In a harsh June 21, 2012 opinion (here), Southern District of New York Judge Paul A. Crotty rejected the motion to dismiss of Goldman Sachs and three individual defendants in the securities class action lawsuit pertaining to the infamous “built to fail” Abacus CDO transaction and other ill-fated deals. Judge Crotty did, however, grant the defendants’ motion to dismiss with regard to the plaintiffs’ claims based on the company’s failure to disclose its receipt of a Wells Notice.


What makes the decision interesting, besides the sharpness of the Judge’s tone, is that in order to establish that Goldman’s alleged misstatements and omissions about its business ethics and conflicts of interest practices and policies are actionable, the plaintiffs relied on Goldman’s misstatements and alleged fraudulent conduct in connection with the Abacus transaction and three other CDO deals. Judge Crotty found that Goldman’s alleged conduct and statements in connection with the CDO deals made the statements to Goldman’s shareholders about its business practices and ethics materially misleading.

The order is also interesting because of the weight Judge Crotty gives to admissions Goldman made in the Consent it entered in its July 2010 agreement to settle the enforcement action the SEC had filed against Goldman about the Abacus transaction. As described here, in the Consent, in which Goldman neither admitted nor denied liability, the company “acknowledges” that the Abacus marketing materials “contained incomplete information” and that it was a “mistake” for the materials to state that the Abacus CDO reference portfolio was selected by ACA Management without disclosing the role of short-interest investor Paulson & Co. or that Paulson’s interests were adverse to those of the Abacus CDO investors.

These concessions fell short of an admission of fraud, but as Jan Wolfe notes in a June 22, 2012 Am Law Litigation Daily article about Judge Crotty’s decision (here), “if Goldman and its lawyers thought that this linguistic compromise would help it avoid trouble in shareholder suits, it turns out they were wrong.”

In addition to the Abacus transaction, the plaintiffs’ conflict of interest allegations also are based on three other CDO transactions – Hudson, Anderson and Timberwolf. With respect to the Hudson transaction, the plaintiffs allege that Goldman had said its interests were aligned with those of CDO investors based on a $6 million equity investment, while omitting that it also had a 100% short position at the time, representing a $2 billion interest.

With respect to the Anderson CDO transaction, Goldman stated that it would hold up to 50% of the equity tranche, worth $21 million, but omitted its $135 million short position. And with respect to the Timberwolf transaction, Goldman stated that it was purchasing 50% of the equity tranche, but failed to disclose that it was the largest source of assets in the structure and held a 36% short position in the CDO.

The plaintiffs claim that Goldman’s conduct, discloses and omissions with respect to these CDO transactions made a number of the company’s disclosures  to shareholders about its conflicts of interest policies and procedures and its commitment to legal compliance and ethics (including its commitment to “integrity” and “honesty”) materially misleading.

The defendants argued that these statements are non-actionable statements of opinion, puffery or merely corporate mismanagement. Judge Crotty called these arguments “Orwellian,” adding that:

Words such as “honesty”, “integrity”, and “fair-dealing” so not mean what they say; they do not set standards; they are mere shibboleths. If Goldman’s claim that “honesty” and “integrity” are mere puffery, the world of finance may be in more trouble than we recognize.

Judge Crotty concluded that Goldman’s conduct and disclosures in connection with the four CDO transactions “made its disclosures to its own shareholders, concerning its business practices, materially misleading,” adding that given “Goldman’s fraudulent acts, it could not have genuinely believed its statements” about its business practices and ethics. Goldman should not be able to “pass off” its “repeated assertions” as “mere puffery.” Moreover, Goldman’s “allegedly manipulative, deceitful and fraudulent conduct” in hiding its conflicts of interests in the four CDO transactions “takes the Plaintiffs’ claim beyond mere mismanagement.”

On the issue of scienter, Judge Crotty specifically relied on Goldman’s concessions in the SEC settlement, among other things, including internal emails. He noted that Goldman clearly played an active role in the Abacus asset selection process: “How else could Goldman admit that it was a ‘mistake’ not to have disclosed such information.” Crotty found that “given Goldman’s practice of making material misrepresentations to third-party investors, Goldman knew or should have known” that its statements about its conflicts of interest practices and business ethics “were inaccurate and incomplete.”

Judge Crotty also concluded that scienter allegations as to each of the individual defendants were sufficient, as each of them “actively monitored” Goldman subprime deals and assets and each knew that Goldman was “trying to purge those assets from its books and stay on the short side.”

Judge Crotty did, however, dismiss plaintiffs’ claims that Goldman had misled its shareholders by failing to disclose its receipt of a Wells Notice, noting that because a Wells Notice “indicates not litigation but only the desire of the Enforcement staff to move forward,” and therefore is a “contingency” that need “not be disclosed.” He also found that the plaintiffs’ had not shown that the company’s nondisclosure of the Wells Notice made the company’s prior disclosures about “ongoing governmental investigations” materially misleading.


