The Voice of the Shareholders

One way to consider the current situation of Goldman Sachs is in terms of the old question of where a business places its priorities. As has often been observed, any company has to face three sets of priorities that are not always (ever?) in alignment. There are the priorities of the workers, which tend to vary according to position on the organizational food chain. Then there are the priorities of external business connections. Traditionally these have been the priorities of the customers; but, as supply chains become more complex and more distributed, the priorities of suppliers must also be taken into account. So here, again, there can been considerable variation in those priorities. Finally, there are the priorities of the shareholders; and, because shareholders are rarely interested in anything other than return-on-investment, these are the priorities most likely to be at cross-purposes with the more business-related ones.

In this context it is interesting to observe that, in the context in which the SEC has filed charges of civil fraud against Goldman Sachs, the Department of Justice is investigating those charges, and Goldman Sachs has begun an internal review of its business practices, we now have a report of the "vox populi" of the shareholders. Here is the BBC News summary of that report:

A filing by the bank with the regulator, the Securities and Exchange Commission (SEC), said several lawsuits had been brought against it, accusing the firm of a "breach of fiduciary duty, corporate waste, abuse of control, mismanagement and unjust enrichment".

Shareholders accused Goldman of failing to implement proper risk management procedures while designing and selling complex mortgage-backed derivatives that lost investors huge sums of money.

"[The] defendants failed to implement controls with respect to the evaluation, approval and management of the structure, risk, marketing and distribution" of the derivatives, the filing said.

They also alleged there was a conflict of interest in the way in which the derivatives were sold.

"[The] transactions were neither approved or reviewed by independent members of the [Goldman] board, but instead were reviewed and approved by long-term members of management whose compensation was directly linked to the approval and completion of the proposed transactions."

'Damaged reputation'

Shareholders also accused the bank of not fully disclosing facts that should have been made public.

In one action against the firm, shareholders alleged the bank was forewarned it may face charges concerning its role in the sale of the complex derivatives, but failed to disclose this fact.

As a direct result of Goldman's dealings in mortgage derivatives, and the resultant charges of fraud by the regulator, shareholders said the bank "has been significantly and materially damaged, faces billions of dollars of liability and has suffered serious damage to its reputation and image".

In its filing, Goldman said it expected further shareholder actions to be brought against it.

It is important to note that these are civil lawsuits. In other words the shareholders are seeking compensation for corporate mismanagement, rather than punitive measures for criminal acts. As is always the case when shareholders are involved, it's all about the money.

So what do the shareholders hope to achieve, and is this an effective way to achieve it? Put another way, for what do the shareholders expect compensation? The GS shares had their worst quarter in 4Q 2008, and most smoothing functions will show that the price has been on relatively steady recovery since then. That price is still some distance from the highs of October of 2007, but are the shareholders actually trying to use civil litigation to make up for losses on the New York Stock Exchange? If so, what will they do next? Sue Harrah's for paying out according to odds that probabilistically favor the house? Are we not at least on the threshold of a working definition of "frivolous lawsuit?"

What makes these actions even more suspect is that the shareholders already have a voice. If they really think that Goldman Sachs has a serious problem with poor management, then they can vote in a new Board of Directors to press for reorganization of the company on a large scale. Through such voting they can even deny the CEO a seat on the Board. Isn't this the way corporate governance is supposed to work?

From a point of view of "risk management," there is a good chance that this "shareholder activism" is more likely to make things worse than improve them. It would seem that the most likely consequence of this breaking news will be a decline in the GS price. (According to the Yahoo! Finance Real-Time ticker, the price is down but not yet to a point of 1% of the opening value.) This seems more like an example of irrationality in the face of crisis, rather than a case for the virtues of self-regulation through corporate governance!