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MILLS v. ESMARK

United States District Court, Northern District of Illinois, E.D


August 16, 1982

CARYN J. MILLS AND SUSAN M. MILLS, NOT INDIVIDUALLY BUT DERIVATIVELY ON BEHALF OF ESMARK, INC., A DELAWARE CORPORATION, PLAINTIFFS,
v.
ESMARK, INC., A DELAWARE CORPORATION; DONALD P. KELLEY; ROGER T. BRIGGS; EDWARD J. HARRISON; WILLIAM P. CARMICHAEL; GEOFFREY C. MURPHY; ROBERT E. PALENCHAR; JAY D. PROOPS; PHILIP L. THOMAS; EARL J. GRIMM; JACK A. VICKERS; SAMUEL B. CASEY, JR.; LESTER CROWN; ARCHIE R. DYKES; JEROME C. EPPLER; WILLIAM B. JOHNSON; JAMES J. O'CONNOR; RICHARD TERRELL; AND ELMO R. ZUMWALT, JR., DEFENDANTS.

The opinion of the court was delivered by: Aspen, District Judge:

          MEMORANDUM OPINION AND ORDER

Plaintiffs, Caryn J. Mills and Susan M. Mills, brought this derivative action on behalf of Esmark, Inc. ("Esmark") against the corporation, its directors and certain of its officers. Plaintiffs allege that the assignment and award of restricted Esmark common stock and performance units to key employees of the corporation in 1979 and 1980 violated Esmark's Long Term Growth Plan ("LTGP"), the Delaware Constitution and the fiduciary duty owed shareholders by Esmark's officers and directors. Plaintiffs also allege that the circumstances under which the defendants obtained shareholder approval of the LTGP in 1979 and awarded restricted stock to key Esmark employees in 1980 violated the Securities Exchange Act of 1934. Plaintiffs allege further that the award of $1,000,000 to defendant Jack A. Vickers in 1980 was improper and a waste of corporate assets. Plaintiffs assert finally that Esmark's Corporation Committee and Board of Directors violated the purpose of the corporation's Management Incentive Plan by declaring an award for the 1981 fiscal year in 1980. Presently before the Court are certain defendants' motions to dismiss plaintiffs' second amended complaint with prejudice or, in the alternative, for summary judgment.

The crux of plaintiffs' charges were contained in a letter of demand received by the Esmark Board of Directors on March 31, 1981.*fn1 Plaintiffs subsequently filed a complaint which this Court dismissed to afford time for Esmark's Special Litigation Committee ("SLC") to respond to plaintiffs' allegations. Mills v. Esmark, 91 F.R.D. 70 (N.D.Ill. 1981). The SLC ultimately concluded that litigation involving the charges raised in the initial complaint would not be in the best interest of Esmark. SLC Report, pp. 10-12. Upon receipt of the SLC's Report, plaintiffs filed an amended complaint asserting the original claims and adding further claims against the defendants for breach of fiduciary duty and violation of the federal securities laws. Plaintiffs have since filed a second amended complaint advancing still further claims for breach of the LTGP and the Management Incentive Plan and for violation of the Delaware Constitution. Plaintiffs also allege that the SLC failed to exercise independent and good faith business judgment in evaluating their substantive claims. Defendants now seek dismissal of this action on the merits in light of the SLC's recommendation.

I. The Special Litigation Committee Report

The Supreme Court held in Burks v. Lasker, 441 U.S. 471, 480, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979), that the authority of disinterested directors to terminate shareholder derivative actions is a matter properly resolved with reference to the applicable state law. See also Abramowitz v. Posner, 672 F.2d 1025, 1026 (2d Cir. 1982). In the present case, therefore, this Court must look to the law of Delaware, the state of Esmark's incorporation, to determine the effect of the SLC's conclusion that it is not in the best interest of the corporation to pursue this litigation.*fn2

A. The Standard for Reviewing Findings of a Special Litigation
    Committee

The effect of a decision by a committee of independent directors not to pursue derivative claims asserted by shareholders in a demand was addressed by the Delaware Supreme Court in Zapata Corporation v. Maldonado, 430 A.2d 779 (Del.Supr. 1981). The Zapata Court made clear that, as a general rule, "a board decision to cause a derivative suit to be dismissed as detrimental to the company, after demand has been made and refused, will be respected unless it was wrongful." Id. at 784. The Court reasoned that the decision of disinterested directors not to pursue derivative claims "falls under the `business judgment' rule and will be respected if the requirements of the rule are met."*fn3 Id. at n. 10. See also United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-64, 37 S.Ct. 509, 61 L.Ed. 1119 (1917); Galef v. Alexander, 615 F.2d 51, 57-58 (2d Cir. 1980). Accordingly, shareholders who initiate an action purportedly on behalf of the corporation cannot maintain that action in derivative context once a committee of independent and disinterested directors determine that litigation is not in the best interests of the corporation. Swanson v. Traer, 249 F.2d 854, 859-60 (7th Cir. 1957).