Judge Crotty’s opinion clearly quells any suggestion that Goldman’s SEC settlement – in which it made a number of admissions – offers an alternative to the “neither admit nor deny” SEC settlement approach which has proven so controversial. A frequent justification for the “neither admit nor deny” approach is that defendants can’t admit liability in an SEC settlement for fear the admissions will be used against them in related shareholder litigation. Some (including even Judge Jed Rakoff, who has been so critical of the neither admit nor deny settlements) had suggested that the Goldman settlement — in which the company admitted no fraud but only mistakes – offered a middle ground.

However Judge Crotty found that Goldman’s attempts to argue in support of its motion to dismiss the share holder suit that it had neither admitted nor denied liability in the SEC settlement were “eviscerated” by the company’s concession that it had made a “mistake” in not disclosing Paulson’s role in the Abacus transaction. The fact that the plaintiffs were able to rely on the company’s SEC settlement concessions, and that the concessions also entered directly into Judge Crotty’s analysis of both misrepresentation and scienter issues, eliminates the Goldman settlement approach as an enforcement action settlement alternative that other defendants might be able to accept.

It is interesting that so many of the misstatements or omissions on which the shareholder plaintiffs rely were not made directly to shareholders themselves, but rather were made to CDO investors. The misleading omission in statements to the CDO investors were relied upon to show that statements that were made to Goldman shareholders about the company’s business practices and ethics were misleading.

There is a particularly harsh aspect to Judge Crotty’s decision, in that the statements to shareholders to  which he referred in denying defendants’ motion to dismiss were the company’s statements about it business ethics and integrity. What makes this particularly troubling is that his assessment that these statements were misleading was not based – as would usually be the case at this stage of the proceedings – on plaintiffs’ mere unproven allegations. Judge Crotty’s conclusions were based, at least in part, on the company’s own admissions.

Goldman likely recognized long ago that this case might well survive a motion to dismiss. (The company wouldn’t have agreed to pay over half a billion dollars to settle the SEC enforcement action if it didn’t recognize that there were serious problems with the Abacus transaction, and in addition the separate state court fraud action brought by the bond insurer on the Abacus transaction had previously survived a dismissal motion.) Nevertheless, Judge Crotty’s opinion, and in particular the harshness of its tone, has to represent an unwelcome and troubling development.

One final note has to do with Judge Crotty’s ruling with regard to the Wells Notice nondisclosure allegations. The question of whether the receipt of a Wells Notice must be disclosed is frequently debated, and many companies, out of an abundance of caution, will disclose it. Judge Crotty’s conclusion that a Wells Notice represents a “contingency” that need not be disclosed will clearly be relevant for companies considering whether nor not they must disclose receipt of a Wells Notice, and may lead more companies to withhold disclosure of receipt of a Wells Notice.

I have in any event added the Goldman decision to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

Professor Peter Henning has an interesting post about the Goldman decision on the Dealbook blog (here).

Is the Business Judgment Rule Available as a Defense for Corporate Officers: One of the questions that is receiving close scrutiny in the litigation the FDIC has filed against former directors ad officers of failed banks as part of the current wave of bank failures is whether or not corporate officers – as opposed to corporate directors – can rely on the business judgment rule as a defense to claims of ordinary negligence. As discussed here, at least one court has held under Georgia law that officers can rely on the business judgment rule to preclude claims for ordinary negligence.

However, as California attorney Jon Joseph wrote in his April 11, 2012 guest post on this blog (here), courts applying California law on the issue and considering whether corporate officers as well as directors can rely on the business judgment rule have split on the issue. The ruling in the FDIC lawsuit against former IndyMac CEO that Perry could not rely on the business judgment rule is on interlocutory appeal to the Ninth Circuit.

Because of this mixed case law, the June 7, 2012 ruling in the FDIC’s lawsuit against certain former officers of County Bank of Merced, California is of interest. In the decisions, which can be found here, Eastern District of California Judge Lawrence O’Neill held that the defendant officers cannot rely on the statutorily codified business judgment rule under California Corporations Code Section 309, because the statute by its terms refers only to officers not directors.

However, with respect to the defendant officers’ efforts to rely on the common law business judgment rule, Judge O’Neill also denied the defendants’ motion to dismiss — but not on the basis that they could not rely on the business judgment rule; rather, he said only that “the business judgment rule is an affirmative defense which involves factual issues to preclude its application to dismiss the complaint’s claims.”

While Judge O’Neill did find that the defendants’ entitlement to rely on the common law business judgment rule is a factual issue, what he did not say is that the defendants were not entitled to rely on it as a matter of law. Which can be interpreted to suggest at least by negative inference that there is a common law business judgment rule separate and apart from the statutory provision, and defendants can rely on the common law rule, if they can establish as a factual matter that the qualify for the rule’s protection.

Hat tip to Alan Makins, who had a post about the ruling in the County Bank case in his California Corporate & Securities Law Blog, here.