Transcript

IN THE SUPREME COURT OF THE UNITED STATES

JILL S. KAMEN, Petitioner v. KEMPER FINANCIAL SERVICES, INC., ET AL.

No. 90-516

March 27, 1991

The above-entitled matter came on for oral argument before the Supreme Court of the United States at 11:06 a.m.

APPEARANCES:

RICHARD M. MEYER, ESQ., New York, New York; on behalf of the Petitioner.

MICHAEL R. DREEBEN, ESQ., Assistant to the Solicitor General, Department of Justice, Washington, D.C.; on behalf of the Securities and Exchange Commission, as amicus curiae in support of the Petitioner.

JOAN M. HALL, ESQ., Chicago, Illinois; on behalf of the Respondents.

PROCEEDINGS

11:06 a.m.

CHIEF JUSTICE REHNQUIST: We'll hear argument next in No. 90-516, Jill S. Kamen v. Kemper Financial Services.

Spectators are admonished the Court remains in session. There is to be no talking in the courtroom until you get out beyond the walls here.

Mr. Meyer, you may proceed whenever you are ready.

ORAL ARGUMENT OF RICHARD M. MEYER ON BEHALF OF THE PETITIONER

MR. MEYER: Mr. Chief Justice, and may it please the Court:

This action was brought by a shareholder of Cash Equivalent Fund to recover damages for two wrongs. The one at issue before the Court today is a proxy violation, the deception of the fund shareholders by a proxy statement which induced them to approve a management agreement with the investment advisor, which I will refer to as KFS, by misrepresenting comparative fees paid to KFS by other mutual funds managed by KFS. That misrepresentation was in violation of rules of the Securities and Exchange Commission.

The --

QUESTION: Mr. Meyer, can I just ask one question? What remedy do you seek for that violation?

MR. MEYER: We are seeking damages, and --

QUESTION: And who is the we? To whom would the damages be paid?

MR. MEYER: We ask that the damages be paid to the fund.

QUESTION: To --

MR. MEYER: To Cash Equivalent Fund, which is the mutual fund involved.

QUESTION: I see. So it's in the nature of a derivative action, then?

MR. MEYER: This is a matter which the Solicitor General takes --

QUESTION: Right.

MR. MEYER: -- a somewhat different view of. We have always taken the view that it is in the nature of a derivative action, yes.

This -- the matter now before the Court requires the review of an unprecedented holding by the court of appeals for the Second Circuit that the claim must be dismissed --

QUESTION: The Seventh Circuit.

MR. MEYER: Seventh Circuit. I beg your pardon. That the claim must be dismissed because a plaintiff must, prior to bringing the action, in all cases, make a precomplaint demand upon the board of directors to bring the action, even if such a demand would be futile.

I propose to discuss this morning three questions. First, whether a demand must be made even though futile. Second, the practical consequences of requiring a precomplaint demand. And finally, the question of what law applies.

On the first question, whether a demand must be made even if futile --

QUESTION: Can you answer that question without explaining first what law applies?

MR. MEYER: I agree --

QUESTION: Or are you going to say it doesn't make any difference?

MR. MEYER: I am going to say that it doesn't make any difference. That's correct. And the order, I agree, Justice White, does suggest that it is presented in inverse order, but I believe that you will see, as the argument unfolds, the conclusions become compelling. At least I hope they will become compelling.

Beginning with the question of making a demand when it is futile, it's an ancient precept of the common law that the law does not require a futile act. And that precept has been applied to demand on directors by this Court in cases going back well over 100 years. The decision by the court of appeals for the Seventh Circuit is the only judicial decision that I have been able to find or that has been cited by any party suggesting that even though the demand is futile it must nevertheless be made. These futility --

QUESTION: Excuse me there. It has been proposed by several respected organizations, such as the American Bar Association, I gather, and the American Law Institute.

MR. MEYER: The American Law Institute and the American Bar Association have adopted -- taking the American Law Institute, which has been a little more active in the area, a -- what they call a tentative draft, which is, I think they are now up to tentative draft number 10, which suggests what is called the universal demand requirement. That is, demand may be made in every case, and that this will obviate the difficulty of determining whether or not the demand is in fact futile. It will compel a demand. And indeed this is somewhat in line with the reasoning of the Seventh Circuit which cites at some length the tentative draft of the American Law Institute. The basic -- excuse me.

QUESTION: It goes along with this. Does the American Law Institute, like the Seventh Circuit opinion here, also say that the business judgment rule would not be applied to the determination of the directors?

MR. MEYER: The -- no, I don't believe they say that. On the contrary, the basic rationale followed by the court of appeals in this case is that the introduction of a universal demand requirement is suggested by the recent developments in the growth of special litigation committees. Even where, as in the present case, the board of directors is directly implicated in the wrong, the court below says the board can create a special litigation committee by -- perhaps by expanding its number, bringing in people who were not involved in the wrongdoing. These committees supposedly will dispassionately review the facts of the matter, make a recommendation to the board of directors, and the board will act accordingly.

