A company’s proxy statement relating to its compensation plan is not materially misleading if it discloses the number of securities underlying the company’s obligation to deliver shares when an option-holder exercises options under the plan, a federal appeals court has ruled.
In suing The Boeing Co., a shareholder claimed that the company violated Item 10 of SEC Rule 14a-101 because a proxy statement about its compensation plan did not tell investors that the number of options that could be issued was not limited by the plan’s restriction on the number of shares of stock available for issuance under the plan.
But the 2nd Circuit—in the first federal appellate decision in the country to address the issue—said Boeing’s proxy satisfied the SEC rule.
“[T]he proxy statement informs investors that ‘[t]he aggregate number of shares of Boeing stock available for issuance under the … Plan will not exceed 30 million.’ The proxy statement further explains that this number may be increased by three million shares if Boeing acquires another company. ... This disclosure adequately informs investors of the amount of securities that could be issued to satisfy Boeing’s obligation to deliver shares under the Plan when an option-holder exercises options,” the court wrote.
The plaintiff’s attorney, A. Arnold Gershon of Ballon Stoll Bader & Nadler in New York, told Compliance Week that the court “got it wrong from beginning to end.”
The Boeing proxy gave shareholders “no information about the plan that’s of any use to them,” said Gershon. “It doesn’t disclose the number of shares underlying the options. It doesn’t disclose the costs of the plan. Stockholders who were voting for this plan were unwittingly giving the board of directors the power to grant an unlimited number of options.”
Kistenbroker
But David Kistenbroker of Chicago, who represented the Boeing defendants, said that the court “got it right” by “rejecting the plaintiff’s argument that the [SEC] rule requires the identification of the number of options that could be issued or would be issued rather than the number of shares underlying the options.”
Kistenbroker, a partner with Katten Muchin Zavis Rosenman, noted that, “in a new plan, there’s been no grant of options at the time of the proxy’s publication. It’s impossible to predict how many options might be granted. … That’s why the rule is written the way it is.”
"Specifically Informed"
The suit against Boeing arose out of the company’s solicitation of proxies at its 2003 annual meeting to approve the company’s “incentive stock option plan,” which permitted the grant of stock options to employees and directors.
The proxy stated: “The aggregate number of shares of Boeing stock available for issuance under the 2003 Plan will not exceed 30 million, which represents approximately 3.75 percent of the currently outstanding shares of Boeing stock eligible to vote as Feb. 28, 2003. The Board of Directors, in its sole discretion, may increase the aggregate number of shares of Boeing stock available for issuance under the 2003 Plan by an additional three million.”
Leatrice Seinfeld, a Boeing stockholder, filed a shareholder derivative suit arguing that the proxy statement was materially misleading under Item 10 of SEC Rule 14a-101, which specifies the information that must be included in a proxy describing a cash or non-cash compensation plan. The rule requires such a proxy to set forth the “title and amount of securities underlying such options.”
The lawsuit claimed that Boeing’s proxy was misleading because “stockholders were not specifically informed that the limit on the number of shares available for issuance under the plan did not constrain the number of options that Boeing might issue under the plan to employees and directors,” the 2nd Circuit wrote. “Mainly, this was because the options could be settled in cash, allowing Boeing to issue options without ever requiring that shares issue.”
In response, Boeing said that no investor would have read the proxy statement to
mean that there was such a limit on the number of options that could be issued under the plan, and that the SEC rule did not require the proxy to state the number of options that might be issued.
Securities Underlying Options
A federal judge in the Southern District of New York dismissed the suit, finding that Item 10 does not require a proxy statement to disclose the number of options that may be granted under a compensation plan.
The 2nd Circuit agreed, rejecting the plaintiff’s argument that the term “amount of securities underlying options” should be interpreted to mean the “amount of options.”
The plaintiff also argued that the SEC rule should be read in conjunction with Statement No. 123 of the Financial Accounting Standards Board, which, according to the court, “suggests that the economic consequences of granting options are best accounted for the at the time of grant, and not the time of exercise.”
But the court, citing an earlier suit against a compensation plan by Symbol Technologies, said that “technical accounting standards governing the appropriate timing for recognition of revenues and costs simply do not change the SEC’s straightforward regulations, including those laid out in Item 10, governing proxy statement disclosure.”
Defense counsel Kistenbroker said it “really would have turned the law on its ear” if the court had ruled in favor of the plaintiff. “For a new plan, it would have been an impossibility to adequately disclose the number of options. It’s simply not knowable. It would be guesswork,” he said.
But plaintiff’s counsel Gershon said the court has “allowed directors unlimited discretion in granting stock options. There’s no limit in the amount of dilution to [shareholders’] economic interest that can follow,” he said, noting that the 2nd Circuit panel would be asked to reconsider its ruling and, if that fails, review by the entire court would be sought.
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