In Re Citigroup Inc. Shareholder Derivative Litigation

OPINION

This is a shareholder derivative action brought on behalf of Citigroup Inc. (“Citigroup” or the “Company”), seeking to recover for the Company its losses arising from exposure to the subprime lending market. .Plaintiffs, shareholders of Citigroup, brought this action against current and former directors and officers of Citigroup, alleging, in essence, that the defendants breached their fiduciary duties by failing to properly monitor and manage the risks the Company faced from problems in the subprime lending market and for failing to properly disclose Citigroup’s exposure to subprime assets. Plaintiffs allege that there were extensive “red flags” that should have given defendants notice of the problems that were brewing in the real estate and credit markets and that defendants ignored these warnings in the pursuit of short term profits and at the expense of the Company’s long term viability.

Plaintiffs further allege that certain defendants are liable to the Company for corporate waste for (1) allowing the Company to purchase $2.7 billion in subprime loans from Accredited Home Lenders in March 2007 and from Ameriquest Home Mortgage in September 2007; (2) authorizing and not suspending the Company’s share repurchase program in the first quarter of 2007, which allegedly resulted in the Company buying its own shares at “artificially inflated prices;” (3) approving *112 a multi-million dollar payment and benefit package for defendant Charles Prince, whom plaintiffs describe as largely responsible for Citigroup’s problems, upon his retirement as Citigroup’s CEO in November 2007; and (4) allowing the Company to invest in structured investment vehicles (“SIVs”) that were unable to pay off maturing debt.

Pending before the Court is defendants’ motion (1) to dismiss or stay the action in favor of an action pending in the Southern District of New York (the “New York Action”) or (2) to dismiss the complaint for failure to state a claim under Court of Chancery Rule 12(b)(6) and for failure to properly plead demand futility under Court of Chancery Rule 23.1. For the reasons set forth below, the motion to stay or dismiss in favor of the New York Action is denied. The motion to dismiss is denied as to the claim in Count III for waste for approval of the November 4, 2007 Prince letter agreement. All other claims are dismissed for failure to adequately plead demand futility pursuant to Rule 23.1.

I. BACKGROUND

A. The Parties

Citigroup is a global financial services company whose businesses provide a broad range of financial services to consumers and businesses. Citigroup was incorporated in Delaware in 1988 and maintains its principal executive offices in New York, New York.

Defendants in this action are current and former directors and officers of Citigroup. The complaint names thirteen members of the Citigroup board of directors on November 9, 2007, when the first of plaintiffs’ now-consolidated derivative actions was filed. 1 Plaintiffs allege that a majority of the director defendants were members of the Audit and Risk Management Committee (“ARM Committee”) in 2007 and were considered audit committee financial experts as defined by the Securities and Exchange Commission.

Plaintiffs Montgomery County Employees’ Retirement Fund, City of New Orleans Employees’ Retirement System, Sheldon M. Pekin Irrevocable Descendants Trust Dated 10/01/01, and Carole Kops are all owners of shares of Citigroup stock.

B. Citigroup''s Exposure to the Sub-prime Crisis

Plaintiffs allege that since as early as 2006, defendants have caused and allowed Citigroup to engage in subprime lending 2 that ultimately left the Company exposed to massive losses by late 2007. 3 Beginning in late 2005, house prices, which many believe were artificially inflated by speculation and easily available credit, began to *113 plateau, and then deflate. Adjustable rate mortgages issued earlier in the decade began to reset, leaving many homeowners with significantly increased monthly payments. Defaults and foreclosures increased, and assets backed by income from residential mortgages began to decrease in value. By February 2007, subprime mortgage lenders began filing for bankruptcy and subprime mortgages packaged into securities began experiencing increasing levels of delinquency. In mid-2007, rating agencies downgraded bonds backed by subprime mortgages.