QUESTION: Well, Mr. Meyer, under the Seventh Circuit's view, if a demand is made and refused, what's the legal effect of that on the suit? Can it go forward?

MR. MEYER: That is a question --

QUESTION: Under the Seventh Circuit's holding?

MR. MEYER: That is a question that has not been answered. And the Seventh Circuit --

QUESTION: And how do you understand its holding in that regard? What would be the effect?

MR. MEYER: I understand it in the following way, that assuming that a special litigation committee is formed and makes a recommendation, which invariably is a recommendation that the litigation not go forward, that's invariably the case --

QUESTION: Well, it may or may not be. Let's assume it is a recommendation not to go forward.

MR. MEYER: All right. The question then becomes one of reviewing the determination of the special litigation committee, and the focus of the litigation has now changed. We are now looking to see not whether the original complained of conduct was inappropriate. We're not looking to see whether a fiduciary accused of self-dealing has satisfied the fiduciary's normal burden of justifying the intrinsic fairness of his dealings with his corporation. We are looking instead to see whether an independent committee (a) had some kind of bias or conflict of interest, and (b) whether it exercised a judgment that was so egregious that no reasonable businessman could be said to have come to a similar judgment.

This is such an enormous burden to place upon a shareholder who is, in this particular case and in many of these cases, attempting to enforce the public policies, important public policies --

QUESTION: Well, then the legal issue changes, as I understand you, Mr. Meyer? The plaintiff has a harder row to hoe if a demand is made and turned down than if the plaintiff can simply show that a demand would be futile?

MR. MEYER: Mr. Chief Justice, I submit that the plaintiff has an impossible row to hoe.

QUESTION: Well, could you answer my question? I asked you to compare two burdens.

MR. MEYER: Yes. The burden of reviewing -- the burden that the plaintiff has where a demand is made and turned down is virtually insuperable.

QUESTION: So the futility exception really gives the plaintiff a leg up, then. It allows it to litigate under different standards than if its demand is turned down?

MR. MEYER: That's correct. That's correct, and the futility exception is the one that has been recognized by this Court for well over 100 years and by every court that has ever passed upon the question. The --

QUESTION: But Mr. Meyer, excuse me. I thought the Seventh Circuit had explicitly repudiated imposing upon the disappointed would-be plaintiff that kind of a burden. I thought what the Seventh Circuit is saying is in exchange for always requiring a request to be made we will not impose the normal business judgment rule.

MR. MEYER: At one point in its opinion the Seventh Circuit does suggest that. At other points in its opinion it suggests quite the contrary. But I submit to you that the first suggestion made by the Seventh Circuit, I don't know if it comes in that order, but in our discourse it's the first suggestion, is an illogical suggestion to follow.

After all, why go to the trouble of forming a special litigation committee, having it go through an extensive investigation, hiring counsel, making a report, and then coming back to court and the court saying we're going to totally ignore it. We'll pretend it hasn't occurred, and we will review the bringing of the litigation as though it didn't exist. Manifestly it must have some purpose, and manifestly if these special litigation committees are to exist, which ineluctably follows from the imposition of a universal demand requirement, then the courts must give some deference to the recommendations of special litigation.

QUESTION: I thought the Seventh Circuit went through -- I don't know where it is in the opinion. Oh, yes, on 13A of the petition for cert. We seem to be dealing with 13A and 14A today. The opinion gives four reasons why demand may be inappropriate, and it went through the bases, possible bases for requiring demand, and only one of which is what you have just addressed. Another purpose of it is to let the corporation take over the suit if it wishes. Now, that purpose would be fully served whether or not you apply the business judgment rule.

MR. MEYER: There are a number of reasons why demand may not be futile. In this case, clearly demand was futile. And I would submit that the arguments that even where it is futile some good may nevertheless come out of making a demand is not really an appropriate consideration for courts to consider. For example, in the Fox case which is oft cited in the briefs, the Court came to the conclusion that demand would be futile because under the statute the corporation was disabled from bringing the claim. And that's a little bit different from what we have here.

But in that case the petitioner argued that even though the corporation could not bring the claim -- it also involved a mutual fund -- demand would serve many useful intra-corporate purposes. It would cause the directors to focus on the contract with the investment advisor. They might revise the contract. They might even fire the investment advisor. All other intra-corporate rearrangements could be made.

That's always true, but I submit that the purpose of the Federal Rules of Civil Procedure are, while undoubtedly having some effect on corporate governments, are really directed toward corporate litigation and not with the operation of corporate law internally. And therefore I don't subscribe, obviously, to the Seventh Circuit's views on this matter.

The third point that I want to talk to, and I would like to address this as briefly as possible because I do want to reserve, if permitted, some time for rebuttal. The third point I want to address is what law applies to the case. Our view is that State law should apply to the case, in this case Maryland law, unless that State law is so inconsistent with the enforcement of the important Federal public policies underlying the proxy rules, in this case section 20 of the Investment Company Act, that to insist upon the enforcement of the rule and impose burdens upon plaintiffs seeking to enforce that public policy would thwart the public policy.

