<PAGE>
UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF NEW YORK
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ULTRAK, INC., :
derivatively on behalf of No. 00 CV 6303 L(B)
DETECTION SYSTEMS, INC., :
Plaintiff, :
-against- :
AMENDED
KARL H. KOSTUSIAK, DAVID B. : SHAREHOLDER'S
LEDERER, DONALD R. ADAIR, DERIVATIVE
MORTIMER B. FULLER III : COMPLAINT
and EDWARD C. McIRVINE,
:
Defendants,
:
-and-
:
DETECTION SYSTEMS, INC.,
:
Nominal Defendant.
:
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Plaintiff Ultrak, Inc. ("Ultrak"), by and through its attorneys, Ward,
Norris, Heller & Reidy, LLP and Willkie Farr & Gallagher, for its amended
complaint in this action alleges as follows:
INTRODUCTION
------------
1. Ultrak brings this action against the members of the Board of Directors
of Detection Systems, Inc. ("DSI" or the "Company") to preliminarily and
permanently enjoin the triggering of certain provisions of, and to invalidate,
three employment, non-competition, disability and retirement agreements (the
"Agreements") which the defendant directors caused the Company to enter into
with its Chief Executive Officer, President and Chairman, Karl H.
<PAGE>
Kostusiak ("Kostusiak"), and its then Vice President, Business Development,
David B. Lederer ("Lederer").
2. The Agreements are shockingly unfair to the Company. They contain terms
that are so egregious and provide for payments to Kostusiak and Lederer that are
so excessive on their face that they could only have been the product of a
flagrant abuse of defendants' responsibilities as directors of the Company, and
a breach of their fiduciary duties to the Company and its shareholders.
3. The Agreements provide that upon a "change in control" of the Company --
defined broadly to include not only a sale or merger of the Company, but also a
change in only 35% of its Board of Directors (i.e., only two of the five
directors) -- Kostusiak and Lederer (who was not even a full time employee of
the Company at the time that the Agreements were entered into) can quit -- even
if the new Board does not change their titles or responsibilities -- and
unilaterally require the Company to pay them colossal sums in relation to the
Company's size and income.
4. At the time the Agreements were approved, the then present value of the
payments to Kostusiak and Lederer, if triggered, would have amounted to almost
$11,000,000 -- i.e., nearly one-fifth of the Company's entire market
capitalization at the time, and nearly two-and-a-half times its entire net
income for the fiscal year ended March 31, 1999. If the Agreements were
triggered as of July 1, 2000, payments under them to Kostusiak and Lederer would
amount to almost $8,000,000, over 13% of the Company's market capitalization and
230% of its entire net income for the fiscal year ended March 31, 2000.
5. Equally amazing, the Agreements provide that if either Kostusiak or
Lederer is terminated for cause - narrowly defined to include, among other
things, such
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egregious acts as theft of Company funds -- he would still be entitled to
receive full benefits for three years or for the remainder of the five year
duration of the Agreements, whichever is longer, subject only to repayment of
any monetary damages suffered by the Company. Furthermore, based on information
made publicly available by the Company, the making of such payments could cause
the Company to violate various covenants included in its credit agreement.
6. The Agreements are so excessive and egregiously unfair on their face
that they discourage and impair transactions, such as a sale or merger of the
Company, that would enhance shareholder value, while entrenching current
management. Equally important, they impair the ability of shareholders to
exercise their franchise to replace even two of the five Company directors, thus
severely impinging upon DSI shareholders' rights to exercise corporate
democracy. The Agreements have the intended effect of artificially limiting
efforts to enhance shareholder value or any change in composition of the
Company's Board of Directors because would-be acquirors or even shareholders
desiring to obtain just minority representation on the Board face the prospect
that, if successful, they will trigger the dissipation of a sizeable portion of
the Company's value to Kostusiak and Lederer.
7. Accordingly, plaintiff brings this action for preliminary and permanent
injunctive relief enjoining the making of any payments under the Agreements and
to invalidate, set aside or rescind the Agreements, as well as for monetary
damages, and for other relief.
PARTIES
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8. Plaintiff Ultrak, Inc. is a corporation organized and existing under the
laws of the State of Delaware with its principal place of business in Texas.
Ultrak beneficially owns 1,335,100 shares of the common stock of DSI,
representing approximately 21% of the outstanding shares of common stock. Ultrak
is the largest shareholder of DSI.