Much of Citigroup’s exposure to the sub-prime lending market arose from its involvement with collateralized debt obligations (“CDOs”) — repackaged pools of lower rated securities that Citigroup created by acquiring asset-backed securities, including residential mortgage backed securities (“RMBSs”), 4 and then selling rights to the cash flows from the securities in classes, or tranches, with different levels of risk and return. Included with at least some of the CDOs created by Citigroup was a “liquidity put” — an option that allowed the purchasers of the CDOs to sell them back to Citigroup at original value.

According to plaintiffs, Citigroup’s alleged $55 billion subprime exposure was in two areas of the Company’s Securities & Banking Unit. The first portion totaled $11.7 billion and included securities tied to subprime loans that were being held until they could be added to debt pools for investors. The second portion included $48 billion of super-senior securities, which are portions of CDOs backed in part by RMBS collateral. 5

By late 2007, it was apparent that Citigroup faced significant losses on its sub-prime-related assets, including the following as alleged by plaintiffs:

• October 1, 2007: Citigroup announced it would write-down approximately $1.4 billion on funded and unfunded highly leveraged finance commitments.

• October 15, 2007: Citigroup issued a press release reporting a net income of $2.88 billion, a 57% decline from the Company’s prior year results.

• November lh 2007: Citigroup announced significant declines on the fair value of the approximately $55 billion in the Company’s U.S. subprime-relat-ed direct exposures, and estimated that further write downs would be between $8 and $11 billion.

• November 6, 2007: Citigroup disclosed that it provided $7.6 billion of emergency financing to the seven SIVs the Company operated after they were unable to repay maturing debt. The SIVs drew on the $10 billion of so-called committed liquidity provided by Citigroup. On December 13, 2007 Citigroup bailed out seven of its affiliated SIVs by bringing $49 billion in assets onto its balance sheet and taking full responsibility for the SIVs’ $49 billion worth of assets.

• January 15, 2008: Citigroup announced it would take an additional $18.1 billion write-down for the fourth quarter 2007 and a quarterly loss of $9.83 billion. Citigroup also announced that the Company lowered its dividend to $0.32 per share, a 40% decline from the Company’s previous dividend disbursement.

*114 • By March 2008, Citigroup shares traded below book value and the Company announced that it would lay off an additional 2,000 employees, bringing Citigroup’s total layoff since the beginning of the subprime market crisis to more than 6,000.

• July 18, 2008: Citigroup announced it lost $2.5 billion in the second quarter, largely caused by $7.2 billion of write-downs of Citigroup’s investments in mortgages and other loans and by weakness in the consumer market.

Plaintiffs also allege that Citigroup was exposed to the subprime mortgage market through its use of SIVs. Banks can create SIVs by borrowing cash (by selling commercial paper) and using the proceeds to purchase loans; in other words, the SIVs sell short term debt and buy longer-term, higher yielding assets. According to plaintiffs, Citigroup’s SIVs invested in riskier assets, such as home equity loans, rather than the low-risk assets traditionally used by SIVs.

The problems in the subprime market left Citigroup’s SIVs unable to pay their investors. The SIVs held subprime mortgages that had decreased in value, and the normally liquid commercial paper market became illiquid. Because the SIVs could no longer meet their cash needs by attracting new investors, they had to sell assets at allegedly “fire sale” prices. In November 2007, Citigroup disclosed that it provided $7.6 billion of emergency financing to the seven SIVs the Company operated after they were unable to repay maturing debt. Ultimately, Citigroup was forced to bail out seven of its affiliated SIVs by bringing $49 billion in assets onto its balance sheet, notwithstanding that Citigroup previously represented that it would manage the SIVs on an arms-length basis.

