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In Re Huron Consulting Group, Inc., Shareholder v. Huron Consulting Group

March 27, 2012


Appeal from the Circuit Court of Cook County ,Case No. 99 CH 30826 Honorable Martin S. Agran,Judge Presiding.

The opinion of the court was delivered by: Justice Connors

JUSTICE CONNORS delivered the judgment of the court, with opinion. Presiding Justice Quinn and Justice Harris concur in the judgment and opinion.


¶ 1 Plaintiff Brian Hacias filed this consolidated shareholder derivative lawsuit on behalf of Huron Consulting Group. He asserted several claims of breach of fiduciary duty, unjust enrichment, gross mismanagement, and waste of corporate assets against Huron, the members of its board of directors, and three former executives arising out of accounting irregularities and financial losses sustained over the course of several years. He also asserted breach of contract and professional negligence claims against Huron's independent auditor. Plaintiff also alleged that he did not make a demand on the board of directors to bring this lawsuit on Huron's behalf, as he was required to do under applicable law, because such a demand would be futile. The circuit court dismissed his complaint for failing to adequately plead demand futility. Plaintiff now appeals, alleging that the circuit court erred in considering extrinsic evidence when evaluating the sufficiency of the allegations in his complaint. Additionally, he claims that the circuit court erroneously denied his motion for leave to amend the complaint. For the following reasons, we affirm.


¶ 3 Plaintiff is a shareholder of Huron Consulting Group, a Delaware corporation. Defendants include several Huron executives employed at the time that the alleged wrongdoing occurred in this case (executive defendants). Gary Holdren was Huron's chief executive officer, chairman, and president. Wayne Lipski was Huron's chief accounting officer. Gary Burge was Huron's vice president, treasurer, and chief financial officer. Plaintiff also named members of the board of directors as defendants, including George Massaro, Dubose Ausley, James Edwards, H. Eugene Lockhart, John Moody, and John McCartney (director defendants). Huron is also a nominal defendant in this action. Additionally, plaintiff named PricewaterhouseCoopers, Huron's independent auditor, as a defendant in this case.

¶ 4 Huron provides accounting, financial, and corporate transaction services in various industries. Huron experienced rapid growth between October 2004 and July 2009, primarily due to its aggressive strategy of acquiring other accounting and consulting firms. In an effort to retain the employees of the consulting firms it acquired, it allocated to the owners of the acquired firms, the so-called "selling shareholders," millions of dollars to distribute to their employees as financial incentives to keep them employed with Huron after the acquisition.

¶ 5 Providing such bonuses to future employees is common practice and the "Generally Accepted Accounting Principles" (GAAP) instruct that such retention payments must be accounted for as compensation expenses. As such, the expenses would offset Huron's earnings. However, between 2006 and early 2009, Huron accounted for the incentive payments as "goodwill," which did not offset earnings and had the effect of artificially increasing Huron's earnings per share. Plaintiff alleges that by "materially understat[ing its] publicly reported expenses," Huron "deceiv[ed] Wall Street analysts and other financial market participants concerning Huron's true financial performance" between 2006 and early 2009.

¶ 6 On July 31, 2009, Huron publicly acknowledged that it improperly accounted for the incentive payments between 2006 and early 2009 and admitted that it "materially misstated" its financial results. Huron announced that it would have to restate its financial results for those years. Huron's restatement of earnings revealed that it overstated its income by a total of $57 million. Consequently, plaintiff alleged, instead of meeting or exceeding analysts' expectations during that period, Huron would have missed its expectations every quarter. Huron also announced that the Securities and Exchange Commission (SEC) and the United States Attorney's Office (USAO) for the Northern District of Illinois opened inquiries into Huron's practices.

¶ 7 Huron also announced that three of its executives had resigned as a consequence of these accounting issues. Holdren resigned as chairman and chief executive officer, Lipski resigned as Huron's chief accounting officer, and Burge resigned as vice president, treasurer, and chief financial officer. However, Huron announced that Burge would continue to serve as treasurer until the end of 2009.

