The First Circuit Court of Appeals Articulates a Stricter Independence Standard for Fund Directors When Evaluating Demand Futility in Shareholder Derivative Cases

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The U.S. Court of Appeals for the First Circuit, in Unión de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan, v. UBS Financial Services Inc. of Puerto Rico, No. 11-1605, --- F.3d ----, 2013 WL 49818 (1st Cir. Jan. 4, 2013), recently applied a stricter independence standard for fund directors and their business relationships in the context of shareholder derivative litigation against investment advisers. The Court’s ruling may heighten courts’ scrutiny of board directors’ current and prospective business relationships with investment advisers and their affiliates.

Shareholders in a derivative action must first make a demand on the board before filing a complaint or plead why such demand would be futile. Demand is futile when a majority of the board is comprised of directors who cannot consider the lawsuit impartially. Failure to properly plead “demand futility” often leads to the dismissal of shareholder derivative actions.

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