Union de Empleados v. UBS Financial Services: Appellants Get a Second Chance

In Union de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan, Union de Empleados de Muelles de Puerto Rico AP Welfare Plan v. UBS Fin. Serv. Inc. of Puerto Rico, UBS Trust Co. of Puerto Rico, et.al, Union de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan (“PRSSA”) and Union de Empleados de Muelles de Puerto Rico AP Welfare Plan (“AP”) (collectively, “Appellants”) alleged that UBS Financial Services Inc. of Puerto Rico (“UBS Financial”), UBS Trust Company (“UBS Trust”), and the Directors of the entities (collectively, “Defendants”) committed securities fraud by heavily investing in bonds.  No. 11 1605, 2013 WL 49818 (1st Cir. Jan. 4, 2013).  The district court dismissed the case; however, the appellate court vacated the dismissal and remanded the case for further proceedings.

The Appellants are Puerto Rico pension plans that invested in closed-end investment funds.  According to the complaint, AP owned shares in four such funds, while PRSSA owned shares in three of four of the same funds.   The board of each fund was identical.  Similarly, each had the same investment advisor, UBS Trust.  Acting in its role as investment advisor, UBS Trust purchased $757 million worth of bonds issued and underwritten by UBS Financial, an affiliate, and then sold those bonds to the funds.  Appellants alleged that the funds were so heavily invested in these bonds that when the value of the bonds dropped, the funds suffered serious financial losses.

Appellants filed a derivative action.  “A shareholder derivative action permits a shareholder of a corporation to bring suit to enforce rights the corporation is unable or unwilling to enforce on its own behalf.”  The trial court dismissed the action, finding that plaintiffs had not sufficiently pled demand futility.  The trial court declined the request to file an amended complaint designed to cure the pleading deficiencies. 

The court of appeals determined that the law of the state of incorporation governed the standard for demand futility.  Since, the funds were incorporated in Puerto Rico, the court looked to the law of that jurisdiction.  Because Puerto Rico had not set out standards for demand futility, the court opted to apply the law of Delaware.  Id.  (“we look to Delaware corporate law, on which Puerto Rico corporate law is modeled.”).  Under Rales v. Blasband, plaintiffs were required to allege facts that created “a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” 634 A.2d 927 (Del. 1993).  Demand, therefore, would be excused only if the majority of the board is interested or lacks independence.

An identical eleven-person board governed each of the four funds.  For the Appellants to prove demand futility, they had to create a reasonable doubt that six of the directors were not disinterested or independent.  The court held that the Appellants alleged sufficient facts to meet this burden. 

First, the complaint pointed to relationships between the directors and the Defendants that could preclude a finding that they were disinterested and impartial.  Directors Ubinas, Highley, and Ferrer were not only on the board for each of the four funds, but they all served in various executive positions with either, or both, UBS Trust and UBS Financial.  Director Roussin was a director of each of the four funds and a full-time employee of UBS Financial.  The court found that these divided loyalties raised reasonable doubt about the ability of these directors to act in a disinterested fashion in evaluating Appellants’ demand.

Lastly, the court looked at Directors Belaval and Leon, who shared nearly identical circumstances.  Both directors were executives of Triple S.  Triple S had a lucrative relationship with both UBS Trust and UBS Financial.  Because of the prior dealings these directors had, on behalf of Triple S, with both institutional Defendants and the possibility that they will need the business assistance of the UBS Defendants in the future, a reasonable doubt was created about their independence. 

Secondly, the trial court “misconstrued plaintiffs’ burden of demonstrating that the benefits . . . that the individual directors received” as part of their relationship with UBS Trust or UBS Financial were of “subjective material significance.” 

The court held that the Appellants’ derivative claim should not have been dismissed.  The dismissal was vacated and the case remanded for further proceedings.

The primary materials for this case may be found on the DU Corporate Governance website.