This may sound like a heads, I win, tails, you lose proposition, but it's -- there is support for it in the cases. Galef v. Alexander, which is cited in our brief, is on point. We also mention Levitt v. Johnson. And there is a --

QUESTION: Where -- what courts decided these cases?

MR. MEYER: These are appellate courts, circuit courts.

QUESTION: Federal courts of appeals?

MR. MEYER: Federal courts of appeal.

There is a decision by this Court in Boil v. United Technologies which did indicate that Federal common law would prevail where State tort law would threaten a result that was contrary to what was involved in that case, the Government defense contractor defense.

Unless there are further questions I would like to reserve the remaining time for rebuttal.

QUESTION: Very well, Mr. Meyer.

Mr. Dreeben, we'll hear from you.

ORAL ARGUMENT OF MICHAEL R. DREEBEN ON BEHALF OF THE SECURITIES AND EXCHANGE COMMISSION, AS AMICUS CURIAE IN SUPPORT OF THE PETITIONER

MR. DREEBEN: Thank you, Mr. Chief Justice, and may it please the Court:

Prior to the decision below it was the law in virtually all jurisdictions that shareholders need not make demand before commencing a derivative action where that demand would be futile. In this case the court of appeals abolished the traditional futility exception and replaced it with a rule that requires universal demand in every case.

In our view, the court of appeals erred in addressing this question as one of Federal common law for the courts of appeals to decide as they perceive the policy balances to require. Rather, State law should govern this area of core governance of corporations' internal affairs, absent a conflict with Federal policy.

QUESTION: Mr. Dreeben, that's a little odd, isn't it, because this is an action brought under a Federal statute?

MR. DREEBEN: That's correct, Justice O'Connor.

QUESTION: A Federal cause of action. And the cases saying that you nevertheless look to State law are a little unusual, it seems to me.

MR. DREEBEN: Well, I think the case that's closest related to the particular problem here today is Burks v. Lasker.

QUESTION: Yes.

MR. DREEBEN: It's quite similar, really.

QUESTION: Yes.

MR. DREEBEN: It was another derivative action under the Investment Company Act.

QUESTION: Yes. I guess I just don't understand that case, and why, when you have a cause of action based on violation of a Federal law you would have to look to State law for one of these initial sort of procedural requirements.

MR. DREEBEN: Well, there are two responses I'd like to give to that. First of all, the question of whether demand is required or not is a Federal question because the cause of action arises under a Federal statute. There is no doubt about that. The next issue is from what source does Federal law derive the rule of decision. This Court has in many contexts held that even when a question is governed by Federal law, Federal law may turn to State law rather than fashioning an entire body of law on its own. I think the Kimbell Foods case is the outstanding example of this, and the Court applied a very similar principle in Burks v. Lasker when it comes to the law of corporations. Corporations, after all, are created under State law.

When Congress regulated in the Investment Company Act, as it did in the other securities acts to regulate corporate activities, it did not provide for Federal chartering of corporations. It relied on States to charter corporations and to basically regulate the activities of corporations subject only to the predominant Federal policy. So Federal law displaces State law to the extent it is necessary to achieve Federal goals. Otherwise State law governs.

QUESTION: What if the State law says that there will be a demand made in every case?

MR. DREEBEN: That -- in our view the initial step for a court to follow is to adopt that rule, and then to consider whether it infringes any Federal policy to follow it. That question, of course, isn't here today, since we don't have a State that provided for universal demand, although there are several. I think that the real way to answer whether it conforms to Federal policy is to look at what happens after demand is made.

Does that -- does the making of demand in a particular State give the corporation a leg-up in dismissing the derivative action? If it does and the corporation is invested with too much power to cut off a Federal claim, there may very well be a conflict with Federal policy. But it probably will not flow from the demand requirement itself. It more likely will flow from what happens after demand is made and refused.

QUESTION: And how do you read the Seventh Circuit's holding about -- insofar as that is concerned?

MR. DREEBEN: Well, the Seventh Circuit thought it could achieve a nice distinction, a very logical, tidy distinction between a Federal rule of universal demand and State law governing what happens after demand is made. The problem with that approach is, although it sounds nice in theory, in fact it doesn't work. The reason it doesn't work is because many States place an integral connection between whether a shareholder has to make demand and what standard of review is subsequently applied to the board of directors' decision.

So Delaware, for example, which is a leading State in corporate law, says that if a demand is required of the shareholder and not excused, then the directors' subsequent decision not to sue is judged very deferentially under the business judgment rule. On the other hand, if demand is futile because the board is either biased or too implicated in the transaction to act on it, then a much higher standard of review applies when the corporation attempts to terminate the suit.

QUESTION: Mr. Dreeben, I understood the Seventh Circuit to avoid that problem by federalizing the latter question as well, that is by saying how much deference you give to the board decision is also a Federal question, and we will not adopt as a matter of Federal law the business judgment rule.

