . . will
not suffice to excuse demand.”204 And while FXCM was not faced with a takeover
threat from any particular party, that alone is not enough to successfully allege an
entrenchment motive.205 Given the precipitous decline in FXCM’s share price in the
wake of the Flash Crash—which could conceivably subject the Company to takeover
201 Id. 202 Id. 203 Id. ¶ 108. 204 Cottle, 1990 WL 34824, at *8. 205 See Nomad Acquisition Corp., 1988 WL 383667, at *5 (“[A] board need not be faced with a specific threat before adopting a rights plan.”). 39 bids that did not capture the Company’s full value—it is clear from the Complaint
that the Board’s adoption of the Rights Plan “could, at least as easily, serve a valid
corporate purpose as an improper purpose, such as entrenchment.”206 Furthermore,
that FXCM had never previously faced serious threats from activist stockholders or
outside activist investors does not imply that the Board lacked a legitimate business
purpose for adopting and amending the Rights Plan at issue here. Finally, I note that
no accumulation of shares is alleged and no request to waive the Plan has been
presented to, let alone declined by, the Board. Such circumstances, should they
occur, may invoke equitable relief not available here, in a figurative vacuum. The
Plaintiff cannot allege any damages that flow from the adoption of the Rights Plan
about which he complains, and accordingly, no liability threatens the directors in
that regard. I find that demand is not excused as to the adoption of the Rights Plan.
3. The Amended Severance Agreements and the Bonus Plans
The Plaintiff also argues that the Board breached its fiduciary duties by
approving the amended severance agreements and the bonus plans. The decision to
approve the bonus plans took place after the Plaintiff filed his initial complaint, by
206 Cottle, 1990 WL 34824, at *8; see also 1 Arthur Fleischer, Jr. & Alexander R. Sussman, Takeover Defenses: Mergers and Acquisitions § 5.06[D][2] (7th ed. 2015) (“With respect to the requirement of a reasonably perceived threat, it [is] . . . clear . . . that the courts will be willing to accept that virtually any company is vulnerable to hostile takeover tactics which could subject the company and its stockholders to significant disadvantage and that a board is justified in adopting a pill to protect against this risk.” (footnote omitted)). 40 which time Reyhani had filled a vacancy on the board created by Fish’s departure.207
Thus, with respect to this decision, the operative Board for demand-futility purposes
consists of Niv, Ahdout, Grossman, Sakhai, Yusupov, Brown, Davis, Reyhani,
Gruen, LeGoff, and Silverman.208 Brown, Davis, Reyhani, Gruen, LeGoff, and
Silverman were outside directors, and they constituted a majority of the Board.
Since the Plaintiff first attacked the amended severance agreements in his initial
complaint, the relevant Board is almost the same as that for the bonus plans, except
that Fish was still a director and Reyhani had yet to take his seat.209
The Plaintiff argues that demand is excused as to these transactions because
the outside directors who approved them were dominated and controlled by the
insider defendants, who stood to benefit financially from the transactions. The
executives who received the amended severance packages “would[, upon
termination,] be entitled to (1) two times their annual base salary on the termination
date, [and] (2) their annual target bonus (which is 200% of the executive’s annual
base salary).”210 These executives received a base salary of $800,000. Niv, Sakhai,
Ahdout, and Yusupov also became subject to new incentive-based bonus plans, as a
207 Compl. ¶ 23. 208 Since the Plaintiff concedes that demand as to the bonus plans must be shown to be futile with respect to the Board as it existed after the Plaintiff amended his initial complaint, Pl.’s Answering Br. 39, I do not analyze the question of the relevant Board for determining demand under the framework set out in Braddock v. Zimmerman, 906 A.2d 776 (Del. 2006). 209 Again, I follow here the Plaintiff’s view as to the relevant Board for demand-futility purposes. Pl.’s Answering Br. 39. 210 Compl. ¶ 113. 41 result of which their compensation more than doubled between 2014 and 2015. And
in April 2016, FXCM amended these bonus plans in a way that allegedly made it
easier for the executives to obtain bonuses. The Plaintiff’s theory of demand futility
is that the outside directors lacked independence as to these transactions because
their board positions, and the compensation associated with them, would be in
jeopardy if they voted against deals that financially benefited the controlling insider
defendants.