C. Plaintiffs’ Claims

Plaintiffs allege that defendants are liable to the Company for breach of fiduciary duty for (1) failing to adequately oversee and manage Citigroup’s exposure to the problems in the subprime mortgage market, even in the face of alleged “red flags” and (2) failing to ensure that the Company’s financial reporting and other disclosures were thorough and accurate. 6 As will be more fully explained below, the “red flags” alleged in the eighty-six page Complaint are generally statements from public documents that reflect worsening *115 conditions in the financial markets, including the subprime and credit markets, and the effects those worsening conditions had on market participants, including Citigroup’s peers. By way of example only, plaintiffs’ “red flags” include the following:

• May 27, 2005: Economist Paul Krug-man of the New York Times said he saw “signs that America’s housing market, like the stock market at the end of the last decade, is approaching the final, feverish stages of a speculative bubble.”

• May 2006: Ameriquest Mortgage, one of the United States’ leading wholesale subprime lenders, announced the closing of each of its 229 retail offices and reduction of 3,800 employees.

• February 12, 2007: ResMae Mortgage, a subprime lender, filed for bankruptcy. According to Bloomberg, in its Chapter 11 filing, ResMae stated that “[t]he subprime mortgage market has recently been crippled and a number of companies stopped originating loans and United States housing sales have slowed and defaults by borrowers have risen.”

• April 18, 2007: Freddie Mac announced plans to refinance up to $20 billion of loans held by subprime borrowers who would be unable to afford their adjustable-rate mortgages at the reset rate.

• July 10, 2007: Standard and Poor’s and Moody’s downgraded bonds backed by subprime mortgages.

• August 1, 2007: Two hedge funds managed by Bear Stearns that invested heavily in subprime mortgages declared bankruptcy.

• August 9, 2007: American International Group, one of the largest United States mortgage lenders, warned that mortgage defaults were spreading beyond the subprime sector, with delinquencies becoming more common among borrowers in the category just above subprime.

• October 18, 2007: Standard & Poor’s cut the credit ratings on $23.35 billion of securities backed by pools of home loans that were offered to borrowers during the first half of the year. The downgrades even hit securities rated AAA, which was the highest of the ten investment-grade ratings and the rating of government debt. 7

Plaintiffs also allege that the director defendants and certain other defendants are liable to the Company for waste for: (1) allowing the Company to purchase $2.7 billion in subprime loans from Accredited Home Lenders in March 2007 and from Ameriquest Home Mortgage in September 2007; (2) authorizing and not suspending the Company’s share repurchase program in the first quarter of 2007, which allegedly resulted in the Company buying its own shares at “artificially inflated prices;” (3) approving a multi-million dollar payment and benefit package for defendant Prince upon his retirement as Citigroup’s CEO in November 2007; and (4) allowing the Company to invest in SIVs that were unable to pay off maturing debt.

D. The Procedural History

1. The New York Action

The first New York Action was filed on November 6, 2007 in the United States District Court for the Southern District of New York. On August 22, 2008, the five *116 pending derivative actions were consolidated as In re Citigroup, Inc. Shareholder Derivative Litigation, No 07 Civ. 9841, and on September 23, 2008, the Court appointed lead counsel and lead plaintiffs. Plaintiffs filed a consolidated complaint on November 10, 2008, alleging: (1) violation of the Securities Exchange Act of 1934 (“Exchange Act”) § 10(b) and Rule 10b-5 (derivatively on behalf of Citigroup); (2) breach of fiduciary duties of care, loyalty, and good faith; (3) breach of fiduciary duty for insider trading and misappropriation of information; (4) breach of fiduciary duty of disclosure; (5) waste of corporate assets; and (6) unjust enrichment. Defendants filed a motion to dismiss on December 23, 2008, and pursuant to the schedule set by the Federal District Court, the motion to dismiss the New York Action will be fully briefed by late February 2009.

2. The Delaware Action

This action was commenced on November 9, 2007, and the four pending actions were consolidated on February 5, 2008. Defendants filed a motion to dismiss the Consolidated Amended Derivative Complaint on April 21, 2008. Plaintiffs responded by filing a Consolidated Second Amended Derivative Complaint (the “Complaint”), which was accepted by the Court on September 15, 2008. Pending before the Court is defendants’ motion to dismiss or stay.

