United States District Court, D. Delaware
IN RE CATERPILLAR INC. DERIVATIVE LITIGATION.
REPORT AND RECOMMENDATION
CHRISTOPHER J. BURKE, Magistrate Judge.
Presently pending before the Court in this consolidated shareholder derivative action is the motion ("Motion") of Defendants David L. Calhoun, Daniel M. Dickinson, Eugene V. Fife, Juan Gallardo, David R. Goode, Jesse J. Green, Jr., Jon M. Huntsman, Jr., Stuart L. Levenick, Peter A. Magowan, Dennis A. Muilenberg, Douglas R. Oberhelman, William A. Osborn, James W. Owens, Charles D. Powell, Edward B. Rust, Jr., Susan C. Schwab, Joshua I. Smith, Gerard Vittecoq, Miles D. White, Steven H. Wunning and Nominal Defendant Caterpillar Inc. ("Caterpillar" or the "Company") seeking to dismiss, pursuant to Federal Rules of Civil Procedure 23.1 and 12(b)(6), the Verified Amended Consolidated Complaint filed by Plaintiffs City of Lansing Police and Fire Retirement System ("City of Lansing") and Asbestos Workers Philadelphia Pension Fund ("Asbestos Workers" and, collectively with City of Lansing, "Plaintiffs"). (D.I. 21) For the reasons that follow, the Court recommends that Defendants' Motion be GRANTED without prejudice.
A. Factual Background
1. The Parties
Plaintiffs are stockholders of Caterpillar who have owned Caterpillar stock at all relevant times for purposes of the instant action. (D.I. 18 at ¶¶ 11)
Nominal defendant Caterpillar is a publicly traded company that is incorporated in Delaware and maintains its principal place of business in Peoria, Illinois. ( Id. at ¶ 12) Caterpillar is the world's largest manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. ( Id. ) Caterpillar also sells financial products and insurance to customers through a worldwide dealer network. ( Id. )
Caterpillar's Board of Directors (the "Board") is currently composed of sixteen directors. That number includes fifteen independent, non-employee directors (Defendants Calhoun, Dickinson, Fife, Gallardo, Goode, Greene, Huntsman, Magowan, Muilenburg, Osborn, Powell, Rust, Schwab, Smith, and White (the "Independent Directors")), as well as Caterpillar's Chief Executive Officer ("CEO") Defendant Oberhelman. Defendant Owens was Caterpillar's CEO and Chairman of its Board from February 2004 through 2010 (collectively, with the Independent Directors and Defendant Oberhelman, the "Director Defendants"). ( Id. at ¶ ¶ 24, 30; D.I. 22 at 5)
Defendants Oberhelman, Levenick, Vittecoq, and Wunning (the "Officer Defendants" and, collectively with the Director Defendants, the "Individual Defendants") served as Caterpillar executive officers during the relevant time period. (D.I. 18 at ¶ ¶ 22, 31-34) Defendant Oberhelman has served as Caterpillar's CEO and Chairman of its Board since 2010. ( Id. at ¶ 22) Defendant Levenick is a Group President of Caterpillar who oversees customer and dealer support for the Company. ( Id. at ¶ 31) Defendant Vittecoq is a Group President and executive office member of Caterpillar, with administrative responsibility for the Company's energy and power systems group. ( Id. at ¶ 32) Defendant Wunning is a Group President of Caterpillar with administrative responsibility for the Resource Industries Group. ( Id. at ¶ 33) The Officer Defendants are "covered employees" as that term is defined in 26 U.S.C. § 162(m)(3) of the Internal Revenue Code and Treasury Regulation 1.162-27(c)(2); they are also "named executive officers" ("NEOs") as that term is defined in 17 C.F.R. § 229.402(a)(3). ( Id. at ¶ 34)
2. Section 162(m)
26 U.S.C. § 162(m) ("Section 162(m)") limits publicly held corporations from deducting annual compensation over $1 million paid to a "covered employee[, ]" defined by the statute as the corporation's CEO and its other "4 highest compensated officers." 26 U.S.C. §§ 162(m)(1) & (3). However, Section 162(m) includes an exception to this limit-for compensation that qualifies as "performance-based[, ]" meaning that it is paid "solely on account of the attainment of one or more performance goals[.]" Id. § 162(m)(4)(C). For remuneration to qualify as "performance-based" compensation, it must also meet the following requirements: (1) the performance goals referenced above must be determined by a compensation committee of the corporation's board of directors, comprised solely of two or more outside directors; (2) the material terms under which the remuneration is to be paid must be disclosed in advance to the corporation's shareholders, and must be approved in advance by a majority of such shareholders in a separate shareholder vote; and (3) before the remuneration is paid, the compensation committee must certify that the performance goals and any other material terms were satisfied. Id.
Treasury regulations implementing Section 162(m) further explain that these performance goals must be preestablished and objective. 26 C.F.R. § 1.162-27(e)(2)(i). A performance goal satisfies the "preestablished" requirement if it is established in writing by the compensation committee not later than 90 days after the start of the period of service to which the goal relates, so long as the outcome is substantially uncertain at the time the goal is set. Id. Nevertheless, in no event will a performance goal be considered "preestablished" if it is set after 25% of the relevant period of service has elapsed. Id. And a performance goal is considered to be "objective" if a third party with knowledge of the relevant facts could determine whether the goal is met. Id.
