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CALIFORNIA CORPORATE & SECURITIES LAW

Ninth Circuit Finds That Purpose Of Stock Rights Plan Matters

Most equity award plans that I come across include a statement of the plan’s purposes.  I haven’t tended to give these provisions a whole lot of thought, but an opinion issued yesterday by the Ninth Circuit Court of Appeal makes it clear that a plan’s purpose clause can be very important indeed.  The case arose from the retirement of the plaintiff, a Mr. Foster Rich, from Booz Allen Hamilton, Inc. (BAH).  While working at BAH, Mr. Rich participated in the company’s stock rights plan (SRP) pursuant to which he was granted the right to purchase BAH shares.  When Mr. Rich retired from BAH, he had accumulated 30,500 shares.  BAH then exercised its right to repurchase those shares and paid Mr. Rich $4,507,900, or $147.80 per share.  That is a lot of money, but a little over a year later BAH sold a portion of its business to The Carlyle Group and holders of BAH stock received $763 per share. Because Mr. Rich was no longer a BAH shareholder, he did not receive any compensation from that transaction.  Presumably, Mr. Rich would have received $23,271,500 had his shares not been repurchased.  It seems that while Mr. Rich became wealthy under the SRP, he didn’t become nearly as wealthy as others.

Mr. Rich sued alleging breach of contract and Employee Retirement Income Security Act (“ERISA”) claims.  The Ninth Circuit Court of Appeals, citing the SRP’s statement of purpose, held that it was not subject to ERISA:

The main purpose of the SRP was not to provide retirement or systematically deferred income. The SRP states that its purpose is “to provide incentives for [BAH] Officers to continue to serve as employees of the Company and its subsidiaries.” A July 1995 memorandum to BAH partners explained: “[T]he stock program’s purpose is to provide for the Firm’s capital needs. Stock is not intended to be-and is not viewed by the Board as in fact being-an alternate form of compensation.” This is consistent with BAH’s stated philosophy and objectives regarding the SRP: “Stock is the single vehicle that provides for the orderly transition of ownership of [BAH] from one generation of Officers to the next,” “[t]he long-term capital needs of [BAH] will be provided for by the Officers,” and “[BAH] will not use other sources to fund long-term capital requirements.” With respect to retirement income, BAH communicated to partners that the SRP “should not be viewed principally as an estate-building vehicle since equity returns will be modest. Liquidation of stock at retirement is a return of capital rather than a source of retirement income.”

Rich v. Shrader, 2016 U.S. App. LEXIS 9488 (9th Cir. 2016).  The court, as quoted above, also noted a description of the SRP’s purpose in a memorandum to BAH “partners”.  This may be something to think about when responding to Item 1(a) of Form S-8 (“Briefly state the general nature and purpose of the plan, its duration, and any provisions for its modifi cation, earlier termination or extension to the extent that they affect the participants.”).

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