This Court's review of the SLC's report, therefore, is limited to an inquiry into the disinterested independence of the members of the SLC and the appropriateness and sufficiency of the committee's investigative procedures. Zapata, supra, 430 A.2d at 784. Cf. Galef, supra, 615 F.2d at 59; Auerbach, supra, 47 N.Y.2d at 623-24, 419 N.Y.S.2d 920, 393 N.E.2d 920. The "second step" of the trial court's inquiry under Zapata, a complete and independent review of the substantive basis of the shareholder plaintiffs' claim, is not appropriate in a case such as this where a special litigation committee, established by the board in response to a proper shareholder demand, has determined that litigation would not advance the best interests of the corporation.*fn4 Abramowitz, supra, 672 F.2d at 1030; Maldonaldo v. Flynn, 671 F.2d 729, 731 (2d Cir. 1982) (per curiam).

The limited scope of inquiry permitted in this context under Delaware law and the business judgment rule does not, however, bar all substantive review of the SLC's conclusions and recommendations. In cases where, as here, the shareholder plaintiffs articulate specific grounds on which to question the good faith of a special litigation committee's investigation, the Court must examine the committee's treatment of the merits of the shareholders' underlying claims in order to determine the appropriate weight to be given to the committee's recommendations. To shield our eyes entirely from the merits would prevent us from evaluating the underlying independence of the committee.

     B. Assessment of the Good Faith and Independence of the
               Esmark Special Litigation Committee

In the present case, Esmark's Board of Directors appointed two "outside" directors, Dr. Archie R. Dykes and Admiral Elmo R. Zumwalt, Jr. (Retired) to head the Special Litigation Committee. Although Dr. Dykes and Admiral Zumwalt were each named as defendants in this action, neither is alleged to have participated in the decisions of the Esmark Compensation Committee or to have received any payment or benefit challenged by plaintiffs in this lawsuit. The disinterested independence of Dr. Dykes and Admiral Zumwalt is not impaired merely because they were named as nominal defendants in this case.*fn5 Cf. Klotz v. Consolidated Edison Co. of New York, Inc., 386 F. Supp. 577, 580-82 (S.D.N.Y. 1974). To hold otherwise would allow a small number of shareholders to "incapacitate an entire board of directors" merely by naming the entire board as defendants. Zapata, supra, 430 A.2d at 785.

Dr. Dykes' and Admiral Zumwalt's status as nominal defendants for the purpose of evaluating plaintiffs' state law claims does not, however, establish their disinterested independence for the purpose of evaluating plaintiffs' claims under section 14 of the Securities Exchange Act of 1934. As Esmark directors, Dr. Dykes and Admiral Zumwalt each participated in the alleged wrongdoing by approving the alleged misrepresentations concerning the LTGP contained in the 1979 Esmark Proxy Statement. As a practical matter, neither Dr. Dykes nor Admiral Zumwalt can be expected to exercise truly independent judgment in evaluating the propriety of their own decision to approve the proxy statement.*fn6 Accordingly, the SLC's conclusions as to plaintiffs' section 14 claim will not be afforded deference under the business judgment rule.*fn7

Plaintiffs assert a variety of alternative theories to cast doubt upon the independence or disinterestedness of the SLC in its evaluation of the state law claims asserted in the complaint. For example, plaintiffs allege that Dr. Dykes and Admiral Zumwalt earn more money each year from their directors' fees than their limited number of shares of Esmark stock. This fact does not, however, establish any particular bias against shareholders' interests or improper affiliation with management.*fn8 Similarly, Dr. Dykes and Admiral Zumwalt's consistent participation in unanimous decisions on a variety of issues by the Esmark Board of Directors does not establish any lack of independence from management.*fn9 Indeed, several of the Board's decisions at issue in this case deviated from management's initial recommendations. Plaintiffs cannot avoid application of the business judgment rule by advancing generalized charges of bias or lack of independence.

Plaintiffs assert that the SLC's lack of independence is also evidenced by its failure to disclose a variety of facts and documents favorable to the claims advanced in their complaint. The viability of this argument as a means of invalidating the SLC's recommendations requires the Court to engage in some substantive analysis of the significance of the "undisclosed" facts and documents in relationship to the underlying allegations of wrongdoing in plaintiffs' complaint. For example, one of the claims raised in plaintiffs' "Presentation to the Special Litigation Committee" and reiterated in the second amended complaint is that the value of each share of restricted Esmark stock awarded to key Esmark employees in 1979 and 1980 under the LTGP was excessive because the total number of outstanding shares of Esmark was cut in half during that period as the result of the restructuring of Esmark and the disposition of the Trans Ocean Oil, Inc. to Mobil Oil Corporation. "Consequently," plaintiffs argue, "the retirement of [54% of Esmark's shares] approximately doubled the earnings per share on the remaining shares [including those restricted shares awarded under the LTGP], doubled the proportion of voting percentage of [those] remaining shares and had the effect of substantially increasing the market value of [those] shares." Second Amended Complaint, ¶ 44.A. Plaintiffs allege that, under these circumstances, the Esmark Board of Directors should have exercised its power to reduce the number of restricted shares awarded under the LTGP to reflect the increased "value" of each share.