MR. DREEBEN: Well, I am not sure that the court said exactly either of those things. If it said -- if it thought it was saying that it's a Federal question what standard of review applies to the board of directors' decision, then in effect it overruled Burks v. Lasker, because Burks v. Lasker held that the power of corporate directors to terminate a derivative action, even based on a Federal statute, derives in the first instance from State law unless it conflicts with Federal policy. So there's a two-pronged inquiry.

I don't think that the court of appeals actually intended that. I think what the court of appeals thought is that we can have a Federal rule, which it thought was procedural, of universal demand followed by the application of State law as it's found. But the real difficulty with that proposition, I think, is that State law simply does not draw the distinction between demand and the standard of review in every instance. In some cases, in many, it ties them together. And once a shareholder makes a demand under Delaware law, the business judgment rule applies in every single case.

So under the Seventh Circuit's Federal universal demand rule you have two options. One option would be to say since the shareholder made a demand we now apply the Delaware standard of review. It's the business judgment rule, in every single case, even though Delaware might have applied a different standard because demand was actually futile.

The other alternative -- that alternative I think is not only conceptually incorrect, it overrides State policy needlessly.

The other alternative would be for the court to engage in a hypothetical inquiry. Would Delaware have excused demand in this case? If we answer that question we'll then know what standard of review Delaware wanted to apply. But if you engage in that inquiry you're right back where you started. You're litigating demand futility, and the court of appeals rule serves no purpose.

The basic reason why the court of appeals got off on the wrong foot, I think, is it evaluated the demand question as one of Federal procedure. It's really not. It's really a rule that governs substantive law of corporate internal affairs. A corporation may have a claim that can be asserted in court, but it is an artificial entity, and the question in a derivative action is who has the right to speak for a corporation. Normally it's the board of directors under State law, but State law almost universally recognizes an exception for derivative actions where the directors have wrongfully refused to protect corporate claims. In that instance shareholders may step in and speak for the corporation.

The demand rule stands as a threshold requirement that helps to regulate when shareholders can do that. The demand rule says that before shareholders may take the extraordinary step of usurping the board of directors' prerogatives, they have to make a demand on the directors to see whether the directors want to take over the suit or how they will react to it, to give them a chance to make a corporate judgment.

State law, however, recognizes that in some instances it would only obstruct the protection of shareholder rights, who are, after all, the owners of the corporation, to have to go to the very board of directors that may be implicated in the transaction --

QUESTION: Well, how would it obstruct them if you can do pretty much what you want in the way of prosecuting your suit after a demand is turned down? Wouldn't it simplify things?

MR. DREEBEN: It would simplify things if there were a coherent way of applying it, and the way of applying it were consistent with Federal law. But the way that many States regulate derivative actions is that if demand is excused the courts take a more active role in regulating the directors' efforts to cut it off. If demand is required, then the directors have a greater power. They can rely on their business judgment and say this derivative action should be terminated.

QUESTION: Well, might not the States change some of their laws if -- in that regard, if a demand under this statute were treated as a matter of Federal law, and you say you require it in every case?

MR. DREEBEN: Well, it's certainly possible the States might be forced to change their internal law of corporations if Federal law reached out and grabbed a portion of it. But there is no authorization --

QUESTION: This whole statute is a Federal statute. I mean, it specifies for what the basis of suit is. It's not as if you're suing under a State cause of action.

MR. DREEBEN: That's true, Chief Justice Rehnquist, and if the Court in Burks v. Lasker had ruled that it is always a Federal question when directors can terminate a derivative action under a Federal statute, then we would not be here today arguing that State law is the primary source. But once Burks v. Lasker and its principles are established there is really no alternative but to borrow the coherent set of State law rather than simply taking one piece of it here and another piece of it from Federal law.

Thank you.

QUESTION: Thank you, Mr. Dreeben.

Mrs. Hall, we'll hear from you.

ORAL ARGUMENT OF JOAN M. HALL ON BEHALF OF THE RESPONDENTS

MRS. HALL: Mr. Chief Justice, and may it please the Court:

The district court correctly dismissed the proxy claim in this case, and the court of appeals correctly affirmed that dismissal. We respectfully submit that regardless of whether this Court chooses to apply Federal law or State law, and regardless of whether the futility exception is applied or the futility exception is abolished, this Court should affirm the dismissal of the proxy claim in this case.

I would like to make three points. First, both courts below correctly concluded that the allegations of futility in the complaint in this case were totally inadequate to excuse the making of a demand upon the directors.

Second, both courts below correctly concluded that Federal law should apply in dealing with the demand issue on this Federal cause of action. And third, the court of appeals correctly held that under Federal law the futility exception to the demand requirement should be eliminated in order to promote important policies underlying the demand requirement, including judicial economy.

Turning first to the insufficiency of the allegations, the district court found that if you disregard the conclusory allegations in petitioner's complaint only two factual allegations of futility remain, that the directors receive fees for serving as directors, and the directors voted to send out the challenged proxy material. Petitioner cites no case, State or Federal, in which boilerplate allegations of futility such as these have been held to excuse demand.

