City of Pontiac General Employees' Retirement System v. Bush

Background

The City of Pontiac General Employees’ Retirement System filed a shareholder derivative action on behalf of Cisco Systems, Inc. against Cisco’s Board of Directors and Chief Executive Officer. The complaint asserted breach of fiduciary duty, unjust enrichment, and violations of federal securities laws. It alleged that, since at least 2015, the defendants publicly misrepresented Cisco’s success in leadership diversity and its promotion of diversity, despite an alleged lack of African Americans in leadership positions, on the Board, and on the senior Executive Leadership Team.

The plaintiff made a pre-suit demand on Cisco’s Board on August 5, 2020. The Board rejected the demand on December 10, 2020. The individual defendants filed a motion to dismiss the complaint. Cisco filed a motion that both sought dismissal based on the pleading requirements for derivative actions and sought to terminate the derivative litigation because Cisco’s Board had conducted what Cisco described as a reasonable, good-faith investigation and rejected the demand under the business judgment rule.

Discovery-stay rule

The federal securities statute generally stays discovery while a motion to dismiss is pending, unless particularized discovery is necessary to preserve evidence or prevent undue prejudice. The court treated the parties’ joint discovery letter as the plaintiff’s motion for particularized discovery. The plaintiff did not argue that discovery was needed to preserve evidence, so the question was whether denying discovery would cause undue prejudice.

The court held that discovery was not needed for the individual defendants’ motion to dismiss or for Cisco’s pleading-based dismissal argument. Those arguments challenged whether the complaint was adequately pleaded. The plaintiff could respond to them without obtaining information through discovery.

The court distinguished Cisco’s request to terminate the derivative litigation. A motion based on a board or special litigation committee’s investigation and decision to reject a demand can require discovery into the committee’s independence, good faith, investigation, and the information it considered. The court noted that the extent of discovery often depends on how detailed and thorough the committee’s report is.

Why discovery was warranted

Cisco submitted declarations describing an investigation by a two-member Demand Review Committee assisted by outside counsel. According to those declarations, the investigation lasted three and a half months, involved interviews of 22 witnesses, and reviewed approximately 3,000 documents totaling about 50,000 pages. The Committee concluded that Cisco’s disclosures were accurate and that pursuing the plaintiff’s claims would not be in Cisco’s best interests. The full Board adopted the Committee’s findings and recommendation on December 10, 2020.

The court nevertheless found discovery warranted because Cisco had not produced a written Committee report. The Board’s seven-page resolution said that the Committee had presented its conclusions and recommendations, but did not meaningfully describe what the investigation’s evidence showed. The resolution also did not identify most of the 22 witnesses or explain the substance of their statements, and generally recited the categories of documents reviewed without describing their contents or significance.

The court emphasized that it was not holding that a written report was legally required. Instead, without a written report, the plaintiff had no documented account of the Committee’s analysis, thoroughness, or good faith. The declarations and Board resolution did not provide enough information to determine whether the investigation was robust or merely pro forma. The court therefore concluded that discovery was the only meaningful way for the plaintiff to oppose Cisco’s motion to terminate.

Order

The court granted the plaintiff’s motion for discovery. It ordered Cisco to produce:

The court stated that, although no written Committee report existed, a PowerPoint presentation used for the Committee’s oral presentation and Board meeting minutes could fall within the first category. The court also granted the plaintiff’s request to depose Michael Capellas, a Committee member who could testify about the evidence reviewed and the Committee’s analysis.

The court stated that if Cisco withdrew its pending motion to terminate the derivative litigation without prejudice to renewing it later if the complaint or an amended complaint survived a motion to dismiss, the discovery order would be stayed. If Cisco continued to pursue the termination motion, the court ordered the discovery to proceed. Judge Thomas S. Hixson did not decide the underlying claims or the pending motions to dismiss or terminate in this discovery order.