These Treasury regulations further require that before any shareholder vote, the company must disclose "the employees eligible to receive compensation; a description of the business criteria on which the performance goal is based; and either the maximum amount of compensation that could be paid to any employee or the formula used to calculate the amount of compensation to be paid to the employee if the performance goal is attained[.]" Id. § 1.162-27(e)(4)(i). Moreover, if a compensation committee has the authority to change the targets of a performance goal in a Section 162(m) plan after shareholder approval of the goal, then the material terms of the goal must be disclosed to and reapproved by the corporation's shareholders at least every five years. Id. § 1.162-27(e)(4)(vi).
3. The Incentive Compensation Plans at Issue
At issue in this lawsuit are two incentive compensation plans in place at Caterpillar: the Long-Term Incentive Plan (the "LTIP") and the Executive Short-Term Incentive Plan (the "ESTIP" and, together with the LTIP, the "Plans"). (D.I. 18 at, 2; D.I. 22 at 5-6)
a. The LTIP
The LTIP is a broad-based plan under which nearly all Caterpillar employees and Board members are eligible to participate. (D.I. 22, ex. A at 21-22) As of 2010, Caterpillar had approximately 94, 000 employees. ( Id. at 22) The LTIP is administered by the Compensation Committee (the "Committee") of the Board,  and its stated purpose is to provide key participants with "cash-based incentives, stock-based incentives and other equity interests in the Company, thereby giving them a stake in the growth and prosperity of the Company, aligning their interests with those of stockholders and encouraging the continuance of their services with the Company[.]" ( Id. at 21) In the time periods referenced in the Complaint, the LTIP set a maximum amount of compensation per eligible participant in a given year of 800, 000 shares of stock, or $5 million in cash. ( Id. at 22) Caterpillar's stock price on May 2, 2012 was $102.77, which would have then equated to an award of $87, 216, 000 for any participant eligible to receive the maximum amount of stock allowed under the LTIP. (D.I. 18 at, 52) Despite being eligible to participate in the LTIP, none of the Independent Directors have actually received any performance-based incentive compensation under that Plan. Instead, in 2009, the Independent Directors began to receive an annual fixed cash retainer for their Board service. (D.I. 22, ex. A at 67) In February 2011, the Board amended the compensation for Independent Directors to include a combination of cash and equity in the form of non-performance-based, time-vested restricted stock units, set at a total fixed value of $250, 000 annually. ( Id., ex. Bat 61-62)
b. The ESTIP
The ESTIP is an annual incentive compensation plan covering only Caterpillar's executive officers. (D.I. 22, ex. B at 17-18) Thus, the Independent Directors are not eligible to receive compensation under the ESTIP. ( Id. ) The participants in the ESTIP may receive cash awards if they meet annual performance goals established by the Committee. ( Id. at 17-18, 65)
c. The Approval and Re-approval of the Plans
(1) 2006 Approval of the LTIP and ESTIP
Both the LTIP and the ESTIP were established in 2006. A 2006 Proxy Statement summarized the features of both Plans, including the performance goals to be established under the Plans in light of Section 162(m). (D.I. 22, ex. D at 31, 36) Stockholders subsequently voted to approve the Plans at the 2006 Annual Meeting. ( Id., ex. E at 69)
(2) 2010 Re-approval of the LTIP
The Board sought shareholder votes on certain amendments to the LTIP at the 2010 Annual Meeting. (D.I. 22, ex. A) One such amendment was an increase in the amount of stock available for equity awards under the LTIP, from approximately 7, 000, 000 shares to approximately 27, 000, 000 shares. ( Id. at 21) Additionally, the 2010 Proxy Statement stated that approval of the amendments to the LTIP "will also constitute re-approval, for purposes of Section 162(m)... of the performance goals included in the Plan... that are to be used in connection with awards under the Plan that are intended to qualify as performance-based' compensation for purposes of Section 162(m)." ( Id. ) The Proxy Statement described the following fourteen possible performance criteria that the Committee could use to determine executive compensation intended to satisfy Section 162(m):
(i) revenue; (ii) primary or fully-diluted earnings per share; (iii) earnings before interest, taxes, depreciation, and/or amortization; (iv) pretax income; (v) cash flow from operations; (vi) total cash flow; (vii) return on equity; (viii) return on invested capital; (ix) return on assets; (x) net operating profits after taxes; (xi) economic value added; (xii) total stockholder return; (xiii) return on sales; or (xiv) any individual performance objective which is measured solely in terms of quantifiable targets related to the Company or the businesses of the Company; or any combination thereof.
( Id. at 24) The 2010 Proxy Statement also stated that "the Compensation Committee may elect to provide compensation outside those requirements [for qualification as performance-based compensation pursuant to Section 162(m)] when necessary to achieve its compensation objectives." ( Id. at 56) The shareholders voted to approve the proposal to amend the LTIP (and thus re-approve the Section 162(m) performance goals) at the 2010 Annual Meeting. (/d., ex. F at 3)
(3) 2011 Re-approval of the ESTIP
At the 2011 Annual Meeting, the Board sought shareholder votes on approval of the amended and restated ESTIP, including re-approval of the Plan's Section 162(m) performance criteria. (D.I. 22, ex. Bat 17-18) The ESTIP's performance criteria that could be used to determine executive compensation included the same fourteen criteria as disclosed in 2010 for the LTIP, as well as two additional criteria: "realized 6Sigma benefits" and "operating profit after capital charge[.]" ( Id. at 18) As with the LTIP, the 2011 Proxy Statement explained that, with regard to the ESTIP, "the Compensation Committee may elect to provide compensation outside those requirements [for qualification as performance-based compensation pursuant to Section 162(m)] when necessary to achieve its compensation ...