United States District Court, D. Minnesota
DAVID M. KITLEY, derivatively on behalf of IsoRay, Inc., Plaintiff,
ISORAY, INC., DWIGHT BABCOCK, PHILIP J. VITALE, MICHAEL W. MCCORMICK, THOMAS LAVOY, and ALAN HOFFMANN, Defendants.
M. PERRY, PERRY & PERRY, PLLP, AND THOMAS J. MCKENNA,
GAINEY MCKENNA & EGLESTON, FOR PLAINTIFF.
GREGORY L. WATTS, WILSON SONSINI GOODRICH & ROSATI, P.C.,
AND JULIE H. FIRESTONE, BRIGGS & MORGAN, PA, FOR
MEMORANDUM OPINION AND ORDER GRANTING DEFENDANTS'
MOTION TO DISMISS
R. TUNHEIM CHIEF JUDGE UNITED STATES DISTRICT COURT
David Kitley filed this shareholder-derivative action against
the former CEO of IsoRay, Inc. (“IsoRay”), Dwight
Babcock, and IsoRay's four current directors: Thomas
LaVoy, Philip Vitale, Michael McCormick, and Alan Hoffmann
(the “Director Defendants”). Kitley's action
arises under state law and includes claims for breach of
fiduciary duties, gross mismanagement, and unjust enrichment.
Defendants move to dismiss the Complaint. Because Kitley both
lacks derivative standing and fails to demonstrate that a
demand on IsoRay's board would be futile under Minnesota
law, the Court will grant Defendants' motion and dismiss.
is a Minnesota corporation whose “primary business
involves developing, manufacturing, and marketing radiation
‘seed' therapy used to treat cancer.”
(Verified S'holder Am. Derivative Compl. (“Am.
Compl.”) ¶¶ 2, 12, Jan. 23, 2017, Docket No.
34.) Seed therapy allows physicians to “deliver higher
doses of radiation to more specific areas of the body,
compared with the conventional form of radiation therapy
(external beam radiation) that projects radiation from a
machine outside of the body.” (Id.
¶¶ 24.) IsoRay supplies purified Cesium-131
“for use in low-dose radiation seed therapy.”
(Id. ¶ 2.) Cesium-131 is a radioactive isotope
of the element cesium used to treat certain cancers.
(Id. ¶¶ 22-23, 25.) Cesium-131 is most
commonly used to treat prostate cancer. (Id. ¶
2.) According to the Complaint, IsoRay's future growth
will depend on Cesium-131 being used to treat non-prostate
cancers, such as lung cancer. (Id. ¶¶
19, 2015, the medical journal Brachytherapy
published an online article about a study that evaluated
using Cesium-131 seed therapy to treat lung cancer.
(Id. ¶ 3, 68.) The next day, before the stock
market opened, IsoRay issued a press release titled
“IsoRay's Cesium-131 Lung Cancer Treatment Reports
96% Success in Local Control and 100% Survival in Five Years
in High Risk Patients in Newly Published Report” (the
“Press Release”). (See Id. ¶¶ 4,
90-91.) The Press Release stated that the study showed
“improved results using IsoRay's Cesium-131 seeds,
” that patients had “outstanding” outcomes,
and that the five-year survival rate was
“exceptional” for the patients that received
Cesium-131 seed therapy. (Id. ¶ 4.) Then-CEO of
IsoRay, Dwight Babcock, was quoted several times in the Press
Release. (Id. ¶ 88.) That day, May 20,
IsoRay's stock price peaked at $3.35 per share, up from
$1.62 at the market's close on May 19. (Id.
¶ 86, 93.) It was also on May 20 that Kitley purchased
his IsoRay shares - after IsoRay had issued the Press Release
and after the market had opened.
noon the next day, May 21, Adam Feuerstein, a writer for a
financial-news website, published an online article titled
“IsoRay Takes Liberties with Lung Cancer Study Results
to Prop Up Drug Price.” (Id. ¶ 96.) The
Feuerstein article “disclosed, for the first time, that
IsoRay had selectively reported the conclusions” of the
Brachytherapy article, “omitting critical and
material comparisons and conclusions.” (Id.
¶ 97.) For example, treatment with Cesium-131
“demonstrated statistically equivalent rates of [tumor]
control” as two other, non-Cesium-131 treatment
regimes. (Id. ¶ 98.) That day, May 21,
IsoRay's stock price peaked at $3.79 per share before
Feuerstein published his article, and closed at $2.01.
(Id. ¶ 95, 100.) At the time that Kitley filed
this action, IsoRay's stock price was approximately $0.62
per share. (Id. ¶ 102.)
28, 2015 - one week after Feuerstein published his article -
IsoRay's investors filed a class-action complaint in the
United States District Court for the Eastern District of
Washington against Babcock and IsoRay, alleging violations of
federal securities laws. Complaint, In re IsoRay, Inc.
Sec. Litig., 189 F.Supp.3d 1057 (E.D. Wash. 2016) (No.
15-5046), ECF No. 1. In June 2016, the district court denied
Babcock's motion to dismiss. IsoRay, 189
F.Supp.3d at 1080. The court found that the class-action
complaint sufficiently alleged that the Press Release
contained false and misleading statements. Id. at
1069-72. It also found that the class-action plaintiffs
sufficiently alleged that Babcock knew that the Press Release
contained false and misleading statements. Id. at
1078-79. While the class action was pending, Babcock resigned
from all his positions with IsoRay. (Am. Compl. ¶ 13.)
class action settled later in 2016. See In re IsoRay,
Inc. Sec. Litig., No. 15-5046, 2016 WL 7234807 (E.D.