The Federal law as to facts which would be sufficient to excuse the making of a demand is well stated in the Kauffman case. In Kauffman the First Circuit said that demand could be excused only upon a particularized showing that the directors are so antagonistic to the interests of the corporation that they could not discharge their duties.

In our case the directors are not named as defendants, nor are they alleged to have engaged in any wrongdoing whatsoever. This is particularly significant because full discovery on the merits was available to petitioner in this case.

QUESTION: Ms. Hall, you may be dead right that the allegations are insufficient, but neither the court of appeals -- the court of appeals didn't rely on that ground, did it?

MRS. HALL: They did, Your Honor. They did, Your Honor.

QUESTION: But the questions presented by the cert. petition don't raise that. I thought we took a case assuming that there were sufficient allegations. You may be right, but I'm just saying I'm not sure that's one of the issues we're addressing under the cert. petition.

MRS. HALL: I think that issue is properly before the Court and that it provides an independent ground for affirming the judgment of dismissal, Your Honor.

QUESTION: I see.

MRS. HALL: And it also is one part of the holding of the court of appeals. The Seventh Circuit has alternative holdings. They specifically find that the allegations are insufficient, and then they go forward with this alternative holding abolishing the futility exception.

QUESTION: Can we say that's all -- well, that's an alternative holding rather than dicta, then?

MRS. HALL: It is an alternative holding, we believe. The Seventh Circuit expressly states that the district court found the allegations of futility insufficient, as do we.

QUESTION: Well -- gee, I -- see, I didn't understand.

MRS. HALL: At both A16 and A17 of the Seventh Circuit opinion, the Seventh Circuit finds the allegations of futility to be --

QUESTION: 16 and 17?

MRS. HALL: -- insufficient.

QUESTION: What page was that on?

MRS. HALL: At A16, Your Honor. The court of appeals states the district court thought these allegations insufficient to excuse a demand under rule 23.1, as do we. That's at the conclusion of the first paragraph under Roman numeral I. And at A17 -- no, I've got the wrong page number there. Well, there's another place in the opinion where the district court -- the court of appeals refers to the able opinion of the court of appeals finding that these allegations of futility are insufficient, and then states we are in accord.

QUESTION: Mrs. Hall, I'm having trouble finding what you're -- even A16. I have a --

QUESTION: I think if you say 6A, Ms. Hall, you'll get to the --

MRS. HALL: I'm sorry. 6A.

QUESTION: -- portion of the appendix where the "as do we" language is found.

MRS. HALL: 6A, Your Honor. Roman numeral I, the first paragraph, the last sentence in the paragraph. "Judge Nordberg thought these allegations insufficient to excuse a demand under rule 23.1, as do we."

QUESTION: Well, but they do. But for quite separate reason that you always have to make a demand. That's how I interpreted that.

MRS. HALL: I think it's an alternative holding, Your Honor, and provides an alternative ground for affirmance of the dismissal in this case.

QUESTION: I don't see -- it isn't necessarily alternative. Then they go, he goes on to explain why we do, and the reason we do is that you always have to make a demand, and therefore these allegations are not sufficient to excuse a demand. Isn't that the --

MRS. HALL: I think he -- I think he also reviews these particular allegations and finds them insufficient, and goes on to say in addition that he is abolishing futility as an exception to the demand requirement.

Your Honors, even after substantial discovery in this case petitioner did not make any charges of wrongdoing against these directors, and we think that the allegations of futility in this case were completely inadequate, whether the Court chooses to apply Federal law or State law.

We think that both courts below properly chose to apply Federal law to the demand issue in this Federal cause of action for two reasons. The first reason is that petitioner induced both courts below to apply Federal law, and waived any argument that State law applies. petitioner cited only Federal law to the district court. petitioner did not mention State law until her reply brief in the court of appeals, and even then she argued only that if the court did not apply Federal law, then State law should be applied.

The district -- the court of appeals found that the State law argument had been waived, relying upon a rule of that court, a rather unremarkable rule which holds that reply briefs are to be limited to matters in reply. The court of appeals has consistently applied that rule in both civil and criminal cases. Petitioner here failed to comply with that rule, and the court of appeals properly concluded that the State law argument had been waived.

QUESTION: Well, what should apply in another suit where the State law argument is not waived?

MRS. HALL: In that instance, Justice O'Connor, we submit that Federal law would apply, and that's the second reason why we think Federal law properly applies in this case. In Burks this Court stated that legal rules that govern legal -- Federal causes of action are to be treated as raising Federal questions. And since Federal law applies to this Federal cause of action, the question then becomes what is the source of this Federal law? Is the Federal court going to look to Federal common law or to State law?

In Burks this Court looked to State law to supply the Federal rule of decision on the question regarding directors' power to terminate shareholders' derivative litigation. The Court found that applying State law to the corporate law issue in that case would relieve the Federal court of the burden of fashioning out of whole cloth an entire body of Federal corporate law.

