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The Delaware Court of Chancery has dismissed a case that claimed Goldman Sachs breached its fiduciary duty to shareholders through a compensation structure that encouraged employees to take undue risks. On Oct. 12, Vice Chancellor Sam Glasscock III dismissed In re the Goldman Sachs Group Inc. Shareholder Litigation, finding that “the Plaintiffs have not provided particularized factual allegations that raise a reasonable doubt whether the process by which Goldman’s compensation scheme allocated profits between the employees and shareholders was implemented in good faith and on an informed basis.” Kevin Brady, a litigation partner at Wilmington, Del.’s Connolly Bove Lodge & Hutz who isn’t involved in the case, said the ruling is Glasscock’s first major corporate law decision since his appointment this summer. Glasscock’s introduction to the opinion stated that corporate actors have broad freedom to pursue corporate opportunities that don’t run afoul of their fiduciary duty, a system that has “made the corporate structure a supremely effective engine for the production of wealth.” “So long as such individuals act within the boundaries of their fiduciary duties, judges are ill-suited by training (and should be disinclined by temperament) to second-guess the business decisions of those chosen by the stockholders to fulfill precisely that function,” Glasscock wrote. Co-lead plaintiffs Southeastern Pennsylvania Transportation Authority and International Brotherhood of Electrical Workers Local 98 Pension Fund, both Goldman Sachs stockholders, sued the financial services company and 14 individual current and former directors. The plaintiffs’ lawsuit claimed the director defendants breached their fiduciary duties from 2007 through 2009 by approving a “pay for performance” compensation structure that linked total employee compensation to company performance. They also claimed the directors failed to properly oversee risky business decisions and unethical and illegal practices that stemmed from the structure. Another case claim was that the compensation payments were corporate waste. The plaintiffs contended that Goldman Sachs’s compensation structure motivated its employees to increase net revenue without regard to risk. They also alleged that the structure put the interests of Goldman’s management and stockholders at odds. Stockholders received about 2% of the firm’s revenue in the form of dividends, but their equity was at risk if the company’s stock plummeted. They claim the structure fostered risky trading practices, over-leveraging of the company’s assets and significant exposure to risky loans and credit risks. In 2008, for example, the trading and principal investment segment produced $9.06 billion in net revenue, but allegedly lost more than $2.7 billion because of discretionary bonuses to employees. They also pointed to the company’s July 2010 million settlement with the U.S. Securities and Exchange Commission to resolve allegations that it misstated and omitted facts about a collateralized debt obligation (CDO) in marketing materials. The CDO’s performance depended on subprime residential mortgage-backed securities. Goldman agreed to pay $535 in civil penalties and a $15 million in disgorgement of profits. After a lengthy analysis, Glasscock determined that the plaintiffs did not plead particularized facts that raised reasonable doubts about either a majority of the director defendants’ disinterestedness and independence or that Goldman’s compensation system was formed by the exercise of business judgment. Glasscock’s ruling also referenced the 2009 Chancery ruling in In re Citigroup Inc. Shareholder Derivative Litigation. In that case, the chancery court dismissed shareholder claims against the company for allegedly improper monitoring and management of risks related to the subprime mortgage market, but allowed a corporate waste claim related to the chief executive officer’s compensation. Glasscock also wrote that the conduct at issue here mostly involves legal business decisions. “There is nothing intrinsic in using naked credit default swaps or shorting the mortgage market that makes these actions illegal or wrongful,” Glasscock wrote. “These are actions that Goldman managers, presumably using their informed business judgment, made to hedge the Corporation’s assets against risk or to earn a higher return. Legal, if risky, actions that are within management’s discretion to pursue are not ‘red flags’ that would put a board on notice of unlawful conduct.” Neither the plaintiffs, nor their lawyers at Haverford, Pa.-based Chimicles & Tikellis and Atlanta-based Chitwood Harley Harnes responded to requests for comment. Goldman’s lawyers at Richards, Layton & Finger in Wilmington, Del., referred questions to the company. Goldman declined to comment, according to spokesman Stephen Cohen. Sullivan & Cromwell of New York also represented Goldman. The Goldman ruling is “another example of the amount of discretion that the Delaware Court of Chancery is giving directors and officers in terms of exercising business judgment in fulfillment of their obligations,” said Brady of Connolly Bove. Brady also said that the plaintiffs’ counsel are very experienced, so it’s probable that they “put in as much as they could find to meet that standard of [pleading] specificity” that Glasscock repeatedly discussed in the case. “In the end, the courts deferred to the law that gives directors broad discretion to exercise their business judgment in fulfilling their obligations under Delaware law to Goldman Sachs,” Brady said. Sheri Qualters can be contacted at [email protected].

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