The "fact" purportedly favorable to plaintiffs which was not disclosed in the SLC's report was that the Esmark Board of Directors increased the number of shares awarded to key employees under the LTGP when Esmark declared a 5 for 4 stock split in 1981. Presumably, this undisclosed fact is viewed by plaintiffs as evidence of the Board's inconsistency in the administration of the LTGP or simply as evidence of the Board's power to alter the number of shares awarded under the LTGP. In either event, however, we do not view the SLC's failure to address this fact as material evidence of its lack of independence. The SLC's report does distinguish in general terms between the equity effect of a stock split and the kind of corporate restructuring involved in this case.*fn10 SLC Report, p. 110. Given the entirely different nature of each transaction, the SLC's failure to specifically distinguish one from the other is not evidence of bias or domination.

Plaintiffs also argue that the SLC should have disclosed that defendant Jack A. Vickers, a member of the Esmark Board of Directors, voted favorably on a resolution which included a provision which compensated him in the amount of $1,000,000 for his role in the Esmark restructuring. Although the SLC report defends the reasonableness of such compensation, it does not discuss the implications of Vicker's vote in his own favor.*fn11 The SLC's failure to consider these implications reflects the fact that this allegation was not fully developed until after the SLC report was issued and that Admiral Zumwalt had a personal recollection that Vickers did not vote on his own compensation. Zumwalt Dep. at p. 12. Neither of these considerations, however, cast doubt upon the SLC's ability to independently evaluate plaintiffs' underlying claim that the payment of $1,000,000 to Vickers was a waste of corporate assets. Second Amended Complaint, ¶ 47. The "fact" undisclosed in the SLC report supports neither a separate cause of action against Vickers under Delaware law, 8 Del.Corp.Code § 144(a)(1), nor an inference that the SLC was biased or dominated by those accused of wrongdoing.

Plaintiffs also contend that the SLC failed to disclose various documents purportedly favorable to their claim. One of those documents was a legal opinion, authored by lawyers in the firm of Mayer, Brown & Platt, which expressed some doubt over Esmark's assessment of the tax benefits arising from the corporate restructuring program.*fn12 Second Amended Complaint, ¶ 50.I. The underlying significance of plaintiffs' tax liability claim was not, however, fully developed until after the SLC report was issued.*fn13 Moreover, the SLC's discussion of the tax issue with Howard J. Doherty, a partner of Arthur Young & Co., manifests that the committee analyzed the merits of plaintiffs' allegation in some detail.*fn14 The absence of any specific reference to the Mayer, Brown & Platt opinion reflects the generalized nature of plaintiffs' claim at the time of the investigation rather than the lack of independence of the SLC.

Plaintiffs also suggest that the SLC should have disclosed the existence of a corporate insurance policy which would indemnify key employees of Esmark in the event of the successful prosecution of this suit. Second Amended Complaint, ¶ 50.I. The existence of such an insurance policy no doubt would, to some extent, dilute the morale problem of Esmark executives cited by the SLC as one of several reasons for not pursuing this litigation. Although we do not agree with Dr. Dykes' subsequent assertion that the insurance issue is irrelevant to consideration of the wisdom of pursuing this lawsuit, Dykes Deposition at pp. 61-62, neither do we agree that the SLC's failure to address this issue evidences any lack of independence or disinterestedness.*fn15 Indeed, if the SLC's intention was to conceal all facts and documents inconsistent with its ultimate conclusion, it would not have included a summary or discussion of the variety of substantive criticisms launched against Esmark's restructuring and handling of the LTGP by sources other than the plaintiffs.*fn16

The final nondisclosure cited by plaintiffs as evidence of the SLC's lack of independence is the fact that the Esmark Compensation Committee deviated from its prior formula in determining the number of restricted shares of Esmark stock to be awarded under the LTGP in 1981. This purported deviation, and the resulting higher number of shares awarded, forms the basis of "Plaintiffs' First Claim" in the second amended complaint. The SLC's failure to address this issue in detail does not, however, evidence any lack of independence or good faith. The propriety of the formula used in calculating the 1981 grant of restricted stock was not raised as an issue in this lawsuit until plaintiffs filed their first amended complaint in August of 1981, one month after the SLC issued its report.*fn17 The SLC cannot be held to a standard which would require them to anticipate all of plaintiffs' future arguments.

