A Federal court recently kept alive allegations that a systems software company misled investors about its digital defenses, citing an executive’s touting of the company’s rigorous security posture. 

Shareholders filed a derivative lawsuit against current and former directors of a financial institution for an alleged “cover up” of abusive and fraudulent sales techniques and unauthorized transactions in customer accounts. 

The individual defendants asked the court to dismiss the suit, arguing the shareholders failed to sufficiently challenge the board’s decision making process, a legal argument known as “demand futility.” Since the company was incorporated in Ohio, the defendants argued the legal standards of that state should control. Pursuant to Ohio law, it is the plaintiffs’ burden to plead that “a majority of the directors are so personally and directly conflicted or committed to the decision in dispute that they cannot reasonably be expected to respond to a demand in good faith and within the ambit of the business judgment rule.”

The shareholders made numerous arguments as to why a demand on the board would have been futile, including prior relationships between the directors, corporate sponsorships that would impact how certain directors may vote, recent bylaw amendments to guaranty indemnification of the directors, and the existence of directors and officers liability (“D&O”) insurance to shield the directors from personal financial loss. The court, however, was not persuaded, and applying Ohio law, dismissed the complaint on the grounds the shareholders were not excused from making a demand on the board. The court further found the shareholders failed to show that any of the director defendants faced a substantial likelihood of personal liability on the asserted breach of fiduciary duty or securities fraud claims, which would have allowed the shareholders to allege demand futility.

A former employee of a financial advisory firm initiated a Financial Industry Regulatory Authority arbitration action against her former employer, alleging unlawful termination under federal and state law. 

When the arbitrators issued an award in favor of the firm and dismissed the claims, the former employee filed suit in state court in an effort to vacate the arbitral decision. The employer then removed the suit to federal court. Using a “look-through” approach that considered the substance of the parties’ underlying dispute, that court determined it had jurisdiction over the petition to vacate, but declined to overturn the arbitration award.

In an 8-1 ruling, the U.S. Supreme Court concluded the Federal Arbitration Act (“FAA”) does not sanction federal courts to search an underlying arbitration dispute for a federal question in order to establish jurisdiction to confirm, vacate, or modify an arbitral award. In doing so, the high court reversed a Fifth Circuit order that had found the trial court correctly asserted jurisdiction over the former employee’s attempt to overturn the arbitral decision. Federal courts typically have jurisdiction whenever an action turns on a “federal question.” However, the Court’s decision, authored by Justice Kagan, noted that the FAA's provisions do not themselves support federal jurisdiction, so a federal court must find an independent basis for jurisdiction to resolve an arbitral dispute. In order to determine whether it has an independent jurisdictional basis, a court must look to the face of the application to confirm or deny the arbitral award. Taken by themselves, disputes regarding the enforceability of an award usually only raise matters of state law, the Court observed. And in the dispute at issue, the face of the applications did not support the exercise of jurisdiction, whether on the basis of “diversity” (meaning parties from different states) or by turning upon a question of federal law.  

The Court next looked at whether a federal court could use the so-called “look-through” approach to identify a basis for asserting jurisdiction that was not apparent on the face of the application, but which could be gathered from the underlying dispute. In its decision in Vaden v. Discover Bank, the Court had previously approved the look-through approach in the context of FAA Section 4 when it held that, in determining whether a federal court has jurisdiction over the subject-matter of a case for purposes of a motion to compel arbitration, a federal court may “look through” the petition to the underlying dispute between the parties. As Justice Kagan explained, however, Vaden was based on a different section of the FAA, which did not apply to an application to confirm or vacate an award.” In declining to apply Vaden’s look-though approach here, Justice Kagan noted “Congress could have replicated Section 4's look-through instruction in Sections 9 and 10,” or it “could have drafted a global look-through provision, applying th[at] approach throughout the FAA. But Congress did neither.” Sections 9 and 10 of the FAA “do not mention the court's subject-matter jurisdiction at all,” Kagan wrote, “so under ordinary principles of statutory construction, the look-through method for assessing jurisdiction should not apply.”

Instead, the Court concluded federal courts must use traditional jurisdictional rules and may only look to the application to determine whether they have jurisdiction over petitions to confirm or vacate domestic arbitral awards. As such, federal jurisdiction may not be available to parties disputing an arbitral award when the only basis for jurisdiction is that the underlying dispute involves a federal question.