In Bader v. Blankfein, No. 09-0309-cv (2d Cir. Dec. 14, 2009), Bader brought a derivative action on behalf of nominal-defendant Goldman Sachs Group, Inc. (“Goldman”) against Blankfein and other named director-defendants (collectively “Blankfein”).  Bader alleged Blankfein violated section 14(a) of the Securities and Exchange Act of 1934 (“1934 Act”) and SEC regulations by negligently issuing a proxy statement that lacked requisite disclosures and contained materially false statements and omissions.  The U.S. District Court for the Eastern District of New York granted Blankfein’s motion to dismiss.  In affirming the lower court’s decision, the U.S. Second Circuit Court of Appeals held, among other things, (1) a pre-suit demand on Goldman’s Board of Directors was required before Bader commenced this action, and (2) a pre-suit demand on Goldman’s Board would not have been futile.

Goldman’s 2007 proxy statement (“Proxy”) was prepared according to Schedule 14(a) and Item 402 of Regulation S-K.  Item 402 required Goldman to disclose the value of stock option grants to its CEO and its four highest compensated officers.  Goldman elected to value stock option grants using grant date present values.  SEC regulations in effect at the time required that Goldman make additional disclosures if it used a variation of common option pricing models to calculate grant date present value.  Required additional disclosures included, among other things, a description of the pricing model and any model adjustments for non-transferability or risk of forfeiture. 

Although Goldman allegedly used an alternative pricing model, its Proxy did not contain a description of the pricing model employed.  In addition, its Proxy did not contain any model adjustments.  Furthermore, Bader alleged option values contained in the Proxy understated the true value of the option grants by approximately 50%.  Consequently, he commenced this action and alleged the grant date present values set forth in the Proxy were materially false, in violation of Section 14(a) of the 1934 Act and SEC Rule 14a-9.  Moreover, Bader alleged that the miscalculations were due to Blankfein’s negligent actions.  Importantly, however, Bader failed to make a pre-suit demand on Goldman’s Board of Directors before commencing this action. 

Blankfein moved to dismiss the case because Bader failed to make a pre-suit demand.  The trial court granted Blankfein’s motion.  On appeal, Bader argued, among other things, (1) “there is no pre-suit demand requirement for shareholder derivative suits under section 14 of the 1934 Act because proxy misstatements are not a product of business judgment”; and (2) “in the alternative, demand was excused . . . as futile because [Goldman’s] directors were either interested or not independent.”

First, Bader argued that there was no pre-suit demand requirement because SEC regulations at issue required “full disclosure,” which is not a product of directors’ business judgment.  The court, however, held that disclosure of stock option values is a product of business judgment, and thus, pre-suit demand is required in an action brought under Section 14 of the 1934 Act.  Specifically, SEC regulations at issue implicated a business judgment because Blankfein decided what option pricing model to use and what disclosures were required.  Put another way, “[t]he information [regarding option valuation that was] required to be disclosed could not have been done automatically or without thought.”  Therefore, Bader should have made a demand upon Goldman’s Board of Directors prior to commencing the Section 14 derivative action at bar.  

Second, Bader argued pre-suit demand would have been futile because Goldman’s Board of Directors were interested or not independent.  In rejecting this argument, the court deferred to the lower court’s judgment: Bader’s “‘complaint[,] [even if amended, would] not create a reasonable doubt that the majority of the directors are disinterested and independent, and therefore fails to establish that it would have been futile to make demand upon Goldman’s Board of Directors prior to commencing this action.’”  Because Goldman’s Board of Directors were clearly disinterested and independent, a pre-suit demand was required before Bader commenced the action at bar. 

In sum, the U.S. Second Circuit Court of Appeals affirmed the lower court’s order dismissing Bader’s suit because Bader failed to make a pre-suit demand on Goldman’s Board of Directors before bringing a Section 14 derivative action, and because Bader failed to show that a pre-suit demand would have been futile. 

The primary materials for this post are available on the DU Corporate Governance website.