II. MOTION TO DISMISS OR STAY IN FAVOR OF THE NEW YORK ACTION

A. Legal Standard

Defendants seek a stay of this action in favor of the New York Action. Under McWane, this Court may, in the exercise of its discretion, stay an action “when there is a prior action pending elsewhere, in a court capable of doing prompt and complete justice, involving the same parties and the same issues.” 8 Such discretion allows the Court, for reasons of comity and the fair and orderly administration of justice, to ensure that a plaintiffs choice of forum is not defeated and to properly confine litigation to the forum in which it is first commenced. 9 Where, however, the actions are contemporaneously filed such that the action pending elsewhere is not considered “first-filed,” the Court will consider the motion “under the traditional forum non conveniens framework without regard to a McWane-type preference of one action over the other.” 10 Where, as here, the actions were filed within the same general time frame, the Court considers the actions simultaneously filed so as to avoid a “race to the courthouse.” 11 Because the actions were filed only a few days apart, I consider them contemporaneous. 12

*117 Additionally, even where there is a first filed derivative or class action, this Court has recognized the difficulty presented by the McWane doctrine. A shareholder plaintiff in a derivative suit alleges claims in the right of the corporation rather than directly; thus, representative actions raise the concern that the best interest of the class might diverge from the best interest of the representative plaintiffs attorneys. To avoid exacerbating this potential conflict, the Court gives less weight to the first filed status of a lawsuit, and instead “will examine more closely the relevant factors bearing on where the case should best proceed, using something akin to a forum non conveniens analysis.” 13 I turn now to the forum non conveniens standard.

When assessing whether to stay or dismiss an action under the doctrine of forum non conveniens this Court considers six factors:

1) the applicability of Delaware law in the action; 2) the relative ease of access to proof; 3) the availability of compulsory process for witnesses; 4) the pen-dency or non-pendency of any similar actions in other jurisdictions; 5) the possibility of a need to view the premises; and 6) all other practical considerations which would serve to make the trial easy, expeditious and inexpensive. 14

A party is not entitled to a stay as a matter of right; rather, the granting of a motion to stay rests with the sound discretion of the Court. This Court is rightfully hesitant to grant motions to stay based on forum non conveniens, and the doctrine is not a vehicle by which the Court should determine which forum would be most convenient for the parties. 15 Rather, a defendant bears the burden of showing entitlement to a stay or dismissal on grounds of forum non conveniens: in a case where a stay will likely have substantially the same effect as a dismissal, the defendant must show that one or more of the factors, either separately or together, would subject the defendant to sufficient hardship to warrant staying the proceedings. 16

*118 B. Forum Non Conveniens Analysis

Although there may be some overlap with the New York Action, defendants have failed to meet their burden of showing hardship that would entitle them to a stay or dismissal in favor of the New York Action. 17 First, Delaware law applies to this action. Citigroup is incorporated in Delaware, and the fiduciary duties owed by its officers and directors are governed by Delaware law. Defendants argue that this case does not pose novel issues of Delaware law and only calls for application of the established doctrines governing Caremark and waste claims to the facts in this case. Of course, the contextual application of Delaware fiduciary duty law is not novel. This case, however, raises important issues regarding the standards governing directors and officers of Delaware corporations, and Delaware has an ongoing interest in applying our law to director conduct in the context of current market conditions — conditions which change rapidly and pose new challenges for directors and officers of Delaware corporations. 18

Second, the relative ease of access to proof should not be accorded much weight in this case. Although access to proof may be marginally easier in New York, collecting evidence from other jurisdictions is regularly handled with ease in this Court. 19

Third, the availability of compulsory process for witnesses should not be given much weight in this case. Although witnesses may be located in New York, “the process of issuing commissions to take discovery in another state is efficient, effec *119 tive, and routinely accomplished.” 20 Defendants have failed to identify documents or witnesses that will be unavailable if litigation continues in Delaware.