“Independence means that a director’s decision is based on the corporate
merits of the subject before the board rather than extraneous considerations or
influences.”211 A plaintiff may establish a director’s lack of independence by
alleging facts creating “a reasonable doubt that a director is so beholden to an
interested director that his or her discretion would be sterilized.”212 To raise doubts
about a director’s independence, a plaintiff “must allege particularized facts
manifesting ‘a direction of corporate conduct in such a way as to comport with the
wishes or interests of the corporation (or persons) doing the controlling.’”213
“Allegations as to one’s position as a director and the receipt of director’s fees,
without more, however, are not enough for purposes of pleading demand futility.”214
211 Aronson, 473 A.2d at 816. 212 Highland Legacy Ltd. v. Singer, 2006 WL 741939, at *5 (Del. Ch. Mar. 17, 2006). 213 Aronson, 473 A.2d at 816 (quoting Kaplan v. Centex Corp., 284 A.2d 119, 123 (Del. Ch. 1971)). 214 In re The Ltd., Inc. S’holders Litig., 2002 WL 537692, at *4 (Del. Ch. Mar. 27, 2002); see also Benihana of Tokyo, Inc. v. Benihana, Inc., 891 A.2d 150, 175 (Del. Ch. 2005) (“[T]he fact that directors receive fees for their services does not establish an entrenchment motive on their part.” 42 Moreover, “conclusory allegations of domination and control are insufficient to
excuse pre-suit demand.”215 And “[s]tock ownership alone, even a majority interest,
is insufficient proof of ‘domination or control’ over a board of directors.”216 Instead,
the plaintiff must allege “particularized facts showing that an individual person or
entity interested in the transaction controlled the board’s vote on the transaction.”217
The Plaintiff has failed to allege facts supporting a reasonable inference that
the insider defendants controlled and dominated the outside directors with respect to
the challenged transactions. The Plaintiff alleges that “[t]he combination of their
high-level executive and director positions, their influence over the Company’s
Board and their aggregate stock holdings, qualifies the FXCM Insider Defendants
as controlling shareholders.”218 But the conclusion that the insider defendants were
controllers is unsupported by any specific factual allegations detailing the manner in
which these defendants supposedly exerted control over the outside directors. True,
(citing Kahn v. MSB Bancorp, Inc., 1998 WL 409355, at *3 (Del. Ch. July 16, 1998), aff’d, 734 A.2d 158 (Del. 1999))). 215 Ash v. McCall, 2000 WL 1370341, at *7 (Del. Ch. Sept. 15, 2000). 216 Katz v. Halperin, 1996 WL 66006, at *8 (Del. Ch. Feb. 5, 1996) (quoting Aronson, 473 A.2d at 815). 217 Kahn v. Roberts, 1994 WL 70118, at *5 (Del. Ch. Feb. 28, 1994); see also Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1054 (Del. 2004) (“A stockholder’s control of a corporation does not excuse presuit demand on the board without particularized allegations of relationships between the directors and the controlling stockholder demonstrating that the directors are beholden to the stockholder.”); In re Paxson Commc’n Corp. S’holders Litig., 2001 WL 812028, at *9 (Del. Ch. July 12, 2001) (“Even where the potential for domination or control by a controlling shareholder exists, the complaint must allege particularized allegations that would support an inference of domination or control.”). 218 Compl. ¶ 64. 43 the insider defendants collectively held 27.7% of FXCM’s voting power. But while
a minority stockholder may in appropriate circumstances be deemed a controlling
stockholder who dominated the directors, “[a]n allegation of controlling stock
ownership does not raise, per se, a reasonable doubt as to the board’s
independence.”219 Instead, the plaintiff must “plead particularized facts alleging
that directors, constituting a majority of the board, were dominated or controlled by
a party with an interest in the transaction and thus unable to independently exercise
business judgment.”220 Such facts are wholly absent from the Complaint.
Accordingly, since the Plaintiff’s theory of demand futility here depends on the
existence of a controlling stockholder with the ability and willingness to terminate
the outside directors’ directorships, I conclude that demand is not excused under
Aronson’s first prong as to the amended severance agreements and the bonus plans.