Wash. Oct. 20, 2016). Shortly before the parties in the class
action settled, Kitley filed this shareholder derivative
action. (See Verified S'holder Derivative Compl.
(“Compl.”), Sept. 29, 2016, Docket No. 1.)
THE DEFENDANTS AND KITLEY'S ALLEGATIONS
Kitley filed this action, IsoRay's board comprised one
officer-director - LaVoy,  who was then CEO and board chair - and
three outside directors: Vitale, McCormick, and Hoffmann.
(Am. Compl. ¶¶ 14-17.) Also at this time,
IsoRay's audit committee had three members: LaVoy,
Vitale, and Hoffmann (chair). (Id. ¶¶
17-18.) Vitale is a board-certified urologist who has studied
prostate cancer. (Id. ¶ 15.) In May 2015,
Babcock was IsoRay's CEO; LaVoy and Vitale were both
outside directors; LaVoy was the audit-committee chair;
McCormick was an audit-committee member; and neither
McCormick nor Hoffmann were on IsoRay's board.
(Id. ¶¶ 13-17.)
asserts state-law claims for breach of fiduciary duties,
gross mismanagement, and unjust enrichment stemming from the
Press Release and the Defendants' alleged failure to
correct it. (Id. ¶¶ 150-164.) Kitley's
allegations are effectively two-fold. First, Kitley alleges
that the Defendants breached their fiduciary duties by
allowing IsoRay to issue a false and misleading Press
Release. Second, Kitley alleges that Defendants
breached their fiduciary duties by failing to maintain
internal controls over IsoRay's issuance of false and
misleading statements. For both of these reasons, Kitley
alleges that demand on IsoRay's board would be futile.
(See Id. ¶¶ 107-149.)
respect to the Press Release, Kitley alleges that LaVoy and
Vitale “had to know” that the Press Release was
false and misleading. (Id. ¶¶ 122, 130,
141.) Kitley relies on their statuses in May 2015 as both
outside directors and audit-committee members (and LaVoy as
the audit-committee chair) to support his
allegation. (Id. ¶¶ 123-141.) With
respect to internal controls, Kitley alleges that none of the
Director Defendants did anything to correct the Press Release
and have still done nothing to correct it. (Id.
¶¶ 129, 137, 140, 144, 146.) Kitley relies on their
statuses as directors and audit-committee members (except for
LaVoy) to support his allegation. (Id.) Kitley
argues that the Director Defendants face liability for
breaching their duty of loyalty and failing to act in good
faith because they have “consciously disregarded an
obligation to be reasonably informed about the business and
its risks or consciously disregarded the duty to monitor and
oversee the business.” (Pl.'s Mem. Opp. Defs.'
Mot. to Dismiss at 22, Apr. 20, 2017, Docket No. 51 (quoting
In re Citigroup Inc. S'holder Derivative Litig.,
964 A.2d 106, 125 (Del. Ch. 2009)).)
STANDARD OF REVIEW
federal court hearing an action on the basis of diversity
jurisdiction applies state substantive law but federal
procedural rules. E.g., Torti v. Hoag, __
F.3d __, 2017 WL 3528447, at *3 (8th Cir. Aug. 17,
2017). Kitley's Complaint invokes diversity jurisdiction
(Am. Compl. ¶¶ 8-9), so Federal Rule of Civil
Procedure 23.1 applies to his shareholder-derivative action.
Kanter v. Barella, 489 F.3d 170, 176 (3d Cir. 2007);
Hockstein v. Collins, No. 14-4020, 2015 WL 5737073,
at *3 (D. Minn. Sept. 30, 2015).
23.1 “imposes a heightened pleading standard on
complaints in derivative actions.” Gomes v. Am.
Century Cos., 710 F.3d 811, 815 (8th Cir.
2013). It “require[s] derivative plaintiffs to satisfy
more stringent pleading requirements than the notice pleading
regime of Rules 8 and 12(b)(6).” Stepak v.
Addison, 20 F.3d 398, 402 (11th Cir. 1994);
see also In re Sonus Networks, Inc. S'holder
Derivative Litig., 499 F.3d 47, 66 (1stCir.
23.1(b)(1) requires that a shareholder-derivative complaint
“allege that the plaintiff was a shareholder or member
at the time of the transaction complained of.” This is
commonly called the “contemporaneous-ownership”
rule (or “derivative standing” or
“shareholder standing”). See, e.g.,
Bangor Punta Operations, Inc. v. Bangor & A.R.
Co., 417 U.S. 703, 708-09, 708 n.4 (1974); Iron
Workers Mid-South Pension Fund v. Davis, 93 F.Supp.3d
1092, 1098 n.3 (D. Minn. 2015). The meaning of and compliance
with Rule 23.1's contemporaneous-ownership rule is a
question of federal law. Silverstein ex rel. Tetragon
Fin. Grp. Ltd. v. Knief, 843 F.Supp.2d 441, 444-45
contemporaneous-ownership rule “stems from the
equitable nature of derivative litigation which allows a
shareholder ‘to step into the corporation's shoes
and to seek in its right the restitution'” that the
shareholder could not otherwise obtain. Lewis v.
Chiles, 719 F.2d 1044, 1047 (9th Cir. 1983)
(quoting Cohen v. Beneficial Loan Corp., 337 U.S.
541, 548 (1949)). It is “a procedural requirement
which, in effect, denies a putative derivative plaintiff
standing to challenge wrongdoing that predated the time the
plaintiff became a shareholder.” In re Facebook,
Inc., Initial Pub. Offering Derivative Litig., 797 F.3d
148, 157 (2d Cir. 2015). Accordingly, the rule prevents
“the federal courts from being used to litigate
purchased grievances” - claims brought by ...