Facts:
In late 2005, housing prices, artificially inflated by speculation and easily available credit, began to plateau and then to deflate. Adjustable-rate mortgages began to reset, leaving homeowners with higher monthly payments, which led to an increase in defaults and foreclosures. During this period, Citigroup, a global financial services company, was exposed to the subprime lending market through its involvement in collateralized debt obligations (CDOs), which are repackaged pools of lower-rated securities created by obtaining asset-backed securities like residential mortgage backed securities (RMBSs) and then selling rights to the cash flows from those securities in classes with different levels of risk and return. Citigroup was also exposed to the subprime mortgage market through its use of structured investment vehicles (SIVs), which are created by selling short-term debt and buying longer-term debt to yield higher returns. Without making a pre-suit demand, a group of plaintiffs, including Montgomery County Employees’ Retirement Fund and City of New Orleans Employees’ Retirement System, sued a number of Citigroup directors who were members of the Audit and Risk Management Committee and considered audit committee experts. The plaintiffs alleged that from as early as 2006, the defendant directors and officers caused and allowed Citigroup to engage in subprime lending that ultimately left the bank exposed to massive losses by late 2007. In particular, the plaintiffs alleged that the defendants breached their fiduciary duty by (1) failing to adequately oversee and manage Citigroup’s exposure to the problems in the subprime mortgage market, even when there were obvious “red flags,” and (2) failing to ensure that Citigroup’s financial reporting and other disclosures were thorough and accurate. They also alleged a waste of Citigroup’s corporate assets.
Issue Presented:
What do shareholders have to allege to demonstrate that it would be futile to demand that the board sue the directors for failure to adequately protect the corporation from exposure to the subprime lending market?