In re Goldman Sachs Grp., Inc. S’holder Litig., C.A. No. 5215-VCG (Del. Ch. Oct. 12, 2011) (Glasscock, V.C.)

In this memorandum opinion addressing stockholder plaintiffs’ breach of fiduciary duty claims relating to alleged excessive compensation and lack of oversight, Vice Chancellor Glasscock held that plaintiffs had not pled particularized facts sufficient to show demand futility under Aronson or Rales. As a result, the Court dismissed with prejudice plaintiffs’ derivative claims under Chancery Court Rule 23.1.

Plaintiffs, stockholders of Goldman Sachs Group, Inc. (“Goldman”), brought a derivative action against the Goldman directors for breaches of fiduciary duties and corporate waste relating to alleged excessive compensation at Goldman. Plaintiffs also asserted a Caremark claim for failure to adequately monitor Goldman’s operations, which allegedly led to overly risky business decisions, as well as unethical and illegal practices.

The complaint alleged that Goldman’s compensation system linked its employees’ compensation to Goldman’s earnings. A compensation committee, which reviewed net revenue projections and compared Goldman’s compensation-to-revenue ratio to the ratios employed by competitors, was responsible for approving the annual compensation received by Goldman’s executives. Plaintiffs alleged that the compensation structure encouraged management to pursue excessive risk and emphasize short-term profits in order to maximize yearly bonuses, at the expense of stockholders’ interests. Plaintiffs argued that by approving such a compensation system, the Goldman directors breached their fiduciary duties. The defendants moved to dismiss the complaint for failure to make pre-suit demand.

Because the compensation claims involved active decisions by the Goldman board, the Court analyzed whether pre-suit demand was excused under the Aronson test. Under Aronson, demand is excused only where plaintiffs allege particularized facts sufficient to create a reasonable doubt that (1) the directors are disinterested and independent or (2) the challenged decision was otherwise the product of a valid exercise of business judgment. The Court found that plaintiffs failed to satisfy the first prong of Aronson because all but two directors were disinterested in the compensation decision, and none of the charitable or business links between the directors and Goldman demonstrated any director’s lack of independence. Plaintiffs likewise failed to satisfy the second prong of Aronson, as plaintiffs did not create a reasonable doubt that (1) the action was taken honestly and in good faith or (2) the board was adequately informed in making its decision. In considering that Goldman had adopted an exculpatory provision under Section 102(b)(7) of the Delaware General Corporation Law, the Court explained that plaintiffs could satisfy the second prong only by demonstrating that the Goldman directors acted with an intentional dereliction of duty or a conscious disregard for their responsibilities, amounting to bad faith. The Court also rejected plaintiffs’ argument that the compensation levels constituted corporate waste. The Court held that plaintiffs’ allegations failed to establish that no reasonable person in the directors’ position would have approved the disputed levels of compensation.

Plaintiffs also alleged that the Goldman board failed to monitor a business strategy that couraged extreme leverage, significant exposure to risk, and trading positions in conflict with its clients. While plaintiffs acknowledged that Goldman had an oversight system in place to help manage the corporation’s risk, they alleged that a properly functioning audit committee would have alerted the Goldman board to potential conflicts of interests between Goldman and its clients. As examples, plaintiffs cited several mortgage-related products, including one that resulted in SEC charges and a $550 million settlement. These failures, plaintiffs argued, violated the Goldman board’s duty to monitor the corporation as required by the Court in Caremark.

Because plaintiffs’ oversight claims involved alleged failures to act, the Court analyzed whether pre-suit demand was excused under the Rales test. Under Rales, the Court must consider whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations. Directors who face a “substantial likelihood of personal liability” cannot make an impartial decision because they are deemed interested in the transaction. Particularized facts showing that the Goldman directors consciously failed to monitor or oversee the corporation’s operations would establish the lack of good faith necessary for personal liability. The Court held that while plaintiffs alleged various “unethical” conduct and were able to show that one transaction contained disclosure omissions, without more, plaintiffs did not demonstrate the willful ignorance of “red flags” that warrants Caremark liability. The Court also cited Citigroup for the proposition that directors may face liability for failure to monitor business risk. The Court held, however, that a corporation’s determination of the appropriate amount of risk involves business judgment and is not subject to substantive evaluation by a court.

Having held that plaintiffs’ claims were subject to dismissal for failure to establish demand futility, the Court found no need to consider defendants’ motion to dismiss under Chancery Court Rule 12(b)(6).

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