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Pasternack v. Shrader

United States Court of Appeals, Second Circuit

July 13, 2017

BRUCE PASTERNACK, Plaintiff-Appellant,
v.
RALPH W. SHRADER, C.G. APPLEBY, SAMUEL R. STRICKLAND, JOSEPH E. GARNER, DENNIS O. DOUGHTY, FRANCIS J. HENRY, CHRISTOPHER M. KELLY, DANIEL C. LEWIS, JOSEPH W. MAHAFFEE, JOHN D. MAYER, PATRICK F. PECK, BOOZ ALLEN HAMILTON INCORPORATED, GARY D. AHLQUIST, MARTIN J. BOLLINGER, LLOYD W. HOWELL, JR., WILLIAM C. JACKSON, PAMELA M. LENTZ, ERIC A. SPIEGEL, Defendants-Counter Claimants-Appellees, REGINALD BOUDINOT, PAUL KOCOUREK, Consolidated-Plaintiffs-Appellants EXPLORER COINVEST LLC, EXPLORER HOLDING CORPORATION, EXPLORER INVESTOR CORPORATION, CREDIT SUISSE SECURITIES (USA) LLC, Consolidated-Defendants, DEANNE M. AGUIRRE, SHUMEET BANERJI, PETER BERTONE, CHRISTIAN BURGER, HEATHER L. BURNS, MARK J. GERENCSER, DAVIG G. KNOTT, HELMUT MEIER, HORACIO D. ROZANSKI, JOE SADDI, DOUGLAS G. SWENSON, STEVEN B. WHEELER, CARLYLE GROUP, CARLYLE PARTNERS V, L.P., Defendants.

          Argued: December 15, 2016

         Retired officers of Booz Allen Hamilton ("Booz Allen") allege that they received insufficient payment in connection with Booz Allen's sale of a division to another company. They sue Booz Allen and others in the United States District Court for the Southern District of New York (Kaplan, J.), asserting liability under the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1001 et seq., the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq., federal securities law, and common law. Each claim was resolved adversely to plaintiffs, either by dismissal or by denial of leave to amend. We affirm the district court's dismissal of the ERISA claims because the plan through which Booz Allen distributed its stock to plaintiffs is not an employee pension benefit plan within the meaning of ERISA. However, we vacate the judgment to the extent that it denied the motion by one plaintiff for leave to amend to add securities-fraud claims. Leave to amend was denied on the ground that the claim was waived by a release, and on the ground of delay. That release, however, is unenforceable by virtue of Section 29(a) of the Securities Exchange Act of 1934, and there is no other sustainable basis on which to deny leave to amend. As to all the remaining claims, we affirm.

          MARK M. ELLIOTT (Jared R. Clark on the brief), Phillips Nizer LLP, New York, NY, for Plaintiff-Appellant Bruce Pasternack.

          MICHAEL Q. ENGLISH, Finn Dixon & Herling LLP, Stamford, CT, for Plaintiff-Appellant Reginald Boudinot.

          Mark Kelly, Kelly & Hazen, New York, NY, for Consolidated-Plaintiffs-Appellants Reginald Boudinot and Paul Kocourek.

          J. SCOTT BALLENGER (Everett C. Johnson, Jr., J. Christian Word, Sarah A. Greenfield, and Jonathan Y. Ellis on the brief), Latham & Watkins LLP, Washington, DC, for Defendants-Counter Claimants-Appellees.

          Before: WINTER, JACOBS, and POOLER, Circuit Judges.

          JACOBS, Circuit Judge.

         The plaintiffs are retired officers of Booz Allen Hamilton, a privately-held corporation. Bruce Pasternack, Reginald Boudinot, and Paul Kocourek allege that they were improperly denied compensation when, after their retirement, Booz Allen Hamilton sold one of its divisions to the Carlyle Group (the "Carlyle Transaction"). They sued Booz Allen Hamilton and several of its officers (collectively "Booz Allen"), as well as various individuals and entities involved in the Carlyle Transaction. Numerous amended complaints were filed by each plaintiff. On appeal, we review the legal sufficiency of various claims under the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1001 et seq., the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq., federal securities law, and common law. In general, all three plaintiffs allege that Booz Allen improperly discriminated among different Booz Allen officers and violated the duties of due care, loyalty, and good faith, in violation of ERISA. Kocourek separately argues that Booz Allen fraudulently induced him and others to sell Booz Allen stock at prices below fair value, in violation of federal securities regulations and other law.

         The United States District Court for the Southern District of New York (Kaplan, J.) dismissed the ERISA claims on the ground that Booz Allen's stock-distribution program was not a pension plan within the meaning of ERISA, and denied as futile leave to amend to "augment" the ERISA claims with new allegations. The RICO claims were dismissed on the ground that they were barred by the Private Securities Litigation Reform Act of 1995 ("PSLRA"), see 18 U.S.C. § 1964(c). Kocourek's request to amend his complaint to add securities-fraud claims was denied on the grounds of futility and undue delay. It appears that the district court did not directly address Kocourek's proposed common law claims; so Kocourek asks us to remand to the district court for reconsideration of those claims. No other claim is before us on appeal.

