Corporate Governance and the Problem of Executive Compensation: The Source of the Problem and the Consequences (Part 2)
In In re Goldman Sachs, plaintiffs challenged the compensation structure put in place at the investment banking firm. A seven part series on the decision starts here. Primary materials, including the decision in the case, can be found at the DU Corporate Governance web site.
In considering whether to allow the case to go beyond the pleading stage, the lower court first considered the independence of the board. Despite a number of connections between members of the board and Goldman (or the Goldman foundation), the court found that plaintiffs had not raised "reasonable doubt" about independence at the pleading stage.
In effect, the court disregarded allegations that directors were not independent because the company's foundation paid significant amounts to charities supported by the directors. It was as if this benefit did not give directors an incentive to favor management in order to retain their seat on the board. The same opinion also found that significant business relationships alleged by plaintiffs did not cross the reasonable doubt threshold.
In addition, however, plaintiffs sought to show a breach of fiduciary obligations by presenting allegations about the amount of compensation relative to other peer companies. Plaintiffs asserted that the amount of compensation was "anywhere from two to six times the amounts that its peers." In finding the claims insufficient to allow the case to go forward, the court questioned the peer companies used by plaintiffs.
Plaintiffs provide comparisons of Goldman’s average pay per employee to firms such as Morgan Stanley, Bear Stearns, Merrill Lynch, Citigroup, and Bank of America. The Plaintiffs note that these firms are investment banks, but do not provide any indication of why these firms are comparable to Goldman or their respective primary areas of business.
More importantly, the allegations of significant disparities in relation to peer companies was not enough to state a claim for breach of fiduciary duties.
A broad assertion that Goldman’s board devoted more resources to compensation than did other firms, standing alone, is not a particularized factual allegation creating a reasonable doubt that Goldman’s compensation levels were the product of a valid business judgment.
In other words, alleging that compensation was disproportionate relative to peer companies was not even enough to allow the case to go to discovery.
The case was summarily affirmed by the the Supreme Court in SPTA v. Blankfein. The Court had this to say in toto:
To the extent that: (a) the issues raised on appeal are factual, the record evidence supports the trial judge's factual findings; (b) the errors alleged on appeal are attributed to an abuse of discretion, the record does not support those assertions; (c) the issues raised on appeal are legal, they are controlled by settled Delaware law, which was properly applied.
This case illustrates that, in Delaware, courts have little interest in allowing shareholders to challenge compensation decisions based upon the amount. As long as the board has a majority of independent directors and is "informed, allegations of disproportionate payment will not save a case from dismissal." Efforts, therefore, to use fiduciary duties to prevent continued increase in compensation or the payment of disproportionate amounts is not likely to happen under state law.
With state law foreclosed, reforms have focused on federal law. Congress has increasingly intervened, shifting compensation matters from the states to the federal scheme. SOX and Dodd-Frank have included a mix of provisions addressing compensation issues. Loans to executive officers and directors have been prohibited. Boards have been forced to seek clawbacks of compensation in certain circumstances. Say on pay has been implemented. And, as we will discuss in the next posts, control over the process for determining compensation has increasingly been shifted to the SEC.