The opinion of the court was delivered by: BRIEANT
This action was tried before me on June 25, 28, 29, 30 and July 1, 1976, without a jury. Post-trial briefs and proposed findings of fact and conclusions of law have been submitted and considered. What follows, together with the formal numbered findings being filed simultaneously herewith, to the extent not inconsistent, and the stipulated facts docketed June 24, 1976, constitute the Court's findings and conclusions.
Since 1967, plaintiff Barbara C. Freedman, a citizen of New York, has owned at least 32 shares of common stock of defendant Exxon Corporation, formerly Standard Oil Company (New Jersey), hereinafter "Exxon", out of approximately 224,268,760 shares outstanding on May 17, 1973 ("the meeting date"). The named defendants in addition to Exxon are now or were officers and directors of Exxon.
Plaintiff sues derivatively on behalf of Exxon, claiming in Count One that the individual defendants violated Section 14(a) of the Securities Exchange Act of 1934 ("the 1934 Act"), 15 U.S.C. § 78n(a), and Rule 14a-9, 17 C.F.R. § 240.14a-9, promulgated thereunder by the Securities and Exchange Commission ("SEC"), by soliciting proxies for the May 17, 1973 annual meeting of Exxon, by a Proxy Statement which contained untrue statements of material fact and omitted to state material facts. Plaintiff further contends in Count Two that some of the defendants violated Section 16(b) of the 1934 Act, 15 U.S.C. § 78p(b), by making short-swing profits through the exercise of "stock appreciation rights" (SARs), described below, granted to them by Exxon pursuant to the terms of the 1973 Incentive Program authorized at the meeting. Finally plaintiff asserts in Count Three that the grant of SAR's, and the extension of the life of certain existing qualified stock options after the meeting, was without any consideration flowing to Exxon, and therefore violated applicable state corporation laws forbidding waste, or gifts of corporate assets. Exxon is a New Jersey corporation having its principal office in this District.
This Court has subject matter jurisdiction of this action pursuant to § 27 of the 1934 Act, 15 U.S.C. § 78aa, and principles of pendent jurisdiction. Plaintiff has the capacity and standing to bring this derivative action on behalf of Exxon. Although she made no demand on Exxon's Board of Directors to sue, I find such a request would be a futile and useless act. Berkwich v. Mencher, 239 F. Supp. 792 (S.D.N.Y. 1965).
Exxon and its more than 400 subsidiaries and affiliated companies conduct a substantial business in the United States and in more than one hundred other countries throughout the world. Directly, and through its affiliates, it is engaged principally in the exploration and production of crude oil and natural gas from lands owned, leased or held under concession; and in the extraction, refining, transportation and marketing of petroleum products and petrochemicals. At all relevant times the common stock of Exxon has been registered under § 12 of the 1934 Act, and has been listed and traded on the New York Stock Exchange.
The individually named Exxon management defendants may be classified in the following categories: Messrs. Barrow, Campbell, Jr., Cox, Garvin, Kauffmann, Piercy and Milbrath are presently or were at the time of trial, officers and directors of Exxon. Mr. Jamieson was Chairman of the Board and Chief Executive Officer of Exxon, until his retirement as an employee on July 31, 1975. He continues to serve as an "annuitant director." Messrs. Collado, Vazquez and Wright are former directors and officers of Exxon. Messrs. Anderson, Holloway, Peyton and Baze are or were at the time of trial, officers of Exxon. Messrs. Franklin, Learson, Long, MacNaughton and Peterson are, or were, so-called "outside" or non-employee directors of Exxon.
The specific positions and titles, and relevant time periods concerning the individual defendants are set forth in the Stipulated Facts, pp. 3-9.
Factual Background of the Controversy.
On May 15, 1968, by proceedings not questioned here, Exxon's shareholders approved and adopted the 1968 Incentive Program. That program was intended to replace the 1964 Incentive Program, and was to continue for five years from June 1, 1968 until May 31, 1973.
