In re Qualcomm Inc. FCPA Stockholder Derivative Litigation

• Court: Court of Chancery of Delaware
• Decided: June 16, 2017
• Docket: 11152-VCMR
• Status: Published

Opinion

COURT OF CHANCERY OF THE STATE OF DELAWARE

TAMIKA R. MONTGOMERY-REEVES New Castle County Courthouse VICE CHANCELLOR 500 N. King Street, Suite 11400 Wilmington, Delaware 19801-3734

Date Submitted: April 18, 2017 Date Decided: June 16, 2017

Blake A. Bennett, Esquire Peter J. Walsh, Jr., Esquire Cooch and Taylor, P.A. Andrew H. Sauder, Esquire 1000 West Street, 10th Floor Potter Anderson & Corroon LLP Wilmington, DE 19899 1313 North Market Street, 6th Floor Wilmington, DE 19801

RE: In re Qualcomm Inc. FCPA Stockholder Derivative Litigation, C.A. No. 11152-VCMR

Dear Counsel:

This letter resolves Defendants’ motion to dismiss Plaintiffs’ Verified

Amended Stockholder Derivative Complaint (the “Complaint”). The Complaint

alleges that the Qualcomm Inc. (“Qualcomm”) board’s conscious disregard for red

flags resulted in violations of the Foreign Corrupt Practices Act (“FCPA”) and a

March 2016 U.S. Securities and Exchange Commission (“SEC”) cease-and-desist

order. Plaintiffs’ Complaint asserts claims for breach of fiduciary duty, waste, and

unjust enrichment against the Qualcomm directors and former Chief Financial

Officer. Defendants moved to dismiss under Court of Chancery Rule 23.1 for failure

to make demand or allege demand futility and Rule 12(b)(6) for failure to state a In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 2 of 17

claim. For the reasons stated herein, I grant Defendants’ Rule 23.1 motion to dismiss

all counts in Plaintiffs’ Complaint.

I. BACKGROUND

The facts in this opinion derive from the Complaint, the documents attached

to it, and the documents incorporated by reference into the Complaint.1

A. The Foreign Corrupt Practices Act

On March 1, 2016, the SEC determined that between 2002 and 2012,

Qualcomm violated the FCPA. The FCPA is a federal anti-bribery statute that

forbids illicit payments to foreign government officials to obtain or retain business

overseas.2 It also requires that publicly traded companies like Qualcomm establish

adequate internal controls to ensure (1) that they execute only authorized

transactions and (2) that all company transactions are accurately recorded. The

FCPA further requires that publicly traded companies actually make and keep

accurate accounting records for all transactions and dispositions of company assets.3

1 In re Morton’s Rest. Gp., Inc. S’holders Litig., 74 A.3d 656, 659 n.3 (Del. Ch. 2013) (“To be incorporated by reference, the complaint must make a clear, definite and substantial reference to the documents.” (quoting DeLuca v. AccessIT Gp., Inc., 695 F. Supp. 2d 54, 60 (S.D.N.Y. 2010)) (internal quotation marks omitted)). 2 Compl. ¶ 4. 3 Id. ¶ 65. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 3 of 17

B. The Red Flags

Plaintiffs allege that the Qualcomm board pursued a business expansion plan

emphasizing the Asia Pacific region, particularly China, which resulted in FCPA

violations. According to the Complaint, China is a country of focus for U.S. FCPA

regulators because of the large number of state-owned enterprises and the culture of

gift giving.4 As such, Plaintiffs assert that U.S. companies doing business in China

are on notice of the importance of FCPA compliance.5

The Complaint alleges that the Qualcomm board and its Audit Committee

knew of several red flags regarding FCPA compliance in China and Korea. On April

20, 2009, the Qualcomm Audit Committee was presented with an Internal Audit

Update, which showed that certain gifts were not being appropriately logged on the