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9. Nominal defendant DSI is a corporation organized and existing under the
laws of the State of New York with its principal place of business at 130
Perinton Parkway, Fairport, New York 14450. DSI is a supplier of equipment to
the electronic protection industry, and designs, manufactures and markets
electronic detection, control and communication equipment for security, fire
protection, access control and closed circuit television applications, offering
products primarily for the commercial and mid- to high-end residential portions
of the market. DSI is named as a nominal defendant solely in a derivative
capacity, and this action is brought in order to obtain relief on its behalf.
10. Defendant Kostusiak is, and at all relevant times has been, the Chief
Executive Officer, President, and Chairman of the Board of Directors of the
Company. Upon information and belief, Kostusiak is a citizen and resident of New
York.
11. Defendant Lederer is, and at all relevant times has been, a director of
the Company. Prior to April 1, 1998, Lederer was Executive Vice President of the
Company. Between April 2, 1998 and April 2000, Lederer was employed part-time by
the Company as its Vice President, Business Development. According to the
Company's recently-filed Form 10-K for the fiscal year ended March 31, 2000, in
April 2000, Lederer once again became employed full-time and was again given the
title of Executive Vice President. Despite this newly-disclosed change in his
employment status, the Company's Form 10-K still reports that Lederer is
employed pursuant to the part-time employment agreement described herein, so
that it does not appear that there has been any change to or reduction in the
benefits Lederer receives under the Agreements. Upon information and belief,
Lederer is a citizen and resident of New York.
12. Defendant Donald R. Adair is, and at all relevant times has been, a
director of the Company. Adair executed the Agreements on behalf of the Company
and is
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Chairman of the DSI Board of Directors' Compensation Committee which approved
the Agreements. Upon information and belief, Adair is a citizen and resident of
New York.
13. Defendant Mortimer B. Fuller III is, and at all relevant times has
been, a director of the Company. Fuller is a member of the DSI Board of
Directors' Compensation Committee which approved the Agreements. Upon
information and belief, Fuller is a citizen and resident of New York.
14. Defendant Edward C. McIrvine is, and at all relevant times has been, a
director of the Company. McIrvine is a member of the DSI Board of Directors'
Compensation Committee which approved the Agreements. Upon information and
belief, McIrvine is a citizen and resident of Virginia.
15. Defendants Kostusiak, Lederer, Adair, Fuller and McIrvine are sometimes
referred to collectively herein as the "Director Defendants."
JURISDICTION AND VENUE
----------------------
16. This Court has jurisdiction over this action pursuant to 28
U.S.C.ss.1332, in that the action is between citizens of different States and
the matter in controversy exceeds the sum or value of $75,000.
17. Venue is properly laid in this District pursuant to 28 U.S.C.ss.1391,
in that a substantial part of the events and omissions giving rise to
plaintiff's claim occurred in this District.
SUBSTANTIVE ALLEGATIONS
-----------------------
18. Ultrak has been a shareholder of DSI since 1998. By March of that year,
Ultrak had acquired 5% of the outstanding shares of common stock of DSI. Ultrak
increased its
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holdings of DSI common stock in the following two years. By June 1999, Ultrak
owned 1,335,000 shares, representing 21% of the outstanding common stock. During
this time, Ultrak held DSI common stock primarily for investment purposes.
19. The Company's recent financial performance has been poor. The Company
reported net income for the fiscal year ending March 31, 2000 of only $3.47
million, or 55(cent) per share -- as compared to $4.47 million, or 71(cent) per
share, for the fiscal year ending March 31, 1999.
20. During the past five years, the performance of DSI's stock has been
dismal. Based on figures reported by the Company itself in its 1999 proxy
statement, the stock showed a mere 4.1% compound annual growth rate between 1994
and 1999. Meanwhile, the two stock indices to which the Company compared itself
in its 1999 proxy statement -- the Nasdaq Index and the Electronic Industry
Index -- showed compound growth rates over the same period of 27.9% and 38.3%,
respectively.
21. As the Company's largest shareholder, Ultrak was disappointed in these
results and approached Kostusiak about its concerns and enhancing shareholder
value. Kostusiak and the other Director Defendants have been unresponsive and
have done nothing to improve shareholder value. As a result, Ultrak decided to
seek to replace a majority of the Board of Directors at the Company's upcoming
annual meeting, which is expected to take place in August 2000.
22. Notwithstanding the Company's dismal financial and stock performance,
the Director Defendants caused the Company to enter into highly lucrative
employment, disability, non-competition and retirement agreements on or about
June 1, 1999 with Kostusiak and Lederer. The Agreements consist of an Employment
Agreement and a Non-Competition, Disability, and Retirement Agreement with
Kostusiak and a Part-Time Employment, Non-Competition,
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Disability, and Retirement Agreement with Lederer.
