The opinion
UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF NEW JERSEY
VISWANATHA PALEMPALLI,
Derivatively on Behalf of
COGNIZANT TECHNOLOGY
SOLUTIONS CORPORATION
Plaintiff,
v.
MICHAEL PATSALOS-FOX, JOHN N.
FOX, JR., MAUREEN BREAKIRON-
EVANS, LEO S. MACKAY, JR., ZEIN
ABDALLA, FRANCISCO D’SOUZA,
KAREN MCLOUGHLIN, RAJEEV
MEHTA, GORDON J. COBURN, Civ. No. 21-12025 (KM) (CLW)
STEVEN SCHWARTZ,
RAMAKRISHNAN OPINION (Redacted)
CHANDRASEKARAN, JOHN E.
KLEIN, JONATHAN CHADWICK,
THOMAS M. WENDEL, LAKSHMI
NARAYANAN, and ROBERT E.
WEISSMAN,
Defendants,
-and-
COGNIZANT TECHNOLOGY
SOLUTIONS CORPORATION, a
Delaware Corporation,
Nominal Defendant.
KEVIN MCNULTY, U.S.D.J.:
Plaintiff Viswanatha Palempalli, a shareholder of Cognizant Technology
Solutions Corporation (“Cognizant”), brought this derivative action against
certain current and former members of Cognizant’s Board of Directors
(“Board”), as well as several current and former executive officers of the
company, for breach of fiduciary duty, waste of corporate assets, unjust
enrichment, and violation of section 10(b) of the Exchange Act and SEC Rule
10b-5. (DE 1.)1 All defendants have moved to dismiss the complaint under
Federal Rule of Civil Procedure 23.1, asserting that Palempalli cannot show
that the Board wrongfully refused his litigation demand. (DE 26; DE 28.)2 In
addition, all defendants argue that the claims against them should be
dismissed pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to
state a claim. For the reasons set forth below, the motions to dismiss are
DENIED without prejudice.
I. BACKGROUND
I recite the facts as pled in the complaint, assuming them to be true for
purposes of this motion. See Fowler v. UPMC Shadyside, 578 F.3d 203, 210
(2009). Cognizant is a corporation that helps companies to outsource their
information technology and other business practices. (Compl. ¶¶ 21, 48.)
Cognizant is incorporated in Delaware and based in New Jersey; however, more
than half of Cognizant’s employees are located in India. (Id.)
Palempalli is a Cognizant stockholder. (Id. ¶ 20.) Among the defendants
are eleven individuals who were current or former members the Board at the
time the action was commenced: Michael Patsalos-Fox, John N. Fox, Maureen
Breakiron-Evans, Leo S. Mackay, Jr., Zein Abdalla, Francisco D’Souza, John E.
Klein, Jonathan Chadwick, Thomas M. Wendel, Lakshmi Narayanan, and
1 Certain citations to the record are abbreviated as follows:
DE = docket entry
Compl. = Complaint (DE 1)
Mot. = Memorandum of Law in Support of Motion to Dismiss filed by
defendants Michael Patsalos-Fox, John N. Fox, Jr., Maureen Breakiron-Evans, Leo S.
Mackay, Jr., Zein Abdalla, Francisco D’Souza, Karen McLoughlin, Rajeev Mehta,
Ramakrishnan Chandrasekaran, John E. Klein, Jonathan Chadwick, Thomas M.
Wendel, Lakshmi Narayanan, Robert E. Weissman, and Cognizant Technology
Solutions Corporation (DE 52)
Opp. = Opposition to Motion to Dismiss filed by Viswanatha Palempalli (DE 54)
2 Defendants Gordon J. Coburn and Steven Schwartz join in the portion of
Cognizant’s brief that moves to dismiss the complaint under Rule 23.1. (DE 26-1 p. 1.)
Robert E. Weissman. (Id. ¶¶ 22–27, 33–37.) The defendants also include five
current or former executive officers: Karen McLoughlin, Rajeev Mehta, Gordon
Coburn, Steven Schwartz, and Ramakrishnan Chandrasekaran. (Id. ¶ 28–32.)
