In Re Caremark Intern, Inc. v. Derivative Litigation

698 A.2d 959 (1996)

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Nature of the Case

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Facts

Caremark (D) was subject to criminal and civil penalties amounting to $250 million. As part of a plea agreement D was to plead guilty to a single count of mail fraud and pay civil and criminal fines. The present suit was filed in 1994 seeking to recover on behalf of the company those losses from individual defendants who constituted the board of directors of the company. Pending is a motion to approve as fair and reasonable a proposed settlement of this derivative action. D was a Delaware corporation that was created in November of 1992 when it spun off from Baxter International. D became a publicly held company listed on the NYSE. The business practices that created these legal problems predated the spin-off. D was involved in providing patient care and managed care services. A substantial portion of the revenues generated by D were derived from third-party payments, insurers, and Medicare and Medicaid reimbursement programs. The government payments were subject to Anti-Referral Payments law. From its inception, D entered into a variety of agreements with hospitals and physicians, and health care providers for advice and services as well as distribution agreements with drug manufacturers as had its predecessor prior to 1992. D entered into agreements with physicians some of whom prescribed or recommended services and products that Caremark provided to Medicare recipients and other patients. These contracts were not prohibited by ARPL law but this raised the possibility of unlawful kickbacks. D had a guide that was updated annually by its lawyers which provided that no payments would be made in exchange for or to induce patient referrals. Due to the scarcity of ARPL court decisions, D continually stated that it was uncertain concerning its interpretation of the law. Eventually D's predecessor was put under investigation in 1991. During this period of time, pre-D had over 7,000 employees and ninety branch offices with a decentralized management structure. In May 21991, pre-D began organizing itself to centralize management. Steps were taken by pre-D to stop certain payments to physicians even though they believed that what was being ceased was actually legal. A new version of the internal guide was published by D reflecting these changes in 1992. Internal advice still remained constant that what had been going on was perfectly legal. D disclosed the investigations and acknowledged the possible scope of penalties in its annual report. Price Waterhouse was part of the internal audit team and concluded that the systems that D had in place had no material weaknesses in their control structure. Despite this positive report, the board's Audit and Ethics Committee adopted new internal audit procedures. D's sales force received ongoing education regarding ARPL and the proper use of D's form contracts. A new ethics manual prohibited payments in exchange for referrals and set up a toll-free ethics hotline. More procedures were added again in 1994, and a fifth revised Guide was published. D, along with a sales employee of Genentech, Inc. and a physician were indicted under ARPL for $1.1 million in payments to the physician to induce him to distribute Protropin, a human growth hormone drug marketed by D. These payments started in 1986, lasted until 1993, and were hidden in the guise of research grants, and consulting agreements. As a result, five stockholder derivative actions suits were filed and then consolidated; all alleging that D's directors breached their fiduciary duty of care by failing to adequately supervise D's employees or to institute corrective measures. D's filed motions to dismiss based on defects in the pleadings for not alleging particularized facts and that D's charter eliminates directors' personal liability for money damages to the extent permitted by law. In 1995, D took immediate action and terminated even legal contracts so as to eliminate the possibility of illegal conduct and temptation. A plea agreement was reached with the government, and no senior officers or directors were charged with wrongdoing by the government. The government even stipulated that no senior executive participated in, condoned, or was willfully ignorant of wrongdoing in connection with the home infusion practices. D then began settlement negotiations with Ps. A memo of understanding was reached and approved by the Board and then offered to the court for its approval.