23. The Agreements provide for a five-year term of employment for Kostusiak
and Lederer, including generous salary, bonuses, incentive compensation, stock
options, medical and insurance benefits. In addition, the Agreements provide
that upon retirement, Kostusiak and Lederer will receive retirement benefits,
non-competition payments, and payments for consulting services. As detailed
below, the Agreements also provide for extraordinary and wasteful payments to
Kostusiak and Lederer upon a "change in control".
24. The Agreements contain terms that are so unfair to DSI and provide for
payments to Kostusiak and Lederer so exorbitant as to constitute naked gifts of
the Company's assets to these defendants.
25. Under the Agreements, either Kostusiak or Lederer can be terminated for
cause. "Cause," however, is defined exceedingly narrowly, and consists only of
misappropriation of funds or trade secrets, personally profiting from an illegal
Company transaction with a third party, knowingly illegal action, and excessive
absenteeism. Moreover, even if terminated for cause, these defendants would
still be entitled to the full range of benefits under the Agreements for the
remainder of the term or three years, whichever is longer -- subject only to
repayment to the Company of any monetary damage suffered by it as a result of
their wrongdoing. This provision means that Kostusiak or Lederer could literally
steal from the Company and still receive virtually all payments under the
Agreements.
26. The Agreements also contain extraordinary "golden parachute" provisions
in the event of a "change in control" of the Company. "Change in control" is
defined broadly to include a sale or merger of the Company, or even a change in
only 35% of the Board of Directors
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<PAGE>
(i.e., a minority of only two in five directors). Thus, in the latter instance,
Kostusiak and Lederer would become entitled to benefits even though no actual
change in control took place and a majority of the current Board of Directors
continued in office. Moreover, upon any such "change in control," Kostusiak and
Lederer may quit, merely upon 30 days' notice to the Company, and still receive
a full package of benefits; there is no requirement that they be fired or
demoted. Thus, unlike other severance arrangements -- which exist both to
protect key officers against termination following a change in control and to
ensure that their services, where desired, will be available after a change in
control -- the Agreements benefit only Kostusiak and Lederer and confer no
benefit on the Company.
27. The benefits to which Kostusiak and Lederer would be entitled upon a
"change in control" are exorbitant:
(a) Under the Agreements, upon a change in control, Kostusiak and Lederer
are entitled to cash severance payments of three times their highest total cash
compensation (including salary and bonuses) in any of the three fiscal years
completed prior to termination. At the time they were approved by the Company on
June 1, 1999, these cash payments, if triggered, would have amounted to
$1,846,299 and $1,477,110 to Kostusiak and Lederer, respectively.
(b) Under the Agreements, Kostusiak and Lederer or their spouses would be
entitled to receive retirement benefits from age 69 until the later of their
death or the death of their spouses. These retirement benefits are in addition
to all other retirement benefits that Kostusiak and Lederer may be entitled to
from the Company, such as by participation in the Company's pension and 401(k)
plans. Assuming an 85-year lifespan and spouses of similar age, on June 1, 1999,
the present value of these payments, if triggered, would have amounted to
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$1,588,526 and $578,084 to Kostusiak and Lederer, respectively. To fund these
obligations, the Company would be obligated to deposit cash (or an annuity
policy paid for in cash) in the full amounts set forth above into a "rabbi
trust" for the benefit of Kostusiak and Lederer.
(c) The Agreements would entitle these defendants to cash payments
representing the amounts the Company would expend on "benefits" on their behalf
for a three-year period following termination. Under conservative assumptions
based on benefits for general health and welfare, auto, and funding of these
defendants' 401(k) plans, on June 1, 1999, these payments, if triggered, would
have amounted to $83,400 and $75,300 to Kostusiak and Lederer, respectively.
(d) The Agreements would entitle these defendants to annual fees equal to
or greater than $154,500 and $123,600, respectively, for Kostusiak and Lederer,
subject to adjustment for inflation, and continuing through age 69, for abiding
by non-competition agreements between these defendants and the Company. On June
1, 1999, the present value of these payments, if triggered, would have been
$1,172,808 and $1,019,488 to Kostusiak and Lederer, respectively. To fund these
obligations, the Company would be obligated to deposit cash (or an annuity
policy paid for in cash) in the full amounts set forth immediately above into a
"rabbi trust" for the benefit of Kostusiak and Lederer.
(e) Under the Agreements, both Kostusiak and Lederer and their spouses
would continue to receive medical benefits throughout their lifetimes. Under
conservative assumptions of monthly medical payments, lifespans, spouses' ages,
inflation and discount rate, on June 1, 1999, the present value of these
payments, if triggered, would have been $448,400 and $472,400 to Kostusiak and
Lederer, respectively.