Cognizant itself is a nominal defendant. (Id. ¶ 21.)
A. The Bribery Scheme
In September 2016, Cognizant announced an internal investigation into
improper payments made to foreign officials in violation of the Foreign Corrupt
Practices Act of 1977 (“FCPA”), as amended, 15 U.S.C. §§ 78dd-1, et seq., and
other applicable laws. (Id. ¶ 49.) The announcement also stated that Coburn,
Cognizant’s president, had resigned. (Id.) In the months that followed,
Cognizant disclosed that certain members of its senior management had
engaged in a bribery scheme in India related to real estate and the
procurement of permits for certain facilities. (Id. ¶¶ 49–50.) The scheme dated
back to 2010 and allegedly involved $6 million in improper payments. (Id. ¶
50.)
In addition, the Securities and Exchange Commission (“SEC”) charged
Cognizant, Coburn, and Schwartz with FCPA violations. (Id. ¶ 51.) The alleged
misconduct included bribes to officials in India, false and misleading
statements made in reports filed with the SEC, and false representations to
Cognizant’s auditor. (Id. ¶¶ 51–52.) The SEC and Cognizant have since reached
a settlement. (Id. ¶ 67.) The criminal action against Coburn and Schwartz is
ongoing. See USA v. Coburn, 2:19-cr-120-KM (the “DOJ Action”).
B. Damage to Cognizant
Between February 2015 and September 2016, Cognizant repurchased
13.6 million shares of its stock at an average cost of $59.86 per share, totaling
over $800 million. (Compl. ¶¶ 62–63.) Then, following the announcement of the
internal investigation in September 2016, Cognizant’s stock price fell to $47.71
per share; in plaintiffs’ view, this drop in price meant that Cognizant overpaid
for its own stock by about $160 million. (Id. ¶ 63.) Additionally, Cognizant
agreed to pay $25 million to the SEC to settle the allegations that it violated the
FCPA (the “SEC Settlement”). (Id. ¶ 67.) Cognizant has incurred over $60
million in investigative costs. (Id. ¶ 68.) Pursuant to an indemnification
agreement, Cognizant is also paying Coburn and Schwartz’s legal defense
costs. (Id.) As of January 2020, Cognizant has paid $15 million for Schwartz’s
legal fees. (Id.)
C. The Litigation Demand
Cognizant received three litigation demands related to the bribery
scheme, the first of which the Board received in December 2016 (the “Carder
Demand”).3 (Id. ¶ 75.) The Board met in March 2017 to discuss the Carder
Demand, during which it appointed a Demand Review Committee to investigate
the claims. (Id. ¶ 85.) The Demand Review Committee conducted its
investigation with the assistance of outside counsel and met with outside
counsel several times. (Id. ¶¶ 86–91.) In September 2018, the Demand Review
Committee recommended that the Board reject the Carder Demand. (Id. ¶ 91.)
The Board met with the Demand Review Committee in December 2018 and
decided to follow the recommendation to reject the demand. (Id. ¶ 92.)
In March 2019, the Board received its second demand. (Id. ¶ 94.) The
Demand Review Committee met on April 17, 2019 to discuss that demand. (Id.)
Then, Palempalli sent his litigation demand on April 29, 2019 (the “Palempalli
Demand”). (Id. ¶ 95.) On May 1, 2019, the Demand Review Committee advised
Palempalli’s counsel that Cognizant had established a Demand Review
Committee in response to similar allegations made by another stockholder, and
that the same Demand Review Committee would review the Palempalli
Demand. (Id. ¶ 74.) The Demand Review Committee met on May 9, 2019, to
3 For consistency, the court adopts the naming convention used in the briefs and
attachments. Because certain background facts are redacted in the complaint, but not
in defendants’ publicly filed briefing, I have cited them in unredacted form. At pp. 7
and 8 of the unredacted opinion, I have highlighted references to facts and contentions
that remain sealed and nonpublic; I have filed a second, redacted version of the
opinion that omits those passages.
discuss the two litigation demands. (Id. ¶ 94.) On May 14, 2019, the Board met
and rejected both litigation demands. (Id. ¶¶ 96–97.)
