Academic journal article
By Robinson, Terence L., Jr.
Brigham Young University Law Review , Vol. 2005, No. 1
In today's fierce business world some corporate directors feel the need to try anything possible to gain an edge, even if it means engaging in illegal business practices. Reports highlighting corporate corruption and greed frequent the news.1 Politicians around the nation are lining up to support harsher penalties for corporate abusers.2 The recent scandals involving Enron,3 WorldCom,4 and the Bank of New York5 are a few of the more publicized examples of corporate corruption. The increase in the number of shareholder derivative suits is another sign of growing corporate corruption.6 While shareholder derivative suits are a common means through which shareholders enforce their rights, cunning investors may also abuse these suits to make a quick profit. For this reason it is important to protect the rights of shareholders to bring derivative actions while preventing cunning litigants from abusing such actions for personal profit.
These competing interests have caused a split between the Second and Fifth Circuit courts of appeal7 concerning the scope and interpretation of Federal Rule of Civil Procedure 23.1.8 Rule 23.1 provides, in part, that any shareholder who brings a derivative suit must have owned shares in the corporation at the time the transaction complained of occurred.9 The Fifth Circuit has allowed an exception to this general rule-known as the "continuing wrong" doctrine.10 Under the continuing wrong doctrine, a shareholder may bring a derivative suit if the injurious effects of the alleged wrongful transaction continued while the shareholder owned shares in the corporation, even if the actions upon which the shareholder's claim is based arose before his acquisition of shares in the corporation.11
Recently, the second Circuit openly refused to accept the continuing wrong doctrine in In re Bank of New York Derivative Litigation (hereinafter Bank of N.Y. II).12 In its decision, the court decided to offer its own interpretation of Rule 23.1 rather than apply the continuing wrong doctrine. The court held that the contemporaneous ownership requirement of Rule 23.1 is not satisfied if the shareholder has not "owned stock in the corporation throughout the course of the activities that constitute the primary basis of the complaint."13 The court clarified what constitutes the primary basis of a complaint by stating that the "plaintiff must have owned stock in the corporation before the core of the allegedly wrongful conduct transpired."14 By establishing its "core of the conduct doctrine," the second Circuit correctly rejected the continuing wrong doctrine by stringently interpreting Rule 23.1 in a manner that (1) prevents shareholders from using the derivative suit to forum shop, (2) prevents shareholders from using the derivative suit to litigate "purchased grievances," and (3) allows both courts and litigants to reach equitable results in shareholder derivative suits.
This Note examines the differences between the second and Fifth Circuits' approaches when applying the contemporaneous ownership requirement. Part II begins with a brief background of shareholder derivative suits and concludes with a discussion of their modern development, focusing on Rule 23.1. Part III explains the factual and procedural background of Bank of N.Y. II, presents a brief synopsis of the majority opinion written by Judge José A. Cabranes,15 and contrasts the holding of the opinion with the modern day continuing wrong doctrine. Part IV examines the effects of the Bank of N.Y. II holding, focusing on its divergence from the continuing wrong doctrine and the future of the core of the conduct doctrine. Part V contains a brief conclusion. Ultimately, this Note argues that Bunk of N.Y. II correctly eliminated the continuing wrong doctrine because the doctrine weakened the contemporaneous ownership requirement of Rule 23.1 to the point that it did not effectively protect against litigation of purchased grievances, litigation by uninjured and uninterested shareholders, and manufactured federal diversity jurisdiction. …