Fourth, although there is an action pending in New York that arises out of the same nucleus of operative fact, the pen-dency of such action does not give rise to the hardship required to establish entitlement to a stay. Although some overlap may result, the pendency of a similar action in another jurisdiction regarding corporate governance issues under Delaware law does not necessarily override the interest of Delaware in resolving such claims. Defendants argue that a stay should be granted because the New York Court is the only court capable of granting complete relief because the New York Action includes claims that can only be adjudicated in federal court, specifically claims under Exchange Act § 10(b) and Rule 10b-5. In response, plaintiffs argue that this Court should refuse to grant a stay because the complaint in the New York Action contains meager Caremark allegations compared to the Complaint in this action. According to plaintiffs, the claims in the New York Action are primarily for securities fraud and insider trading and set forth demand futility allegations based on defendants’ misrepresentations, omissions, and insider sales.

While the authority of one Court to grant complete relief may be a relevant consideration under the pendency of similar actions prong of the forum non conve-niens analysis, it is not outcome determinative. In this case, it does not even approach the required showing of hardship defendants would have to make in order to warrant a stay of the proceedings, and I need not further scrutinize the arguments on this prong of the test.

Finally, the “important and atypical practical considerations,” described by the Bear Stearns Court as sui generis, are not present in this case. 21 In Bear Stearns, the Court was faced with a case involving the Federal Reserve Bank and the Department of the Treasury in which inconsistent rulings could “negatively impact not only the parties involved, but also the U.S. financial markets and the national economy.” 22 In light of, among other things, “the persuasive practical reasons against embarking unnecessarily on a collision course with our sister court in New York in these extraordinary circumstances,” the Court granted the motion for a stay after finding that the defendants had shown that failure to stay the action would result in overwhelming hardship. 23 Defendants in this action have not shown analogous practical circumstances or that proceeding in Delaware would result in significant hardship. The essence of defendants’ argument in favor of the stay is that the Court in the New York Action is capable of hearing all the claims and that it would be more expedient and convenient to litigate in New York rather than Delaware. 24 Such considerations, however, without more, are not sufficient to entitle defendants to a stay on forum non conveniens grounds.

*120 III. THE MOTION TO DISMISS UNDER RULE 23.1

A. The Legal Standard for Demand Excused

The decision whether to initiate or pursue a lawsuit on behalf of the corporation is generally within the power and responsibility of the board of directors. 25 This follows from the “cardinal precept of the General Corporation Law of the State of Delaware ... that directors, rather than shareholders, manage the business and affairs of the corporation.” 26 Accordingly, in order to cause the corporation to pursue litigation, a shareholder must either (1) make a pre-suit demand by presenting the allegations to the corporation’s directors, requesting that they bring suit, and showing that they wrongfully refused to do so, or (2) plead facts showing that demand upon the board would have been futile. 27 Where, as here, a plaintiff does not make a pre-suit demand on the board of directors, the complaint must plead with particularity facts showing that a demand on the board would have been futile. 28 The purpose of the demand requirement is not to insulate defendants from liability; rather, the demand requirement and the strict requirements of factual particularity under Rule 23.1 “exist[] to preserve the primacy of board decision-making regarding legal claims belonging to the corporation.” 29

Under the familiar Aronson test, to show demand futility, plaintiffs must provide particularized factual allegations that raise a reasonable doubt that “(1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.” 30 Where, however, plaintiffs complain of board inaction and do not challenge a specific decision of the board, there is no “challenged transaction,” and the ordinary Aronson analysis does not apply. 31 Instead, to show demand futility where the subject of the derivative suit is not a business decision of the board, a plaintiff must allege particularized facts that “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.” 32

In evaluating whether demand is excused, the Court must accept as true the well pleaded factual allegations in the Complaint. The pleadings, however, are held to a higher standard under Rule 23.1 than under the permissive notice pleading standard under Court of Chancery Rule 8(a). To establish that demand is excused under Rule 23.1, the pleadings must comply with “stringent requirements of factual particularity” and set forth “particularized factual statements that are essential to the *121 claim.” 33 “A prolix complaint larded with conclusory language ... does not comply with these fundamental pleading mandates.” 34