On May 17, 1973, just two weeks prior to the expiration of the 1968 Program, the shareholders approved the 1973 Incentive Program, which also had a five year term, extending from June 1, 1973 until May 31, 1978. This vote was solicited and obtained pursuant to the Proxy Statement which is claimed to be false and misleading.
While most of the basic concepts in these two programs had developed out of earlier executive incentive plans, it is the 1968 and 1973 Programs which are the focal points of plaintiff's claims, for the acts complained of were carried out pursuant to those two Programs. It is to the details of the 1968 and 1973 Programs that we must now turn.
The 1968 and 1973 Incentive Programs were similar. Each included a Stock Option Plan and a Bonus Plan. Only the Stock Option Plans concern us here. Under each Stock Option Plan, the total number of shares as to which options could be granted during the five year life of the plan was 1.5 million. Of this total, an individual Board member could receive no more than 30,000 shares, and the options of Directors as a group were limited to 250,000 shares during the life of each Program.
In addition, each Program provided that (1) options could be granted only during the five year term of the Program; (2) options granted were not assignable except as specially provided in case of death; (3) either qualified or non-qualified stock options could be granted; (4) the option price was to be 100% of the fair market value of the stock at the time of the grant of the option; (5) all shares purchased pursuant to an option must be fully paid for at the time of exercise; and (6) after one year of continued employment with Exxon following the grant, options were exercisable as to one-half of the optioned shares only, and as to the remaining one-half, two years of such continuous service were required.
Finally, both the 1968 and 1973 Incentive Programs, as presented to the shareholders and as set forth in the proxy statements, contained provisions for amendments. Section XX of the 1968 Program stated in relevant part:
"The Board can from time to time amend this Program, or any provision thereof, except that:
(1) The maximum number of shares that may be effectively optioned to eligible employees, or to members of the Board either individually or as a group, cannot be increased;
(2) The classes of eligible employees cannot be changed;
(3) The minimum limitations with respect to the required continuity of employment following the grant of options, and the prices at which shares may be optioned, cannot be decreased; * * *"
Section XX of the 1973 Program was identical, except that subsection (3) contained the following additional provision: ". . . and no option can be authorized that is exercisable more than ten years after the date of grant."
In two important respects, however, the 1968 and 1973 Incentive Programs were different. First, the 1968 Program had limited the number of shares which could be optioned in each year to an individual member of the Board to 10,000 shares, and limited grants to the Board of Directors as a group, to 75,000 shares in a year. These annual limitations were eliminated from the 1973 Program. Secondly, the 1973 Incentive Program expressly provided that an option granted under either plan may include a stock appreciation right, issued either at the time of grant of the option, or at a later date by an amendment to the option.
The stock appreciation right ("SAR") is described as follows in Section XII of the 1973 Proxy Statement (p. 50):
"A stock appreciation right shall entitle the optionee to surrender to the Corporation unexercised the option in which it is included, or any portion thereof, and to receive from the Corporation in exchange therefor that number of shares having an aggregate value equal to the excess of the value of one share over the purchase price per share specified in such option times the number of shares called for by the option, or portion thereof, which is so surrendered."
The corporation is entitled to elect to settle its obligation by the payment of cash equal to the aggregate value of the shares it would otherwise have to deliver. Section XII provides that a SAR is exercisable only to the extent that the option in which it is included is still exercisable. With a modification not relevant here, the closing price of Exxon shares on the New York Stock Exchange on the trading day preceding the date of exercise of the SAR is used for purposes of valuation.
To understand these incentive programs, their effect and purpose, some general observations may be helpful. The larger, more profitable American corporations which have achieved their success against overwhelming international competition, have done so through the efforts of highly skilled, experienced managerial and executive personnel who generally have little or no ownership of the business and no share in the customary rewards of shareholders. Keeping the high level of motivation of these employees, retaining their loyalty in the future, and protecting their skills, experience and specialized knowledge from raids by competitors or others, is the biggest single responsibility of top management, which naturally is also interested in its own compensation. Vengeful, progressive income taxes directed against the managerial class have made it impractical to motivate and reward solely with large salary payments. Their net effect after taxes soon becomes marginal, costing the corporation more than it brings to the executive. Also, other incentives costing less may be more effective than mere salary, or may be tied in more directly with such matters as corporate earnings, and stock market performance.
