DAVID B. SHAEV, Appellant v. LAWRENCE SAPER; ALAN B. ABRAMSON; DAVID ALTSCHILLER; JOSEPH GRAYZEL, M.D.; GEORGE HELLER; ARNO NASH; DATASCOPE CORP.
No. 02-2206
UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT
February 21, 2003
2003 Decisions, Paper 771
Before: SLOVITER, McKEE, and ROSENN, Circuit Judges.
PRECEDENTIAL. Appeal from the United States District Court For the District of New Jersey. D.C. No.: 01-CV-3744 (JAP). District Judge: Honorable Joel A. Pisano. Argued:
A. Arnold Gershon, Esq. (Argued)
BALLON, STOLL, BADER & NADLER
1450 Broadway, 14th Floor
New York, NY 10018
Counsel for Appellant
Louis M. Solomon, Esq.
Andrew J. Levander, Esq.
SWIDLER BERLIN SHEREFF FRIEDMAN
405 Lexington Avenue
The Chrysler Building
New York, NY 10174
Counsel for Appellees
OPINION OF THE COURT
ROSENN, Circuit Judge:
This case presents important questions pertaining to corporate governance and responsibility. They involve the application and alleged violations of Securities Exchange and Treasury Regulations with respect to shareholder proxy statements soliciting shareholder approval of executive incentive compensation plans. Datascope Corporation (Datascope or the Company), a corporation chartered under the laws of Delaware, has its principal place of business in Montvale, New Jersey, where it is engaged in the manufacture of complex cardiology, vascular, and other medical proprietary products. The Company’s board of directors (Board) issued a proxy statement to its shareholders soliciting support for an amendment to its Management Incentive Plan (MIP) which determined the bonus compensation to be awarded to Datascope’s president, Lawrence Saper.
Datascope shareholder David Shaev brought a derivative lawsuit under the Federal Securities Exchange Act of 1934 and applicable regulations alleging that the proxy statement made false and misleading statements regarding material facts. The District Court dismissed Shaev’s claim on the pleadings and declined to exercise supplementаl jurisdiction over Shaev’s excessive compensation claim under Delaware law. Shaev timely appealed. We vacate and remand.
I.
For the purposes of defendants’ motion to dismiss, we must accept as true Shaev’s allegations in his complaint and make all reasonable inferences in his favor. Hayes v. Gross, 982 F.2d 104, 105-06 (3d Cir. 1992). The defendant’s motion to dismiss automatically halted discovery. Thus, Shaev has not had the opportunity to substantiate some of his allegations.
Saper has been the Chief Executive Officer (CEO) and chairman of the Board of Datascope since 1964. Saper and his immediate family hold approximately 19% of Datascope’s shares, which are traded on NASDAQ. As of July 1, 1996, Saper entered into an employment agrеement with Datascope for a term of five years with an automatic extension, unless either party gave notice of an intent to terminate the contract. Saper receives an annual base salary with increases as determined by the Board or the Compensation Committee. On September 22, 1999, the Compensation Committee increased Saper’s annual base salary to $1 million per year. Saper also became entitled to receive bonuses under various long-term and annual incentive compensation plans. On May 26, 1999, Saper received an immediately-exercisable option to purchase 70,000 shares of stock at an exercise price equal to the market price of the stоck, expiring May 25, 2009. Using an option-pricing model, Shaev alleges that this option was worth $1,016,200. Additionally, the complaint alleges that Saper’s annual lifetime retirement payments are worth approximately $1,406,400 per year and cost the company $10,000,000.
On December 7, 1999, Datascope adopted a supplemental Management Incentive Plan that provided for bonus payments to eligible executives. The payments were contingent on attainment of various corporate goals and some subjective
On May 16, 2000, the Board’s Compensation Committee amended the 1999 supplement. The Board adopted the 2000 amendment for a nine-month performance period commencing October 1, 1999, and continuing through July 30, 2000. The performance goals for that nine-month performance period were adopted on December 7, 1999. However, as of December 7, 1999, the maximum Saper bonus was $2,225,000. In the May 16, 2000, amendment, the Board increased to $3,285,714 the amount of compensation that would be awarded to Saper if Datascope met the performance goals adopted five months earlier. The performance period ended approximately six weeks latеr.
