Corporate Governance

Security Police and Fire Professionsals v. Blankfein: Executive Compensation and Fiduciary Obligations

By J. Robert Brown

We are a bit behind in corporate governance developments.  Back in December, shareholders filed a derivative suit challenging Goldman Sach's compensation practices.  The complaint essentially alleges that compensation practices were not performance based.  As the first operative paragraph alleges:   

• the members of Goldman's Board of Directors (the 'Board') abdicated their responsibility to administer the Company's compensation plans in the best interests of the Company and its shareholders, and instead have blindly 'rewarded' executives for corporate performance that has absolutely nothing to do with the skill of the Company's employees. Over the last decade, Goldman's directors have reserved and issued as compensation to employees an amount approaching 50% of the Company's annual net revenues. Because the majority of the Company's revenues depend on the reported values of the firm's investments, however, these revenues are impacted by market forces and not necessarily the productivity of Goldman Sachs employees. Nevertheless, year after year, Defendants have caused the Company to pay billions of dollars in incentive based compensation, regardless of whether the Company's performance could be attributed to the skill of the employees Defendants determined to so generously compensate.

The complaint does note that Goldman has been remarkably consistent in the amount paid in compensation over the years.  Id. at 19 ("From 1999-2008 that percentage [of monies used to pay employee compensation] has not varied from the range of 44-49% of the revenues."). 

As for 2009, the complaint contains an additional charge.  The Company's success "has not been the product of the skill and business acumen of the Company's employees, but is attributable directly to the multi-trillion dollar infusion of capital by the American taxpayers to bail out the entire financial services industry."  

Whatever the merits of the case, they are, in the first instance, irrelevant.  The case will turn not on whether a fiduciary violation may have occurred but whether the plaintiffs have met the standard for demand excusal.  That in turn depends upon whether a majority of the board of directors are independent.  Plaintiffs allege that the board lacked a majority of independent directors because most of them sat on the compensation committee (the committee that approved "compensation decisions that were wholly divorced from the performance of the Company") and the audit committee (which "allowed or permitted the above failure to occur in the Company's internal controls"). 

Ordinarily, this case would be slated for dismissal.  Goldman is incorporated under Delaware law.  The Delaware courts do not generally permit a loss of independence solely because of membership on a committee.  See Wood v. Baum, 953 A.2d 136 (Del. 2008)("Plaintiff also asserts that membership on the Audit Committee is a sufficient basis to infer the requisite scienter.  That assertion is contrary to well-settled Delaware law.").  

The suit, however, was filed in New York.  Under the internal affairs doctrine, the courts must still apply Delaware law.  New York courts have sometimes evidenced a more liberal approach towards the definition of independent and, as a result, a New York court may be slower to dismiss the case at the demand excusal stage. 

The Complaint is posted on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on January 21, 2010 (boomark / email).