Plaintiffs have not alleged that a majority of the board was not independent for purposes of evaluating demand. Rather, as to the claims for waste asserted in Count III, plaintiffs allege that the approval of certain transactions did not constitute a valid exercise of business judgment under the second prong of the Aronson test. Plaintiffs allege that demand is futile as to Counts I, II, and IV because the director defendants are not able to exercise disinterested business judgment in responding to a demand because their failure of oversight subjects them to a substantial likelihood of personal liability. According to plaintiffs, the director defendants face a substantial threat of personal liability because their conscious disregard of their duties and lack of proper supervision and oversight caused the Company to be overexposed to risk in the subprime mortgage market.

Demand is not excused solely because the directors would be deciding to sue themselves. 35 Rather, demand will be excused based on a possibility of personal director liability only in the rare case when a plaintiff is able to show director conduct that is “so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability therefore exists.” 36

B. Demand Futility Regarding Plaintiffs’ Fiduciary Duty Claim,s

Plaintiffs’ argument is based on a theory of director liability famously articulated by former-Chancellor Allen in In re Carem ark, 37 Before Caremark, in Graham v. Allis-Chalmers Manufacturing Compan y, 38 the Delaware Supreme Court, in response to a theory that the Allis-Chalmers directors were liable because they should have known about employee violations of federal anti-trust laws, held that “absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to *122 suspect exists.” 39 Over thirty years later, in the context of approval of a settlement of a class action, former-Chancellor Allen took the opportunity to revisit the duty to monitor under Delaware law. In Caremark, the plaintiffs alleged that the directors were liable because they should have known that certain officers and employees were violating the federal Anti-Referral Payments Law. In analyzing these claims, the Court began, appropriately, by reviewing the duty of care and the protections of the business judgment rule.

With regard to director liability standards, the Court distinguished between (1) “a board decision that results in a loss because that decision was ill advised or ‘negligent’ ” and (2) “an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss.” 40 In the former class of cases, director action is analyzed under the business judgment rule, which prevents judicial second guessing of the decision if the directors employed a rational process and considered all material information reasonably available — a standard measured by concepts of gross negligence. 41 As former-Chancellor Allen explained:

What should be understood, but may not widely be understood by courts or commentators who are not often required to face such questions, is that compliance with a director’s duty of care can never appropriately be judicially determined by reference to the content of the board decision that leads to a corporate loss, apart from consideration of the good faith or rationality of the process employed. That is, whether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through “stupid” to “egregious” or “irrational”, provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. To employ a different rule — one that permitted an “objective” evaluation of the decision — would expose directors to substantive second guessing by ill-equipped judges or juries, which would, in the long-run, be injurious to investor interests. Thus, the business judgment rule is process oriented and informed by a deep respect for all good faith board decisions. 42

In the latter class of eases, where directors are alleged to be liable for a failure to monitor liability creating activities, the Caremark Court, in a reassessment of the holding in Graham, stated that while directors could be liable for a failure to monitor, “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.” 43

In Stone v. Ritter, the Delaware Supreme Court approved the Care-mark standard for director oversight liability and made clear that liability was based on the concept of good faith, which the Stone Court held was embedded in the fiduciary duty of loyalty and did not constitute a freestanding fiduciary duty that *123 could independently give rise to liability. 44 As the Stone Court explained:

Caremark articulates the necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations. Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith. 45

Thus, to establish oversight liability a plaintiff must show that the directors knew they were not discharging them fiduciary obligations or that the directors demonstrated a conscious disregard for their responsibilities such as by failing to act in the face of a known duty to act. 46 The test is rooted in concepts of bad faith; indeed, a showing of bad faith is a necessatry condition to director oversight liability. 47

