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Louisiana Municipal Police Employees Retirement System v. Blankfein

May 19, 2009


The opinion of the court was delivered by: Sand, J.


Plaintiff Louisiana Municipal Police Employees Retirement System brings this derivative action on behalf of Goldman Sachs Group, Inc. ("Goldman Sachs" or the "Company"), a Delaware corporation traded on the New York Stock Exchange ("NYSE").*fn1 At the time that the Complaint was filed, Goldman Sachs' Board of Directors consisted of thirteen individuals, each of whom is named as a Defendant. Three directors, Messrs. Blankfein, Winkelried, and Cohn, also serve as Goldman Sachs executives. The remaining ten directors ("Outside Directors") are not employees of Goldman Sachs. The Complaint also names as Defendants the Company's Chief Financial Officer and its Chief Compliance Officer, Messrs. Viniar and Cohen, neither of whom sits on the Company's Board.

Plaintiff alleges that Defendants, either actively or passively, participated in an industry-wide securities market manipulation scheme for auction-rate securities ("ARS").*fn2 Plaintiff thus brings five causes of action on behalf of Goldman Sachs. Plaintiff alleges that each Defendant breached his or her fiduciary duties by having actual or constructive knowledge that the Company was manipulating the market for ARS and failing to provide adequate oversight over this conduct (Count I). Similar allegations underpin the abuse of control and gross mismanagement claims against Defendants (Count III, IV). Plaintiff further alleges that certain Defendants personally sold Goldman Sachs stock in the open market while in possession of material, non-public information, and seeks a constructive trust on the proceeds of those sales under Delaware law (Count II). Finally, Plaintiff claims that the Company was defrauded under Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and SEC Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5,when the Company repurchased its own stock at allegedly artificially inflated prices (Count V).

Defendants move to dismiss arguing, inter alia, that Plaintiff has failed to make a pre-suit demand that the Goldman Sachs Board of Directors, itself, bring this suit on behalf of the Company. Plaintiff concedes that it did not make a demand on the Board. However, Plaintiff argues that any such demand would have been futile, and is therefore excusable, because a majority of the Company's directors lack independence and are not disinterested. For the reasons set forth below, the Court finds that a demand of the Company's Board was not futile and thus dismisses Plaintiff's action for failure to satisfy the demand requirement, which is a precondition for bringing this action.

I. Background

The Complaint alleges that Defendants were involved in a scheme to manipulate the ARS market by, among other things, failing to provide adequate oversight and halt allegedly illegal and improper trading practices. Defendants are specifically accused of permitting improper misrepresentations regarding the health and liquidity of the ARS market. (Compl. ¶¶ 78, 79.) Plaintiff alleges that Defendants permitted this to occur in the face of several red flags concerning the potential for misconduct in regards to the ARS market as well as deterioration in the ARS market in 2007.

As the basis for its assertion that Defendants ignored red flags, Plaintiff contends that during the period of 2007--2008, Defendants should have had heightened awareness of potential impropriety connected to the ARS market because of a cease and desist proceeding brought by the SEC in 2006. The 2006 SEC proceeding (2006 Proceeding) concerned allegations that Goldman Sachs encouraged illegal trading practices in the ARS market-specifically, insufficient dealer disclosure of actions designed to create the appearance that auctions were successful and legitimate when, in fact, they were neither. (Compl. ¶¶ 66--72.) Goldman Sachs allegedly agreed to pay a large fine as part of a settlement and was censured and ordered to cease and desist from the improper practices (2006 Settlement). (Compl. ¶ 73.) Plaintiff argues that the 2006 Proceeding and Settlement put Defendants on notice of the potential for manipulative conduct in connection with the ARS market by Goldman Sachs' employees and thus heightened the Defendants' obligation to be alert to any misconduct in the future.

Plaintiff also alleges that Defendants ignored several other red flags. Plaintiff alleges that in 2007, Defendants knew that the tightening of the credit market would lead to a collapse in demand for ARS and yet permitted representations that the ARS market was healthy and particularly liquid, and accordingly that ARS would be a good investment for investors with cash-equivalent needs. (Compl. ¶¶ 63--65, 75--79.) Plaintiff further alleges that Defendants continued to increase the intensity of its marketing of ARS throughout 2007 despite the consistent failures of monthly auctions beginning in August 2007. (Compl. ¶¶ 79--84.) Plaintiff additionally alleges that Defendants permitted this representation despite the decision of the Financial Accounting Standards Board in March 2007 to require that ARS be listed on investors' balance sheets as "short-term investments" rather than "cash equivalents." (Compl. ¶ 77.) This event allegedly caused Goldman Sachs to retain more ARS inventory than it could financially handle because its corporate investors began to dispose of their ARS upon learning that the ARS were less liquid than they had previously thought, in an effort to avoid a decline in their liquidity ratings. (Compl. ¶ 77.)

Plaintiff alleges that in February 2008, Goldman Sachs realized that it could no longer maintain the illusion of a healthy ARS market and accordingly stopped supporting auctions altogether and simply walked away from the ARS market. (Compl. ¶ 83.) As a result, Plaintiff alleges that Goldman was charged with violations of federal and state securities laws in 2008. Goldman Sachs agreed to a settlement in 2008 with state agencies (2008 Settlement) that included, among other things, a repurchasing of ARS from Goldman Sach's high net-worth customers and a payment of a $22.5 million fine, although Goldman Sachs never explicitly admitted to any wrongdoing.*fn3 (Compl. ¶¶ 85--92.) Plaintiff alleges that the misconduct that resulted in the 2008 Settlement was a result of Defendants' failure to exercise proper oversight.

II. Discussion

Plaintiff brings this case as a derivative action on behalf Goldman Sachs. It is a "cardinal precept" of Delaware law that boards of directors, not shareholders, manage the business and affairs of corporations.*fn4 Aronson, 473 A.2d at 811. The decision to bring a lawsuit on behalf of a corporation, or to refrain therefrom, is a decision properly placed in the hands of the corporation's board. Spiegel v. Buntrock, 571 A.2d 767, 773 (Del. 1990). Thus, when a corporation might possess a legal claim, "it is the corporation, acting through its board of directors, which must make the decision whether or not to assert the claim." Grimes v. Donald, 673 A.2d 1207, 1215 (Del. 1996).

Because a "derivative action impinges on the managerial freedom of directors," a stockholder may not pursue a derivative action on behalf of the corporation unless the stockholder: (a) has first demanded that the directors pursue the corporate claim and the directors have wrongfully refused to do so; or (b) establishes that pre-suit demand is excused because the directors are deemed incapable of making an impartial decision regarding the pursuit of the litigation. Wood v. Baum, 953 A.2d 136, 140 (Del. 2008); see also Kamen, 500 U.S. at 101; Ross v. Bernhard, 396 U.S. 531, 534 (1970); e.g., Fed. R. Civ. P. 23.1. A shareholder can meet this second requirement-demand futility- by establishing that there is a reasonable doubt that (1) the challenged transaction was otherwise the product of a valid exercise of business judgment and (2) the directors are disinterested and independent. Aronson, 473 A.2d at 814. If a derivative plaintiff fails to make demand, the directors "are entitled to a presumptionthat they were faithful to their fiduciary duties [and] the burden is upon the [derivative] plaintiff . . . to overcome that presumption." Beam v. Stewart, 845 A.2d 1040, 1048--49 (Del. 2004) (emphasis omitted).*fn5

It is uncontested that Plaintiff failed to make demand in this case. Moreover, upon reviewing the pleadings, the Court finds that the Complaint fails to establish a reasonable doubt as to the Defendants' independence or the business judgment ...

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