Plaintiffs also point to the scope of the SLC investigation as evidence of its lack of independence. Of the nineteen witnesses formally interviewed in the course of that investigation, twelve were named as co-defendants in this action. Second Amended Complaint, ¶ 50.J. With the exception of plaintiffs' counsel, the balance of those interviewed had some prior connection to Esmark's administration of the LTGP.*fn18 Although this distribution of witnesses might appear at the surface to be weighted in favor of the defendants, plaintiffs have failed to identify any person the SLC should have but failed to interview. The SLC proceeded on the assumption that only those individuals with some prior connection to the LTGP could, based upon personal knowledge, shed any light on the events underlying plaintiffs' claim. That assumption does not establish the SLC's lack of independence or disinterestedness.

In light of all these considerations, the Court concludes that, on the whole, the Esmark SLC's evaluation of plaintiffs' allegations was conducted in good faith and in a manner genuinely independent of those accused of wrongdoing. With those exceptions noted, the claims alleged in plaintiffs' second amended complaint which were considered in detail and rejected by the SLC are dismissed with prejudice.*fn19 It is so ordered. The Court will address plaintiffs' remaining claims in seriatim to determine whether there exists any genuine issue of fact material to resolution of this case.*fn20

    II. Claims Not Resolved by the Esmark Special Litigation
                            Committee

With the possible exception of plaintiffs' claim under section 14(a) of the Securities Exchange Act of 1934, those issues which remain after the SLC's inquiry were not presented to the board of directors in the form of a proper demand as required by Rule 23.1. Fed.R.Civ.P. Although we earlier enforced the demand requirement in response to plaintiffs' initial complaint, Mills v. Esmark, 91 F.R.D. 70 (1981), we decline to do so again at this later stage of the litigation. A further demand and further investigation would likely prolong rather than cut short this dispute. Moreover, because the defendant directors have now taken a clear and unequivocal position on the merits of this entire controversy in their motion for summary judgment, a further demand on the board would not be fruitful. Cf. Nussbacher v. Continental Illinois Bank & Trust Co., 518 F.2d 873, 879 (7th Cir. 1975), cert. denied, 424 U.S. 928, 96 S.Ct. 1142, 47 L.Ed.2d 338 (1976).

A. The 1981 LTGP Grant to Key Esmark Employees

On December 11, 1980, the Esmark Compensation Committee authorized an LTGP grant of 33,290 restricted shares of Esmark common stock to be made on behalf of key Esmark employees on January 2, 1981.*fn21 Plaintiffs allege in their "First Claim" under Count I that the Compensation Committee's formula for calculating the number of shares awarded under the 1981 grant violated the terms of the LTGP, was without corporate purpose and constituted a waste of corporate assets in violation of defendants' fiduciary duties to shareholders. Plaintiffs object specifically to the Compensation Committee's failure to tie the 1981 award of restricted stock to an "earnings goal" over the period ("performance period") from the date the award was made to the date the award vests with the participant (i.e. January 2, 1981 to January 2, 1984).*fn22

Defendants' motion for summary judgment asserts that the Compensation Committee's calculation of the 1981 grant of restricted stock was entirely consistent with the purpose as well as the express terms of the LTGP. Defendants point out that the earnings per share of Esmark common stock jumped from $4.40 in 1979 to $21.90 in 1980 largely as the result of Esmark's restructuring program. Because that restructuring involved the one-time disposition of a substantial percentage of Esmark's total assets, defendants contend that it would be unrealistic to expect that Esmark's earnings in subsequent years would exceed or even approach those earnings achieved in 1980.*fn23 Thus, defendants suggest, the perpetuation of a formula which sets progressively higher earnings targets over the performance period would not be a practical incentive to management and would not advance the fundamental purpose of the LTGP.

Defendants also contend that the Compensation Committee acted within its authority under the terms of the LTGP when it abandoned the concept of an earnings goal in the 1981 grant. Although the LTGP provides for the establishment of an earnings goal, the plan also provides that the Compensation Committee has discretion to establish a "percentage ['share percentage'] of the Shares of Restricted Stock assigned to a Participant's Account to which he will be entitled if still a Participant at the end of the related Performance Period." LTGP, ¶ 2.K. Defendants argue that this language in the LTGP grants to the Compensation Committee discretion to award restricted stock to an employee regardless of the company's earnings as long as the employee in question is still a participant in the plan at the end of the period. Fifty percent of the restricted stock bestowed by the Committee under the 1979 and 1980 granted was awarded under this provision. The Committee raised the share percentage to 100 percent for purposes of the 1981 grant to insulate the entire award from the inevitable drop in earnings after 1980 and thus avoid the management incentive problem noted above.