¶ 8 After making these announcements, plaintiff alleged, Huron's stock dropped by more than 69%, representing a marketing capitalization loss of over $650 million. Plaintiff alleged that notwithstanding Huron's financial issues, the members of the board of directors earned an average of $330,438 in annual salary. That amount was "higher than the average director compensation awarded at 16 of the top 20 Fortune 500 companies."

¶ 9 As a result of the accounting errors and resulting financial losses, plaintiff filed this 10-count derivative complaint. Plaintiff asserted three counts of breach of fiduciary duty against the directors and the executives. He alleged a separate breach of fiduciary duty claim against the directors alone. Plaintiff also asserted claims for unjust enrichment, abuse of control, gross mismanagement, and waste of corporate assets against the directors and executives. Plaintiff also asserted professional negligence and breach of contract claims against PricewaterhouseCoopers.

¶ 10 Because this is a shareholder derivative suit, plaintiff was required by Delaware Chancery Court Rule 23.1 (Del. Ch. Ct. R. 23.1) to either plead that he made a demand on the board of directors to bring this lawsuit on behalf of Huron or state with particularity why making such a demand would have been futile. Plaintiff did not make a demand but, rather, pleaded demand futility. Generally, he asserted that the directors were incapable of evaluating the demand claim in a disinterested and independent manner that protects the best interests of the corporation. The detailed allegations of plaintiff's demand futility claims will be discussed in our analysis below.

¶ 11 Huron and the director defendants (hereinafter, collectively referred to as defendants) filed a combined motion to dismiss plaintiff's complaint under section 2-619.1 of the Code of Civil Procedure (Code) (735 ILCS 5/2-619.1 (West 2008)). They sought dismissal of the complaint under sections 2-619(a)(2) and 2-619(a)(9) of the Code (735 ILCS 5/2-619(a)(2), (a)(9) (West 2008)), arguing that plaintiff lacked standing to bring the claim on Huron's behalf because he had not established that making a demand on Hurons directors would have been futile.*fn1 They also sought dismissal under section 2-615 of the Code based on plaintiff's failure to state a claim for relief with respect to the 10 derivative claims. 735 ILCS 5/2-615 (West 2008).

¶ 12 In support of their section 2-619(a) motion, defendants attached the "Declaration of J. Wesley Earnhardt," who is "an associate at Cravath, Swaine & Moore LLP and counsel to defendant Huron Consulting Group, Inc." Earnhardt attached 14 documents to the "declaration," which he described as "true and correct" copies of those documents. Among those documents were certain public filings of defendant Huron, FTI Consulting, Inc., and CRA International, Inc., filed under the Securities Exchange Act of 1934 (15 U.S.C. § 78a (2010)); a "letter sent by Robert B. Weiser, Esq. and Joseph Gentile, Esq. to Richard Prendergast, Esq. on September 29, 2009"; a "letter sent by Francis P. Barron, Esq. to Robert B. Weiser, Esq. and Joseph Gentile, Esq. on October 1, 2009"; a memorandum of law in support of defendants' motion to stay a cause of action pending in federal court; a copy of a consolidated derivative complaint filed in that federal action on January 15, 2010; and a copy of the minute order denying the motion to stay.

¶ 13 The circuit court granted defendants' motion to dismiss with prejudice "for failure to satisfy Delaware law." In analyzing each of plaintiff's demand futility allegations, the court relied upon the documents contained in the Earnhardt declaration. The court concluded that plaintiff failed to establish that demand was excused and, therefore, he could not "obtain relief on any of the claims raised" in the complaint. This appeal followed.


