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.

Issues Addressed

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.”

Bonus: Professor Bainbridge provides erudite insights on the policy underpinnings of the business judgment rule as applied in this case, in a post here.


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 competitors.

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 positions.

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). Where the complaint involves board inaction, the Court looks to the standard set forth in Rales v. Blasband, 634 A.2d 927 (Del. 1993). 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.