1. Plaintiffs ’ Caremark Allegations

Plaintiffs’ theory of how the director defendants will face personal liability is a bit of a twist on the traditional Caremark claim. In a typical Caremark case, plaintiffs argue that the defendants are liable for damages that arise from a failure to properly monitor or oversee employee misconduct or violations of law. For example, in Caremark the board allegedly failed to monitor employee actions in violation of the federal Anti-Referral Payments Law; in Stone, the directors were charged with a failure of oversight that resulted in liability for the company because of employee violations of the federal Bank Secrecy Act. 48

In contrast, plaintiffs’ Caremark claims are based on defendants’ alleged failure to properly monitor Citigroup’s business risk, specifically its exposure to the subprime mortgage market. In their answering brief, plaintiffs allege that the director defendants are personally liable under Caremark for failing to “make a good faith *124 attempt to follow the procedures put in place or fail[ing] to assure that adequate and proper corporate information and reporting systems existed that would enable them to be fully informed regarding Citigroup’s risk to the subprime mortgage market.” 49 Plaintiffs point to so-called “red flags” that should have put defendants on notice of the problems in the subprime mortgage market and further allege that the board should have been especially conscious of these red flags because a majority of the directors (1) served on the Citigroup board during its previous Enron related conduct and (2) were members of the ARM Committee and considered financial experts.

Although these claims are framed by plaintiffs as Caremark claims, plaintiffs’ theory essentially amounts to a claim that the director defendants should be personally liable to the Company because they failed to fully recognize the risk posed by subprime securities. When one looks past the lofty allegations of duties of oversight and red flags used to dress up these claims, what is left appears to be plaintiff shareholders attempting to hold the director defendants personally liable for making (or allowing to be made) business decisions that, in hindsight, turned out poorly for the Company. Delaware Courts have faced these types of claims many times and have developed doctrines to deal ■with them — the fiduciary duty of care and the business judgment rule. These doctrines properly focus on the decision-making process rather than on a substantive evaluation of the merits of the decision. This follows from the inadequacy of the Court, due in part to a concept known as hindsight bias, 50 to properly evaluate whether corporate decision-makers made a “right” or “wrong” decision.

The business judgment rule “is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” 51 The burden is on plaintiffs, the party challenging the directors’ decision, to rebut this presumption. 52 Thus, absent an allegation of interestedness or disloyalty to the corporation, the business judgment rule prevents a judge or jury from second guessing director decisions if they were the product of a rational process and the directors availed themselves of all material and reasonably available information. The standard of director liability under the business judgment rule “is predicated upon concepts of gross negligence.” 53

Additionally, Citigroup has adopted a provision in its certificate of incorporation pursuant to 8 Del. C. § 102(b)(7) that exculpates directors from personal liability for violations of fiduciary duty, except for, among other things, breaches of the duty of loyalty or actions or omissions not in good faith or that involve intentional misconduct or a knowing violation of law. Because the director defendants are “exculpated from liability for certain conduct, ‘then a serious threat of liability may only be found to exist if the plaintiff pleads a *125 non-exculpated claim against the directors based on particularized facts.’” 54 Here, plaintiffs have not alleged that the directors were interested in the transaction and instead root their theory of director personal liability in bad faith.

The Delaware Supreme Court has stated that bad faith conduct may be found where a director “intentionally acts with a purpose other than that of advancing the best interests of the corporation, ... acts with the intent to violate applicable positive law, or ... intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.” 55 More recently, the Delaware Supreme Court held that when a plaintiff seeks to show that demand is excused because directors face a substantial likelihood of liability where “directors are exculpated from liability except for claims based on ‘fraudulent,’ ‘illegal’ or ‘bad faith’ conduct, a plaintiff must also plead particularized facts that demonstrate that the directors acted with scienter, i.e., that they had ‘actual or constructive knowledge’ that their conduct was legally improper.” 56 A plaintiff can thus plead bad faith by alleging with particularity that a director knowingly violated a fiduciary duty or failed to act in violation of a known duty to act, demonstrating a conscious disregard for her duties.