Qualcomm gift logs. At the Audit Committee’s July 20, 2009 meeting, committee

members received reports of potential FCPA violations. And in December 2009, the

Audit Committee learned of whistleblower allegations of FCPA violations. In

addition, a presentation given at the January 25, 2010 Audit Committee meeting

shows that “[a] large number of activities such as business meals, business

4 Id. ¶¶ 71-72. 5 Id. ¶ 75. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 4 of 17

entertainment, marketing and gifts with known government related entities have not

been recorded in the Qualcomm China Gift logs.”6 A similar problem was presented

with respect to Korean gift logs at the same meeting. Finally, for the audit period

from January 1, 2010 through March 31, 2011, the Complaint alleges that

PricewaterhouseCoopers noted that “QCA” did not have certain FCPA compliance

processes in place.7 Defendants assert that QCA is a company that Qualcomm had

recently acquired, but the Complaint does not allege what QCA is.

C. The SEC Cease-and-Desist Order

On March 1, 2016, the SEC determined that cease-and-desist proceedings

should be instituted against Qualcomm as a result of alleged FCPA violations. In

anticipation of the institution of cease-and-desist proceedings, Qualcomm reached a

settlement with the SEC, which was announced simultaneously with the cease-and-

desist proceedings. The SEC released the terms of the settlement in the form of a

cease-and-desist order.8

6 Skaistis Aff. Ex. 9. 7 Compl. ¶¶ 79-84, 92. 8 Id. Ex. A. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 5 of 17

The cease-and-desist order shows that the SEC found that Qualcomm violated

the FCPA in the following ways: (1) from 2002 until 2012, Qualcomm provided

frequent meals, gifts, and entertainment to Chinese officials who were considering

whether to adopt Qualcomm technology; (2) Qualcomm hired relatives of Chinese

officials, including a Chinese executive’s son that Qualcomm’s human resources

department originally determined was not “a skills match” and should not be hired;

(3) Qualcomm’s books and records did not fairly and accurately account for the

illegal gifts but rather recorded them as generic marketing or sales expenses; and (4)

Qualcomm lacked adequate internal controls to provide reasonable assurances that

only authorized transactions were executed and that all transactions were accurately

recorded. The order required that Qualcomm pay a penalty of $7.5 million and make

periodic reports to the SEC for two years.

II. ANALYSIS

A. Standard for Demand Futility

Stockholders bringing derivative claims must satisfy the demand requirement

in Court of Chancery Rule 23.1 by either making demand on the board of directors

or alleging that demand would be futile. In cases challenging board inaction,

Delaware courts analyze demand futility under the test established in Rales v. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 6 of 17

Blasband.9 Under Rales, “a court must determine whether or not the particularized

factual allegations of a derivative stockholder complaint create a reasonable doubt

that, as of the time the complaint is filed, the board of directors could have properly

exercised its independent and disinterested business judgment in responding to a

demand.”10 A plaintiff may satisfy the Rales test for demand futility by

demonstrating that a disabling interest excusing demand exists because the

complaint’s underlying claims pose a substantial threat of liability to a majority of

the board.11 “Demand is not excused solely because the directors would be deciding

to sue themselves.”12 Rather, to excuse demand, the alleged derivative claims

against the board must be sufficiently strong such that a majority of the members of

the board face a “substantial likelihood” of personal liability.13 “The analysis of

9 Melbourne Mun. Firefighters’ Pension Trust Fund v. Jacobs, 2016 WL 4076369, at *6 (Del. Ch. Aug. 1, 2016). 10 Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993). 11 Melbourne, 2016 WL 4076369, at *6. 12 In re Citigroup Inc. S’holder Deriv. Litig., 964 A.2d 106, 121 (Del. Ch. 2009). 13 Melbourne, 2016 WL 4076369, at *6. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 7 of 17

whether a majority of the board faces a substantial likelihood of personal liability ‘is