For the purpose of a motion seeking dismissal of plaintiffs' claim on the merits, defendants' reading of the Esmark LTGP is not persuasive. That the Compensation Committee had the authority to establish a share percentage insulated from the earnings goal does not, a fortiori, establish that the Committee also had authority to raise the share percentage to 100 percent in order to avoid the requirement of setting an earnings goal altogether.*fn24 Moreover, the earnings goal was intended to encourage key Esmark employees to pursue policies which would advance Esmark's long-term corporate growth. Even if the Esmark restructuring had the effect of rendering the earnings goal obsolete, the restructuring certainly did not render the objective of long-term corporate growth obsolete. Whether the one-time disposition of a large percentage of Esmark's assets advanced Esmark's long-term growth to a sufficient extent to justify the abandonment of the earnings goal measured over several years is a legal and factual question which cannot be resolved on this record.*fn25

Plaintiffs also contend that the Compensation Committee inflated the number of shares to be awarded under the LTGP in 1981 by modifying the formula used to calculate the award.*fn26 Defendants, apparently believing that the SLC's treatment of this issue in Robert Palenchar's interview was sufficient to justify dismissal of this claim under the business judgment rule,*fn27 do not offer any new evidence or new justifications for the 1981 modification. Palenchar's explanation for the modification, the substance of which is covered by the terms of the Court's protective order in this case, does not isolate why each modification was made or how such modifications served the interests of the corporation. The Court cannot, therefore, dismiss plaintiffs' claim concerning the calculation of the 1981 grant at this stage of the litigation.

Plaintiffs allege further that the individual defendants violated their fiduciary duty as well as the LTGP when, at the same time they approved the 1981 grant, the defendants "recommended that agreements be signed between ESMARK and each of its principal officers by which those officers' compensation would be guaranteed for two years (three years in [defendant] KELLY'S case) if the officer lost his position because of a merger or acquisition of ESMARK, for which there was no consideration."*fn28 Second Amended Complaint, ¶ 31. This allegation, standing alone, does not state a claim upon which relief can be granted. Plaintiffs fail to allege that Esmark and its principal officers actively entered into the agreements at issue. Plaintiffs also fail to allege that any merger or acquisition of Esmark has taken place since the agreements became effective. Whether any future merger or acquisition would result in a waste or gift of corporate assets because of these purported agreements is a matter not ripe for consideration here.

Accordingly, the Court grants defendants' motion to dismiss with prejudice those allegations contained in plaintiffs' first claim (Count I) which relate to Esmark's purported agreement with its principal officers to guarantee compensation in the event of a merger or acquisition.*fn29 The Court denies defendants' motions for dismissal with prejudice as to the balance of plaintiffs' first claim under Count I. It is so ordered.

B. Violation of the Delaware Constitution

In their "second claim" under Count I, plaintiffs assert that the awards of restricted stock under the LTGP in 1979 and 1980 (including the 1980 and 1981 LTGP grants) violated Article IX, Section 3 of the Delaware Constitution. That section provides:

  No corporation shall issue stock, except for money
  paid, labor done or personal property, or real estate
  or leases thereof actually acquired by such
  corporation.

Plaintiffs argue that because a recipient of restricted stock under the LTGP could be divested of his award before the end of the performance period by leaving Esmark's employ or failing to achieve the earnings goal, the grants of restricted stock under the LTGP were issued for future services, not labor done or money paid.

Plaintiffs' claim is only viable with respect to the award of restricted stock under the 1980 LTGP grant. The 1979 and 1981 LTGP awards of restricted stock were composed entirely of Esmark treasury stock. Grimm Affidavit 2, ¶ 2. Esmark did not issue any stock in connection with those awards. Thus, the Delaware prohibition against the issuance of stock cannot apply to the 1979 and 1981 grants.

On the other hand, it is undisputed that Esmark did issue 34,270 shares of $1 par value stock in connection with the 1980 LTGP awards. Defendants seek to avoid the prohibition of the Delaware Constitution on the ground that the issuance and award of restricted stock in 1980 was a means of compensating key Esmark employees for "previously rendered services," not future services. Esmark Board of Directors' Resolution, January 24, 1980. The defendants' characterization of these awards does not, however, dispose of plaintiffs' claim as a matter of law. As a practical matter, the 1980 LTGP award of restricted stock includes attributes of compensation for future as well as past services.*fn30 The Court cannot determine on the basis of this record whether the 1980 LTGP grant of restricted stock was intended primarily as compensation for past or future services.

Accordingly, defendants' motions to dismiss with prejudice are granted on plaintiffs' second claim (Count I) as to the 1979 and 1981 LTGP grants. Defendants' motions are denied as to the 1980 LTGP grant. It is so ordered.

