Kitley v. IsoRay, Inc.
0:16-cv-03297
D. MinnesotaOct 19, 2017Background
- IsoRay, a Minnesota corporation, issued a May 20, 2015 press release touting favorable results for Cesium-131 seed therapy in lung cancer; IsoRay’s CEO Babcock was quoted.
- The press release sharply increased IsoRay’s stock price; plaintiff Kitley purchased shares on May 20, after the press release and market open.
- A critical article the next day and a subsequent securities class action alleged the press release was selective and misleading; the class action against IsoRay and Babcock later survived a motion to dismiss and settled.
- Kitley filed a shareholder-derivative suit alleging breach of fiduciary duty, gross mismanagement, and unjust enrichment based on the press release and alleged deficient internal controls; he did not make a pre-suit demand.
- At filing, IsoRay’s board included four director-defendants (LaVoy, Vitale, McCormick, Hoffmann); Kitley alleged they knew or should have known the release was false and failed to correct or oversee disclosures.
- The court dismissed with prejudice, holding Kitley lacked Rule 23.1 contemporaneous-ownership (derivative standing) and, alternatively, failed to plead demand futility under Minnesota law.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Derivative standing (Rule 23.1 contemporaneous-ownership) | Kitley invokes the continuing-wrong doctrine: the misconduct (press release + deficient controls) was ongoing so post-transaction ownership suffices | Kitley bought shares after the sole actionable statement (May 20 press release); continuing-wrong doesn't cover a pre-purchase discrete misstatement | Dismissed for lack of derivative standing: plaintiff purchased after the central wrongful act and did not own stock throughout the relevant course of conduct |
| Demand futility under Minnesota law | Demand excused because a majority of the board faced liability (breach of loyalty/failure of oversight); relies on Rales standard | Minnesota requires a more stringent showing; availability of statutory special litigation committee (SLC) and lack of particularized facts make futility unproven | Even if standing existed, demand futility not shown: allegations do not create no-possibility that board or an SLC would respond |
| Director knowledge of falsity (Press Release) | Knowledge can be imputed to directors because the release concerned IsoRay’s core operations and audit-committee members | Core-operations inference rarely applies to outside directors; no particularized facts tying directors to day-to-day issuance or showing audit committee actual knowledge | Directors’ positions and generalized allegations insufficient to infer they knew the release was false; no demand-futility from this theory |
| Failure-of-oversight / internal controls (bad-faith standard) | Directors consciously disregarded duty to monitor internal controls and failed to correct false statements, so demand is futile | Plaintiff alleges no particularized red flags, no direct facts of conscious disregard; bad-faith standard higher than negligence | Allegations do not show conscious disregard or bad faith; failure-of-oversight claims insufficient to excuse demand |
Key Cases Cited
- Bangor Punta Operations, Inc. v. Bangor & A.R. Co., 417 U.S. 703 (U.S. 1974) (derivative-suit contemporaneous-ownership rule discussed)
- Cohen v. Beneficial Loan Corp., 337 U.S. 541 (U.S. 1949) (equitable basis for derivative suits and corporation-as-plaintiff principles)
- Daily Income Fund, Inc. v. Fox, 464 U.S. 523 (U.S. 1984) (limitations on use of federal courts for purchased grievances)
- Kamen v. Kemper Financial Services, Inc., 500 U.S. 90 (U.S. 1991) (federal court applies state law to demand futility for state-law derivative claims)
- Rales v. Blasband, 634 A.2d 927 (Del. Ch. 1993) (Delaware test for demand futility referenced by parties)
- In re Bank of New York Derivative Litigation, 320 F.3d 291 (2d Cir. 2003) (contemporaneous-ownership and continuing-wrong analysis)
- Janssen v. Best & Flanagan, 662 N.W.2d 876 (Minn. 2003) (Minnesota on substance and value of board decisionmaking for demand requirement)
- In re Medtronic, Inc. Derivative Litigation, 68 F. Supp. 3d 1054 (D. Minn. 2014) (Minnesota demand-futility standard and role of SLC under Minn. Stat.)