In the case of In Re The Goldman Sachs Group, Inc.
Shareholder Litigation, C.A. No. 5215-VCG (Oct. 12, 2011), read opinion here,
Vice Chancellor Glasscock, in his first major corporate law decision, granted
defendants' motion to dismiss a derivative action brought against Goldman's
current and former directors for failure to make a pre-suit demand. At issue
was Goldman's compensation structure which the plaintiffs said, "created a
divergence of interest between Goldman's management and its stockholders in
that compensation for the firm's management was based on a percentage of net
revenue and without regard to risk."
Kevin F. Brady of Connolly Bove Lodge & Hutz LLP
prepared this summary.
The plaintiffs alleged that the directors breached their
fiduciary duties by: (i) failing to properly analyze and rationally set
compensation levels for Goldman's employees; (ii) committing waste by
"approving a compensation ratio to Goldman employees in an amount so
disproportionately large to the contribution of management, as opposed to
capital as to be unconscionable"; (iii) failing to adequately monitor Goldman's
operations; and (iv) "allowing the Firm to manage and conduct the Firm's
trading in a grossly unethical manner."
By way of background, Goldman employed a "pay for
performance" program which linked the total compensation of its employees to
the company's performance. Goldman's Compensation Committee, which was used to
oversee the development and implementation of its compensation plan, was
responsible for reviewing and approving executives' annual compensation.
However, the Compensation Committee did not work in a vacuum. It consulted with
senior management about projections of net revenues as well as "the proper
ratio of compensation and benefits expenses to net revenues." The Compensation
Committee also did a market check comparing Goldman's compensation to that of
Goldman's Audit Committee assisted the board in
overseeing "the Company's management of market, credit, liquidity, and other
financial and operational risks." The Audit Committee was also required "to
review, along with management, the financial information that was provided to
analysts and ratings agencies and to discuss 'management's assessment of the
Company's market, credit, liquidity and other financial and operational risks,
and the guidelines, policies and processes for managing such risks.'" Goldman
also managed risk by sometimes taking positions opposite to the position of its
clients such that when the subprime mortgage markets collapsed, Goldman
actually profited more from its short positions than it lost from its long
Evaluating Failure to Make Demand - Aronson
or Rales or Both
For the stockholders to establish that demand was excused,
the Court looks at the action (or inaction) by the board to determine the
proper standard of review. For actions taken by the board, the Court turned to
the two-pronged test in Aronson v. Lewis, 473 A.2d 805 (Del. 1984) [an enhanced version of this opinion is available to lexis.com
Where the complaint involves board inaction, the Court looks to the standard
set forth in Rales v. Blasband, 634 A.2d 927 (Del. 1993) [enhanced version]. Under Aronson,
a plaintiff can show demand futility by alleging particularized facts that
create a reasonable doubt that either: (1) the directors are disinterested and
independent or (2) "the challenged transaction was otherwise the product of a
valid exercise of business judgment.
Under Rales, a plaintiff must plead particularized
facts that "create a reasonable doubt that, as of the time the complaint [was]
filed, the board of directors could have properly exercised its independent and
disinterested business judgment in responding to a demand."
The plaintiffs argued that: (i) Goldman's board of
directors was interested or lacked independence because of financial ties
between the directors and Goldman; (ii) there was a reasonable doubt as to
whether the board's compensation structure was the product of a valid exercise
of business judgment; (iii) there was a substantial likelihood that the
directors will face personal liability for the dereliction of their duty to
oversee Goldman's operations; and (iv) the board's approval of the compensation
scheme constituted waste.
As to the first prong of Aronson, the Court found
that the plaintiffs had failed to carry their burden in that they had not pled
particularized factual allegations that raise a reasonable doubt as to a
majority of the directors' disinterestedness and independence. This included a
detailed discussion relating to the allegations that the directors are
interested because the private Goldman Sachs Foundation had made contributions
to a charitable organization to which the directors were affiliated.
Turning to the second prong under Aronson, the
Court noted that the plaintiffs had to allege "particularized facts sufficient
to raise: (1) a reason to doubt that the action was taken honestly and in good
faith, or (2) a reason to doubt that the board was adequately informed in
making the decision." Because Goldman's charter has an 8 Del. C. §
102(b)(7) provision, the plaintiffs had to also plead particularized facts that
demonstrate that the directors acted with scienter, i.e., there was an
"intentional dereliction of duty" or "a conscious disregard" for their responsibilities,
amounting to bad faith.
