The opinion of the court was delivered by: POLLACK
This derivative action against Revlon, Inc. and its directors has been submitted for judgment as to liability on stipulated facts. Jurisdiction is posited on diversity and on questions arising under the federal securities laws.
In a stipulation entered into by the parties on April 9, 1979, and filed on June 22, 1979, it was agreed that "this action shall be adjudicated with the same force and effect as if a trial had been held on the issue of liability and the . . . agreed facts and exhibits constituted the evidence at said trial." The parties, having determined that the issue of liability in this case could be decided on stipulated facts, thereby waived their right to present live testimony and removed such attendant issues as witness credibility from the purview of this Court.
This action concerns the administration of Revlon's Executive Stock Option Plan (hereinafter "the plan"), which was adopted by the stockholders in 1957, and, as detailed below, amended from time to time thereafter. In particular, the case arises out of the cancellation in June 1974 of outstanding stock options held by certain Revlon employees and the issuance in exchange of a like number of new options at a lower price to replace the cancelled options. This cancellation and exchange program was conducted by Revlon's Stock Option Committee pursuant to the authorization it had been given in May 1974 by the Board of Directors, which had at the same time in May adopted resolutions amending the plan in certain ways to accommodate the cancellation and exchange. Neither the cancellation and exchange nor the amendments to the plan in respect thereof were submitted to a vote by the stockholders.
Plaintiff asserts that the May 1974 amendments were null and void because the Board's power to unilaterally amend the plan which admittedly it had to begin with had lapsed prior to that time. Plaintiff's argument is as follows: as adopted in 1957, the plan gave the Board power to modify the plan at any time up until June 1, 1967 (the original termination date of the plan); the Board subsequently adopted resolutions extending its power of modification to June 30, 1973; however, neither the Board nor the stockholders adopted any resolution prior to June 30, 1973 expressing an extension of the Board's power of modification beyond that date; as a result, the Board's power to modify the plan lapsed on June 30, 1973, and all power of modification reverted to the stockholders. Hence, the May 1974 amendments, which were not voted on by the stockholders, are claimed to have been a nullity.
Plaintiff asserts further that without the May 1974 amendments, the plan did not countenance the cancellation and exchange of options, which, according to plaintiff, is simply a device for lowering the price of outstanding options. Plaintiff claims that the Board thus exceeded its power in conducting the cancellation and exchange in violation of the plan, and, moreover, also exceeded the maximum number of shares that could be issued under the plan.
Plaintiff also attacks the cancellation and exchange on the ground that the Board of Directors expressly stated in proxy statements issued in 1961 and 1963 that it would not effect a price reduction in stock options through a cancellation and exchange without obtaining shareholder approval. This representation was allegedly binding on the Board in 1974 and prohibited it from conducting the cancellation and exchange without shareholder approval. In addition, plaintiff claims that the Board made similar representations in listing applications filed with the New York Stock Exchange ("N.Y.S.E.") in 1961 and 1963, and that when the Board conducted the cancellation and exchange in 1974, it violated this "agreement" with the N.Y.S.E. and also violated the rules of the N.Y.S.E.
Finally, plaintiff claims that the proxy statements issued by Revlon in 1973, 1974, and 1975 violated § 14(a) of the Securities Exchange Act of 1934 by being materially false and misleading with respect to those portions dealing with the stock option plan.
For the reasons discussed hereafter, the 1974 addition to the pool of options by reason of cancellations of unexercised options under the "exchange" program will not be given effect and the validity of grants of options in 1974 and thereafter will be upheld only to the extent that shares were otherwise available for option. Liability will be adjudged to the extent that grants resulted in the issuance of options under the plan beyond the maximum number of options authorized by the plan and to the extent that any employee was granted options on more shares than would have been permissible under the plan without the cancellations.
The Executive Stock Option Plan was adopted by the Board of Directors on January 23, 1957, subject to the approval of the stockholders. The 1957 proxy statement recommended that the stockholders approve the plan because
It is now generally recognized that stock option plans constitute an effective method of attracting and retaining valued management personnel . . . In the opinion of the Board of Directors, this (plan) will strengthen the desire of such personnel to remain as employees and stimulate their efforts on the Company's behalf, which should contribute to the Company's future welfare and success.
The plan, a full copy of which was appended to the proxy statement, was duly approved by a majority of the shareholders at their annual meeting.
As originally adopted, the plan provided, inter alia, that it was to be administered by a Stock Option Committee consisting of three or more directors, excluding directors who were eligible to participate in the plan; the term of all options granted was to be seven years or less; options were to be exercisable not earlier than 18 months from their issuance, after which the optionee could exercise annually up to 20% of the shares to which the option related; the option price was to be at least 95% of the market price of the stock on the day the option was granted.
