On July 14, 2010, the United States District Court for the Southern District of New York, in the case of In Re: Pfizer Inc. Shareholder Derivative Litigation, C.A. No. 09 Civ. 7822 (JSR), read opinion here, issued a decision which denied in part the defendants’ motion to dismiss a derivative complaint alleging, among other things, that present and former directors and senior executives of Pfizer Inc. violated their fiduciary duties under Delaware law, when they “intentionally approved or deliberately disregarded Pfizer’s alleged promotion of off-label drugs and its payment of alleged illegal kickbacks to health care professionals.” The alleged illegal marketing activities took place from 2001 through 2008.

Kevin F. Brady of Connolly Bove Lodge & Hutz LLP provided this summary.

Since 2000, Pfizer had been involved in claims of illegal “off-labeling” marketing resulting in the payment of a number of fines. In September 2009, the United States Department of Justice announced that Pfizer had agreed to a settlement in which it would pay $2.3 billion in fines and penalties arising from illegal “off-label” marketing by Pfizer and one of its subsidiaries of various regulated drugs. Thereafter, several derivative actions were filed seeking to recover from the alleged corporate wrongdoers. The cases were consolidated and on December 16, 2009, the defendants moved to dismiss the Complaint in its entirety. Plaintiffs asserted causes of action claiming that the defendants, among other things: (i) published false and misleading proxy statements and financial statements in violation of federal and state law; and (ii) breached their fiduciary duties to Pfizer by causing or consciously disregarding the illegal marketing activity.

The defendants moved to dismiss the Complaint for failure to plead demand futility. Plaintiffs did not contest that they issued no such demand on the board, but instead argued that demand was excused because the directors’ misconduct could not have been a valid exercise of business judgment, and because a majority of the current board was charged with the alleged misconduct and therefore would be conflicted from assessing the demand.

In a derivative action, the shareholder must either demand that the corporation’s board of directors pursue the action or else show why such demand would be futile. As this Court correctly noted, Delaware law provides alternative tests for determining whether demand would have been futile, one applicable to situations where the board’s business judgment is being challenged (see Aronson v. Lewis) and one where it is not (see Rales v. Blasband). Under Aronson, the plaintiff must allege particularized facts sufficient to create “a reason to doubt that ‘(1) the directors are disinterested and independent [or that] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.’”

Under Rales, demand is not excused unless 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. The Court noted that “[t]his test can be met if the complaint’s particularized allegations raise a “substantial likelihood” of personal liability by a majority of the board.”

The parties here differed as to which standard applied. Defendants argued that the Rales test applied because the Complaint lacked particularized allegations from which it can be inferred that the defendants intentionally authorized the improper marketing practices. Indeed, the defendants claimed that the particularized allegations of the Complaint allege only a failure of oversight, which would implicate In re Caremark International Inc. Derivative Litigation, which meant that “only a sustained or systematic failure of the board to exercise oversight — such as an utter failure to attempt to assure a reasonable information and reporting system exists — will establish the lack of good faith that is a necessary condition to liability.” Defendants argued that the Complaint failed to plead demand futility under this standard because there is no question that Pfizer had a reporting system in place and the only particularized allegations of disregard of that system were insufficient to meet the Caremark standard. Plaintiffs argued that defendants “consciously failed to monitor or oversee” the reporting system which “caused and allowed Pfizer to engage in illegal activity.”

The Court agreed with plaintiffs noting that “the allegations of the Complaint evidence misconduct of such pervasiveness and magnitude, undertaken in the face of the board’s own express formal undertakings to directly monitor and prevent such misconduct, that the inference of deliberate disregard by each and every member of the board is entirely reasonable.” As a result, the Court concluded that plaintiffs have pleaded with sufficient particularity that “a majority of directors face a substantial likelihood of personal liability because they deliberately disregarded reports of the illegal marketing practices eventually resulting in the 2009 settlement.” As a result, the motion to dismiss those claims was denied

With respect to the allegations regarding the disclosure issues, the court found that either: (i) the plaintiffs failed to identify any actionable omissions in the proxy materials or financial reports; (ii) defendants did not omit information and that the relevant Proxies contained adequate disclosures; or (iii) defendants did not need to disclose information regarding “self-flagellation” unless it rendered any particular statement false or misleading. As a result, the other counts were dismissed.