C. Violation of the Esmark Management Incentive Plan

The Esmark Incentive Plan ("MIP"), adopted annually by the Board of Directors pursuant to stockholder authorization obtained in 1969, provides that certain employees of Esmark are eligible for cash awards upon the attainment of prescribed targets involving company earnings and/or personal goals. Awards under the MIP are entirely separate from grants made under the LTGP. In their eighth claim under Count I, plaintiffs allege that the Esmark Compensation Committee and Board of Directors "violated the adopted purpose of the Management Incentive Plan" by issuing the maximum awards permitted under the MIP for the 1981 fiscal year in 1980, before the results of the 1981 fiscal year were determined and "without regard to any incentive." Second Amended Complaint, ¶ 48.

Without expressing an opinion as to the underlying merits of any future action based upon Esmark's 1981 MIP award, the Court notes that plaintiffs' current allegation does not state a claim upon which relief can be granted. Although plaintiffs allege that the Board's acceleration of the 1981 MIP award violated the adopted purpose of the plan, plaintiffs do not identify that purpose, explain how the acceleration of the award violated the purpose or whether the acceleration violated the terms of the plan itself.*fn31 Plaintiffs' unexplained conclusion that these awards were made "without regard to any incentive" is not sufficient to raise this allegation to the level of a claim upon which relief can be granted. Accordingly, plaintiffs' eighth claim of Count I is dismissed. It is so ordered.

D. Violation of Securities Laws

In Counts II and III, plaintiffs allege that Esmark's 1979 Proxy Statement contained a variety of material misrepresentations and omissions with regard to the LTGP in violation of section 14 of the Securities Exchange Act of 1934 and Rule 14a-9 of the Securities and Exchange Commission.*fn32 Second Amended Complaint, ¶¶ 54, 57-59. Plaintiffs also allege that the 1981 award of restricted stock under the LTGP constituted a device or scheme to defraud Esmark and its shareholders in violation of section 10 of the Securities Exchange Act of 1934 and Rule 10b-5 of the Securities and Exchange Commission.*fn33 Second Amended Complaint, ¶ 56. As a threshold matter, defendants argue that these claims should be dismissed with prejudice on the ground that each such allegation is merely an attempt to bootstrap plaintiffs' state law claims into federal securities law violations. Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 477-79, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977). Upon examination of the specific allegations underlying plaintiffs' securities law claims, the Court finds defendants' threshold argument persuasive as to the entirety of Count III and parts of Count II of plaintiffs' second amended complaint.

Plaintiffs allege in Count III that the Esmark 1979 Proxy Statement describing the LTGP "became materially false and misleading" as the result of defendants' various decisions to change the method by which LTGP awards were calculated and distributed in 1980 and 1981. Although framed as a claim under section 14 of the Securities Exchange Act, the crux of plaintiffs' objection in Count III is directed against the propriety and lawfulness of the changes made in the LTGP, not the accuracy or completeness of the proxy statement as such. Plaintiffs' reference to the proxy statement as a device to bootstrap the state law claims into federal securities law violations does not rise to the level of an independent claim for relief under section 14 of the Securities Exchange Act. Cf. Santa Fe Industries, supra, 430 U.S. at 478, 97 S.Ct. at 1303; Issen v. GSC Enterprises, Inc., 508 F. Supp. 1278, 1289-90 (N.D.Ill. 1981).

All of the misconduct alleged in Count III occurred after the issuance of the proxy statement. Plaintiffs make no allegation in this count that the representations contained in the 1979 proxy statement were materially false or misleading when made. Plaintiffs thus have failed to allege a violation of Rule 14a-9 which prohibits only those misrepresentations or omissions which are false or misleading "at the time and in the light of the circumstances under which [they are] made." 17 C.F.R. § 240.14a-9(a) (1981). Accordingly, the Court grants defendants' motions for summary judgment as to Count III of plaintiffs' second amended complaint. It is so ordered.

Plaintiffs raise a separate section 14 securities claim in Count II of the second amended complaint. Although Count II also alleges a variety of material misrepresentations and omissions in the Esmark 1979 Proxy Statement, the substance of most of the misrepresentations and nondisclosures detailed in this count purport to establish that the proxy statement was materially misleading when issued rather than upon the occurrence of future events.*fn34 The crux of plaintiffs' first claim under Count II, therefore, relates to the manner in which the LTGP was presented to Esmark shareholders for approval. Although related to plaintiffs' state claims, this federal securities law claim has a life of its own which must be evaluated on the merits.