The total number of shares originally available under the plan was 140,000, the optioned stock to consist of either unissued or re-acquired (treasury) stock. No employee was eligible to receive options to purchase more than 10,000 shares. The plan was to terminate on June 30, 1967, but the Board of Directors was given power to modify or terminate the plan at any time prior to June 30, 1967.
Amendments of the plan 1959-1963
Notwithstanding the power given the Board to modify the plan, Revlon's Board of Directors developed a practice of submitting most amendments to the plan to the stockholders for approval. In 1959, for example, the Board adopted, subject to shareholder approval, a resolution that the plan
be and hereby is amended by changing paragraphs 2 and 5 thereof to read as follows:
The total number of shares . . . shall not exceed 200,000 . . .
5. EXPIRATION AND TERMINATION OF THE PLAN
Options may be granted under the Plan at any time . . . prior to June 30, 1969, on which date the Plan will expire. Such options shall remain in effect until they have been exercised or have expired. The Plan may be terminated or modified at any time prior to June 30, 1959 by the Board of Directors.
Pursuant to this Board resolution, the 1959 proxy statement submitted for shareholder consideration "a proposal to increase the number of shares of the Company's Common Stock subject to the Plan from 140,000 to 200,000 shares, and to extend its expiration date from June 30, 1967 to June 30, 1969." The proxy statement did not, however, fully set forth the plan or even paragraphs 2 and 5 as amended, and thus, did not state or suggest that the proposal involved the Board's power to modify the plan, or that adoption of the proposal would extend the Board's power of modification to June 30, 1969.
Nonetheless, the submitted proposal was duly approved by the shareholders, as recommended by the proxy statement.
Virtually this same series of events was replayed in 1961, when the plan was amended to increase the number of available shares to 600,000
, and to extend the plan's expiration date to June 30, 1971; and again in 1963, when the plan was amended to increase the number of available shares to 806,000 and to extend the expiration date to June 30, 1973. In each of these years, the Board adopted a resolution setting forth the pertinent paragraphs of the plan as amended, and in each case the Board's power of modification was extended in paragraph 5 to be coterminous with the new expiration date of the plan. The proxy statements in each of these years, however, did not fully set forth the amended paragraphs, but simply presented the shareholders with proposals "to increase the number of shares . . . subject to the plan . . . and to extend its expiration date." No mention was made in the proxy statements that the Board's power to modify the plan had been or would be similarly extended.
In addition, both the 1961 and 1963 proxy statements contained the following statement:
Unless submitted to stockholders for their approval, no adjustments or reduction of the exercise price of any option shall be made, in the event of a decline in the market price, such as by cancellation of outstanding options and subsequent regranting of options at a lower price.
This statement also appeared on listing applications submitted by Revlon to the New York Stock Exchange in 1961 and 1963.
In both years, the proposed amendments were approved by the stockholders.
Conversion of the plan to a "qualified" plan
The Board of Directors deviated somewhat from its practice of submitting proposed amendments of the plan to the stockholders in 1964, when it unilaterally adopted amendments designed to convert the plan from a "restricted" plan to a "qualified" plan under § 422 of the Internal Revenue Code. Under these amendments, the term of options became five years or less; the option price became 100% of the market price of the stock on the day of the grant; and, most importantly, no option could be exercised while any option previously granted at a higher price was outstanding. The provision that no option could be exercised until at least 18 months after issuance was continued as before.
Although, as mentioned, the amendments made in converting the plan from a restricted to a qualified plan were not submitted to the shareholders, they were fully disclosed in the 1965 proxy statement, when shareholder approval of an amendment was sought and obtained permitting the Stock Option Committee to grant options at less than 100% of market value to executives of companies acquired in mergers. The 1965 proxy statement did not repeat the statement contained in the 1961 and 1963 proxy statements viz., that unless submitted to the stockholders for their approval, no adjustments or reduction of the exercise price shall be made, in the event of a decline in the market price, such as by cancellation of outstanding options and subsequent regranting of options at a lower price; nor did any of the proxy statements issued subsequent to 1965 contain such a statement.
Amendments of the plan 1966-1971
In 1966, the Board of Directors adopted a resolution, subject to shareholder approval, that the plan
be and . . . hereby is amended by changing Paragraph 2 to increase the number of shares of stock subject thereto from 814,060 to 1,014,060 . . . and by providing in Paragraph 5 thereof that the date on which the Plan will expire is February 1, 1974 instead of February 1, ...