Under the 2000 amendment, Saper could have received 83% of the increase in the earnings of the company at the high end of earnings per share. As a shareholder, Saper would also get 19% of the remaining 17% if dividends were issued, leaving only 14% of the remainder to the shareholders.
On October 27, 2000, the Board issued a proxy statement in connection with its annual meeting to be held on December 12, 2000. The proxy statement solicited shareholder approval of the 2000 amendment. However, the proxy statement did not include the material features of the 1999 supplement which it amended, and it did not mention the 1997 Plan which the 1999 MIP supplemented.
The proxy statement explained that the Board intended to administer the amendment in a way that would allow the Company to deduct bonuses and incentive payments for tax purposes. Furthermore, the proxy stated that “[s]hareholder approval of the Management Incentive Plan is required in order for the Management Incentive Plan to be effective and for bonuses payable thereunder to a ‘covered employee’ within the meaning of
Saper earned $3,285,714 in bonus compensation in FYE 2002. According to the proxy statement, $1,485,714 of that amount was subject to shareholder approval of the amendment. See Dist. Ct. op. at A 6. The proxy statement also stated that “[i]n the event that the Management Incentive Plan is not approved by the shareholders of the Corporation, the Compensation Committee may grant Mr. Saрer another bonus for FYE 2000, a portion of which may not be deductible under
Shaev filed a derivative action in the United States District Court for the District of New Jersey. Shaev did not make
On April 2, 2002, District Judge Pisano dismissed Shaev’s securities claim with prejudice under
II.
The threshold question we must decide is the validity of the defendants’ challenge to the plaintiff’s right to sue in behalf of the Company without first having made a demand upon its Board of Directors to take appropriate action for relief. In a derivative lawsuit, the shareholder must make a demand on the board of directors of the corporation to take action to correct the wrongdoing, or allege the reasons for the plaintiff’s failure for not making the effort. See
Shaev alleges that he brings this action derivatively as the right of and for the benefit of the Company. He asserts that he has been a stockholder of the Company continuously for many years and throughout the period of the alleged wrongs. He acknowledges that he made no demand upon the Board of Directors of the Company to file and prosecute this action “because such demand would be futile and, therefore, excused.” In support of his claim of futility, he avers that three of the six members of the Board are financially interested in Saper’s payments. Saper, of course, was the beneficiary of the stock options and incentive benefits set up for him. The other two board members, defendants Altschiller and Grayzel, are alleged in the complaint to lack independence because their consulting fees, bonuses, stock options and other perquisites are subject to Saper’s control.
Plaintiff further alleges that under Delaware law, demand on the Board of Directors is excused when three of the six Board members are neither disinterested nor independent. Furthermore, the complaint alleges that the entirе Board is neither disinterested nor independent since every member of the Board is potentially
The District Court did not address this issue; however, the parties have briefed it on appeal. Under Delaware law, a demand on a board of directors is excused where half of the members of an even numbered board are alleged to be interested or lack independence. Beneville v. York, 769 A.2d 80, 86 (Del. Ch. 2000) (“As a doctrinal matter, it thus makes little sense to find that demand is refused in an evenly divided situation.“). The complaint also alleges that Saper, as Chief Executive Officer, has the power to engage consultants. Board member Altschiller has since September 1, 1998, been a consultant for the Company, initially at $100,000 per year, but his compensation was increаsed on December 1, 1998, to $135,500 per year. In August 1999, he was given a discretionary bonus of $25,000. He has also been the recipient of options to purchase Company stock. The complaint further alleges that he is “financially dependent and beholden” to Saper for his consulting engagement fees and benefits he receives from the Company.
As for Board member and defendant Grayzel, the complaint alleges that he has been a consultant for the Company since January 1968 and was paid fees “of $161,700 in each of the fiscal years ending 1998, 1999, and 2000.” In addition, the complaint avers that the Company paid him a discretionary bonus of $30,000 in FYE 1998 and 1999, and granted him stock options as well; that he too is dependent and beholden to Saper fоr consulting engagement fees and benefits he receives from the Company.