We submit that this case is much different than Burks. This case also involves a Federal cause of action, so Federal law applies. But at the next step, which is selecting the source of the Federal law, we submit that there is no need here to look to State law. Here the Federal court has a fully developed body of Federal common law of demand which stems from this Court's decision in Hawes in 1882 which created a demand requirement. Here the Court does not need to fashion entirely out of whole cloth a law of, Federal common law of demand. That law already exists.

QUESTION: Well, how about the question of the effect of the demand requirement? What happens if the demand is rejected? Now what law do we look to?

MRS. HALL: Your Honor, the question of standard of review is not before the Court in this case, and the commission is in agreement with us on that point, that this Court should not reach that issue in this case. The court of appeals --

QUESTION: Well, we certainly have to be concerned with it, because it seems to me the questions are very much interrelated ultimately.

MRS. HALL: We think, Your Honor, that under Burks the question of standard of review would be governed by State law, and in fact that statement appears in the opinion of the court of appeals.

QUESTION: But I take it the Solicitor General's point is that that just brings us around to where we began, because Delaware's law is predicated on the assumption that there are two types of situations, one where there is demand and one where there is demand excused. And the reason that Delaware can afford to be very -- to give great deference to its directors in the demand required case is because there are whole other class of cases where demand is excused and the suits can then go forward without that deference.

So you're really asking us to apply a State law which has not at all been developed for the contingency of demand being required in every case. That is the Solicitor General's argument, is it not?

MRS. HALL: I believe it is, Your Honor. I can't speak for the Solicitor General. Let me say again that the standard of review is not presented in this case, and there are no questions of Delaware law presented in this case. If State law applies it's only a Maryland law.

QUESTION: Well, I am suggesting, as Justice O'Connor suggested, I believe, that it's necessarily involved because you're asking us to adopt a standard that might be completely unworkable.

MRS. HALL: I think the standard is not unworkable, Your Honor. What the court of appeals did was to adopt a very straightforward rule that in every derivative case the shareholder must make a demand before proceeding to the Federal court. The court of appeals said nothing about what the standard of review should be. Therefore what the court of appeals has done applies only to steps that the shareholder must take before the shareholder is permitted to go to court. After the shareholder goes to court the very same State law which now exists can be applied, only at that time --

QUESTION: But that law provides either no answer or an answer that is quite incorrect because it is premised on a false assumption.

MRS. HALL: No. At that point, for example in a case which Delaware characterizes now as demand excused, the shareholder plaintiff would still be required under the court of appeals' opinion to make a demand. However, the shareholder could then file suit if the demand was refused and contend that this is a case in which demand should have been excused. The Federal court could then rule upon that with the benefit of actual experience rather than having to deal with hypothetical facts about what the board would have done had it been presented with a demand.

Your Honors --

QUESTION: It may well be that even though you do come full circle, I suppose, and have to confront the same State law issues, you may not have to do it in as many cases.

MRS. HALL: That's correct, Your Honor.

QUESTION: In some of the cases, presumably, the corporation will decide to take up the cudgels on behalf of the shareholder.

MRS. HALL: Either the corporation will decide to take up the cudgels on behalf of the shareholders, or in fact the board of directors of a corporation when they are presented with demand have a whole range of intra-corporate dispute resolution mechanisms available to them. For example, the shareholder may be acting on mistaken information. The corporation may be able to furnish correct information and settle the dispute that way. There's a whole range of options that the board of directors can exercise when presented with a demand which may totally obviate the suit so that it never, never appears in the Federal courts.

QUESTION: But where those options do fail, you really don't have any answer to the SG's argument that you may have to get into the same kind of inquiry that we have up to now been conducting or the courts have been conducting under the futility rubric.

MRS. HALL: I have two answers. One is the answer we have already discussed, which is that some of those cases may never end up in court. The second answer is, if they do end up in court, the court can then conduct its analysis on the basis of actual facts rather than hypotheticals, which is how litigation normally is conducted.

This case differs from Burks for another reason, which is that the court in Burks in dealing with the question of when directors may properly terminate shareholders' litigation was concerned with an issue of the directors' powers, which this Court found to be a core issue of corporate law --

QUESTION: Mrs. Hall, more precisely, what exactly was the question decided in Burks what -- as to what the directors could do? Was it whether they should, would prosecute litigation or whether they would terminate a shareholder's prosecution?

MRS. HALL: It -- I believe the precise question, Your Honor, was whether they had the power to terminate, whether a special litigation committee appointed by the board of directors had the power to terminate a suit brought under the 1940 act.

QUESTION: Brought by whom?

MRS. HALL: A shareholder.

QUESTION: By the shareholder.

MRS. HALL: A derivative suit.

QUESTION: Thank you.

MRS. HALL: In this case we're not -- we are confronted with an issue involving the futility exception to the demand requirement which is not a core issue of corporate law. This question deals with the relationship between the shareholder and the Federal court, and what the shareholder has to do before he is permitted to file suit in the Federal court. It is not an issue of corporate law. It is an issue relating to demand, and as I mentioned, we have a fully developed body of Federal common law of demand stemming from this Court's decision in Hawes.

