Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No 76 C 4312 - Hon. Prentice H. Marshall, Judge.
Before Swygert, Sprecher and Bauer, Circuit Judges.
This appeal of a derivative shareholder suit raises numerous issues relating to the legality of several actions taken by the Board of Directors of Sears, Roebuck & Co. with respect to its employee stock-option plan. The plaintiff claims that these actions were void because they did not comply with the shareholder plan authorizing these options and because they constituted waste of corporate assets. Additionally the plaintiff claims that the various proxies mailed to shareholders respecting these actions transgressed the antifraud provisions of section 14 of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a). The district court granted summary judgment for the defendants, and we affirm.
In 1967 the shareholders of Sears, Roebuck and Co., acting on recommendation of the Board of Directors, approved a stock option plan which would authorize the grant of options covering up to 3,000,000 shares of stock to key employees of Sears, including 300,000 shares that could be optioned to Sears directors. The plan provided that the Salary and Supplemental Compensation Committee, a committee made up of non-employee, "disinterested" directors, would select the employees to receive options and would determine how many options these employees would receive. The exercise price of these options was to be set at the fair market value of the stock on the date the option was granted. Further, the plan specified numerous circumstances under which the options might lapse. For example, qualified options had to be exercised within five years,*fn1 and a former employee had to exercise his options within three months of leaving the company's employ. Finally, the plan gave the Board broad discretion in the administration of the plan: the Board could re-option "unpurchased shares under expired or terminated options" and could issue such rules and interpretations as "it shall deem necessary or advisable for carrying out the purposes of the Plan." A virtually identical program, the only changes having resulted from new tax provisions relating to options, was approved by the shareholders in 1972 and permitted the grant of options covering up to 4,000,000 shares including 300,000 shares for employee-directors.
After the approval of the 1967 plan, the Board of Directors began to grant stock options to employees designated by the Salary and Supplemental Compensation Committee.*fn2 The Committee selections for the more than 15,000 key employees as to whom the Committee had little personal knowledge were completely dependent on the recommendations of Sears management. The personnel department developed guidelines for the selection of eligible employees and amounts to be granted. The application of these guidelines, supplemented by the reports of territorial administrative offices, resulted in a final recommendation by the personnel department. This recommendation was then reviewed and approved by successive levels of the management hierarchy, terminating with the Board of Directors. No such recommendations, however, were made to the Committee with respect to employee-directors. Between 1967 and 1973 the following numbers of options at stated prices were granted: 2,093,016 shares at $56.82 in 1967; 591,612 at $89.82 in 1971; 2,496,194 at $116.44 in 1972; and 7,600 at $101.13 in 1973.
In 1973 the fair market value of Sears stock began to decline. By December of 1973 the price of Sears stock on the New York Stock Exchange was $84.00, causing the 1972 and 1973 options, which were not yet exercisable, to go "underwater." As long as the option price exceeded the market price, which continued to decline and presented little prospect of surpassing the option price, the options were of no present value to the employees. As a result none of these options was ever exercised. To remedy this situation the Committee recommended that the outstanding 1972 and 1973 options be cancelled and that an equivalent number of new options be granted with exercise prices at the currently prevailing fair market price. Thus on January 22, 1974, by action of the Sears Executive Committee, options covering 2,441,910 shares were cancelled, and options covering 2,621,374 shares were granted with an exercise price of $85.94. The value of Sears stock continued to decline, however, and none of these options was exercised either. In September 1974 this cancellation and reissue plan was repeated. The Committee recommended, and the Board adopted and approved, the cancellation of the 1971 and 1974 options and the issuance of options covering 3,489,070 shares at an exercise price of $52.19. Although "key employees" received the new options for old options on a one-to-one basis, the employee-directors were granted new options covering only 75 percent of the shares that were covered under the old options. The last options relevant to this litigation were granted in 1975 at $66.57 per share.
In March 1976, the shareholder's derivative action pending before us now was filed in the Southern District of New York.*fn3 In order to expedite the termination of this action the Board called a special meeting and distributed proxies to shareholders recommending ratification of the directors' actions in cancelling and regranting options. The 1976 proxy statement described and included the text of the 1967 and 1972 plans, gave detailed information regarding employee-director compensation, tabulated the various options cancelled and granted, and contained a copy of the plaintiff's original complaint in this action. Of the 158,753,361 shares entitled to vote, the resolution ratifying the directors' actions was adopted by a vote of 104,801,263 to 15,854,918.
The final amended complaint forwarded three grounds for relief. First, the directors' actions were alleged to be in violation of the 1967 and 1972 plans and therefore void. Second, the cancellation and reissue of stock options at lower exercise prices was alleged to be a waste of corporate assets. Finally, the various proxy statements concerning both the original plans and the subsequent 1976 ratification were claimed to violate federal securities laws. The defendants' motion for summary judgment was granted by the district court*fn4 and this appeal followed.
The plaintiff's first contention is that the two cancellations and subsequent reissues of the cancelled options at lower prices violated the 1967 and 1972 plans. If these reissues did in fact violate the 1967 and 1972 plans, those options would be void under section 505 of the New York Business Corporation Law, which provides:
The issue of such rights or options to directors, officers and employees of the corporation or a subsidiary or affiliate thereof, as an incentive to service or continued service with the corporation, a subsidiary or affiliate thereof, or to a trustee on behalf of such directors, officers and employees, shall be authorized at a meeting of shareholders by the vote of the holders of a majority of all outstanding shares entitled to vote thereon, or authorized by and consistent with a plan which was authorized by such vote of shareholders.
The district court declined to determine whether the reissue violated the plans and held instead that the reissuance was saved from any possible invalidity by subsequent shareholder ratification. We need not decide, however, whether this ratification cured any noncompliance with the plan, since we believe that the reissuance of options did not conflict with the 1967 and 1972 plans.*fn5
The terms of the plans clearly encompass the actions taken in this case. The plans grant the Board the authority to re-option "unpurchased shares under expired or terminated options." Ordinary language makes little distinction between terminate and cancel,*fn6 and we do not understand why any technical distinction between the two should be imputed to a provision ratified by shareholders ...