The Plaintiff attempts to show demand futility under Aronson’s second prong
by alleging that the amended severance agreements and the bonus plans constituted
waste. To successfully plead waste, a plaintiff “must allege particularized facts that
lead to a reasonable inference that the director defendants authorized ‘an exchange
that is so one sided that no business person of ordinary, sound judgment could
219 Heineman v. Datapoint Corp., 611 A.2d 950, 955 (Del. 1992), overruled on other grounds by Brehm, 746 A.2d at 253. 220 Bodkin v. Mercantile Stores Co., 1996 WL 652763, at *2 (Del. Ch. Nov. 1, 1996) (emphasis added). 44 conclude that the corporation has received adequate consideration.’”221 Put
differently, “[i]f . . . there is any substantial consideration received by the
corporation, and if there is a good faith judgment that in the circumstances the
transaction is worthwhile, there should be no finding of waste.”222 This Court has
held that “merely poor, misguided, or loss-making transactions are insufficient for a
finding of waste.”223 Accordingly, the standard for showing waste is “obviously an
extreme test, very rarely satisfied by a shareholder plaintiff.”224 These principles
apply with equal force in the area of executive compensation. “So long as there is
some rational basis for directors to conclude that the amount and form of
compensation is appropriate and likely to be beneficial to the corporation, the grant
will not constitute waste.”225 Thus, “allegations that compensation is ‘excessive or
even lavish . . . are insufficient as a matter of law to meet the standard required for
a claim of waste.’”226
The Plaintiff’s waste claim premised on the insider defendants’ compensation
fails because the Complaint discloses a rational business purpose for the Board’s
decisions in this area: retaining top FXCM executives at a time when the Company
221 In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 136 (Del. Ch. 2009) (quoting Brehm, 746 A.2d at 263). 222 Lewis v. Vogelstein, 699 A.2d 327, 336 (Del. Ch. 1997) (emphasis omitted). 223 Orloff v. Shulman, 2005 WL 3272355, at *11 (Del. Ch. Nov. 23, 2005). 224 Steiner v. Meyerson, 1995 WL 441999, at *1 (Del. Ch. July 19, 1995). 225 Id. at *8. 226 Espinoza v. Zuckerberg, 124 A.3d 47, 67 (Del. Ch. 2015) (quoting In re 3COM Corp., 1999 WL 1009210, at *5 (Del. Ch. Oct. 25, 1999)). 45 was undergoing serious difficulties. These executives were FXCM founders, and
given the dire straits the Company found itself in after the Flash Crash, the Board
could have reasonably concluded that incentivizing them to help the Company
recover was important.227 The Plaintiff may not be satisfied with the quality of the
services provided by these executives, but it is clear from the Complaint that the
Board’s decisions in this area “reflect[] at least some element of bilateral exchange
and that there were rational bases for the Board to agree to [them].”228 I therefore
reject the Plaintiff’s attempt to show demand futility as to the amended severance
packages and the bonus plans via a waste claim.229
4. The Alleged Violations of Regulation 5.16
I turn now to the Plaintiff’s claim that the Defendants breached their fiduciary
duties by allowing or causing FXCM to follow a business model allegedly premised
on violations of Regulation 5.16. The Plaintiff alleges both that the Defendants
adopted a business plan premised on violations of Regulation 5.16 and that they
chose to ignore various red flags related to these purported violations. According to
the Plaintiff, I must evaluate demand futility as to the first theory of liability under
227 See Official Comm. of Unsecured Creditors of Integrated Health Servs., Inc. v. Elkins, 2004 WL 1949290, at *18 (Del. Ch. Aug. 24, 2004) (“Delaware law recognizes that retention of key employees may itself be a benefit to the corporation.”). 228 Zucker v. Andreessen, 2012 WL 2366448, at *10 (Del. Ch. June 21, 2012). 229 For the same reasons, the Complaint fails to adequately plead facts demonstrating that demand is excused with respect to the unjust enrichment claim against the corporate officers, which is, obviously, subsidiary to the breach of duty claim addressed above. 46 Aronson, while the second theory requires me to evaluate demand futility under
Rales. Under either approach, however, the fundamental question is the same: was
the Board as it was constituted when the Plaintiff filed his Complaint 230 capable of
exercising its business judgment in evaluating a demand involving these
allegations?231 The Plaintiff does not allege that the Defendants were interested or
lacked independence with respect to the alleged violations of Regulation 5.16. Thus,
the only avenue for pleading demand futility available to the Plaintiff is to
successfully allege that the Defendants face a substantial likelihood of liability
because they violated the duty of loyalty by allowing or causing the Company to
become a lawbreaker. For the reasons set out below, I find that the Plaintiff has
successfully pled demand futility as to FXCM’s purportedly unlawful conduct.