There is an additional reason for applying a Federal common law of demand, and that is the need for uniform -- uniformity in the rules governing access to the Federal courts. Legal proceedings in the Federal courts should be administered under uniform, predictable rules.

QUESTION: May I interrupt here because I want to be sure I understand.

MRS. HALL: Yes, Your Honor.

QUESTION: On the review -- I know you say it's not before us now --

MRS. HALL: Yes.

QUESTION: But do you have the position there that that is a matter of State law?

MRS. HALL: Yes. I believe under Burks.

QUESTION: But then why doesn't your, why wasn't your uniformity argument apply equally to that?

MRS. HALL: Well, I think --

QUESTION: Because that, in last analysis that's a question of access to the courts.

MRS. HALL: I think that that argument is foreclosed by Burks, and we're not urging the overruling of Burks. And also I think that that issue more directly implicates the power of directors, which is a core issue of corporate law.

QUESTION: Thank you.

MRS. HALL: Whereas our issue deals with the right of shareholders to come to the Federal court.

We think that applying the laws of the 50 States to, with regard to the futility exception to the demand requirement will result in unnecessary litigation over what should be a straightforward matter.

The virtue of a uniform Federal law of demand is particularly evident under the Federal policy that is reflected in the independent director provisions of the Investment Company Act of 1940.

And in the Burks decision this Court considered those independent director provisions and noted that those directors are to serve as watch dogs for the interests of all of the shareholders of the mutual funds. Applying a uniform Federal law of demand will help ensure that the demand rules do not evolve in such a way as to usurp the watch dog role of the independent directors under the Investment Company Act of 1940.

As my third argument, Your Honors, I submit that this judgment can be approved on the separate ground that the court of appeals correctly held that the futility exception to the demand requirement should be abolished. This was a very straightforward rule and would require demand in all cases. We believe that abolishing the futility exception will benefit the Federal judicial system without unduly burdening shareholder laintiffs, and that abolishing the futility exception is a natural evolution of the common law which will help sustain the vitality of the demand requirement.

Looking first at judicial economy, when Hawes was decided the Federal courts were in need of protection from the collusive manufacture of diversity jurisdiction. And today the Federal courts are confronted with cases where the futility exception is routinely used in order to avoid intra-corporate means of resolving disputes.

In each case involving the futility exception the district court must confront as a threshold issue the hypothetical fact-specific question as to whether demand would have been futile because the board is alleged to be biased or to have engaged in some improper conduct. We submit that requiring demand in all cases is preferable to expending time, money, and scarce judicial resources on this hypothetical inquiry as to whether demand would have been futile.

QUESTION: Mrs. Hall --

MRS. HALL: Yes, Your Honor.

QUESTION: Your opposing counsel says that the demand requirement is not just kind of a mechanical thing where you can abolish it and then everything will come out all right -- come out the same way, and then -- but the substantive standard of review of the shareholders' claim is much different under the law of most States where demand has been made and refused than it is where it is shown to be futile. Do you agree with that statement?

MRS. HALL: I do not, Your Honor. As we have been discussing, I think there is no logical or practical reason that you cannot separate the making of a demand from the standard of review, and the court of appeals said several times in their opinion that they were not making any link between the making of a demand and the standard of review to be applied to the board's decision in dealing with the demand. I think that requiring a demand will not place any undue burden on shareholders. All they have to do is write a letter to the board of directors of the corporation, and that in turn allows the board of directors of the corporation to have the option of trying to take some kind of action which will obviate the lawsuit. That does not place any burden on the shareholder plaintiff other than mailing the letter.

It's only at this second stage, which is not before the Court today, the stage of standard of review of the board's action, of that, in connection with that --

QUESTION: May I ask this, Mrs. Hall?

MRS. HALL: Yes, Your Honor.

QUESTION: You're saying -- one of your arguments is you'll save a lot of skirmish -- time skirmishing about futility if you have an automatic demand rule. But basically the -- when you allege futility you're alleging that the decision makers are biased for one reason or another, they're beholden or they've got a financial interest. Is it not true that if you call for a demand in every case the plaintiff will still make the same charges? Won't he say you can't rely on this decision not to litigate because the decision makers are biased? So don't you get back to the same issue that you, as when you have a futility requirement?

MRS. HALL: Not necessarily, Your Honor, because there will be a certain number of cases in which the board will be able to take action which will obviate the need for a lawsuit.

QUESTION: But even -- that's not impossible after a complaint is filed either.

MRS. HALL: It's not impossible, but it becomes very unlikely, and the case law is very clear that demand futility is to be determined as of the time suit is commenced. The courts have recognized that as soon as a lawsuit is filed, positions become hardened, people become adversaries --

QUESTION: Maybe we need more reasonable lawyers on both sides is what we need. There's no reason why that has to be true.

MRS. HALL: It just happens to be true.

QUESTION: Yeah, okay.