The Esmark SLC evaluated the significance of a number of the misrepresentations and omissions alleged in Count II in its treatment of the related state law claims and its attempt to deal with plaintiffs' securities law claim. Although instructive, the SLC's conclusions regarding the 1979 proxy statement are not binding on this Court insofar as those conclusions purport to resolve plaintiffs' federal claims. This is true not only because the members of the SLC allegedly participated in the federal wrongdoing, but also because the focus of the SLC's state law inquiry was different than the focus of this Court's federal securities law inquiry.*fn35

The specific misrepresentations and omissions detailed in Count II fall into a variety of substantive categories relating to the terms and objectives of the LTGP. Defendants challenge the materiality of each of the categories on the premise that there is no substantial likelihood that a "reasonable shareholder" would have considered such disclosures or nondisclosures important in deciding whether to approve the LTGP.*fn36 TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976). Defendants also argue that the disclosures and nondisclosures in the 1979 proxy statement, even if material, are not causally linked to the injury allegedly suffered by Esmark as the result of defendants' administration of the LTGP. Neither of these arguments, however, are sufficient to permit this Court to dismiss plaintiffs' claim as a matter of law.*fn37

The 1979 Esmark Proxy Statement contained a summary description as well as the complete text of the LTGP. The most significant category of misrepresentations and omissions detailed in Count II relates to particular language contained in the LTGP and in the proxy statement's summary of the plan which allegedly implies that the plan is intended to reward key employees for their contribution to Esmark's long-term growth, not their contribution to Esmark's capital gain resulting from the one-time disposition of corporate assets. Second Amended Complaint, ¶ 54.A-B. Defendants counter these alleged misrepresentations with reference to the fact that the express terms of the LTGP rely upon Esmark's "net earnings per common share" as the yardstick to measure awards under the plan. See LTGP, ¶ 2g, h, i. Defendants contend that a reasonable investor would know that "net earnings per common share" includes capital gains.

Taken in isolation, defendants' argument appears persuasive. As an accounting principle, the LTGP's "net earnings per common share" yardstick would include those gains realized upon the disposition of corporate assets. We assume that the proverbial "reasonable shareholder" would understand the meaning of this widely-used accounting term. Cf. Greenapple v. Detroit Edison Co., 468 F. Supp. 702, 711-12 (S.D.N.Y. 1979), aff'd, 618 F.2d 198 (2d Cir. 1980). This is particularly true given that Esmark's 1978 Annual Report used the same term to refer to earnings which clearly included capital gains. See Esmark 1978 Annual Report, p. 39. Defendants' focus on a reasonable shareholder's abstract understanding of "net earnings per common share" does not, however, respond directly to plaintiffs' allegation that the total mix of information available to Esmark shareholders in 1979 suggested that awards under the LTGP would compensate key employees for their contributions to Esmark's long-term growth rather than gains realized upon its short-term shrinkage.*fn38 The total mix of information could well have led a reasonable investor to believe that net earnings per common share under the LTGP meant something other than net earnings per common share in the annual report or other financial documents.

Plaintiffs also challenge the representation in the 1979 Proxy Statement that independent compensation consultants recommended the LTGP to the Esmark Compensation Committee. Second Amended Complaint, ¶ 54.E. In fact, plaintiffs point out, the independent compensation consultants hired by Esmark, Sibson and Company, did not make any recommendations as to which compensation scheme Esmark ought to adopt. Indeed, in his appearance before the SLC, the consultant whose "recommendation" was reported in the proxy statement voiced a number of substantive objections to the formula utilized (and authored) by Esmark in making its LTGP awards.

Defendants challenge the materiality of this misrepresentation on two grounds. First, defendants note that the consultants named by Esmark did present to the Compensation Committee a variety of alternative compensation plans similar to the LTGP. Defendants argue that the difference between presenting a variety of compensation plans and recommending the LTGP is semantic. Although arguably true in the abstract, defendants' argument does not account for the fact that the consultants' objections to the LTGP, as voiced by Robert Sibson, were substantive, not semantic. The "recommendation" language in the proxy statement cannot be glossed over so easily.

Defendants also argue on the authority of the Third Circuit's opinion in Ash v. LFE Corporation, 525 F.2d 215 (3d Cir. 1975), that language in a proxy statement about the role of outside consultants in formulating incentive plans is not material. Ash does not, however, support defendants' position. In Ash, the disputed proxy statement had indicated that the Board of Directors had "proposed" the plan under consideration when, in fact, it had been prepared by outside consultants. The Court declared that this alleged defect in the proxy statement was trivial. 525 F.2d at 218. In the present case, however, the imprimatur reported in the proxy statement was the recommendation of an independent consultant, not merely the proposal of the Board of Directors. The former constitutes an endorsement from an independent group of experts. The latter constitutes a proposal from the corporation's board of generalists. We cannot conclude, therefore, that the misrepresentation alleged in the present case is immaterial as a matter of law.

Accordingly, the Court denies defendants' motions to dismiss with prejudice those allegations of Count II which involve the inclusion of capital gains in the LTGP and the recommendations of independent consultants. It is so ordered.

