Did Individual’s Testimony Lead Company to Recall His Stock?

Stay alert to regulatory changes affecting compensation and benefits, find out about industry trends, and review current surveys and statistics with Benefits & Compensation Management Update.


By Keith M. Hill  

“I adhered to our agreement's terms and did not go work for a competitor. You, on the other hand, breached our agreement when you said that you could recall my stock shares at any time after I testified against you. That's retaliation, and you can't do that,” said Jake, a former company employee, to Don, the company's chief executive officer.

“As stated in the stock agreement, the company possesses a continuing right of recall, and it exercised that right,” Don replied.

FACTS: An individual was hired by an investment management company to develop its retirement plan services division.

The company later adopted a series of stock option plans that let employees purchase its privately held common stock. Each stock purchase was governed by a stock restriction agreement that gave the company the continuing right to call any of its shares for repurchase.

The individual exercised these options and purchased 238,000 shares of privately held common stock.

The individual left the investment management company to work for the financial services company that operated the retirement plan division as a joint venture and then bought it.

The CEO of the investment management company told the individual that the company would not exercise its right of stock redemption unless he went to work for a competitor.

In time, the individual left the financial services company to start a business, which did not compete with the investment management company. He did not sell his stock because he thought the investment management company would only exercise its right of redemption if he began working for a competitor.

The individual was the only current or former employee subpoenaed by the investment management company to testify in arbitration proceedings against the financial services company after a dispute arose between the companies about the retirement plan services division.

Although the individual's testimony was not helpful to the investment management company's position, it prevailed in the arbitration and won a $373 million judgment.

The individual received a letter from the investment management company that said it held the right to recall his shares at any time.

Days after the arbitration proceeding was resolved in favor of the investment management company and the day before the annual dividends were to be paid, the company recalled the individual's shares pursuant to its rights under the stock option agreements.

A former employee claimed a company's share recall violated state law.

The individual filed a lawsuit in federal court, claiming that the company breached the implied covenant of good faith and fair dealing. The company recalled the individual's shares in retaliation for his testimony in the arbitration proceeding in violation of Missouri law, he said.

The district court dismissed the individual's complaint, finding that the stock-option agreement gave the company the right to recall the shares at any time.

ISSUE:  Did the company's stock recall constitute retaliation for the individual's testimony?  

DECISION: The company's action constituted retaliation for the individual's testimony in the arbitration proceeding, a federal appeals court said in reversing and remanding the district court's ruling.

“Missouri law implies a covenant of good faith and fair dealing in every contract,” the court said. An individual properly pleads a breach of that covenant “when he alleges the defendant's action violated public policy,” it said.

“In Missouri, retaliating against an individual for providing truthful testimony in a quasi-judicial proceeding violates public policy,” the court said.

The timing of the company's recall demand and the warning letter indicated that the company meant to retaliate for his testimony, the court said.

The stock options were compensation for the individual's employment, and the company's actions were in violation of public policy, denying him compensation earned through that employment, the court said (Kmak v. Am. Century Cos., Inc.,2014 BL 156161, 8th Cir., No. 13-1530, 6/5/14).

POINTERS: Compensatory stock options fall into two categories: incentive stock options that meet the requirements of Internal Revenue Code Section 422, and nonstatutory stock options that do not satisfy those requirements. ISOs may be granted as compensation only to employees.

Stock options may entitle the holder to buy a specified amount of stock in the company at a later date for a specified, or exercise, price.

Options must be in writing, should express an offer to sell and should provide the period during which the options may be exercised.

Some employers place restrictions on options or the underlying stock when granting nonstatutory stock options to employees, such as forfeiture of the option or stock if the employee does not work for the employer for a prescribed period of time.

For more information, see Compensation and Benefit Library's “Nonstatutory Stock Options” chapter.

By Keith M. Hill

To contact the reporter on this story: Keith M. Hill in Washington at khill@bna.com

To contact the editor responsible for this story: Michael Baer at mbaer@bna.com

This analysis illustrates how courts resolve pay-related disputes. The names and dialogue are fictitious.