All of these allegations, for the purpose of the motion to dismiss, must be taken as true. Under Rales v. Blasband, 634 A.2d 927, 936-37 (Del. 1993), an interested director is one who receives a financial benefit from a corporate transaction. Saper, Altschiller and Grayzel are allegedly interested directors, and it is alleged that they constitute half of the Board. Shaev alleges that a demand on the directors for remedial action would have been futile. If so, demand would be excused because the interest of the Board in the situation was, at the very least, evenly divided.
On remand, the parties can pursue the factual issues relevant to the futility of demand through the use of discovery.
Therе is no point, therefore, to discuss plaintiff’s additional allegations that demand is excused under federal law, were we to decide that Delaware law was to the contrary.
III.
Under the
No solicitation subject to this regulation shall be made by means of any proxy statement . . . which, at the time . . . it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading.
Shareholders have an implied cause of action to seek relief when a false or misleading proxy statement interferes with “fair corporate suffrage.” J.I. Case v. Borak, 377 U.S. 426, 431-32 (1964).
To state a claim under
The Internal Revenue Code (IRC) generally disallows deductions for employee remuneration in a publicly held corporation in excess of $1 million.
only if-- (i) the performance goals are determined by a compensation committee of the board of directors of the taxpayer which is comprised solely of 2 or more outside directors, (ii) the material terms under which the remuneration is to be paid, including the performance goals, are disclosed to shareholders and approved by a majority of the vote in a separate shareholder vote before the payment of such rеmuneration.
Likewise, the Treasury Regulations elaborate on the exception for the $1 million deduction limit under
Shaev’s complaint that the 2000 amendment to the Plan was established too late to qualify for a deduction is well made. The Regulations require that a qualified performance goal be established not later than the ninetieth day of the performance period or before twenty-five percent of the рerformance period has elapsed. The supplement was adopted in December 1999, halfway through Datascope’s fiscal year, and then restated in May 2000. December was too late to establish the necessary performance goals to receive the deduction because the Company’s fiscal year ended in June 2000. By adjusting the amount of the incentive compensation in May 2000 and shortening the time period to less than a year, Datascope’s Board hoped to circumvent the Regulations which allow corporations to create incentives for executives to meet objective, uncertain goals. As an incentive, the outcome of a performance goal, of cоurse, must be substantially uncertain at the time the compensation committee establishes the goal.
In the absence of special circumstances, such as when a new company is formed or when an established company changes its fiscal year in good faith, a performance period shorter than one year makes it much less likely that the MIP will meet this requirement. On the facts as alleged, Datascope’s performance period was too short to meet the Treasury Regulations requirements and improperly impaired their purpose. The incentive plan was only an exception to the general rule that salaries exceeding $1 million were not tax deductible. Therefore, an incentive program that allowed in excess of $1 million must comply strictly with the performance requirements set down by the Treasury Regulations.
Furthermore, even if the Company had estаblished a long enough performance period, the existence of discretion to increase the amount of the bonus so late in the performance period undermined its deductibility. Under the Treasury Regulations, if there is discretion to increase the calculated bonus, the deduction is lost. See
Payments of the Saper bonus, even if the shareholders voted against it, also precluded the deduction. The Regulations state that “[t]he material terms of the performance goal under which the compensation is to be paid must be disclosed to and subsequently approved by the shareholders of the publicly held corporation before the compensation is paid. The requirements of this paragraph . . . are not satisfied if the compensation would be paid regardless of whether the material terms are approved by shareholders.”
The complaint accurately alleges that Datascope’s Board made a materially false statement in the proxy statement when it stated that the bonus would be deductiblе if the shareholders approved it. Regardless of the shareholders’ approval, the bonus would not have been deductible under the Treasury Regulations, and the alleged false statement in the proxy statement is actionable.5
IV.