The remaining misrepresentations and omissions alleged in plaintiffs' first claim under Count II are either not materially misleading or otherwise not actionable under section 14. For example, plaintiffs allege that the representation in the proxy statement that "[t]he Board of Directors believes that the 1974 Stock Option Plan and preceding stock option plans have served the Company well" was misleading because, in fact, the preceding stock option plans had not served the Company well. Second Amended Complaint, ¶ 54.F. Plaintiffs' assessment of the success or failure of prior incentive plans does not, however, render a statement about the Board of Directors' assessment of those plans misleading. Moreover, plaintiffs do not allege and have not otherwise demonstrated any particular connection between the proxy statement's unrealistically favorable view of prior incentive plans and Esmark shareholders' adoption of the LTGP. We cannot infer materiality on this record.

Plaintiffs also allege that the section of the LTGP reprinted in the proxy statement concerning the independence of the Compensation Committee from management was "proven to be false" by subsequent events. Plaintiffs argue that this representation was false when made because defendants knew that Donald P. Kelly, President of Esmark, would dominate the Compensation Committee in contravention of the LTGP. The fact remains, however, that defendants' alleged expectation of Kelly's influence amounted to nothing more than speculation about the future independence of the Committee. Defendants were not obligated to disclose that speculation or otherwise temper the language of the LTGP to reflect such an expectation. It is well established that representations concerning the purported independence of a corporate committee are not generally actionable under the securities laws. Cf. Gaines v. Haughton, 645 F.2d 761, 776-77 (9th Cir. 1981); Cohen v. Ayers, 596 F.2d 733, 745 (7th Cir. 1979).

Plaintiffs next allege that the section of the LTGP providing for the setting of a performance period was proven to be false when the Compensation Committee failed to establish such a period in connection with the 1981 LTGP grant. This bootstrap of plaintiffs' state law claim does not constitute a separate cause of action under the federal securities laws. Santa Fe Industries, supra, 430 U.S. at 477-79, 97 S.Ct. at 1302-04. Plaintiffs do not even purport to allege that this representation in the proxy statement was false when made. Accordingly, plaintiffs' allegation does not rise to the level of a violation of section 14.

Plaintiffs finally assert that the 1979 proxy statement failed to disclose that the restructuring of Esmark in 1980 would unfairly increase the value of the LTGP awards and that the performance periods utilized in calculating awards under the plan would overlap so as to permit the Compensation Committee to count the earnings of a profitable year more than once. Neither of these alleged nondisclosures, however, are actionable under section 14. Defendants were under no obligation to disclose plaintiffs' theory concerning the potential effect of Esmark's restructuring, a project which was not even anticipated at the time the Board submitted the LTGP for shareholder approval.*fn39 Moreover, as already noted, plaintiffs' theory does not accurately describe the effect of Esmark's restructuring. Defendants cannot be held to a standard of disclosure which requires consideration of all possible contingencies and all possible results flowing from those contingencies.

Similarly, defendants were under no obligation to disclose the overlap between performance periods in the LTGP. The terms of the LTGP made relatively clear that since performance periods generally extended over more than one year, the calculation of LTGP awards in successive years would necessarily include overlapping performance periods. In contrast to the conflicting mix of disclosures concerning the inclusion of capital gains in the LTGP formula, nothing in the LTGP itself or in the summary of the LTGP could lead a reasonable shareholder to believe that performance periods would not overlap. This purported nondisclosure, therefore, was not material.

Accordingly, with those exceptions already noted, defendants' motions for summary judgment on plaintiffs' first claim in Count II is granted. It is so ordered.

In their second claim in Count II, plaintiffs allege that the 1981 award of restricted stock under the LTGP constituted a scheme to defraud Esmark and its shareholders in violation of section 10 of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Second Amended Complaint, ¶ 56. This conclusory allegation, however, is clearly insufficient to support a cause of action under section 10. Except for those state law objections raised in Count I, plaintiffs fail to allege how either Esmark or its shareholders were deceived in connection with the 1981 LTGP grant. To the extent the award of the grant itself constituted the scheme or device to defraud, plaintiffs' claim is entirely subsumed within Count I and does not support a cause of action under the federal securities laws. Santa Fe Industries, supra, 430 U.S. at 477-79, 97 S.Ct. at 1302-04. Accordingly, defendants' motions for summary judgment as to plaintiffs' second claim (Count II) is granted. It is so ordered.

III. Conclusion

In summary, defendants' motions to dismiss with prejudice or for summary judgment are granted as to certain allegations contained in plaintiffs' first and second claims under Count I. Defendants' motions are also granted as to the entirety of plaintiffs' third, fourth, fifth, sixth and seventh claims under Count I. Plaintiffs' eighth claim under Count I is dismissed. Defendants' motions are denied with respect to those allegations contained in plaintiffs' first and second claims under Count I as identified in the text of the opinion.

Defendants' motions are also granted as to certain allegations contained in plaintiffs' first claim under Count II and as to all of plaintiffs' second claim under Count II as well as the entirety of Count III. Defendants' motions are denied with respect to those allegations contained in plaintiffs' first claim under Count II as identified in the text of the opinion. It is so ordered.


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