The Plaintiff’s allegations about FXCM’s supposed violations of Regulation
5.16 were principally treated in briefing as a Caremark claim. Typically, Caremark
claims involve “a breach of the duty of loyalty arising from a director’s bad-faith
230 Since the Plaintiff first made allegations pertaining to FXCM’s alleged violations of Regulation 5.16 in his Complaint, I must consider whether demand would have been futile with respect to Board as it was constituted when the Complaint was filed. See Braddock, 906 A.2d at 786 (“[W]hen an amended derivative complaint is filed, the existence of a new independent board of directors is relevant to a Rule 23.1 demand inquiry only as to derivative claims in the amended complaint that are not already validly in litigation.” (footnote omitted)). 231 See In re China Agritech, Inc. S’holder Derivative Litig., 2013 WL 2181514, at *16 (“[T]he Rales test asks whether a director would face a substantial risk of liability as a result of the litigation. To determine whether the participating directors would face a substantial risk of liability in litigation challenging their prior decisions, a reviewing court examines whether the directors had a personal interest in the decisions, were not independent with respect to the decisions, or otherwise would not enjoy the protections of the business judgment rule. Those are precisely the questions that Aronson asks.”). 47 failure to exercise oversight over the company.”232 In Stone v. Ritter,233 our Supreme
Court embraced the theory of director liability set out in Caremark, holding that such
a claim required a showing that “(a) the directors utterly failed to implement any
reporting or information system or controls; or (b) 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.”234 But the allegations here do not really involve “oversight” as that
concept is usually applied (although the allegations here can fit under Stone’s second
clause). The Plaintiff’s allegation here is that the directors are liable as a result of
knowingly causing, or knowingly failing to prevent, violations of positive law.
Where directors intentionally cause their corporation to violate positive law, they act
in bad faith; this state does not “charter lawbreakers.”235 While a Delaware
corporation may “pursue diverse means to make a profit,” it remains “subject to a
critical statutory floor, which is the requirement that Delaware corporations only
pursue ‘lawful business’ by ‘lawful acts.’”236 “As a result, a fiduciary of a Delaware
232 Rich ex rel. Fuqi Int’l, Inc. v. Yu Kwai Chong, 66 A.3d 963, 980 (Del. Ch. 2013). 233 911 A.2d 362 (Del. 2006). 234 Id. at 370. 235 In re Massey Energy Co., 2011 WL 2176479, at *20 (Del. Ch. May 31, 2011). 236 Id. 48 corporation cannot be loyal to a Delaware corporation by knowingly causing it to
seek profits by violating the law.”237
Similarly, knowing failure to prevent such a violation implies bad faith.
“Where directors fail to act in the face of a known duty to act, thereby demonstrating
a conscious disregard for their responsibilities, they breach their duty of loyalty by
failing to discharge that fiduciary obligation in good faith.”238
Here, Regulation 5.16 prohibits an FX trader from:
represent[ing] that it will, with respect to any retail foreign exchange transaction in any account carried by a retail foreign exchange dealer or futures commission merchant for or on behalf of any person: (1) Guarantee such person against loss; (2) Limit the loss of such person; or (3) Not call for or attempt to collect security deposits, margin, or other deposits as established for retail forex customers.239
The Defendants do not meaningfully contend that I may infer from the facts
in the Complaint that the directors were unaware of this legal prohibition against
limitation of customer loss, given the disclosures in the Company’s Form 10-Ks.
Nor do they so argue that the directors were unaware that, with respect to its core
business, retail FX trading, the Company openly and publicly touted that it would
237 Id.; see also Desimone v. Barrows, 924 A.2d 908, 934 (Del. Ch. 2007) (“Although directors have wide authority to take lawful action on behalf of the corporation, they have no authority knowingly to cause the corporation to become a rogue, exposing the corporation to penalties from criminal and civil regulators. Delaware corporate law has long been clear on this rather obvious notion; namely, that it is utterly inconsistent with one’s duty of fidelity to the corporation to consciously cause the corporation to act unlawfully.”). 238 Stone, 911 A.2d at 370 (footnote omitted). 239 17 C.F.R. § 5.16 (emphasis added). 49 forgo pursuing customer losses, beyond margin investment, by its customers; a
policy intended, obviously, to gain market share and corporate profits. The
Defendants do argue that I may not infer that the directors were aware that the no-
debit policy violated the Regulation, at least until the CFTC brought its action
alleging precisely that in August 2016.240 And they point out that the Complaint is
silent about any CFTC action or warning before this time, and about anything else
that would have demonstrated illegality to the Board.