The plaintiffs alleged that the compensation scheme was
approved in bad faith and that the directors were not properly informed when
they made compensation awards. The plaintiffs stated "[n]o person acting in
good faith on behalf of Goldman consistently could approve the payment of
between 44% and 48% of net revenues to Goldman's employees year in and year
out." The Court, however, disagreed finding that "the decision as to how
much compensation is appropriate to retain and incentivize employees, both
individually and in the aggregate, is a core function of a board of directors
exercising its business judgment." Moreover, the Court found that the
plaintiffs had failed to plead with particularity that any of the directors had
the scienter necessary to give rise to a violation of the duty of loyalty.
With respect to the claim that the directors were not
adequately informed, the Court noted stated:
The Director Defendants considered other investment bank
comparables, varied the total percent and the total dollar amount awarded as
compensation, and changed the total amount of compensation in response to
changing public opinion.... At most, the Plaintiffs' allegations suggest that
there were other metrics not considered by the board that might have produced
better results. The business judgment rule, however, only requires the board
to reasonably inform itself; it does not require perfection or the
consideration of every conceivable alternative.
Court Rejects Claim of Waste
To excuse demand on a waste claim, the plaintiffs must
plead particularized allegations that "overcome the general presumption of good
faith by showing that the board's decision was so egregious or irrational that
it could not have been based on a valid assessment of the corporation's best
interests." If "there is any substantial consideration received by the
corporation, and if there is a good faith judgment that in the circumstances
the transaction is worthwhile, there should be no finding of waste." The plaintiffs'
waste allegations dealt with: (i) Goldman's pay per employee is significantly
higher than its peers; (ii) Goldman's compensation ratios should be compared to
hedge funds and other shareholder funds to reflect Goldman's increasing
reliance on proprietary trading as opposed to traditional investment banking
services; and (iii) Goldman's earnings and related compensation are only the
result of risk taking.
Because the plaintiffs failed to provide the Court with
information as to compensation specifics and what was specifically done in
exchange for that payment, the Court could not evaluate whether a transaction
is "so one sided that no business person of ordinary, sound judgment could
conclude that the corporation has received adequate consideration." As a
result, the Court found that absent such facts, "these decisions are the
province of the board of directors rather than the courts."
The Caremark Claim Evaluated Under Rales
The plaintiffs claimed that the board breached its duty
to monitor so the Court applied the Rales standard. Under Rales,
"defendant directors who face a substantial likelihood of personal liability
are deemed interested in the transaction and thus cannot make an impartial
decision. The likelihood of directors' liability is significantly lessened
where, as here, the corporate charter exculpates the directors from liability
to the extent authorized by 8 Del. C. § 102(b)(7)." Because Goldman's
charter contains such a provision, "a serious threat of liability may only be
found to exist if the plaintiff pleads a non-exculpated claim against the
directors based on particularized facts."
Here the plaintiffs argued that: (i) the directors should
have been aware of purportedly unethical conduct such as, among other things,
securitizing high risk mortgage; and (ii) Goldman's trading business often put
Goldman in potential conflicts of interest with its own clients and that the
directors were aware of this and have embraced this goal. The Court, however,
disagreed stating that the alleged "unethical" conduct here is not the type of
wrongdoing envisioned by Caremark. The conduct here involves, for the
most part, legal business decisions that "were firmly within management's
judgment to pursue." With respect to the claim that Goldman's "trading practices
have subjected the Firm to civil liability, via, inter alia, an SEC
investigation and lawsuit, "the Court found that the single transaction
identified by the plaintiffs was insufficient to provide a reasonable inference
of bad faith on the part of the directors.
The Court concluded that with respect to a business risk:
The essence of their complaint is that I should hold the
Director Defendants 'personally liable for making (or allowing to be made)
business decisions that, in hindsight, turned out poorly for the Company.' If
an actionable duty to monitor business risk exists, it cannot encompass any
substantive evaluation by a court of a board's determination of the appropriate
amount of risk. Such decisions plainly involve business judgment.
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