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(f) The Agreements would entitle Kostusiak and Lederer to continue to
receive fringe benefits throughout their lifetimes. Under conservative
assumptions of yearly benefits, lifespans and discount rate, on June 1, 1999,
the present value of these payments, if triggered, would have been $116,049 and
$120,641 to Kostusiak and Lederer, respectively.
(g) Under the Agreements, the Company is obligated to make tax "gross-up"
payments to Kostusiak and Lederer, the net effect of which is to provide
additional amounts to these defendants for the purpose of paying excise taxes
applicable (pursuant to Section 280G of the Internal Revenue Code) to payments
received by these defendants under the Agreements. The gross-up provisions also
require that the gross-up payment include amounts to cover all federal, state
and local income taxes that Kostusiak and Lederer are required to pay by virtue
of receiving the gross-up payment itself. On June 1, 1999, the value of these
cash payments, if triggered, would have been $968,850 to Kostusiak and $782,280
to Lederer.
(h) Under the Agreements, the Company is obligated to repay any policy
loans taken by Kostusiak and Lederer on life insurance policies on their lives,
and to transfer all title in such policies to them.
28. With respect to Lederer, all of these benefits are even more
inappropriate in that Lederer was not even a full-time employee of the Company
at the time the Agreements were approved, and it is extremely unusual that
someone employed by the Company purely on a part-time basis would receive
benefits in the nature of those which the Company provided to Lederer in the
Agreements.
29. In sum, at the time they were entered into by the Company on June 1,
1999, the Agreements, if triggered, would have resulted in payments to
defendants Kostusiak and Lederer with a present value of $6,224,332 and
$4,525,303, respectively -- for a total of
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$10,749,635. At that time, this amounted to nearly 20% of the Company's entire
$55,445,643 market capitalization and nearly two-and-a-half times the Company's
$4,471,000 after-tax net income for the previous fiscal year.
30. If triggered as of July 1, 2000, the Agreements would have resulted in
payments to defendants Kostusiak and Lederer of $5,184,957 and $2,754,892 -- for
a total of $7,939,849 -- i.e., over 13% of the Company's entire market
capitalization at the time and nearly 230% of its $3,468,000 after-tax net
income for the previous fiscal year. Furthermore, based on information which the
Company has made publicly available, the payment of such sums by the Company
could violate various covenants included in its credit agreement.
31. The Agreements, if triggered, will not only result in substantial
dissipation of Company assets, but also impair the ability of Ultrak and any
other shareholder who sought to change the composition of the Board of
Directors, or even to obtain two seats on the Board, from doing so. Under the
express terms of the Agreements, if even a minority of new directors (two out of
five Board members) are elected, Kostusiak and Lederer will have the right to
walk away and take with them a sizeable percentage of the Company's worth. The
Director Defendants therefore have imposed on shareholders an enormous and
gratuitous cost for choosing to elect even a minority of non-management Board
nominees. Any shareholder who realizes that his investment could be diluted in
this manner will surely be reluctant to vote for a change no matter how
beneficial or necessary it may be.
32. The Director Defendants have also taken other recent steps to impair
the ability of stockholders to change the Board of Directors. In February 2000,
these defendants caused the Company to remove provisions from its bylaws that
allowed a majority of shareholders to call a special meeting. As a result,
shareholders can only exercise their rightful
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control over the composition of the Board and take other proper shareholder
action at an annual or special meeting called by the Company. In addition, these
defendants added to the bylaws requirements that shareholders who are nominating
candidates for director or making other proposals do so significantly before the
annual meeting.
CLAIM FOR RELIEF
----------------
33. Plaintiff realleges and incorporates by reference each and every
allegation contained above.
34. This Claim is brought derivatively by plaintiff on behalf of the
Company against the Director Defendants for breach of their fiduciary duties
owed to the Company and its shareholders.
35. The Director Defendants are fiduciaries of the Company and all of its
public shareholders and owe to them the duty to conduct the business of the
Company loyally, faithfully, carefully, diligently and prudently.
36. The Director Defendants breached their fiduciary duties to the Company
by causing the Company to enter into Agreements with Kostusiak and Lederer that
constitute excessive compensation to Kostusiak and Lederer and a waste of the
Company's assets, that contain other provisions which are unconscionable, and
that impose enormous and gratuitous costs on shareholders for choosing to elect
even a minority of non-management Board nominees, thereby impairing the
shareholders' franchise.