Because the problems of management incentives, and the need to hold experienced employees, are so great, Exxon, like most organizations of its size, had a full time executive, whose title was "Senior Advisor Executive Compensation." Until his retirement on February 1, 1976, the witness James F. Moore held this position. Supervising a staff of eight or nine employees, Moore was responsible for programs leading to fixing salaries for approximately 3,000 senior executives of Exxon, and for developing and implementing, under direction of the Board of Directors, incentive programs involving stock options, bonuses, pensions, insurance, employee benefits, and whatever other means his ingenuity and research or that of Exxon's competitors for managerial talent could evolve.
At all relevant times, Exxon had a "Committee on Executive Development and Compensation," called the COED Committee, which met every Monday afternoon to administer, among other things, incentives and compensation, bonus, stock options, and later, SARs, for employees other than directors. COED consisted of all directors who were officers and employees, with Moore attending without vote. In addition, there was a "Board Compensation Committee", referred to as the BCC, consisting of all the "outside" or non-employee directors, also assisted by Moore. The BCC dealt with the compensation of employees who were directors.
Moore's duties required him to be generally familiar with the income tax effect of various incentives, options and plans, on the employee, and upon Exxon. During the relevant period, there were substantial and changing differences in the tax treatment of qualified and non-qualified employee stock options, which need not concern us here. These tax and related effects varied according to the particular individual circumstances of the employee. In making grants of options, qualified or non-qualified, Exxon attempted to adapt the form of incentive to that most helpful to the individual employee.
Exxon's own image of its employee relations was not that of an innovator, nor the most lavish of employers. SARs, for example, were first granted by Xerox Corporation in its 1971 Plan. Moore's research led him in 1972 to suggest the same idea for Exxon's 1973 Program. Nor was Exxon the most lavish or generous of the large oil companies.
As used here, a SAR is only granted appurtenant to an existing or simultaneously granted stock option. Under applicable Internal Revenue provisions, attaching an SAR to an existing qualified stock option automatically converts that stock option into a non-qualified one, even if the SAR is not exercised. This may, or may not be desirable to a particular employee, depending on his own financial and income tax status. Obviously, since the typical stock option is a contract, an SAR may not be added unless both the employee and Exxon agree to it.
An operating example of use of an SAR may be helpful. Assume an employee has an unexpired option for 100 shares, which had been granted more than two years ago at an option price of $60.00 per share, and that an SAR had been granted at the time of issue, or thereafter by agreement. Assume further that the closing price of Exxon on the New York Stock Exchange yesterday was $75.00 per share, then the employee, by surrendering the option today and exercising the SAR, would be entitled to receive the excess of the value of the stock over the option price, multiplied by the number of shares opted. [ i.e. $75. - $60 X 100 = $1,500.00]. The corporation can then elect to pay this sum either in cash or in stock, in which case the individual would receive a total of 20 shares free and clear with a market value of $75.00 per share. An employee may at any time and from time to time exercise an SAR as to a portion only of the optioned shares; alternatively, he can exercise the option in whole or in part, and upon paying $60.00 per share receive shares worth $75.00 to the full extent of the option grant or in part. As will be discussed below, this usually entails the borrowing of money by the employee, with its attendant costs and risks. Grant of an SAR makes a non-qualified option more flexible to the worker, since he need not borrow or hold shares for which he has borrowed.
The 1973 Incentive Program provided specifically for the mechanism through which SARs would be granted. On p. 50 of the 1973 Proxy Statement it was stated: "Any option granted under a shareholder approved stock option plan may include a stock appreciation right, either at the time of grant or by amendment." A shareholder approved stock option plan was defined to mean either the 1968 or the 1973 Incentive Program. Thus, as noted above, Exxon was given express authority to amend options which were outstanding under the 1968 Program so as to include SARs, upon consent of the affected employee.