On June 13, 2019, the Demand Review Committee sent Palempalli a
letter rejecting his demand. (Id. ¶ 75.) The letter stated that the Demand
Review Committee had previously reviewed and rejected the Carder Demand,
and that the earlier investigation “provided a sufficient basis on which to
evaluate and respond to” Palempalli’s litigation demand. (Id. ¶ 75; DE 1-3.)
According to Palempalli, the Demand Review Committee impermissibly failed to
consider subsequent intervening events that he cited, such as the SEC
Settlement or the DOJ Action.4 (Compl. ¶ 76.) Plaintiff filed this action on June
1, 2021, alleging, among other things, that the Board wrongfully refused his
litigation demand. (Id. ¶ 16.) Defendants have moved to dismiss the complaint
under Rule 23.1, asserting that Palempalli cannot show that the Board
wrongfully refused his litigation demand.
II. DISCUSSION
A. Legal Standard
Federal Rule of Civil Procedure 23.1 requires “a plaintiff to plead with
particularity either the efforts made to spur directors to take the action sought,
and why these efforts were unsuccessful, or the reasons why no effort was
made to demand action from the board.” Kanter v. Barella, 489 F.3d 170, 176
(3d Cir. 2007). When a shareholder brings a derivative action in federal court,
the federal procedural requirement of particularized pleading applies in
conjunction with state substantive law. See In re Merck & Co., Inc. Securities,
Derivative & ERISA Litig., 493 F.3d 393, 399 (3d Cir. 2007). Because Cognizant
is a Delaware corporation, Delaware law governs the analysis of the Board’s
demand refusal in this case. See Coyer v. Hemmer, 901 F. Supp. 872, 882
(D.N.J. 1995).
4 The Palempalli Demand states: “ln addition, on February 15, 2019, the
Company agreed to pay $25 million to the SEC to settle allegations that it violated the
FCPA. The SEC also charged two of the Company’s former executives with violating the
FCPA that same day.” (DE 1-1.)
Where, as here, a shareholder makes a demand on the board of directors
and the demand is refused, that refusal is subject to judicial review under the
business judgment rule. Spiegel v. Buntrock, 571 A.2d 767, 774 (Del. 1990).
Under the business judgment rule, the court considers the board of directors’
“independence, the reasonableness of its investigation and good faith.” Id. at
777. By making a demand on the board of directors, the shareholder “tacitly
concedes the independence of a majority of the board to respond.” Id.
A board of directors’ decision to refuse the demand “should only be set
aside if particularized facts are pled supporting an inference that the
committee, despite being comprised solely of independent directors, breached
its duty of loyalty, or breached its duty of care, in the sense of having
committed gross negligence.” Espinoza on behalf of JPMorgan Chase & Co. v.
Dimon, 124 A.3d 33, 36 (Del. 2015). The “gross negligence” inquiry focuses on
whether the directors considered “all material information reasonably available
to them.” Friedman v. Maffei, No. CV 11105-VCMR, 2016 WL 1555331, at *10
(Del. Ch. Apr. 13, 2016) (quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del.
1984). The question is “whether the Board was grossly negligent in failing to
inform itself, or intentionally acted in disregard of the Company’s best interests
in deciding not to pursue the litigation the Plaintiff demanded.” Zucker v.
Hassell, No. CV 11625-VCG, 2016 WL 7011351, at *8 (Del. Ch. Nov. 30, 2016),
aff’d, 165 A.3d 288 (Del. 2017).
B. Reasonable and Good Faith Investigation
Palempalli asserts that the Board’s investigation of his demand was
grossly negligent because the Board failed to inform itself of all material
information related to the demand. Specifically, Palempalli argues that the
Board did not assess (1) the DOJ Action; (2) the SEC Settlement;
(3) Palempalli’s request for tolling agreements; or (4) the implementation of
suggested corporate governance reforms. (Opp. p. 18.) Palempalli’s position is
that the Board’s refusal of his demand was based solely on its investigation
into the Carder Demand, which predated and did not involve those enumerated
issues, and the Board did not conduct an additional investigation. (Id.)