MRS. HALL: Your Honor, I think that this case is a classic example of a situation where a demand should have been made. If the fund directors in this case had been presented with a demand instead of a complaint, they might very well have chosen to distribute a revised proxy material even if they didn't think that anything was wrong with the original proxy material, just in order to avoid the delay and expense of this litigation.

QUESTION: Yeah, but that wouldn't have done any good because they have already hired the investment advisor. It's already been approved. Sending out a subsequent proxy statement wouldn't cure, assuming the original hiring was incorrect.

MRS. HALL: Well, the mutual fund must seek approval of its fees.

QUESTION: Right. And the hypothesis we have here is that they used an incomplete proxy statement to get approval of an improper investment contract.

MRS. HALL: That's correct. What I said is --

QUESTION: And if later on you send out a corrected proxy statement, what good does that do?

MRS. HALL: Well, if, it gives the shareholders the opportunity to vote with that additional information, which petitioner claims they needed to have.

QUESTION: It gives them an opportunity for a petition for rehearing in effect?

MRS. HALL: Right.

QUESTION: Yeah.

MRS. HALL: And it obviates the need for a lawsuit on a proxy claim. Now in this case petitioner did not sue until 6 months after the shareholders' meeting, but even at that time the board of directors, if they had been presented with a demand instead of a complaint, could have called a special shareholders' meeting and sent out revised proxy material and saved themselves the expense and honor of appearing before the Supreme Court on this issue 7 years after the shareholders' meeting.

QUESTION: Or they might have appointed an impartial committee to resolve the question, as some corporations do, I suppose --

MRS. HALL: That's correct, Your Honor.

QUESTION: -- which would also avoid ever having to confront the futility question.

MRS. HALL: That's correct.

Your Honor, petitioner claims that the decision of the court of appeals was a revolutionary decision. We think that it was more evolutionary and in the tradition of the common law, and that the decision of the court of appeals abolishing the futility exception will help to preserve the viability of the demand requirement.

Petitioner basically is taking the view that no corporate director ever can be trusted to act fairly and properly in considering a demand requirement, and it is this view that probably explains why the futility exception is eroding the demand requirement. If shareholder plaintiffs invariably consider corporate directors to be untrustworthy, then they will invariably decide that a demand would be futile and they will always rush to the Federal courthouse to file suit without making a demand.

The inevitable result is that the demand requirement is eroded, and the rule adopted by the court of appeals which eliminates supposed futility as a reason for not making a demand will preserve the viability of the demand requirement and, we suggest, should be adopted by this Court.

The allegations of futility in this case, Your Honors, were totally inadequate. I suggest that my client should no longer be required to defend against this proxy claim where the allegations of futility are so insufficient. These boilerplate allegations that the directors received fees for their services and that they voted to send out the challenged proxy material would not constitute futility under any applicable law.

And this proxy claim should be dismissed, Your Honors, whether this Court chooses to apply Federal law or State law, whether you choose to apply the futility exception or abolish the futility exception. Your Honor, we respectfully request that the dismissal of the proxy claim in this case be affirmed.

QUESTION: Thank you, Mrs. Hall.

Mr. Meyer, do you have rebuttal? You have 3 minutes remaining.

REBUTTAL ARGUMENT OF RICHARD M. MEYER ON BEHALF OF THE PETITIONER

MR. MEYER: Thank you, Mr. Chief Justice. I will be very brief. Hopefully I won't need to use the 3 minutes. At the risk of helping my opponent, I believe Ms. Hall intended to have reference to page 17A of the appendix with respect to the discussion of futility, the last paragraph on that page. I won't take time to read it, but I think if Your Honors read it you will see that the court below says both things. And it's pretty clear that it can't make up its mind whether the allegations are sufficient to establish futility or not, and therefore adopts a rule saying whether or not futile we must insist on demand in all cases.

I should have referred before to the Borak case as a case which insists on applying the Federal standards no matter -- to proxy fraud case no matter what State law would apply, and I submit that on that reasoning, which was adopted in Galef subsequent to the Burks decision, Burks is clearly distinguishable.

Burks was that unusual type of derivative action that really was a business judgment case. There was no self-dealing involved in Burks at all. That was a question of whether management made a business judgment mistake in purchasing Penn Central Commercial Paper from Goldman Sachs. And in fact prior to the decision, I think, management had instituted an action against Goldman Sachs and effected a recovery.

The only other point I might make is that on this question of waiver of State law, the State law question was never really waived. It was never really raised by either party. We said in our initial complaint, we hadn't really made any demand allegations except with respect to 36B. On the motion to dismiss, we amended the complaint, added the demand allegations, and addressed the argument of the defendants by saying we now have allegations in the complaint that excuse demand, that it's not merely a question, as you know from having read the papers, of the fact that they got paid for being directors. That would be simplistic.

Basically those are the points that I wanted to raise on rebuttal, and unless the Court has questions I thank you very much.

CHIEF JUSTICE REHNQUIST: Thank you, Mr. Meyer.

The case is submitted.

(Whereupon, at 12:05 p.m., the case in the above-entitled matter was submitted.)