conducted on a claim-by-claim basis.’”14

B. The Complaint Fails to Allege Demand Futility as to Count I

Count I of the Complaint alleges a breach of fiduciary duty claim for improper

oversight, also known as a Caremark claim. The Delaware Supreme Court in Stone

v. Ritter reiterated the two bases on which directors may be held liable on a

Caremark claim as: “(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.”15

Where, as here, plaintiffs rely on the second basis for a Caremark claim, a complaint

must allege “(1) that the directors knew or should have known that the corporation

was violating the law, (2) that the directors acted in bad faith by failing to prevent or

remedy those violations, and (3) that such failure resulted in damage to the

corporation.”16

14 Id. (quoting Teamsters Union 25 Health Servs. & Ins. Plan v. Baiera, 119 A.3d 44, 58 n.71 (Del. Ch. 2015)). 15 Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006). 16 Melbourne, 2016 WL 4076369, at *8. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 8 of 17

Plaintiffs generally “attempt to satisfy the elements of a Caremark claim by

pleading that the board had knowledge of certain ‘red flags’ indicating corporate

misconduct and acted in bad faith by consciously disregarding its duty to address

that misconduct.”17 Additionally, a plaintiff may adequately plead bad faith by

alleging that the board intentionally directed the corporation to violate the law.

“Under Delaware law, a fiduciary may not choose to manage an entity in an illegal

fashion, even if the fiduciary believes that the illegal activity will result in profits for

the entity.”18 “Delaware law does not charter law breakers,” and “a fiduciary of a

Delaware corporation cannot be loyal to a Delaware corporation by knowingly

causing it to seek profit by violating the law.”19

Here, Plaintiffs do not argue that the Qualcomm board intentionally caused

Qualcomm to violate the law. As such, to adequately plead bad faith, “Plaintiff[s]

must plead particularized facts from which it is reasonably inferable that the [b]oard

consciously disregarded its duties by ‘intentionally fail[ing] to act in the face of a

17 Id. 18 Id. at *9 (quoting Metro Commc’n Corp. BVI v. Advanced Mobilecomm Techs. Inc., 854 A.2d 121, 131 (Del. Ch. 2004)). 19 Id. (quoting In re Massey Energy Co., 2011 WL 2176479, at *20 (Del. Ch. May 31, 2011)). In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 9 of 17

known duty to act.’”20 “Conscious disregard involves an intentional dereliction of

duty which is more culpable than simple inattention or failure to be informed of all

facts material to the decision.”21 Further, “[s]imply alleging that a board incorrectly

exercised its business judgment and made a ‘wrong’ decision in response to red flags

. . . is insufficient to plead bad faith.”22

The Complaint in this case fails to allege particularized facts giving rise to an

inference that a majority of the board faces a substantial likelihood of liability on the

Caremark claim alleged. As in Melbourne, I need not address whether the alleged

red flags actually constitute red flags or whether the board’s response to the alleged

red flags caused damage to Qualcomm because the Complaint fails to plead facts

giving rise to an inference that the board acted in bad faith.

Assuming for purposes of this analysis that the various reports to the Audit

Committee and the board constituted red flags, the Complaint does not allege that

the board consciously disregarded the red flags. Many of the documents the

20 Id. (quoting In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 67 (Del. 2006)). 21 Id. (quoting In re Goldman Sachs Gp., Inc. S’holder Litig., 2011 WL 4826104, at *13 (Del. Ch. Oct. 12, 2011)). 22 Id. (citing In re Citigroup Inc. S’holder Deriv. Litig., 964 A.2d 106, 131 (Del. Ch. 2009)). In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 10 of 17

Complaint cites as red flags also include planned remedial actions. For example,

Plaintiffs cite the April 20, 2009 presentation to the Audit Committee, which states

that “2 of the FCPA related events tested were not recorded on the gift log of the

respective office.”23 But the next line on that page provides recommendations to

address the issue. It states that “the listing of departments and individuals that

receive the annual FCPA certification should be formally reviewed on an annual

basis” and the Senior Vice President of Government Affairs “should re-iterate to all

employees assigned to the Government Affairs department the requirement to record

all FCPA related activities in the gift log.”24 Further, Plaintiffs cite a January 25,