¶ 15 A. Derivative Suit

¶ 16 A shareholder derivative suit permits an individual shareholder to bring suit " 'to enforce a corporate cause of action against officers, directors, and third parties.' " (Emphasis in original.) Kamen v. Kemper Financial Services, Inc., 500 U.S. 90, 95 (1991) (quoting Ross v. Bernhard, 396 U.S. 531, 534 (1970)). It was intended as a vehicle to allow shareholders to protect a corporation's interests from " 'faithless directors and managers.' " Kamen, 500 U.S. at 95 (quoting Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548 (1949)). However, to preserve the balance of control, the shareholder must first demonstrate as a precondition to bringing suit that he made a demand on the corporation to pursue the action and that the demand had been refused or that the demand was " 'excused by extraordinary conditions.' " Kamen, 500 U.S. at 96 (quoting Ross, 396 U.S. at 534).

¶ 17 The demand requirement is not merely a matter of procedure. Kamen, 500 U.S. at 96-97. Rather, it is a substantive determination as to who has the power to control corporate litigation; in essence, it reallocates the governing powers within the corporation. Kamen, 500 U.S. at 101. Because corporations are "creatures of state law" and state law is the "font of corporate directors' powers," the substantive law of the state of incorporation applies in determining whether the shareholder has adequately established that he has satisfied the demand requirement to proceed with the litigation on the corporation's behalf. (Internal quotations omitted.) Kamen, 500 U.S. at 98-99.

¶ 18 Here, the parties agree that because Huron is incorporated in Delaware, the demand requirement is governed by Delaware Chancery Rule 23.1 (Del. Ch. Ct. R. 23.1). Rule 23.1 provides:

"The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort." Del. Ch. Ct. R. 23.1(a).

The derivative plaintiff is required to make a demand on the board of directors to address the alleged wrongdoing on the corporation's behalf. The directors must be allowed to "rectify an alleged wrong without litigation, and to control any litigation which does arise." (Internal quotation marks omitted.) Braddock v. Zimmerman, 906 A.2d 776, 784 (Del. 2006). Alternatively, the plaintiff must sufficiently allege with particularity that the demand requirement is excused because it would be futile. Generally, the demand requirement will be deemed futile where the derivative plaintiff establishes that there is reason to doubt the board's ability to evaluate the demand in a disinterested and independent manner. Braddock, 906 A.2d at 784.

¶ 19 B. Res Judicata

¶ 20 As an initial matter, defendants submit that we should affirm dismissal of plaintiff's derivative suit because it is barred by res judicata. Defendants claim that while this matter was pending on appeal, the United States District Court for the Northern District of Illinois dismissed the same claims of demand futility asserted by other derivative plaintiffs against these defendants in Oakland County Employees' Retirement System v. Massaro, 772 F. Supp. 2d 973 (N.D. Ill. 2011). Therefore, they argue, the district court's ruling bars "this action." Plaintiff contends that under Delaware law, which he claims is applicable here, a dismissal for failure to adequately plead demand futility must be made without prejudice and, therefore, it is non-final for res judicata purposes, citing West Coast Management & Capital, LLC v. Carrier Access Corp., 914 A.2d 636, 645 n.32 (Del. Ch. 2006), for support.

ΒΆ 21 The parties' arguments raise several novel legal issues. For example, we are not convinced that this matter should be analyzed under the doctrine of res judicata as opposed to the doctrine of collateral estoppel. See West Coast Management, 914 A.2d at 642-43 (discussing the trend among federal courts to apply collateral estoppel when evaluating demand futility claims brought by subsequent derivative plaintiffs because the corporation, as the true party in interest, retains the right to pursue the underlying lawsuit). Additionally, although this case was filed in Illinois and is allegedly precluded by a prior decision rendered by a federal district court sitting in Illinois, plaintiff contends that we should apply Delaware's preclusion law because it is part of the substantive analysis of a Rule 23.1 pleading. But see Allianz Insurance Co. v. Guidant Corp., 387 Ill. App. 3d 1008, 1022 (2008) (explaining that there are conflicting decisions in Illinois as to whether the law of the forum state or the law of the rendering jurisdiction applies in determining the preclusive effect of a prior judgment); see also Du Page Forklift Service, Inc. v. Material Handling ...

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