April 25, 2025
For shareholders seeking to police corporate misconduct, the right to assert derivative claims— to sue on behalf of a corporation against officers, directors, and third parties whose actions have harmed the company—is a critical corporate governance tool.
Derivative litigation empowers shareholders to enforce compliance with fiduciary duties and ensure managerial accountability. A stockholder can assert such derivative claims either by filing a derivative complaint on the company’s behalf or by making a demand that the Board of Directors (Board) investigate and, if warranted, initiate a derivative action against the alleged wrongdoers. In either situation, the Board may appoint a Special Litigation Committee (SLC) which often becomes a central player in the investigation, any pending derivative litigation, and possible resolution of these claims.
To properly function, the SLC must be comprised of independent Board members. Once formed, the SLC should conduct a thorough investigation involving a review of internal documents, witness interviews, and consultations with independent counsel or experts, then produce a report of its findings and recommendations. The SLC’s ultimate recommendation may provide grounds for rejecting the claims, settling the action, or continuing to prosecute the lawsuit. If the SLC report recommends dismissal, shareholder plaintiffs have the right to obtain discovery as to the independence of the SLC and the basis for its findings.
Recently, Cohen Milstein has represented shareholder plaintiffs in several proceedings that illustrate the interplay between an SLC and a shareholder derivative litigation. In a pending stockholder derivative action involving Abbott Laboratories, plaintiffs allege a breach of fiduciary duties concerning the contamination of infant formula. An SLC appointed by Abbott’s Board to investigate plaintiffs’ claims moved to stay the case until it had finished its investigation. In partially denying the SLC’s motion, the Court held that plaintiffs were entitled to discovery of the same documents provided to the SLC to prepare its report. The Court noted that “[T]his discovery is necessary to prevent a special litigation committee from cherry-picking the facts highlighted in their report.” Armed with the discovery they obtain through the ruling, shareholders will have the right to challenge the SLC’s independence and conclusions if the SLC report seeks dismissal of the pending derivative litigation.
Similarly, Cohen Milstein recently filed a derivative action against officers and directors of Pegasystems Inc. related to a $2 billion judgment against the company for violating a competitor’s trade secrets. After several shareholders made demands on the company to investigate the board and management, it appointed an SLC, which rejected bringing claims against the alleged wrongdoers. In response, shareholders filed derivative litigation challenging the SLC’s report and independence.
In a different context, Cohen Milstein, on behalf of a shareholder client, recently sent a demand to a company’s board to investigate and commence derivative litigation against a third party who was culpable for participating with the company’s CFO in securities fraud. After an SLC investigation into potential claims, the board agreed to accept the demand and initiated litigation against the third party, which eventually settled for a substantial amount.
In sum, SLCs are a significant aspect of shareholder derivative litigation. They must be genuinely independent, procedurally thorough, and substantively fair. Shareholders, through the courts, must rigorously evaluate these attributes to ensure the integrity of the process and the protection of the corporation’s and shareholders’ interests.