Cohen v. Ayers

Citation449 F. Supp. 298
Decision Date03 April 1978
Docket NumberNo. 76 C 4312.,76 C 4312.
CourtU.S. District Court — Northern District of Illinois
PartiesMurray COHEN, Plaintiff, v. Thomas G. AYERS, William O. Beers, Archie R. Boe, Sidney L. Boyar, James W. Button, Alfred I. Davies, Luther H. Foster, Jack F. Kincannon, John G. Lowe, Gordon M. Metcalf, Charles A. Meyer, Aurelio M. Prado, Julius Rosenwald, II, William I. Spencer, Edgar B. Stern, Jr., A. Dean Swift, Edward R. Telling, W. Wallace Tudor, Thomas F. Wands, Arthur M. Wood, and Sears, Roebuck & Co., Defendants.





Garwin & Bronzaft, New York City, Harrold W. Huff, Robert E. Kehoe, Jr., and Anne Giddings Kimball, Wildman, Harrold, Allen & Dixon, Chicago, Ill., for plaintiff.

Henry J. Silberberg, New York City, for defendants Ayers, Beers, Boe, Button, Davies, Kincannon, Lowe, Prado, Rosenwald, Swift, Telling and Wood.

Joseph J. Skinner, New York City, Arthur Medow, Chicago, Ill., for defendant Sears, Roebuck & Co.

Richard K. Wray, John F. McClure, Burton Y. Weitzenfeld, Arnstein, Gluck, Weitzenfeld & Minow, Chicago, Ill., for defendants Foster, Meyer, Metcalf, Stern, Tudor and Wands.


MARSHALL, District Judge.

This is a derivative action brought by one minority shareholder, Murray Cohen, against Sears, Roebuck and Co. (Sears) and several of its directors and former directors. Plaintiff attacks part of the administration of Sears' 1967 and 1972 stock option plans. Plaintiff contends that defendants breached common law duties and violated § 14(a) and § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78n(a), 78j(b). The action was filed in the United States District Court for the Southern District of New York and was transferred here pursuant to 28 U.S.C. § 1404(a). Defendants' motion for summary judgment is ready for decision. Also pending is defendants' motion to strike the affidavit of Bertram Bronzaft, one of the attorneys for plaintiff, which was filed in opposition to defendants' motion for summary judgment.

Subject matter jurisdiction over the federal securities allegations is based upon § 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa. With respect to the common law aspects of the case, subject matter jurisdiction is asserted on the basis of diversity jurisdiction, 28 U.S.C. § 1332, and principles of pendent jurisdiction. The complaint alleges that plaintiff is a citizen of New Jersey and that defendant Sears is a New York corporation with its principal place of business in Illinois. As for the individual defendants, the complaint alleges that the defendants are citizens of states other than New Jersey, but that "diversity of citizenship jurisdiction is asserted only with respect to defendants who are not citizens of the state of New Jersey." Defendants have admitted the allegations concerning the citizenship of all defendants.

With respect to the state law claims, we must determine which state's law is applicable. Dreis & Krump Mfg. Co. v. Phoenix Ins. Co., 548 F.2d 681, 682 (7th Cir. 1977). Under both Illinois and New York conflict rules, New York law governs the issues. Sears is incorporated in New York and the law of the state of incorporation governs the internal affairs of a corporation. Rogers v. Guaranty Trust Co., 288 U.S. 123, 53 S.Ct. 295, 77 L.Ed. 652 (1933); Paulman v. Kritzer, 74 Ill.App.2d 284, 219 N.E.2d 541 (1966), aff'd, 38 Ill.2d 101, 230 N.E.2d 262 (1967); N.Y.Bus.Corp.Law § 103.

I. Statement of Facts

For many years, Sears has periodically granted stock options to key employees and officers. The purpose of the stock option program is to encourage valued employees to acquire a proprietary interest in Sears as an incentive to spur them to give their best efforts to the corporation. Key employees are those who are exempt from the Fair Labor Standards Act, and now include over 15,000 of Sears' supervisory employees. Typically, the Board of Directors of Sears secured prior approval of its plans from the shareholders.