Turning now specifically to plaintiffs’ Caremark claims, one can see a similarity between the standard for assessing oversight liability and the standard for assessing a disinterested director’s decision under the duty of care when the company has adopted an exculpatory provision pursuant to § 102(b)(7). In either case, a plaintiff can show that the director defendants will be liable if their acts or omissions constitute bad faith. A plaintiff can show bad faith conduct by, for example, properly alleging particularized facts that show that a director consciously disregarded an obligation to be reasonably informed about the business and its risks or consciously disregarded the duty to monitor and oversee the business.

The Delaware Supreme Court made clear in Stone that directors of Delaware corporations have certain responsibilities to implement and monitor a system of oversight; however, this obligation does not eviscerate the core protections of the business judgment rule — protections designed to allow corporate managers and directors to pursue risky transactions without the specter of being held personally liable if those decisions turn out poorly. Accordingly, the burden required for a plaintiff to rebut the presumption of the business judgment rule by showing gross negligence is a difficult one, and the burden to show bad faith is even higher. Additionally, as former-Chaneellor Allen noted in Caremark, director liability based on the duty of oversight “is possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” 57 The presumption of the business judgment rule, the protection of an exculpatory § 102(b)(7) provision, and the difficulty of proving a Caremark claim together function to place an extremely high burden on a plaintiff to state a claim for personal director liability for a failure to see the extent of a company’s business risk.

*126 To the extent the Court allows shareholder plaintiffs to succeed on a theory that a director is liable for a failure to monitor business risk, the Court risks undermining the well settled policy of Delaware law by inviting Courts to perform a hindsight evaluation of the reasonableness or prudence of directors’ business decisions. Risk has been defined as the chance that a return on an investment will be different that expected. The essence of the business judgment of managers and directors is deciding how the company will evaluate the trade-off between risk and return. Businesses — and particularly financial institutions — make returns by taking on risk; a company or investor that is willing to take on more risk can earn a higher return. Thus, in almost any business transaction, the parties go into the deal with the knowledge that, even if they have evaluated the situation correctly, the return could be different than they expected.

It is almost impossible for a court, in hindsight, to determine whether the directors of a company properly evaluated risk and thus made the “right” business decision. 58 In any investment there is a chance that returns will turn out lower than expected, and generally a smaller chance that they will be far lower than expected. When investments turn out poorly, it is possible that the decision-maker evaluated the deal correctly but got “unlucky” in that a huge loss — the probability of which was very small — actually happened. It is also possible that the decision-maker improperly evaluated the risk posed by an investment and that the company suffered large losses as a result.

Business decision-makers must operate in the real world, with imperfect information, limited resources, and an uncertain future. To impose liability on directors for making a “wrong” business decision would cripple their ability to earn returns for investors by taking business risks. Indeed, this kind of judicial second guessing is what the business judgment rule was designed to prevent, and even if a complaint is framed under a Caremark theory, this Court will not abandon such bedrock principles of Delaware fiduciary duty law. With these considerations and the difficult standard required to show director oversight liability in mind, I turn to an evaluation of the allegations in the Complaint.

a. The Complaint Does Not Properly Allege Demand Futility for Plaintiffs’ Fiduciary Duty Claims

In this case, plaintiffs allege that the defendants are liable for failing to properly monitor the risk that Citigroup faced from subprime securities. While it may be possible for a plaintiff to meet the burden under some set of facts, plaintiffs in this case have failed to state a Care-mark claim sufficient to excuse demand based on a theory that the directors did not fulfill their oversight obligations by failing to monitor the business risk of the company.

The allegations in the Complaint amount essentially to a claim that Citigroup suffered large losses and that there were certain warning signs that could or should have put defendants on notice of the busi *127 ness risks related to Citigroup’s investments in subprime assets. Plaintiffs then con