2010 Audit Committee presentation where the committee was informed that “[a]

large number of activities such as business meals, business entertainment, marketing

and gifts with known government related entities have not been recorded in the

Qualcomm China Gift logs.”25 But the same page states corrective actions that the

company will take, including that the Executive Vice President for the Asia Pacific,

the Middle East, and Africa “will hold an all-hands meeting with the employees of

23 Skaistis Aff. Ex. 10. 24 Id. 25 Id. Ex. 9. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 11 of 17

QC China to explain the approval, expense tracking and record keeping requirements

of the Corporate FCPA policy and to emphasize the significance of employee

compliance.”26 It also states that “[k]ey individuals, which meet with government

officials, should be required to submit the completed FCPA log with their expense

report for reimbursement. The QC China Director of Finance should review these

expense reports to verify the accuracy and completeness of the Gift logs.”27

These responses to the red flags show that the board did not act in bad faith.

There is no indication that the board believed Qualcomm could continue to violate

the FCPA without consequences. And no allegations suggest that the Qualcomm

board consciously disregarded the red flags. The allegations in the Complaint do

not adequately plead “an intentional dereliction of duty”28 after the board was aware

of the risk of future FCPA violations through the red flags. In fact, Plaintiffs point

to only two factual allegations as evidence of a failure to respond to the red flags: a

December 31, 2013 target date for the translation of its FCPA compliance materials

26 Id. 27 Id. 28 Melbourne, 2016 WL 4076369, at *9. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 12 of 17

into Chinese29 (which Plaintiffs allege was too late) and the company’s plan to

formulate a long-range FCPA plan30 (which Plaintiffs again contend was too late

because it remained outstanding as of January 27, 2014). These board decisions do

not rise to the level of bad faith. Instead, Plaintiffs here simply seek to second-guess

the timing and manner of the board’s response to the red flags, which fails to state a

Caremark claim.

Further, contrary to Plaintiffs’ assertions, this case is distinguishable from In

re Massey Energy Co.,31 Louisiana Municipal Police Employees' Retirement System

v. Pyott (Allergan I),32 and Westmoreland County Employee Retirement System v.

Parkinson (Baxter).33 In Baxter, the board of directors stopped spending on remedial

measures that the FDA had ordered under a consent order. Instead, the board

publicly announced that it was focusing on a new product.34 The court in Baxter

29 Compl. ¶ 85. 30 Id. ¶ 86. 31 2011 WL 2176479 (Del. Ch. May 31, 2011). 32 46 A.3d 313 (Del. Ch. 2012), rev’d on other grounds, 74 A.3d 612 (Del. 2013). 33 727 F.3d 719 (7th Cir. 2013) (applying Delaware substantive law). 34 Baxter, 727 F.3d at 723. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 13 of 17

inferred that the board believed that it did not need to follow the orders of the FDA

if it could develop a new product before the FDA realized that the company had

stopped attempting to remedy defects in its older product.35 Similarly, this Court

has previously distinguished Massey because “[t]he company’s CEO in Massey

‘believ[ed] he knew better about how to run mines safely than the’ government

agency charged with regulating mine safety and ‘publicly stated that the idea that

governmental safety regulators knew more about mine safety than he did was

silly.’”36 The Qualcomm board, in contrast, recognized the FCPA compliance issues

and reacted with corrective measures in the face of the alleged red flags. As this

Court explained in Melbourne, Allergan I also is distinguishable because “the

board’s alleged bad faith in [Allergan I] was not based on its conscious disregard for

its duty to prevent the company from engaging in illegal conduct. Instead, it was

based on the board’s alleged decision to cause the company to engage in illegal

conduct.”37 The Complaint in this case, unlike Allergan I, does not allege a board

decision to cause Qualcomm to violate the FCPA.