Palempalli also requests limited discovery bearing on the Board’s investigation
and refusal of his demand. (Id. pp. 29–30.)
Palempalli’s position has some merit. True, the Board was not required
to repeat its investigation into allegations duplicating those raised in the
Carder Demand. See Palkon v. Holmes, No. 2:14-CV-01234 SRC, 2014 WL
5341880, at *2 (D.N.J. Oct. 20, 2014). But the Palempalli Demand also
included additional, relevant issues that arose after the Board completed its
investigation of the Carder Demand, and Palempalli has alleged specific facts
indicating that the Board may not have investigated those issues. Cf. Kops v.
Hassell, No. CV 11982-VCG, 2016 WL 7011569, at *3 (Del. Ch. Nov. 30, 2016)
(finding that the meeting minutes specifically stated that the board considered
the subsequent developments raised in the plaintiff’s demand and rejecting the
plaintiff’s argument that the board of director’s investigation was
unreasonable).
The first and only time the Demand Review Committee met to discuss
Palempalli’s demand was on May 9, 2019. XXXXXXXXXXXXXXXXXXXXX
[Redacted]
XXXXXXXXXXXXXXXX Additionally, the Board’s letter refusing the Palempalli
Demand supports Palempalli’s position that the Board based its decision solely
on the prior Carder Demand and did not conduct an additional investigation.
The letter states that “[e]ach of the allegations in the Palempalli Demand has
been previously investigated by the [Demand Review] Committee . . . in
connection with [the Carder Demand]”; “the work done to date, including the
prior work carried out in connection with the Carder Demand, has provided a
sufficient basis on which to evaluate and respond to the demands made in the
Palempalli Demand”; and “incurring additional investigative expense is neither
necessary nor in the best interest of Cognizant and its stockholders.” (DE 1-3.)
Defendants respond that the Board was aware of the SEC Settlement as
early as October 2018—prior to the Board’s refusal of the Carder Demand in
December 2018 and the Board’s receipt of the Palempalli Demand in April
2019. (Mot. pp. 13, 20.) However, the Demand Review Committee concluded its
investigation of the Carder Demand in September 2018. (DE 1-3 p. 3; see also
id. at pp. 9–10.) Similarly, defendants argue that the Demand Review
Committee was retained for at least another year following the refusal of the
Carder Demand to receive updates from counsel concerning additional facts
that may bear on the Demand Review Committee’s previous work related to the
Carder Demand. (Mot. p. 9.) XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
[Redacted]
XXXXXXXXX Defendants also refer to “follow-up work” conducted by counsel
in response to the second demand, which the Demand Review Committee
discussed during its May 9th meeting. (Mot. p. 21.) However, such “follow-up
work” was requested prior to the Board’s receipt of the Palempalli Demand, and
defendants do not state what that “follow-up work” was or whether it related to
the DOJ Action or the SEC Settlement.
The issues surrounding the demand are threshold issues. Having
considered the parties’ arguments, I find that additional discovery is needed to
determine whether the Board wrongfully refused the Palempalli Demand. See
Fagin v. Gilmartin, 432 F.3d 276, 285 n. 2 (3d Cir. 2005). Without more
information regarding the Board’s investigation, I cannot assess the
reasonableness of that investigation. Within 7 days, the parties shall confer
with Magistrate Judge Waldor to set a schedule for limited discovery related to
the issue of the wrongfulness, or not, of the Board’s refusal of the Palempalli
Demand. After the conclusion of such limited discovery, the parties shall file
targeted motions for summary judgment on the issue of the wrongful refusal,
again on a schedule to be determined under the direction of the Magistrate
Judge.
In the meantime, the motions to dismiss are administratively
terminated without prejudice. Defendants may renew the contentions in
their motions to dismiss under Rule 12(b)(6) following a decision on the
motions for summary judgment, if necessary.
III. CONCLUSION
For the reasons set forth above, the motions to dismiss are denied
without prejudice. A separate order will issue.
Dated: November 30, 2022
/s/ Kevin McNulty
___________________________________
Hon. Kevin McNulty
United States District Judge