         We affirm the district court in all respects save one. We vacate the judgment of the district court to the extent it denied Kocourek leave to amend to add securities-fraud causes of action, and we remand the case to the district court to consider those claims.

         I

         Booz Allen is a privately-owned corporation that operates in all material respects like a partnership. The company has no outside investors, avoids outside debt, and is wholly owned by its officers, who are referred to internally as partners.

         A

         Booz Allen allocates its stock via its Stock Rights Plan (the "SRP"). For purposes of this opinion, Booz Allen stock can be classed as "common stock" or "Class B stock, " although the actual operation of the SRP is more complicated. The SRP operates as follows. In an officer's first participation year, the officer is given the option to purchase a block of shares, of which 10% is common stock and 90% is Class B. The officer pays book value for the common stock tranche, and a nominal amount for the Class B tranche. In each successive year, the officer exchanges some of the Class B stock for common stock, so that the percentage of common stock in the initial grant increases annually by 10%. Thus, at the end of the second year, the block is composed of 20% common stock and 80% Class B stock; at the end of the third year, 30% common and 70% Class B; and so on, until at the end of ten years, the block is 100% common stock. The officer pays for the incremental conversions to common stock at the price of half of book value at the time of the initial grant.

         A new, parallel, ten-year process begins every year, as the officer continuously receives new amounts of both common stock and Class B stock.

         When an officer separates from Booz Allen, the disposition of the officer's remaining Class B stock depends on how the officer leaves. If the officer is terminated for cause or leaves the company before retirement, the officer loses the right to exchange the Class B stock for common stock and must return the Class B stock to Booz Allen. If the participant retires with Booz Allen's approval, all outstanding Class B stock may be converted into common stock. Retirees are allowed to continue holding their stock for two years into retirement, after which Booz Allen has the option of repurchasing the retiree's common stock at the current book value.[1] Common stock and Class B stock have voting rights in the management of Booz Allen, and the common stock pays a small annual dividend.

         As a matter of policy, the only owners of Booz Allen stock are the company itself and its partners. Partners can sell their stock only to Booz Allen. Although at least one SRP policy document states that partners may sell their common stock back to Booz Allen at any time, the plaintiffs allege that partners were effectively unable to do so until retirement.

         The SRP is a lucrative arrangement that allows participants to realize handsome profits when they sell their common stock. The relevant measure of the common stock's worth is its book value, i.e., Booz Allen's net assets divided by the number of outstanding shares of common stock. The company undertakes to increase the actual book value of the common stock by 10% annually, and has done so every year since 1978. Participants buy shares either at book value (measured at the time of the initial grant) for the 10% portion of the annual grant composed of common stock, or at half of book value (again measured at the time of issuance) for the remaining 90% of those shares that begin as Class B stock and convert to common stock over the ensuing nine years. Because the book value appreciates at a compounded rate of 10% annually, the current book value in any year will be higher than the purchase price--generally much higher. A participant who received an initial grant of 100 shares in 2001, with a book value of $100 per share, would ultimately pay $5, 500 by 2010 to receive 100 shares of common stock, which by then would be worth $23, 579--a 329% return on investment with nominal risk.

         B

         Plaintiffs Pasternack, Boudinot, and Kocourek are all former officers of Booz Allen. They retired with the company's blessing in 2004, 2005, and 2007, respectively. They all participated in the SRP.

         C

         In 2008, Booz Allen sold its Government Contracting Division to an affiliate of the Carlyle Group. The Carlyle Transaction was approved by a supermajority of Booz Allen stockholders (i.e., participants in the SRP). Then-current stockholders received $763 per share of common stock, an amount far in excess of book value.

         At the time of the Carlyle Transaction, Pasternack and Boudinot had no common stock because Booz Allen exercised its option under the SRP to repurchase their shares two years after their retirement. Since Kocourek's two-year post-retirement period had not elapsed, Kocourek still held common stock, which he sold in the Carlyle Transaction for approximately $20 million.

         D

         The three plaintiffs filed individual complaints in 2009. Initially, there was no allegation that the SRP was governed by ERISA; but each complaint was amended (with the defendants' consent) to add ERISA claims. The three complaints were consolidated.

         Most of the claims in the consolidated complaint were dismissed on motion, including the ERISA claims and RICO claims. Plaintiffs' motion for leave to amend their ERISA claims was denied. Kocourek's separate request for leave to add securities-fraud claims was denied on the grounds of futility and undue delay. A few other claims, not before us on appeal, were dismissed at summary judgment.

         All three plaintiffs appeal the dismissal of the ERISA-based claims, which were dismissed on the ground that the SRP was not covered by ERISA. The plaintiffs also appeal the denial of their motion to amend their ERISA claims. Kocourek separately appeals from the district court's dismissal of his RICO claims and the denial of leave to amend to add securities-fraud claims. Kocourek also seeks to revive his common-law claims for breach of fiduciary duty.

         II

         The district court did not reach the merits of the ERISA claims because it concluded that the plaintiffs failed to allege facts demonstrating ...


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