37. The actions of these defendants in causing the Company to enter into
the Agreements constitute a waste of corporate assets which no reasonably
diligent board of directors acting in a good faith exercise of its fiduciary
duties would have approved. The
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Agreements were so excessive and unfair when approved as to be, on their face,
not the product of a valid exercise of business judgment.
38. The Company and its shareholders have been injured by reason of these
defendants' breach of their fiduciary duties to the Company. Plaintiff, as a
shareholder and derivative representative of the Company, seeks a preliminary
and permanent injunction, damages, and other relief for the Company as
hereinafter set forth.
39. The Company and its shareholders will be irreparably injured if the
making of payments under the Agreements is not enjoined. The shareholders' right
to freely exercise their franchise at the upcoming election and the ability of
the Company to enter into a sale or other transaction which will enhance
shareholder value will be impaired unless such injunctive relief is granted.
Many shareholders otherwise inclined to vote for non-management nominees to the
Board at the upcoming election will nonetheless decline to do so, if the price
of doing so is the transfer of a sizeable portion of the Company's wealth to
Kostusiak and Lederer.
DERIVATIVE ALLEGATIONS
----------------------
40. Plaintiff is now and was, at the time of the transactions that form the
basis of the complaint, a shareholder of the Company.
41. Plaintiff brings this action derivatively in the right of and for the
benefit of the Company to redress injuries suffered and to be suffered by the
Company as a direct result of the Director Defendants' wrongdoing.
42. Plaintiff will adequately and fairly represent the interests of the
Company and its shareholders in enforcing and prosecuting their rights.
43. This action is brought to remedy violations of applicable law.
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44. Plaintiff has not made any demand on the present Board of Directors of
the Company to institute this action because such demand would be a futile and
useless act because approval of the Agreements was so egregious on its face that
it could not have been the product of the Director Defendants' sound business
judgment and clearly represents a waste of corporate assets. As detailed herein,
the provisions of the Agreements entrench current management at the expense of
shareholder democracy and, in the event of a "change in control," impose a
financial burden on the Company so excessive as to be truly extraordinary in
light of the Company's size and income. As noted above, if the Agreements were
triggered as of July 1, 2000, payments under them to Kostusiak and Lederer would
amount to nearly $8 million, over 13% of the Company's market capitalization and
230% of its net income for the entire fiscal year ended March 31, 2000. As the
recipients of the Agreements, defendants Kostusiak and Lederer obviously are the
beneficiaries of their egregiously unfair terms. The remaining Director
Defendants, Adair, Fuller and McIrvine, constituted the Compensation Committee
of the Company which caused the Company to enter into the Agreements in breach
of their fiduciary duties.
45. This action is not a collusive one to confer jurisdiction on a court of
the United States which it would not otherwise have.
WHEREFORE, plaintiff demands judgment as follows:
A. Declaring that the Director Defendants have breached their fiduciary
duties to the Company;
B. Invalidating, setting aside or ordering rescission of the Agreements;
C. Granting preliminary and permanent injunctive relief enjoining the
making of any payments under the Agreements;
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D. Awarding against the Director Defendants and in favor of the Company
damages in the amount sustained by the Company or which will be sustained by the
Company as a result of these defendants' violations of law alleged herein;
E. Awarding plaintiff its reasonable attorneys' fees, experts' fees and
other reasonable costs and expenses; and
F. Granting such other and further relief as this Court may deem just and
proper.
Dated: Rochester, New York
July 11, 2000
WARD, NORRIS, HELLER & REIDY, LLP
By: /s/ Harold A. Kurland
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Harold A. Kurland
Two State Street
Suite 1000
Rochester, NY 14614
(716) 423-5900
WILLKIE FARR & GALLAGHER
By: /s/ Stephen Greiner
------------------------------
Stephen Greiner
Jeanne M. Luboja
787 Seventh Avenue
New York, NY 10019
(212) 728-8000
Attorneys for Plaintiff Ultrak, Inc.
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VERIFICATION
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STATE OF TEXAS )
: .ss:
COUNTY OF DENTON )
MARK L. WEINTRUB, being duly sworn under penalty of perjury, deposes and
says:
I am the Vice President -- Administration and the General Counsel of
Ultrak, Inc., the plaintiff in this action. I have read the foregoing Amended
Shareholder's Derivative Complaint and know the contents thereof to be true
based upon my personal knowledge, except as to those matters stated to be on
information and belief, which I believe to be true based on publicly available
information, and except as to certain analyses of the terms and financial import
of the Agreements (as defined therein), which I believe to be true based on the
advice of Ultrak's advisers.
/s/ Mark L. Weintrub
----------------------------------
MARK L. WEINTRUB
Sworn to before me this
____ day of July 2000
-------------------------------
Notary Public
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