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Executive Stock Option Plan Upheld

7th Circuit Court Seal

Donnawell v. Hamburger, No. 15-1006 (7th Cir. 2015)

Appeal from District Court, ND Illinois, Eastern Div. 12 C 9074
Argued Oct.01, 2015 — Decided Oct.20, 2015

In this appeal of a shareholder derivative suit concerning a stock option plan used as executive compensation, the Plaintiff appealed from dismissal with prejudice by the District Court for the Northern District of Illinois, Eastern Division.

The Plaintiff was a stockholder in DeVry Education Group, a Delaware company that owns and operates for-profit colleges. Plaintiff brought a Shareholder Derivative Action against current and former DeVry Board members. It ended up in Federal Court due to diversity of citizenship (Illinois vs. Delaware).

The 7th Circuit affirmed the District Court’s dismissal, applying Delaware corporate law.

Facts

An incentive plan adopted by the company in 2005 authorized the award of stock options to key employees including the CEO. The 2005 plan limited awards to 150,000 shares per employee per year but the company granted Daniel Hamburger, who became CEO in 2006, options on far too many shares. In 2012 the company reduced its grants under the 2005 plan but allocated still more shares to Hamburger under its earlier 2003 incentive plan, which held that shares that were authorized but not yet allocated could be allocated later. As a result, Hamburger received options in 2012 far above the 150,000 limit. All of the grants were proposed by the company’s Compensation Committee to its independent directors and approved. At the time all members of the Compensation Committee, and all but two board members, were independent directors.

Plaintiff pointed out that under the 2003 plan only the company’s (inactive and dissolved) Plan Committee, not its (current, active) Compensation Committee, could grant stock options. But there was no Plan Committee in 2012 and the only full-time, salaried employee of the company who was also a member of the board of directors was Hamburger himself. He did not choose to act as a one-man Plan Committee; instead, the grant of the additional stock options to Hamburger was approved by the Compensation Committee and independent directors as a whole.

Opinion

The 7th Circuit affirmed the District Court’s dismissal of the action, reasoning primarily along 2 lines:

First, in response to the Plaintiff’s claim that only the (defunct) Plan Committee constituted under the 2003 Plan could award the additional options to Hamburger, the Court noted that even under terms of that Plan any decision by the Plan Committee required approval by the Compensation Committee. The Court also likened the Plan Committee to the “agent” of the Compensation Committee; what an agent can do, a principal certainly can as well. Finally, the Court noted that to obtain optimum tax treatment for performance based compensation such as stock options, pursuant to 26 U.S.C. §162(m)(4)(C) the Compensation Committee’s input would have been necessary.

Second, the Court noted that the directors who actually approved the Compensation Committee’s recommendation were disinterested anyway, so their recommendation was a valid exercise of their business judgment and protected by the “Business Judgment Rule.”

Conclusions

In sum, the 7th Circuit held that the grant of Options issued under the 2003 Plan by the Compensation Committee convened pursuant to the 2005 Plan was not a “clear or intentional violation of the compensation plan” as charged by the Appellant; especially because the “Plan Committee” created by the 2003 Plan was no longer active.

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