The allegations in the complaint that the Board failed to include the 1999 supplement in the proxy statement amounted to a material omission under
We hold that the cryptic references in the proxy statement were insufficient to satisfy Datascope’s disclosure obligations under
The Proxy Statement’s omission of the performance goals is material because the stockholders had no way of knowing that Saper had not earned the $3,285,714 bonus under the terms of the currently existing plan. Thе Proxy Statement contains no discussion of the 1997 Plan or how the 2000 amendment compares with the 1999 supplement or the 1997 Plan.6 The defendants respond that the two Plans have little to do with one another: “there was no need to publish the 1997 Plan again in the Proxy Statement nor was there a need to compare it to the 2000 Plan since both were to be in effect if the shareholders approved the 2000 Plan.” This argument is sophistical because the 2000 amendment was not a stand-alone Plan. On the contrary, it was an amendment to an unstated supplement. To determine the overall incentive effects, stockholders would have had to read the three documents together, and they did not have them.
The terms of the 1997 Plan and the 1999 supplement are also relevant to the stockholders’ assessment of the truth of the statement that the bonus would be tax deductible if approved. Assuming arguendo that the IRS treatment of the bonus was uncertain at the time of the proxy statement, a reasonable investor might take this uncertainty into account in deciding whether to vote to authorize the bonus. The risk that the bonus might not be tax deductible and the information necessary to determine whether it was deductible were material to the average investor’s action at the time of the proxy statement, even if the IRS or a court should ultimately reject Shaev’s argument.
The 1997 Plan and the 1999 supplement were also relevant to the shareholders’ consideration of the 2000 proxy because the Boаrd was asking the shareholders to approve a retroactive increase in Saper’s bonus. There is no authority that the Board has the power to increase Saper’s bonus retroactively. By failing to include the 1999 supplement in the proxy, the Board effectively asked the shareholders to do what the Board itself could not do, and without any notice to stockholders that they were doing it.
The District Court erred in concluding that
The District Court misread the federal regulations when it concluded that Shaev’s complaint demanded access to specific business criteria that the Board was not required to disclose. It is true that under
In order to meet the shareholder approval requirement, the material terms under which the compensation is to be paid must be disclosed . . . It is intended that not all the details of a plan (or agreement) need be disclosed in all cases . . . To the extent consistent with [the SEC] rules, however, disclosure should be as specific as possible. It is expected that shareholders will, at a minimum, be made aware of the general performance goals on which the executive‘s compensation is based and the maximum amount that could be paid to the executive if such performance goals were met.
See H.R. Conf. Rep. No. 103-213, at 587-88 (1993).
We conclude that pertinent information in the 1997 Plan and notice that the proposed bonus substantially would exceed the amount to which Saper would have been entitled under the 1999 supplement were “material” within the meaning of
The District Court erred when it held on a
The defendants argue that whether the bonus was tax deductible was immaterial because the deduction would represent a small figure in comparison with the $300 million revenues of the company. See In re Westinghouse Sec. Litig., 90 F.3d 696, 715 (3d Cir. 1996) (holding that a write-down of .54% of net income was not material).9 Although the potential deduction is small in relation to the overall budget, the deduction is nevertheless material because the Treasury Regulations required management disclosure and stockholder approval of the principal features of the incentive plan in order to qualify for the deduction. Thus, materiality of the required disclosure is not dependent on the quantity of money involved but on its purpose of informing the stockholders.10
V.
The District Court may decline to exercise supplemental jurisdiction over state law claims when the District Court has dismissed all claims over which it has original jurisdiction. See
VI.
To recapitulate, the plaintiff has stated a cause of action on the following grounds: (1) the proxy statement failed to disclose the existence and material terms of the 1997 Plan; (2) the proxy statement failed to disclose the material terms of the 1999 supplement. Importantly, it did not disclose that the amount of compensation to which Saper would be entitled under the 2000 amendment exceeded the $2,225,000 compensation maximum established under the 1999 supplement; (3) the proxy statement omitted the number of eligible executive participants under the Plan, in violation of the Securities Exchange Regulations,
Accordingly, the District Court’s order dismissing Shaev’s securities claim will be vacated and the case remanded to the District Court for further proceedings consistent with this opinion. Costs taxed against the appellees.
A True Copy:
Teste:
Clerk of the United States Court of Appeals for the Third Circuit