The 1968 and 1973 Incentive Programs vested ultimate responsibility for their administration in the Board of Directors, which has, by resolution, delegated those duties to the COED and BCC committees, as noted above.
Under both the 1968 and 1973 Programs, only key employees are eligible for the grant of stock options. This comprises about 3,000 people in managerial and professional positions, but recent experience indicates that only about 900 individuals each year were actually awarded stock options. To govern the process of singling out deserving recipients among younger employees in the middle management and chemical engineering ranks, the COED Committee issued guidelines for the use of supervisors in making recommendations. These guidelines, which did not bind the Committee, stated in part:
"As opposed to bonuses which are primarily intended to recognize an employee's performance in the previous year, the purpose of stock options is to retain key employees by encouraging them to remain with the Company and to increase their shareholdings."
All of Exxon's sixty-one officers and directors are regarded as key employees; all of them received annual grants of stock options.
Under the 1968 Incentive Program, after a decision to award stock options had been made by the granting authority (COED or BCC), an employee with a base salary of $50,000. or more (raised in 1973 to $60,000.) was contacted by the Executive Compensation Staff and was allowed to choose between accepting a qualified option, a non-qualified option, or between 1970 and 1972, a combination option. Employees with salary below $50,000. were awarded non-qualified options, except that between 1970 and 1972 they too were given the choice between non-qualified and combination options.
Qualified options, which were designed to fit Section 422 of the Internal Revenue Code, had a term of five years from the date of grant. Upon exercise, if the individual held the acquired stock for more than three years, any gain on the ultimate sale or exchange of that stock would qualify for long-term capital gains treatment. Non-qualified options had a ten year term from the date of grant. Upon exercise of the option, the individual realizes ordinary income measured by the difference between the option price and the fair market value of the stock. The corporation enjoys an income tax deduction for this same amount, but receives no deduction in connection with exercise by an employee of a qualified option. Neither the grant nor the exercise of a qualified or non-qualified option has any effect on the corporation's stated earnings or its profit and loss statement. The stock delivered to the employee comes from the capital account; in the case of a qualified option, that account is debited for the market value of the shares and then credited for the amount of the cash paid in by the employee, so that the net debit or decline in corporate net worth is the spread between the option price of the shares and their market value. For a non-qualified option, the same adjustment is made with respect to the capital account, except that the decline in net worth is less, because the tax deduction which the corporation receives upon exercise is also credited to the capital account.
In October 1970 the Board of Directors amended the 1968 Stock Option Plan. The purpose of this amendment, authorized by Section XX of the Program, was to take advantage of an IRS ruling which permitted the issuance of combination options. Such an option is a simultaneous grant of a qualified and a non-qualified option for the same underlying shares. While only one of the options could actually be exercised as to any particular optioned share, and once exercised, would reduce pro tanto the number of shares available under the other type of option, the combination option gives the individual greater flexibility in planning the tax and other financial consequences. He can defer his choice between a qualified or non-qualified option from the date of grant to time of exercise. However, due to a change in tax rulings, no combination options were issued by Exxon after January 1973.
Of the 1,500,000 shares authorized under the 1968 Incentive Program, 1,485,090 shares (approximately 99%) had been awarded by the end of 1972, five months prior to the expiration date of the Plan. These options had been awarded in five separate grants: in 1968 at $83.25 per share, in 1969 at $61.13 per share, in 1970 at $71.50 per share, in 1971 at $72.44 per share, and in 1972 at $86.75 per share. Due to low market prices of Exxon stock, and high interest rates prevailing during this period, and perhaps to other factors as well, at the end of 1972, options covering 1,316,548 shares which had been granted under the 1968 Plan remained unexercised. It should be noted that while the 1968 Plan was to expire on May 31, 1973, the options granted under that Plan all had a minimum life of at least five years, which was measured from the date of the grant, and not from the date the Plan commenced. Although the 1968 Plan itself would expire in 1973, in that no more options could be granted pursuant to its terms after ...