With regard to a more complex and nuanced law that did not threaten a key
source of FXCM’s profits, or a more ambiguous Company policy, the Defendants
would undoubtedly be right that something more would need to be pled to invoke
scienter; for example, some indication making it inescapable to the Board that it
must act to prevent implementation of corporate policy, absent which positive law
would be violated. It would be a perverse incentive indeed were directors held liable
because a regulator adopted a legal interpretation at odds with a rationally compliant,
if ultimately unavailing, position adopted by the corporation.241 It would be equally
240 See Defs.’ Reply Br. 11–12 (arguing that the “red flags” offered by the Plaintiff all “suffer from the same fatal flaw—they fail to establish that the Board was aware that FXCM’s negative balance policy violated Regulation 5.16. The fact that the Board was aware of FXCM’s negative balance policy and Regulation 5.16 in light of statements in FXCM’s public filings and marketing materials misses the mark. The pertinent question is whether the Board knew that FXCM was violating Regulation 5.16 and nonetheless permitted FXCM to proceed with its negative balance policy. The [Complaint] is devoid of any such facts”). 241 See Melbourne Mun. Firefighters’ Pension Tr. Fund v. Jacobs, 2016 WL 4076369, at *12 (Del. Ch. Aug. 1, 2016) (“The Complaint . . . acknowledges that the Board consistently expressed— both verbally and through its actions—its view that its business practices were not violative of 50 perverse to hold directors responsible for knowledge of every regulation or law that
might impact their entity, or for every policy undertaken by corporate employees;
that is the basis for the scienter requirement and the focus on purported red flags
implying director knowledge.
Here, I find the situation different from that described above. The primary
pursuit of the Company was retail FX trading.242 The Company pursued clients
explicitly on the ground that FXCM would hold them harmless for loss beyond
investment, in contradistinction to competing FX brokers.243 I infer, and the
Defendants do not seriously contend otherwise, that the directors understood that
FXCM was engaged in this policy. I also infer, based on the facts alleged and the
Form 10-Ks, that the directors were aware of Regulation 5.16 and its prohibition on
advising clients that the Company would limit trading loss. The only question here
is whether, under these facts, I may infer that the directors knew the no-debit policy
violated the Regulation. This the Defendants contest. They point out that the
Complaint fails to allege any enforcement by the CFTC itself of Regulation 5.16
international antitrust laws and elected to address the relevant legal actions by focusing on educating industry participants and government officials as to why its practices were legal and by pursuing appeals.”), aff’d 158 A.3d 449 (Table) (Del. 2017). 242 See Compl. ¶ 28 (“Retail trading is the main source of FXCM’s profits, with 76.6% of its 2014 trading revenues derived from retail and 23.4% from institutional customers.”). 243 See, e.g., id. ¶ 54 (“A narrator on one official marketing video on the FXCM YouTube channel clearly and unequivocally stated: ‘FXCM guarantees a client’s trading risk is limited to the equity in their account. This means you will never owe a deficit balance as a result of trading even if a significant amount of leverage is used. This is an important safeguard most forex brokers don’t provide.’”). 51 against FXCM, despite the Company’s open touting of its policy for a period of
several years following adoption of the Regulation. According to the Defendants,
this bolsters an inference244 that an interpretation exists that the no-debit policy did
not violate Regulation 5.16,245 and thus that an inference of scienter on the part of
the directors is impermissible.