Generally, employee stock option plans are designed to entice valuable corporate employees to remain with the corporation. They are a useful and relatively inexpensive alternative to offering large salaries that will be consumed by taxes. To increase the net salary of employees in high income brackets, the corporation must pay much more than the executive actually receives. Stock options avoid this problem in part. See Comment, Stock Compensation Plans, 1971 Wis.L.Rev. 854, for a discussion of tax implications of stock option programs. One problem with stock option compensation is that the value of the options is uncertain. Assuming that the option is granted for exercise at a fixed price, the option only has value if the market price exceeds the option price. In a rising market, stock options can be a real windfall to the employee. But in the early 1970's the stock market generally and Sears shares specifically declined in value. This case arises out of the efforts of Sears' management to salvage its stock option program after the market decline. We begin with a description of Sears' 1967 and 1972 stock option plans.

In 1967, the Board of Directors of Sears issued a proxy statement recommending that the stockholders authorize the grant of options covering up to 3,000,000 shares of stock to various key employees of Sears. The 3,000,000 options were to include 300,000 shares for employees who were also directors. The plan provided that the Board of Directors would appoint a committee of non-employee disinterested directors who would select the key employees to receive options and how many options each employee would receive. This committee was known as the Salary and Supplemental Compensation Committee. According to the plan, the options could be qualified under § 422 of the Internal Revenue Code for favorable tax treatment as capital gain, or they could be nonqualified for favorable tax treatment. The plan did not set a specific price for shares, but did require that the price per share be at least the fair market value of Sears' common shares on the date the option was granted. The plan gave to the Board of Directors the power to grant options upon such terms and conditions as it might authorize. It also vested the Board with the power to "prescribe such provisions and interpretations not inconsistent herewith as it shall deem necessary for carrying out the purposes of the Plan." In addition, the plan provided that if an employee died or if his or her employment was terminated, the options would lapse after a short interval. Qualified options were to be exercised within five years from the date of grant and nonqualified options were valid for ten years. No options were to be granted under the 1967 plan after November 1, 1976. Without defining the terms "expired" or "terminated," the plan stated that the unpurchased shares under expired or terminated options might again be optioned under the plan. The plan made no mention of cancelling options. The proxy statement, but not the 1967 plan itself, advised that only the shareholders could amend the plan. This plan was adopted by majority vote of the shareholders.

In 1972, the Board of Directors adopted a resolution recommending that the shareholders approve another stock option plan, this time authorizing options to purchase a total of 4,000,000 shares, including 300,000 for employee-directors. As in 1967, the Board of Directors issued a proxy statement to its shareholders in which it described the plan generally and reprinted the text of the plan. There were few differences between the description of this plan and that of the 1967 plan, and most of the differences resulted from changes in the tax consequences of the options due to changes in the Internal Revenue Code since 1967. The provisions of the 1972 plan concerning the granting of options, the administration of the program, and termination of option rights were substantially the same as in the 1967 plan. By a majority vote, the shareholders authorized this plan.

After the shareholders approved the 1967 plan, the Board of Directors began to grant stock options under it. The Salary and Supplemental Compensation Committee, which selected the optionees, consisted of five directors who were not Sears employees. Although the Committee was authorized to select employees to receive options, it relied heavily upon the recommendations of management. Under the direction of the vice president in charge of personnel, management developed a formula for selecting employees and appropriate number of options. That formula took into account suggestions from the territorial administrative offices, as well as from the central personnel office. The final recommendations were then presented to the Committee, which always approved them without change.

On September 21, 1967, the Board granted options for 2,260,016 shares to key employees, including employee-directors. The price of these options was $56.82 per share, the market price of Sears shares at that time. Over the next four years, many of the options were exercised, and a number of them lapsed. Another grant of options was made in June of 1971, for a total of 621,612 options at a price of $89.82 per share, the market price at that time. Only 11,543 of these options were exercised. The market price of Sears stock continued to rise in the early 1970's. Consistent with the plan provision that the price per share must be at least the market value of the shares, the exercise price for grants of options during this time rose as well. On December 12, 1972, options were granted at $116.44 per share under the 1967 plan and under the newly authorized 1972 plan. Options were also granted under both plans on April 2, 1973 at $101.13 per share.

About this time, the market turned around and began to decline. Sears employees now held options granted in 1972 and 1973 that they had no...

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