Monday, July 17, 2017

Stock-distribution plan not ERISA-protected, fraud claims not waived by release

By Amy Leisinger, J.D.

A Second Circuit panel vacated a judgment to the extent that the district court denied leave to amend to add securities fraud claims. According to the panel, the purported release of liability relied on in denying amendment was unenforceable under Exchange Act Section 29(a), but the related Racketeer Influenced and Corrupt Organizations Act claims were properly dismissed as waived. The panel also upheld the dismissal of the plaintiffs’ Employee Retirement Income Security Act claims, noting that the plan through which the stock was distributed is not an employee pension benefit plan within the meaning of the statute (Pasternack v. Shrader, July 13, 2017, Jacobs, D.).

Compensation claims. Booz Allen Hamilton is a corporation that operates like a partnership, wholly owned by its officers. The company allocates its stock via a Stock Rights Plan (SRP), under which an officer receives allocations of common stock and Class B stock; in each successive year, the officer pays to exchange some of the Class B stock for common stock. The SRP allows participants to realize substantial profits when they sell their common stock at book value (i.e., Booz Allen’s net assets divided by the number of outstanding shares of common stock), typically following retirement.

The plaintiffs, retired Booz Allen officers, brought actions alleging that they were improperly denied compensation when, after their retirement, Booz Allen sold one of its divisions to another organization at $763 per share of common stock, an amount far in excess of book value. The Southern District of New York dismissed the plaintiffs’ ERISA claims on the ground that Booz Allen’s stock-distribution program was not a pension plan under ERISA, and the RICO claims were dismissed as barred by the Private Securities Litigation Reform Act. One plaintiff’s request to amend his complaint to add securities fraud claims was denied on the grounds of futility and undue delay in connection with a release of liability.

ERISA claims. The panel affirmed the district court’s dismissal of the ERISA claims, finding that the distribution plan is not an “employee pension benefit plan” under ERISA. An ERISA-protected plain is one that “results in a deferral of income” or “provides retirement income,” the panel noted. The SRP is not connected with retirement, according to the panel; it is a means by which to ensure that Booz Allen is entirely owned by the officers, and the SRP returns capital by buying out the ownership stake accumulated by a separating partner. Income is not deferred under the SRP, the panel found, as the benefit a participant receives in exchange for capital is an ownership stake and managerial authority, which accrues during tenure at Booz Allen, not retirement. Further, the phrase “provides retirement income” does not cover every instance in which a person cashes out an investment at retirement, even though this may be a result, particularly in this case where the purpose of the SRP is to gather working capital and maintain internal control, according to the panel.

Fraud claims. The panel did vacate the judgment to the extent that it denied the motion to amend to add securities-fraud claims. The individual retiree still had shares when the transaction closed, and, in order to receive a payout, he had to sign a letter surrendering the shares, which contained a release clause. Exchange Act Section 29(a) voids provisions binding a person to waive compliance with an Exchange Act provision, and, according to the panel, shareholders may not be forced to forego their rights due to a contract provision. The letter was essentially a contract for the sale of the officer’s securities, and the release clause purported to waive all claims in contravention of Section 29(a), the panel found.

A waiver in the context of settling litigation can be, and often is, acceptable and appropriate, as it does not “waive compliance” but instead results in a remedy for an alleged violation that satisfies “compliance,” the panel stated. The release clause in the letter had nothing to do with satisfying of a pre-existing claim, the court stated, and the denial of leave to amend based on delay and litigation expense was an abuse of discretion.

RICO claims. Although the release clause does not bar the securities-fraud claims, the panel found, it does prevent the plaintiff from asserting his common law and RICO claims. The RICO statute states that a plaintiff may not rely upon conduct actionable as fraud to establish RICO liability, and the release clause effected a waiver of all claims other than securities fraud. These claims were properly dismissed, the panel concluded.

The case is No. 16-217.

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