The Defendants may well be proved correct that, on a developed record, the
Plaintiff cannot demonstrate that the directors willfully acted, or refrained from a
known duty to act, causing the Company to violate the law. I find, however, that the
Regulation itself, on my reading, clearly prohibits touting loss limitations to clients,
and I find that the Company did precisely that. That reading is based on the plain
language of the Regulation; it is, I believe, bolstered by the purposes given by the
CFTC for the adoption of Regulation 5.16, which include avoiding the kind of
excessive trading risk that has crippled FXCM here.246 Given that finding, and given
the strong inference that the directors were aware of the Regulation and the
Company’s policy as well, my reading of Regulation 5.16 is sufficient at the
244 I agree that the Company’s brazen touting of its loss-limitation policy is puzzling, and tends to cut against scienter on the part of the Board, but not sufficiently to rebut the pleadings-stage inferences described in favor of such a finding. 245 According to the interpretations advanced by the Defendants, the Board could have reasonably believed that the no-debit policy did not violate Regulation 5.16, because FXCM did not guarantee its customers against losses; it merely promised not to collect debit balances. 246 See id. ¶ 39 (“Regulation 5.16 was intended to protect companies from ‘extremely volatile events.’ The CFTC remarked in the Supplementary Information of Regulation 5.16 that not all retail forex counterparties have ‘technology [that] allows for automatic liquidation of positions if the account balance falls below margin requirements.’” (alteration in original) (footnote omitted)). 52 pleadings stage to infer scienter. I pause to emphasize that this case presents a highly
unusual set of facts: a Delaware corporation with a business model allegedly reliant
on a clear violation of a federal regulation; a situation of which I can reasonably
infer the Board was aware. I find, under these unusual facts, that a substantial threat
of personal liability renders the Board incapable of disinterestedly evaluating a
litigation demand, and demand is excused. Thus, the Complaint also states a claim,
and the Motion to Dismiss under both Rules 12(b)(6) and 23.1 is denied.247
I note that the Defendants also sought dismissal of this Count on laches
grounds. If, under the facts and law I have found applicable here, the Defendants
wish me to consider laches, they should so notify me. Alternatively, they may
renotice the issue on a developed record. I make no determination on laches here.
B. The Motion to Supplement
Finally, I consider the Plaintiff’s Motion to Supplement the Third Amended
Complaint under Court of Chancery Rule 15(d). The Motion to Supplement was
made after briefing was complete and after oral argument on the Motion to Dismiss.
I then held a separate oral argument on the Motion to Supplement.248 It became
247 See McPadden v. Sidhu, 964 A.2d 1262, 1270 (Del. Ch. 2008) (“Because the standard under Rule 12(b)(6) is less stringent than that under Rule 23.1, a complaint that survives a motion to dismiss pursuant to Rule 23.1 will also survive a 12(b)(6) motion to dismiss, assuming that it otherwise contains sufficient facts to state a cognizable claim.” (footnotes omitted)). 248 The gravamen of the Plaintiff’s new proposed pleading is that the Company had an undisclosed interest in a market maker with which it was making FX trades on behalf of its clients, so that its interests diverged from its clients, in a way that violated the Commodity Exchange Act; and that 53 clear at that oral argument that what the Plaintiff truly desired was to further amend
the Third Amended Complaint, to include allegations relating to the February CFTC
Order.249 The motion was styled a “Motion to Supplement,” I surmise, to avoid the
strictures of Court of Chancery Rule 15(aaa), which prohibits such an amendment
during pendency of a motion to dismiss, after the Plaintiff has filed an answering
brief.250 Having now denied the Motion to Dismiss, in part, the Plaintiff may refile
his motion as a Motion to Amend, to the extent he finds such a motion appropriate.
III. CONCLUSION
For the foregoing reasons, the Defendants’ Motion to Dismiss is granted in
part and denied in part. Consideration of the laches defense is deferred. The parties
should submit an appropriate form of order.
failure to prevent these actions represented bad faith on the part of the FXCM Board. Pl.’s Mot. for Leave to File a Supplement to the Compl. 3–4. 249 See May 17, 2017 Oral Arg. Tr. 7:24–8:13 (“THE COURT: But it is clear to me that since you are saying I need to take into account the supplement in deciding the motion to dismiss, that this is strictly within the purview of [Rule] 15(aaa) no matter how you characterize this, as a supplement or as an amendment. You are seeking to amend the universe of alleged facts under which I have to consider the motion to dismiss. And the question . . . to me . . . is simply this: The fact that, through no fault of the plaintiff, these preexisting facts were unknowable at the time the answer was filed, is that the equivalent of good cause under [Rule] 15(aaa) to allow either an amendment or supplement? That, really, is what we’re talking about here, isn’t it? MR. AMADOR: That sounds right.”). 250 See E. Sussex Assocs., LLC v. W. Sussex Assocs., LLC, 2013 WL 2389868, at *1 (Del. Ch. June 3, 2013) (“Rule 15(aaa) requires a plaintiff that wishes to amend its complaint in response to a motion to dismiss to file its amended complaint before responding to the motion to dismiss.” (citing Ct. Ch. R. 15(aaa))). 54
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