35 Id. at 729. 36 Melbourne, 2016 WL 4076369, at *10 (quoting In re Massey Energy Co., 2011 WL 2176479, at *18-19 (Del. Ch. May 31, 2011)). 37 Id. at *12. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 14 of 17

Plaintiffs also argue that the FCPA establishes a statutory floor for adequate

internal controls, and because the Qualcomm cease-and-desist order describes

internal control violations of the FCPA, the Complaint necessarily states a claim.38

But that argument is misplaced here. A corporation’s violation of the FCPA alone

is not enough for director liability under Caremark. “Delaware courts routinely

reject the conclusory allegation that because illegal behavior occurred, internal

controls must have been deficient, and the board must have known so.”39 Delaware

law, not the FCPA, establishes the standard for director liability, and under Delaware

law, Plaintiffs’ Complaint does not allege bad faith.

Finally, Plaintiffs argue in their answering brief that Qualcomm failed to

establish an effective FCPA compliance program from 2002 through 2009 while the

company violated the FCPA. But the Complaint does not allege those facts, and the

documents from 2004 and 2006 on which Plaintiffs rely were not attached to or

incorporated into the Complaint. Further, even if Plaintiffs had challenged pre-2009

conduct in the Complaint, they do not explain why that claim would not be barred

by laches. Thus, Defendants’ Rule 23.1 motion to dismiss count I is granted.

38 Pl.’s Answering Br. 26. 39 Desimone v. Barrows, 924 A.2d 908, 940 (Del. Ch. 2007). In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 15 of 17

C. The Complaint Fails to Allege Demand Futility as to Count II

Count II alleges a claim for waste against the individual Defendants. Plaintiffs

challenge the illegal bribes that Qualcomm paid in Asia and the compensation that

Qualcomm paid its directors and officers while the corporation violated the FCPA.

To recover on a claim of corporate waste, the plaintiffs must shoulder the burden of proving that the exchange was “so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.” A claim of waste will arise only in the rare, “unconscionable case where directors irrationally squander or give away corporate assets.”40

The board does not face a substantial likelihood of liability on count II because

the Complaint does not allege that the board directed Qualcomm to enter any

wasteful transaction. As to the illegal bribes, nothing in the Complaint suggests that

the board authorized those payments such that the directors would face a substantial

likelihood of liability on a claim for waste. The corporation may very well have a

claim against the employees who provided unauthorized gifts to foreign officials,

but absent any particularized allegations tying the bribery to the board, the directors

are competent to decide whether Qualcomm should pursue that claim.

40 In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 74 (Del. 2006) (quoting Brehm v. Eisner, 746 A.2d 244, 263 (Del. 2000)). In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 16 of 17

As to the waste claim for the compensation of Qualcomm’s directors and

officers, the Complaint does not allege that Qualcomm paid any compensation in

exchange for inadequate consideration. The Qualcomm directors or officers did not

fail to perform any services for which they were paid. Thus, Plaintiffs’ Complaint

does not contain particularized facts giving rise to the inference that the board is not

competent to decide whether to bring the claim alleged in count II. Count II is

dismissed.

D. The Complaint Fails to Allege Demand Futility as to Count III

Count III alleges a claim for unjust enrichment against the individual

Defendants because the Qualcomm financial results were inflated as a result of the

company’s FCPA violations, and the individual Defendants’ incentive compensation

was based on the financial results. The Complaint, however, alleges no basis for

that conclusory statement. It does not allege how the financial results were inflated

or that the financial statements have been restated. Count III, as alleged, does not

pose a substantial likelihood of director liability and is dismissed. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. C.A. No. 11152-VCMR June 16, 2017 Page 17 of 17

III. CONCLUSION

For the reasons stated herein, Defendants’ motion to dismiss under Court of

Chancery Rule 23.1 is granted.

IT IS SO ORDERED.

Sincerely, /s/ Tamika R. Montgomery-Reeves Vice Chancellor